Do rising markets make you a trading genius?

By Greg Kratz
Deseret Morning News
So far this year, the Dow Jones industrial average is up more than 8
percent, the S&P 500 is up more than 6.5 percent and the Nasdaq is up more
than 5.5 percent.
And if you look back to last year, those percentages get even better.
In other words, this investing thing is easy, right? Let's trade!
Well, let's not get carried away.
That's the advice of two professors at Brigham Young University's Marriott
School of Management, who published an article in the Review of Financial
Studies last year.
Steven Thorley, the H. Taylor Peery professor of finance, and Keith
Vorkink, the Richard E. Cook associate professor of finance, completed the
study with Meir Statman, the Glenn Klimek professor of finance at the Leavey
School of Business at Santa Clara University.
And even though Steven says they did much of the research and legwork
six or seven years ago, its findings are relevant today.
"Our motivation was, originally, the somewhat casual observation that an
old saying on Wall Street is correct: Don't confuse brains with a bull market,"
Steven says.
He says their research found that trading volume on Wall Street seemed
higher than usual when the market was rising, but once the market went
down, trading volume dried up. After validating that observation with
research databases, they turned to the question of why.
"We came to the conclusion that it's related to a very well-documented
and now very important behavioral phenomenon called overconfidence. ...
People tend to be overconfident in their own skills," Steven says.
But overconfidence was not the only possible explanation for the jump in
trading. Keith says they also checked the potential impact of the "disposition
effect."
"The disposition effect states that we get satisfaction or, as economists
like to call it, utility, from actually realizing a gain on a trade," Keith says. "For
example, if I buy IBM at $50 a share, and it goes up to $75 a share, I get more
utility from that outcome when I sell IBM at $75 and realize a gain, as
opposed to keeping IBM in my portfolio.
"So the alternative explanation for trading after the market goes up is
that we all want the satisfaction of realizing our trading gains, and hence we
trade."
When the researchers put the two possibilities to the test, however,
overconfidence was clearly more influential.
"When the market goes up, we attribute the gains in our portfolio to our
skill, and hence that makes us more likely to do subsequent trades," Keith
says.
A rising market leaves the average investor feeling like a genius, and
people start talking about their portfolios around the proverbial watercooler.
But those people tend to ignore the overall strength of the market.
 "People shouldn't count their success by a gain in their portfolios," Steven
says. "It should be how much better or worse their portfolio did than standard
benchmarks, like the (Standard & Poor's 500) or the (Dow Jones industrial
average). ... Having a gain of 12 percent in your portfolio really isn't very
good if the general market went up 15 percent."
Ignore that fact, he says, and overconfidence will lead to increased
trading, which in turn leads to more transaction costs and brokerage
commissions, not to mention possible tax issues.
"Probably the most profound (detriment) from our perspective is just that
people spend a lot of time and energy ... to do this trading, when in fact it
doesn't do them any good," Steven says.
Keith says investors should remember how competitive markets are.
Many would be wise to pursue more passive investing in something like an
index fund or exchange traded fund that mirrors the market's natural rise.
"It's difficult to pick which stocks are going to do well, but it's pretty easy
to minimize the fees and costs of trading," Keith says.
So if the stock market's recent rise has pushed your exuberance near the
level of irrationality, sit back, take a deep breath and ponder the results of
this study.
Maybe you are a stock-picking genius. Or maybe your desire to trade
stems more from a bull market and less from brains.
If you have a financial question, send it to gkratz@desnews.com or to the
Deseret Morning News, P.O. Box 1257, Salt Lake City, UT 84110.

E-mail: gkratz@desnews.com

The Private Equity Put

By Emil Lee May 22, 2007

You've heard of the Greenspan Put, right? The theory was that when Alan
Greenspan was the chairman of the Federal Reserve, if anything bad
happened to the economy (and hence the stock market), Greenspan would
bail investors out by dropping interest rates, the same way a put option
hedges against a falling portfolio. As I watch today's stock market make an
Icarus-like climb upward, I wonder if the Greenspan Put has been replaced
with the Blackstone Put.

What I mean by that is, virtually every day, another huge firm gets bought
out by a private equity firm. Sallie Mae (NYSE: SLM), Clear Channel (NYSE:
CCU), Harrah's (NYSE: HET), and First Data (NYSE: FDC) are just some of the
companies being acquired by private equity firms for billions of dollars.
According to a Barron's article by Michael Santoli, there has been a $5 billion
or larger acquisition on 27% of the trading days this year, and the S&P
returns on those days were double the returns of the rest of the non-buyout
days.
As a result, it seems as if private equity activity has not only created a floor
for stock prices, but also helped drive it to new heights.

Musical chairs
There's only one problem with this sequence of events: The private equity
party could turn on a dime. PE firms are making fistfuls and fistfuls of cash
because they can raise enormous amounts of money and borrow at ultra-low
interest rates and extremely lax terms. As a result, they can bag bigger and
bigger elephants, and because the debt market is so accommodating, it
almost ensures those private equity firms will make money.

You see, according to my understanding, private equity firms make the bulk
of their money arbitraging the difference between a company's return on
capital and its after-tax cost of debt. It's kind of like buying a house -- if you
can buy a house, rent it out, and pay off the mortgage and other costs with
the rental income, you are pretty much arbitraging the cost of debt (the
mortgage rate) versus the return on capital employed.

Private equity companies do the same thing, except instead of buying houses
with a ton of debt, they buy entire companies. Their returns are better
because they can add value through hiring better management, and also
because there are only a handful of firms with the clout, financial
wherewithal, and expertise -- as well as the, shall we say, cojones -- to make
these billion-dollar bets. On the other hand, pretty much anyone can get a
mortgage and bid on a house, which drives returns lower.

However, trees don't grow like Jack's beanstalk, and there are a lot of events
that could cause the Private Equity Put to expire out of the money:

Interest rates go up
Interest rates are pretty low by historical standards. This benefits PE firms in
myriad ways. First and foremost, it lowers their cost of debt, which means
their hurdle rates for target acquisitions are lower. In a nutshell, if someone
gave you a billion dollars and only asked for a 1% interest rate payment, you
could buy almost anything and make money. If they asked for a 10% rate,
then you'd be much more limited in what you could do with the money and
still make a profit after paying 10% on that debt.

What could cause interest rates to go up? Bondholders hate inflation because
it causes their future coupon payments to be worth less. So if inflation
increases, interest rates usually go up with it. Interest rates are also low in
the U.S. because the rest of the world, primarily Asia and the Middle East, has
had a voracious appetite for U.S. government debt thanks to those regions'
booming economies -- if this changes, then the cost of debt will go up.

Credit risk premiums increase

What is the price of risk? You pay auto insurance to eliminate the financial
risk of getting into a car accident. When a PE firm buys a company, it has to
pay a risk premium because the company becomes much more financially
unstable with the debt piled on.
However, PE firms lately haven't had to pay much in credit risk premiums
because there are a lot of investors, banks, and hedge funds willing to make
loans to PE firms (also known as leveraged loans). However, this could
change on a dime if any of those loans go under. It's very likely that when the
first high-profile PE-backed company goes under, credit risk premiums will
widen considerably as investors get skittish.

PE returns sour
PE returns have soared, so investors climb all over themselves to give them
more money. As more and more PE firms raise multibillion-dollar funds, the
competition becomes fiercer to put the money to work, which drives up
acquisition prices and drives down returns. If the returns fall too low, then
many institutional investors will probably stop giving PE firms so much
money.

How to play it
I'm hardly alone in thinking that many different things could cause the "PE
Put" to go away, which could bode poorly for the stock market. As a result,
it's hard for me to be enthusiastic as I watch the stock market head higher on
a one-way street. However, if I'm patient, I think I can buy stocks at a
cheaper price if the "private equity put" expires.

AllBusiness

What Is HR Outsourcing?
Tuesday May 22, 8:00 am ET
By AllBusiness.com

Whatever your company's human resources requirements, there's an HR

outsourcing firm out there to meet those needs. Some HR outsourcing firms
are generalists, offering a wide variety of services, while others are
specialists, focusing on specific areas such as payroll or recruiting. Depending
on the size of your business and how much control you want to maintain over
HR functions, you can either outsource all your HR tasks or contract for
services a la carte.

The basic services offered by HR outsourcing firms may include:

* Overseeing organizational structure and staffing requirements

* Recruiting, training, and development
* Tracking department objectives, goals, and strategies
* Employee and manager training
* Benefits administration
* Employee orientation programs

Businesses that outsource HR are typically small-to-midsize firms with

between 25 and 1,500 employees. These businesses view HR outsourcing as
a strategic tool that relieves them of HR responsibilities and enables them to
focus on what they do best. In addition to allowing you to concentrate on
your core business activities, outsourcing provides some key benefits,
including:

* Providing you with skilled professionals who are focused specifically on

HR
* Helping you reduce and manage operating costs
* Improving employee relations

If you need to hand off the entire HR function, consider a professional

employer organization (PEO). A PEO becomes the employer of record,
handling employee relations, payroll, benefits, workers' compensation, and all
the other areas that fall under the HR umbrella, while you manage the
employee's everyday business responsibilities. For a step-by-step guide to
using and hiring a PEO, check out our Buyer's Guide on Outsource Your HR
Using a PEO.

If you don't need the comprehensive services of a PEO, you can contract
specific projects through an HR outsourcing firm to help you:

* Implement a human resource information system (HRIS)

* Create or update employee handbooks and policy manuals
* Develop and implement a compensation program
* Create or review a performance appraisal system
* Write and update affirmative action plans
* Provide sexual harassment training

Referrals, the Yellow Pages, and the Web are the best resources for finding an
HR outsourcing provider. You have the option of working with an international,
national, or regional provider. Any one of those may be able to meet your HR
needs.

Whether you're looking to outsource the entire HR function, a portion of it, or

a specific project, it's good to know you've got options -- lots of them.

Get more tips on hiring Consultants and Contracts on AllBusiness.com.

AllBusiness.com provides resources to help small and growing businesses
start, manage, finance and expand their business. Copyright © 1999 - 2007
AllBusiness.com, Inc. All Rights Reserved.

SeekingAlpha

What Happens to Those Returns When They Move from

Paper to Reality?
Wednesday May 23, 2:42 pm ET
James Picerno submits: Investment performance is often less than it appears.
The top-line number may impress, but after adjusting for real-world frictions,
the net result may disappoint.

Everyone knows this and, for the most part, everyone ignores it. Maintaining
a sunny disposition is essential when it comes to deploying capital, and who
really wants to let reality muck up the fun?

Meanwhile, even for those who demand nothing less than the unadulterated
truth, it's unclear how to adjust top-line returns to calculate something closer
to reality. Although it's easy for everyone to generalize, the final numbers
may not be applicable to anyone. This is also how it goes when you move
from paper to reality in investing.

That said, in those rare instances when someone takes the time to estimate
the damage, the reality burst can be shocking, even if it's not precisely
accurate. One example was dispensed on Tuesday, deep within the walls of
New York's celebrated 21 Club, where Garrett Thornburg, CEO of Thornburg
Investment Management, spoke to a room of journalists (including yours
truly) on the hard facts of net results.

Consider the S&P 500 (CDNX: SPX.V - News), for instance. According to
Thornburg, the 11.7% annualized total return for the index over past 20 years
through 2006's close fades considerably after deducting for a variety of
monetary abrasions that cut into investors' take. Indeed, the annualized
11.7% for the S&P 500 falls to 6.5% after investment management fees,
dividend and capital gains taxes and inflation, according to Thornburg. The
dynamic is at work in other asset classes too. Again using Thornburg's
numbers, we're told that annualized total returns over 20 years are smaller
than they appear. In particular,

# small cap stocks (as per the Russell 2000) fade to 5.9% from 10.9%
# foreign stocks (MSCI EAFE) drop to 3.5% from 8.4%
# long term government bonds (20 year Treasuries) slip to 2.1% from 8.3%
# commodities end up with a negative 0.9% from a nominal 3.1%.
Perhaps the most astonishing evolution is the one assigned to single family
homes. The nominal 4.8% return posted over the 20 years through the end of
last was sliced to a measly real return of 1.2% after taxes, fees and inflation,
according to Thornburg.

Among the conclusions that the analysis inspires is that:

"Taxable fixed-income securities only make sense for the tax-exempt of tax-
deferred investor....", according to the handout that accompanied yesterday's
chat. Meanwhile, "...a 3% real return is a fair objective. More volatile stocks
should aim for more than 3%. Less volatile bonds might aim for less than 3%
(although, high-grade, tax-free bonds have actually exceeded that over the
past 20 years)."
Of course, the past is only a guide, and perhaps a poor one at that. There's
also some play in how one might estimate taxes, fees and inflation.
Meanwhile, an investor's expectations about the future will dominate
strategic design in the here and now. On that note, we might move the
debate along by asking if readers think inflation, taxes and nominal returns
over the next 20 years will be a) higher, b) lower, or c) about the same?

Take your time. This, after all, is a trick question.

Sun 20 May 2007

Learn to manage risk to fine-tune your investments

CAUTIOUS investing - now there is an interesting oxymoron. But it is the
question investors most want answering: how can you maximise returns
without taking undue risk with your savings?

As Henry Ford once said: "The best we can do is size up the chances,
calculate the risk involved, estimate our ability to deal with them, and then
make our plans with confidence."

Maybe with some help, advice and better understanding, we can do even
better.

Perhaps the issue is appreciating how to invest cautiously. After all, if

investors understand risk and its potential impact, they are likely to become
less risk-averse, as they shift their behaviour towards calculated and
managed risk-taking?

If an investor, cautious or otherwise, understands risk, weighs it up against

the returns they need, the discussion changes. What we now have is a
cautious approach to investing - risk management rather than risk avoidance.
It's about managing an individual's capacity for risk as the result of a better,
more realistic understanding of potential outcomes.

So let's start by making some simple assumptions. Investors want their

money to grow more than cash, otherwise they would leave it in the bank.
They are looking for returns in excess of inflation, 'real' returns over the
medium to long term. They therefore need to think beyond cash and consider
alternatives with better potential returns but more risk.
So how do you invest for real returns?

We know different assets behave differently and we also know they generate
different returns over the long term. Cash, for example, is unlikely to match
equities in terms of return. Equities will never offer the comfort or security of
money in the bank, but over time have proved the most effective asset class
in terms of generating returns above inflation.
We also have a pretty good idea what these different investment types will
deliver over the long term, and by comparing current returns with these long-
term expectations we can get a good idea of whether we are rewarded
enough for holding this asset.

If we believe we can get a better return in the future from another asset type,
we take the profit, rebalance the portfolio and buy the cheaper alternative.

So, could we not combine this theory to create an investment portfolio

designed to deliver returns above inflation? This sounds fairly straightforward,
but does it actually work in practice? Yes, it can.

The tricky bit is: how do you decide what to buy, when to buy it and how
much to pay for it and, the biggest question of all, when should you take the
profit, sell it and buy something else?
It is all about value, not price - they are not one and the same.

How can an investor do this? Ask an adviser to help you construct something
that best fits your capacity for risk. What may be cautious investing to you as
an investor may not equate to cautious as defined by the industry. A cautious
investor, for example, would find that more than half of their money would be
invested in stock markets. Does that strike you as cautious?

Currently, Prudential's view is that equities offer better value than property or
bonds. Cash looks attractive in relative terms.

The equity markets we prefer are UK European and selected Asian markets.
Six months ago we would have said we particularly liked Asia, but now we are
seeing this valuation gap close compared with the alternatives.

Know what to expect from your money, how values may rise and fall. Most of
all, understand how the investment 'engine' works. The product wrapper,
whether it is a unit trust, OEIC, Isa or investment bond, is primarily there to
enhance your tax position.

Trusts can also be instrumental in ensuring all your energies have not been
wasted. It would be criminal if, after all the effort of understanding and
embracing investment strategy and portfolio planning, you created an
investment solution that delivered spectacular results, only to see a tax
demand of 40%.

So there's more to this than getting the investment right, but it's a good
place to start.

Get the internal workings fine-tuned first. The bodywork might be smooth and
stylish, but if the engine isn't delivering the right performance it's a very
disappointing journey.

Frank Morton is investments development manager at Prudential

This article: http://business.scotsman.com/index.cfm?id=781252007