MGIC Investment Corp

MTG reported its numbers today. Their net income fell 43.4%.

I had some puts on MTG which I sold for a 28% gain. While I've done much reading, writing and arithmetic on these companies, in the end, the market will react the way it wants to react. MTG had held such a firm line in the 56.50-57.05 area, there appeared to be alot of support.

They are a mortgage insurer in addition to having subsidiaries with subprime exposure. Most recently Chuck Jaffe thought they were a good value. We'll see about that too in part II of this post.

So, in all honesty, I sit here this a.m. NOT knowing what the stock will do. My expectation is that the stock will tumble, and that I left money on the table. However, my expectations have been unmet for so long (like Carmella Soprano), that it could easily zoom north.

This is a constant perplexion, and given that human behavior is what it is, I needed to write this PRIOR to seeing what market reaction would be.

Part II when I can see the early market.

Fantasy Portfolio

I've lost ground--down more than 7K positions--but still in the top 13%. New play--all money an ANR-Alpha Natural Resources.

BAS

First, you know that I make no claims to having any investment prowess. But I've been interested in drillers and oil service. I have a position in BAS. Here's a chart of BAS over the last 5 days (CTML):


I find that little circled dip an interesting activity prior to the stock taking off. We'll see what happens today with BAS.There is a short position, so it might be a short squeeze. But I have HERO, and that did the same thing:

My point--if your stop losses are too tight (I don't use them and I know the admonitions for them) you'll get shaken out. Your stop loss is a public advertisement of your pain level. I've mentioned that I had a couple of stocks where my stop loss was tripped and the stock immediately bounced back--and then took off just as you see here. I'm not suggesting that you throw your stop losses out--for SL's are a prudent capital management tool. But, if you believe that the markets aren't entirely free and objective (like I use to believe) then just be informed.

It's also helpful if you know your support in the stock and watch the stock and how it acts and certain price levels. That's how I feel that technical analysis supports fundamental analysis. It's helped me.

Market Close: 04.10.07

Solar Power

If you are interested in solar power, here's a good lay overview at Trina Solar

Fantasy Portfolio

I'm movin' on up. I'm now in the top 13%--77,768. One of my first stocks that I started with was DAKT. It dropped 20% yesterday. Glad I moved into ANPI now coal.

Coal Stocks, Day 2

Hedge Funds and Systemic Risk - HF Profile (II)

In installment II of our look at Hedge Funds and Systemic Risk, (remember, that none of this is my own work, but rather that of the referenced paper). All page numbers refer to the numbered pages. If you are looking at the PDF doc, the PDF page will be higher than the numbered page.

I wanted to provide a bit of a backdrop of hedge funds (HF's). You may not be a qualified investor and may never will be, so HF's funds may never be in your investment horizon. Nevertheless, they are in the same financial arena as you competing for returns. And the whole point of my writing about this is that if they screw up, it can cost you money.

Let's reflect a moment on the basic tenets of the paper.

• HF's have proliferated;
• They have a high attrition rates;
• Risk profiles (due to leverage and investment styles) are unavailable;
• Operations are not transparent; and
  
• Non-correlated dynamic strategies can correlate into phase locking during periods of market stress.

(I hope not annoyingly, but I'm purposefully repeating some of the core concepts of the paper to solidify them and make them relevant to the current installment without your having to keep going back.)


In their paper, the authors started with a population of 4,781 funds using information from 02/1977 - 08/2004 using the TASS data base. This database does NOT include all hedge funds, but rather is the data base that included all of the information they needed. As these guys appear to be professionals, we can trust that they designed their study to minimize underlying bias in the data. In fact, they go to some pains to explain that, but I'll not do it here.

They parsed this population into HF's that were Live as of 08/04, and those that were in the Graveyard as of 08/04. That split was 2920 and 1861, respectively. Due to the data vagaries, one cannot equate that with a failure rate. See attrition rates below. The authors had to go through and design there study in a way that required them to tweak these numbers so that there was appropriate homogeneity in terms of reported returns etc in the study population. Accordingly, the Live list was reduced and the Graveyard was increased.

Here is a graphic (p. 17) of the final study population by investment style. I would urge you to look at the Appendix A of (p. 84) the paper to read about these styles.





The authors note: "it is apparent from these figures that the representation of
investment styles is not evenly distributed, but is concentrated among
four categories: Long/Short Equity (1,415), Fund of Funds (952),
Managed Futures (511), and Event Driven (384). Together, these four
categories account for 71.9% of the funds in the Combined database."

There's another graphic that is telling. Below (Figure 1) are two pie charts--one showing the composition of the Live Funds and Graveyard funds. Click to make larger or refer to the original study on p. 19.

The authors note "databases are roughly comparable, with the exception of two categories: Funds of Funds (24% in the Live and 15% in the Graveyard database), and Managed Futures (7% in the Live and 18% in the Graveyard database). This reflects the current trend in the industry towards funds of funds, and the somewhat slower growth of managed futures funds."

I'm going to gloss over the section that talks about the correlation matrices. There are three points that are worth noting:

1. In general hedge fund index is not well correlated to the S&P 500 (p. 19)
2. Correlations among/between investment styles can vary widely (p. 23)
   
3. Events such as LTCM can increase correlation--in 1998 10 out of 13 syle-category indexes yielded negative returns. (p. 24)
   

Remember that non-correlation moving to correlation is a key part of systemic risk. To show just how pervasive and lingering affect an event such as LTCM can have on correlations, I'm going to include the author's table (CTML) here (oval and highlighting are my own):



The authors report some excellent detailed data regarding HF's using the TASS database. To give you a sense of the increase in HF's over the period, I want to share the authors' table with you. Three things to keep in mind while reviewing this table:

1. these are additions, only.
2. 2004 is reflective of the study cut off, so I would not use that
3. Funds exiting the database were not tracked.
   

Attrition Rates:

It's important to note that the database used (TASS) by the authors does not included all hedge funds--but rather it is a database that contained all of the information that they needed for their study. The point in considering failure rates is that a hedge fund failure could be one of those "events" like LTCM. In fact, as I wrote this and as I considered the blow up in sub-prime mortgage I wondered if that would pose problems for fixed income arbitrage hedge funds. I asked this of R. Nusbaum on his website.

Here's a screen capture of the ANNUAL average attrition rates in the TASS database:


The authors then go on to build a logit model to estimate liquidations based on the mix of investment styles. This analysis is beyond my ability to convey, but the takeaway is that their estimate is over 11% for the 2004 data base which is 25% higher than the average of 8.8% (p. 63). Here's some information from p 15 cited in their literature review.



I hope that you found this installment interesting. In this installment, I hope that I conveyed:

• The number of hedge funds and the predominant types of investment styles
  
• The increase of hedge funds since inception
• The attrition rates, and how those attrition rates can be affected by events (LTCM and tech bubble), as well as fund performance to include both funds and volatility.
  
• How events can affect the correlation of non-correlative styles (though admittedly, I gave just a small slice and did not produce any of the wonderful tables and work that the authors did. If you are statistically inclined, I hope that you will review their work.)
  

An Armenian Grandmother "Old Country" Story Rememberance

No, I'm not normally up at this ungodly hour, but an old dog with an old bladder has become a nightly interrupt of my sleep.

Last night we were watching Mysteries of the Bible on the History Channel. The installment at 9 p.m. was about the apocrypha (books that didn't quite make it to canonical text of the Bible). What caught my attention was a segment about a book about Solomon--specifically magical powers that Solomon had that enabled him to conjure up evil spirits and have him do his bidding--such as building a temple. I immediately remembered a story told to me as a child......

My Aremenian grandfather came from the "old country". And when I write 'old country' I mean old country--the mountains of Turkey (formely Armenia) where they were goat herders. It also means that they had great superstitions and the spirit world was a very real and frightening world for them. [Now kids are impressionable enough to believe in these netherworld spirits, but logical enough to ask the question as to why she didn't see these spirits now. You see, spirits cannot cross water, and there was a big body of water between those spirit filled mountains and America. As an aside, if you were being chased by a spirit (and they came out at night and such and sometimes inhabited the bodies of goats so that if you picked them up they would start saying, "giddee, giddee, giddee" . I don't know what that means, but I do know that if I were to pick up a baby goat and it starting uttering a thing other than their unusual yelp, I'd drop it in a flash), you ran like hell to a stream and jump over it and you'd be safe. But you know that there would have to be another spirit varietal on the other side. In general, it would be safest not to go out at night, or you would likely have to spend the night in a stream.]

The Armenians, if you do not know, were Christian and there was a great genocidal war where 2/3 of the Armenian population were slaughtered. My grandparents, fortunately, escaped that great terror. But I do understand that my grandfather had a sister that bound her hair and breasts and fought against the Turks. How I wish someone had written down these stories! The war, though, is not my point. There is a story that she used to tell us as children that scared the bejeebers out of us. (Unfortunately ALL of my family from that side are dead, so asking adult questions of these childhood stories is impossible). Anyway, the story goes something like this....

There was a Book of Solomon that if one were to read it would convey great powers--either good or evil--upon the reader. The trick was that it was a ritualistic reading, so that one had to follow the instructions to the letter. As I remember my grandmother's telling of the story, you had to draw a circle ( my grandmother would gesture with an imaginary drawing the imaginary circle--I think that you also had to draw a star of David on the inside) and sit down. With the light of a candle you were to begin to read the book. Now here is the important (and at the time spine electrifying, mind terrifying because I as a child) part. Once you began reading, it was imperative that you not to look up. You see the act of reading the book would conjure up all manner of evil spirits, and if you were to look up you would go insane. My understanding is that later on you would get to the part that either they went away, or you fended them off successfully or had dominion over them.

My grandmother went on to tell of a man in my grandfather's village who had purportedly read this book and was proceeding to impress the other village men (testosterone pumping is universal!) with his powers. Of course the men did not believe him. The man points to the women by the water washing clothes. He takes a grease pencil and makes a special mark on his thumb nail. Suddenly, all of the women begin to undress themselves. The men are aghast (because these are modest women and this is quite a transgression of norm) and entreat the man to make the women stop shaming themselves. He then wipes the mark from his nail, and the women immediately cry out in alarm at their state of undress and quickly put back on their clothes.

We never paid much attention to these stories. We were modern day American kids, and in holding that station thought that most of these stories were just gobbledygook or old wives tales. We even thought the Armenian genocide story to be made up--unfortunately that ghastly story was true. But seeing the Book of Solomon on TV, and most particularly its portrayal of Solomon as a conjurer of evil spirits left me a bit breathless in remembrance of this story told to me many years ago by my Armenian grandmother. I found it odd to have this story at least to have been founded by an actual book even though there is a magical element about it. I'll have to do a little searching on this and will likely find things odder than systemic risk to read. Also, I'm anxious to talk to tell my sister about this.

A small digression from subprime and sytematic risk! At least I have this story down! I hoped that you enjoyed it. The dog is now in, and I can go to winkie land.

Hedge Funds and Systemic Risk - Introduction (I)

In an earlier post, I indicated that I had read the paper referenced below, and I wanted to summarize for you some of the more salient points. I write this post requesting your forgiveness in advance that I'm such a poor conduit for expressing some of the issues in this paper. Despite my inadequacy in purveying the learned information--I'm going to liken this effort to not being able to play the concerto but able to hum (off-key, of course), the tune--I'm nevertheless going to try.

As an individual investor, I find the complexity of the financial markets overwhelming at times. But Albert Einstein found simplicity and elegance in his economic rendering of the theory of relativity to e=mc(2). By that example (and clearly understanding that I'm no Albert Einstein, but rather one who appreciates simplicity), I will see complexity, then, as an obstacle that must be cut through to find the essence--the kernel--that is fully within the grasp of us mere mortals. We'll let the statistical and economic gods wrestle with and collegially debate the more arcane aspects of this learned paper. And, on a strictly selfish basis, I will extract those aspects that I found interesting and worth considering.

But why be interested at all in this paper and its theories and findings? Why should you be interested, wasting your valuable time reading this post? In a word, RISK. Risk v. reward is a time honored means of measuring whether an endeavor will prove fruitful or not. I feel inadequately informed on risk; and maybe you are well-informed. If you are not, then some of these considerations may amplify your awareness of risk. If we do not have a basic understanding of the risks--what those risks are and whether or not the risk profile of the market is rising or falling--then how will we make prudent choices with respect to allocating/protecting our resources?

This paper and my distillation of it is only a slice of overall risk--but I think that it covers one of the greatest risks--an exogenous event that creates a rather serious problem in the markets. Trust me, you will not be able to get out of the market if such an event happens. I couldn't even get current data through Fidelity during the February 28 Shanghai Express that had all the exits blocked.

In the interest of not losing you (or myself) in this exposition, I'm going to break it up into manageable segments. I will create a label for the post "HF and Systemic Risk" so that you can see the series). I'd like to also add that everything expressed herein is 100% attributable to the paper. However, I will have a couple of peanut gallery observations, and I will clearly label them as my own through bracket offsets [.....].

Finally, I would deeply appreciate some feedback as to if you find this exposition of this article helpful at all. Granted, there is a piece of me that is writing to force (and reinforce) my personal distillation of the material, but I would be lying if I stated didn't care if YOU were interested. I'm not looking for any blind encouragement, but rather a sincere judgment on your part as to whether or not this is a good use of your time. You may e-mail me (see profile) or place a comment in the comments section.

First, let me introduce the paper and the authors as well as the abstract. Emphasis added. The link on the header is to the paper.
--------------------------------------------------------------------------------------------

Systemic Risk and Hedge Funds
Nicholas Chany, Mila Getmanskyz,
Shane M. Haasx, and Andrew W. Loyy
This Draft: August 1, 2005

Abstract

Systemic risk is commonly used to describe the possibility of a series of correlated defaults among financial institutions|typically banks|that occur over a short period of time, often caused by a single major event. However, since the collapse of Long Term Capital Management in 1998, it has become clear that hedge funds are also involved in systemic risk exposures. The hedge-fund industry has a symbiotic relationship with the banking sector, and many banks now operate proprietary trading units that are organized much like hedge funds. As a result, the risk exposures of the hedge-fund industry may have a material impact on the banking sector, resulting in new sources of systemic risks. In this paper, we attempt to quantify the potential impact of hedge funds on systemic risk by developing a number of new risk measures for hedge funds and applying them to individual and aggregate hedge-fund returns data. These measures include: illiquidity risk exposure, nonlinear factor models for hedge-fund and banking-sector indexes, logistic regression analysis of hedge-fund liquidation probabilities, and aggregate measures of volatility and distress based on regime-switching models. Our preliminary findings suggest that the hedge-fund industry may be heading into a challenging period of lower expected returns, and that systemic risk is currently on the rise.
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[The latter part of the paper is beyond my experience and education; but it is an outline of how the authors attempt to build a model to measure hedge fund risk. I'd like to provide you with a broad view of what the author's were looking at and some of the characteristics of hedge funds. Remember, that they are attempting to measure systemic risk. To do so, they detail the

• number of hedge funds
• characteristics of these hedge funds to include (1) the dynamic investment strategies, (2) opacity; (3) attrition rates/longevity (or lack of it);
  
• interdependency of financial institutions with hedge funds (from both an investor and creditor stand point);
• correlations/non-correlations the dynamic investment strategies and how outside events can cause these strategies to suddenly correlate resulting in phase locking.
• reliance on linear risk models that do not effectively quantify non-linear risk

The failure of Long-Term Capital Management is a tangible example of how the system can seize up in phase locking. With the proliferation of hedge funds combined with their mortality rate increases the amount of risks to the system in the event of failures.

I'll spend the next installment providing some color regarding the hedge fund profile.]

American Home Mortgage

I'm sure that those of you following the story of the lenders have already seen this story:

"Still, American Home said Friday that earnings will be lower because investors in the secondary-mortgage market and the market for mortgage-backed securities (or MBS) offered to buy its loans at "materially lower" prices.

Lower prices for AA-, A-, BBB-rated MBS and riskier bits known as residual-mortgage securities also triggered losses in American Home's investment portfolio, the lender added."
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As I both understand and have anticipated, the investor market woke up from its drunken yield stupor and finally realized that it needed to be compensated for this extra risk. Accordingly, in order to peddle these loans, prices have to be dropped. Now, if investors are requiring greater yield for the risk (and MarkM had provided a story for that last week), that means that the value of these bonds resident on the balance sheets of those who have bought this stuff, are going to have to be marked down as well.

Do you have bond funds? Do you know their composition? It might make sense to dig a little and find out.

Coal - New Watch List

I've created a new watch list for coal. Note that most of them had quite a good day last Thursday.

Contrahour/Martin Armstrong

I was doing some nibbish stuff on Martin Armstrong and ran across the blog called Contrahour

Anyway, I took the information on cycles and I computed the interim cycles (the actual dates are only given for the quarter cycles). My additions to this original schedule are in green.

Spring Snowfall!

Before

After (the snow last night, this morning)

Poem

War Duty

Through the left lashes of the left
corner of the left eye, a flicker: wings.
The right eye, blind in reserve
on the reverse slope of the nose,
reports nothing. The command
center of the brain commands: No
corroboration. Hold fire. No
retreat, no advance, no war, no peace
until it can be stated: "Dove
or avenging angel binocularly seen."

Alan Dugan
Poems Seven
Seven Stories Press, New York

Martin Goldberg's Market Close

Financial Sense on Line has a number of interesting contributors. I've mentioned before, that they are handwringers--perhaps for very good reasons, as I agree with all of them.

Martin Goldberg is a technician--I particularly enjoy reading his market closes. You can find his most recent one here.

It's worth a look.
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Fantasy Portfolio

Okay, now I'm rank 101044 or in the top 18%. I've sold all my ANPI, and I have two coal plays. Both will (most likely ACI) will pull back on Monday. We'll see. Keep your fingers crossed.

Market Close: 04.05.07

Calculated Risk

CR has a post about the ABS bond market that I encourage you to read.

I have to admit that I'm having a moment of self doubt about that bankruptcy language in the bond prospectus that I wrote about here. (I also posted this on BR's website and Calculated Risk--those folks must think I'm nuts).

I wish someone would (1) tell me to shut up and stop yappin' about it because I have it all wrong, and then be kind enough to extend an explanation to me as to why or (2) would write about it. To me, the issue remains eerily silent.

Anyway, if it becomes an issue, you can say that you read about it first here. Otherwise, you can say that you have read the rantings of a deranged blogger.

Fantasy Portfolio

Hey, my rank has increased to 140,160--in the top 27%.