In the luxury property market, bidding wars are for suckers

In the U.S. housing market, real estate inventory of homes for sale remains fairly tight after the subprime bust, which is one reason why prices have continued to slowly recover in recent years.

However, in market for luxury homes, inventory is much higher.

In other words, there are more homes for sale for high-end buyers to choose from.


This is why in the luxury property market, getting involved in a bidding war doesn’t make a whole lot of sense right now.

The graphic below from Zillow shows the inventory of homes for sale in several U.S. cities, broken down by price point. The top-value tier (shown in orange) has the most inventory.

home-pricesCities’ real estate inventory by home price (Click to enlarge)


Supply and demand

Overall, home prices continue to rise in the U.S., although the pace of gains has slowed a bit recently.

The S&P/Case-Shiller National Home Price Index rose 6.2% in June from a year earlier, and increased about 1% from the previous month, according to data released Tuesday.

One reason home-price gains are cooling is that more sellers are placing their homes on the market, reports Ruth Mantell for MarketWatch.

“The evidence suggests that house prices are leveling off following the sharp increases of 2013, with the improved supply we have seen in recent existing home sale figures putting a cap on price pressures, and demand still below last year’s peaks,” said Andrew Grantham, an economist at CIBC World Markets, in the article.

The inventory of homes for sale looks tight by historical measures, but supply has been rising in recent months. More supply and easing price growth will give buyers more of an edge.

A tale of two housing markets

Yet it appears that recent inventory growth has been concentrated in the high-end or luxury home market.

There are several reasons why supply is constrained in the lower-end market, and looser at the higher end.

In the lower-end market, many investors have paid cash in recent years to “flip” houses at higher prices, or convert them into rental units.

Also, “underwater” mortgages tend to be bunched in the lower end of the market. When a mortgage is underwater, it means that the borrowers owe more on the loan that the house is worth, and they may not be able to sell the house. This can reduce the inventory of homes for sale.

Bidding wars ease

The dichotomy in the U.S. housing market is frustrating for first-time homebuyers, but encouraging for move-up buyers.

“There is inventory coming on line, albeit slowly,” said Nela Richardson, chief economist for Redfin, in a recent Bloomberg article. “The problem is it’s not equally distributed. There is more turnover at the higher end.”

housing-inventory-real-estate-home-price-comparison2014 vs 2013 inventory by home price (Click to enlarge)


“The rising inventory of more expensive properties is giving a boost to sales and easing the bidding wars of the past two years,” according to the report.

The bottom line is that high-end home buyers can probably afford to shop around and wait for a good deal.

It’s a buyer’s market in the luxury real estate sector, if your agent negotiates well. Maybe it really is time to purchase that vacation home in Malibu.

Continue learning: The 10 investing and personal finance books you should be reading this summer


6 things to know about the iPhone 6 launch (and Apple stock)

by Barry Randall, Crabtree Technology portfolio manager

Apple (AAPL) shares are hitting a new all-time high as gadget groupies and investors alike eagerly anticipate the the iPhone 6.

The company is expected to officially unveil its latest handset on September 9. It will be available for sale on September 19.

iphone 6 apple launch

Since the iPhone product line is responsible for 55% of Apple’s revenue and 70% of its profit, the importance of the iPhone 6 can’t be overestimated.

Here are six things you should know about Apple and the iPhone 6:

1 ) The iPhone 6 screen will be bigger… but will it be big enough?

The iPhone 6 will reportedly have a 4.7” (diagonal) screen. This is a jump up from the 4” screen of the iPhone 5. But it is still smaller than the 5.1” screen of the iPhone 5’s primary competitor, the Samsung Galaxy S5. Apple is also reportedly working on a 5.5” iPhone 6, but recent reports have suggested that its release may be delayed until 2015 because of production issues.

2) It will have a sapphire-based screen.

The iPhone 6 is expected to have a synthetic sapphire-based screen. The good news is, sapphire is excellent at crack and scratch resistance. It also enables screens that have thinner bezels, making the useful area of the screen larger for a given size. The bad news is, sapphire is denser than the Gorilla Glass currently used on iPhones, making the device heavier.

3) The iPhone 6 will likely run Apple’s newest operating system, iOS 8.

New operating systems always bring new features and functionality. In this case, Apple’s forthcoming iWatch product is also expected to run iOS 8 (or a pared-down version) and this is expected to enable tight integration of the iWatch’s expected biometric features with a companion iPhone 6 handset.

4) Apple stock has been volatile near iPhone releases.

Apple’s last four iPhone introductions have occurred on June 7, 2010 (iPhone 4), October 4, 2011 (iPhone 4s), September 12, 2012 (iPhone 5) and September 10, 2013 (5s and 5c).  Except for the original iPhone 5 release, Apple’s share price declined a modest amount after the official iPhone release, then began rising again.

For the iPhone 5, the release came shortly before the first of several quarters of sharply decelerating revenue growth for the company as a whole. Apple stock declined sharply from a (split-adjusted) high of $100 in September 2012 to around $55 in April 2013. Only within the last week has Apple reclaimed its all-time high.

5) Apple continues to lose market share, but the market is still growing.

Worldwide, Apple’s smartphone market share continues to fall and was only 11.7% in the second quarter of 2014, down from 13.0% in the year-earlier period.  Apple’s market share in the U.S. was about 42% in Q2, thanks to a) the U.S. residents having higher per-capita incomes, and b) U.S. mobile service providers offering generous subsidies that materially lower the cash cost of a handset at purchase.

That said, worldwide smartphone handset growth was about 25% in the second quarter, meaning that even though Apple is losing share, it is still capturing a slightly growing share of smartphone revenue. And this in turn supports the rest of their very profitable ecosystem, including iTunes and cloud services.

6) “Apple vs. Samsung” is the wrong way to look at Apple’s prospects.

Given the importance of the iPhone to Apple, many have interpreted rival Samsung’s own sharp market share declines as positive for the American technology giant. But that is short-sighted. Both companies are suddenly competing against inexpensive, shockingly capable Android-based smartphones from lesser players like Huawei, Lenovo, Xiaomi and Micromax. While these brand names may be unfamiliar to Americans, they are growing sales at rates much faster than either Samsung or Apple.


As I wrote nearly a year ago, handset manufacturers face the prospect that more and more functionality is moving off of the device and on to the network, whether it’s through social networks like Facebook (FB) and LinkedIn (LNKD), simple messaging apps like WhatsApp or payment apps like Intuit’s (INTU) GoPayment.

Apple certainly has an enviable ecosystem within which users enjoy a lot of utility.

But you have to ask yourself: Is Apple is a better bet now with 11% smartphone market share and the stock at $100, than it was in mid-2010, with 20% market share, and the stock at $35?


DISCLAIMER: The investments discussed are held in client accounts as of July 31, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.

What Wall Street can’t figure out about Millennials


The financial-services industry needs to throw out its traditional playbook if it wants to reach Millennials and play a role in helping them realize their investing goals.

The stakes are high for both sides.

Many Millennials are at risk of falling behind on their financial goals because they haven’t even started investing yet. For example, about half of Americans between the ages of 18 and 29 have zero retirement savings, according to a Federal Reserve survey. Millennials, also known as Generation Y, are generally defined as those in their 20s or early 30s, and they are justifiably wary of the financial industry and the market.

The chart below is from Statista:


For Wall Street, many financial firms that focus on older, wealthier generations such as Baby Boomers are unprepared from the coming general shift. They will have to reshape their services and message to meet the needs of Millennials. To take just one example, traditional marketing and advertising doesn’t really work with many Millennials because they simply shut it out.

In about five years, more than one of three adult Americans will be Millennials, and by 2025 it is projected that this demographic will comprise as much as three-quarters of the workforce, according to the Brookings Institution.


Financial firms and advisers will have to rethink their approach to work with Millennials, who will soon be hitting their peak earning years.

Here are a few ways that Millennials are different from older cohorts:

  • They’re extremely conservative as investors: Millennials are the most fiscally conservative generation since the Great Depression, according to a UBS survey. This makes sense because they’ve seen their parents get hit with two major bear markets the past 15 years. They tend to avoid the stock market and hold a higher percentage of cash than older investors. They’ve also witnessed the effects housing boom and bust.
  • They’re very skeptical: The financial crisis has also made them understandably suspicious of Wall Street and potential conflicts of interest. Millennials require a high level of trust before they give their money to a bank or financial adviser. They verify — using information on the Internet, social media and from personal connections.
  • They defy stereotypes: They may be seen as coddled and spoiled, but it turns out they care a lot about their financial futures and don’t want to repeat their parents’ mistakes. They’re tech savvy and highly educated as a group. They want to have control over their finances, so they’re more likely to be self-directed investors. They want to be comfortable, but they don’t want their lives to be dominated by money, which is often secondary to pursuits such as traveling, family, staying healthy, friends and volunteer work.
  • They have financial challenges: In many ways, it’s not easy to be a Millennial. College tuitions have skyrocketed in recent years, and many graduates are saddled with high levels of student debt. The Class of 2014 is the most indebted ever. Rents and home prices are creeping higher while wages have mostly stagnated. Also, more Baby Boomers are staying in the workforce and delaying retirement after the financial crisis, making it harder for younger investors to find jobs. These are all reasons why Millennials are hitting major milestones later in life such as getting married, buying a house and having children.
  • They tune out marketing and advertising: Perhaps more than any other generation, Millennials understand how marketing and advertising work, and they’re adept at ignoring it or even finding ways to turn it off completely. They don’t click on banner ads or open mass emails.

So, firms that “get it” with Millennials understand their unique habits and concerns. They communicate in language and mediums that resonate with Millennials, and show how their services are different and/or better.

Here are the ways Wall Street needs to change if it wants to be relevant to Millennials:

  • What works with Baby Boomers doesn’t work with Millennials: You can’t market to Millennials in the same way as retirees, but this goes beyond just the message and investments. With social media, the financial-services industry is just doing what it always has — just faster and louder. As mentioned earlier, Millennials are keenly aware of when they’re being advertised or marketed to, and they resent it. Wall Street can’t talk down to Millennials. In some ways, Wall Street has to turn its traditional marketing strategy on its head to reach Millennials.
  • Social media engagement: Social media is where Millennials get a lot of their information and learn about brands. According to recent study, 77% of Millennials own a smartphone and they spend nearly 15 hours a week texting, talking and on social media. However, companies need to engage followers on social media, not just talk AT them with links to their own blog posts and products. It needs to be a two-way street, with shares to other Facebook accounts and retweets to other Twitter handles. It’s important to educate followers, and be a part of the daily discussion with analysis of relevant, timely topics. Be helpful. And it helps to focus on a specific theme or niche, rather than trying to be all things to everyone. The reality is that Wall Street’s approach to social media is probably backfiring for a lot of financial-services firms. Millennials just see these companies the same way they see Grandpa trying to “do Facebook.”
  • Personalize it: Millennials are leading the backlash against conglomerates — the huge companies with big marketing budgets and aggressive sales tactics. Some Millennials are gravitating to companies that take more of a personalized, Mom-and-Pop approach. Many are willing to pay a little extra to “feel good” about the companies they buy from and deal with.
  • Beyond marketing: Millennials as a group do more research than anyone else, BEFORE they even begin the decision process of buying a product or service. They’re very good at using the Internet and social media to find what they want. If a company has a bad product, customer experience or corporate culture — Millennials will see right through it. And then they’ll tell all their friends on social media. No amount of slick marketing can fix a broken corporate culture.

“With advances in technology, the Internet, and mobility, the Millennials have had instant access to better and more information like no other generation before them,” says real estate marketing executive Sean Blankenship. “This has driven an intuitive ability to detect when brands are fake, not truthful, or inauthentic.”

The upside for financial firms is that they can build long-lasting relationships with Millennials if they earn their trust. If a company hits it out of the park with Millennials, they’ll probably stay loyal because they’re so wary of Wall Street. They just see a lot of “junk” out there in the investment world, so it’s up to the financial-services industry to work hard to change that perception.

Here’s what is keeping investors up at night


Higher taxes, protecting wealth and healthcare costs are among investors’ biggest concerns right now.

In the latest installment of Covestor Radio, Kimberly Clouse discusses the things that are keeping investors up at night.

Clouse, Covestor’s Chief Client Advocate and Advisory Board Chair, was recently interviewed by Eric Dye of the Entrepreneur Podcast Network. Below is an edited transcript of the interview (the podcast audio is also available at the end of this blog post):

Eric Dye: Today we’re talking about typical attitudes of U.S. investors, specifically those considered to be mass affluent.

Kimberly Clouse: I’ve been working with families on their personal investments for over 15 years. And through the years clients have often asked me: Am I typical? Are my concerns similar to other people like me? Each year, Spectrem conducts online interviews with affluent households across the U.S. and the most recent report I saw was jointly sponsored by Spectrem and Vanguard. For today’s show I thought it would be most relevant to focus on the mass affluent, but there is also a lot of data available on millionaire households and ultra high net worth households. For today’s show we’ll focus on the mass affluent.

The survey results cover 1,500 mass affluent households, and it’s a research study that was conducted over a yearlong period from the fourth quarter of 2012 through the third quarter of 2013.

Eric Dye: How is mass affluent defined?

Kimberly Clouse: What Spectrem does is look at three wealth segments that exclude the value of someone’s primary residence. So these are investable assets. Mass affluent is $100,000 to $1 million of investable assets. Millionaires are $1 million to $5 million of net worth. Ultra high net worth is over $5 million up to $25 million.

Eric Dye: What are the general characteristics of the mass affluent households?

Kimberly Clouse: According to the study there are more than 28 million mass affluent investors in the U.S., and the typical mass affluent investor is 58 years old and 51% of the group is still working fulltime. Which makes sense because retirement ages are going up, so about half of this group is still working. The top occupations are educator (15%), manager (13%) and healthcare (10%).

Eric Dye: What are the primary concerns of the mass affluent?

Kimberly Clouse: The No. 1 concern is maintaining their current financial position. In fact, 70% of the survey respondents cited this as their top concern. Another primary concern is the financial situation of their children and grandchildren, cited by 58%. Then the data gets interesting to me. Of the top seven concerns of this group, five are all healthcare-related. These include health of the spouse, their own health, a family health catastrophe, the possibility of spending final years in a care facility, and needing someone to care for them in old age. This, to me, is so telling. Even mass affluent families are very concerned about healthcare uncertainty and changes in healthcare policy.

Eric Dye: Do mass affluent investors work with financial advisers?

Kimberly Clouse: There are two different angles here, or ways to get a feel for that behavior. One is the number of mass affluent investors who work with advisers. And the other way is to look at the percentage of the investor’s assets that the adviser controls. On the first metric, over 70% of mass affluent investors use a financial adviser. That figure is actually higher than I expected … On the second metric, which is the amount of assets that mass affluent investors control without professional help, it’s pretty substantial … Mass affluent investors control 55% of their assets on their own with no professional help. So what this tells you is that many mass affluent investors are using advisers, but they’re using advisers for a relatively small percentage of their assets.

Eric Dye: What do mass affluent investors generally think about their financial situations?

Kimberly Clouse: The way the survey tackled this was by asking if respondents agreed with certain statements. They were asked if their financial situation had improved from last year, and more people said yes than in 2012, with 48% agreeing, up from 37% in 2012. Yet, the mass affluent are not feeling very optimistic about their financial future. In 2012, nearly half of them said they felt that their financial situation would be stronger a year later. In 2013, the figure declined to 40%. So we’re seeing a change there.

Eric Dye: Any other thoughts on mass affluent investors?

Kimberly Clouse: The Spectrem/Vanguard survey revealed that like all investors, the mass affluent are worried about tax increases and their implications. About 75% identified this as a key issue. From my perspective, I think investors should focus on what they can control and influence.  You can’t control tax legislation or tax rates. What you can do is understand how tax laws impact your financial situation. Work with your adviser and accountant to implement a tax strategy to help minimize the tax impact. You’ll drive yourself crazy trying to control things you just can’t control.

Clouse’s full interview on Covestor Radio is embedded below:

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. All investments involve risk, the amount of which may vary significantly. Past performance is no guarantee of future results.

Investing in companies on the cusp of change


How often do you hear this from a public company: “We’re happy to share with you that our strategic plan just isn’t working.”

Of course, the answer is rarely, if ever. Companies are programmed to pursue their original plan. The board of directors and senior management set their priorities, allocate capital, make acquisitions, pay bonuses – all based on their strategic plan.

Investors are equally programmed to buy stocks of companies with successful strategies. Earnings are easy to model, valuations fit into historically normal ranges, and the stories are upbeat and comfortable to talk about.

Yet Plan A’s do not always work. Execution sometimes isn’t up to par, customers move away from the company’s products and services, the corporate strategy itself becomes dated or flawed. In some cases, a division no longer fits, and in an extreme case, the company has to file for bankruptcy. Most investors have little if any patience for failing Plan As. The weaker Plan A looks, the faster investors abandon the stock.

This is exactly when we start looking – when Plan A isn’t working.

We want to see a company make a major transition to a better future, driven by an event that will result in big changes in how these companies utilize their assets. That can include new senior management, a spin-off transaction, emerging from Chapter 11 bankruptcy, a major restructuring or turnaround, or some other significant strategic-level change.

If the transition looks particularly promising, we’ll take our position (long-only) and look to stay for several years, as long as the transition remains on track our turnover is about 25% to 30%. Not all events are worth the risk (we currently hold only 34 positions) and we only look at small/mid-sized situations or companies with market caps ranging from $500 million to $10 billion.

Eighteen months into the history of our Smidcap Value portfolio, the returns have been encouraging. The strategy has returned 19.7% since its inception date of September 5, 2013, vs 18.2% for the benchmark S&P 500 Index (SPX).

The return in the quarter was driven by gains across the portfolio, most notably from Carrizo Oil & Gas (CRZO), Dynegy (DYN), Halcόn Resources (HK), Micron Technology (MU), Office Depot (ODP) and Platform Specialty Products (PAH).

We purchased three new names in the quarter: Triumph Group (TGI), Civeo (CVEO), and KBR. Triumph Group has an activist investor helping improve its operations. Civeo is a spin-off looking to convert to a REIT, and KBR has a new CEO and new CFO who are doing a complete review of the company’s operations.

We also sold three positions: Timken (TKR), Hillshire Brands (HSH), and Comverse (CNSI). While Comverse continues to struggle, Timken and Hillshire Brands successfully completed their transitions and reached our price targets.

Our holdings overall continue to deliver the fundamental improvements we expected. One example from the second quarter is Dynegy.

Dynegy emerged from Chapter 11 bankruptcy in October 2012 with a few strikes against it. They included an under-managed roster of ten gas-fired power plants and four undesirable coal-fired power plants, a poor reputation following a contentious bankruptcy battle, and what appeared to be mediocre prospects for meaningful improvement in prices for its electricity.

However, we saw several positives, including a new and highly-experienced management team led by industry veteran Bob Flexon. In addition, there was a healthy balance sheet with little debt, considerable potential to improve costs, and little downside valuation risk given the positioning of its generation plants.

Given this, we purchased the stock and have owned it since our inception. In our opinion, management has improved the underlying value of the assets, made a successful acquisition, and appears poised to make another. Importantly, the company is benefiting from better prices for the electric power it sells.

While Triumph Group’s Aerospace Systems and Aftermarket Services divisions (a combined 33% of revenues) are operating well, the Aerospace Structures unit (67% of revenues) has suffered in recent quarters.

Revenue is weaker due to military program roll-offs and Boeing’s (BA) commercial aircraft production cuts, and margins have suffered as overall costs are too high. Two events have captured our attention.

First, management has announced it is taking sharper, shareholder-friendly steps to reduce costs and improve manufacturing efficiency in the structures division, to make acquisitions to reduce the importance of the Structures division, and to repurchase shares.

And, second, activist investor Atlantic Investment has filed as a shareholder. This group has a history of helping mid- sized industrial companies improve their operations. With these two events, the sizeable potential for better earnings, and the stock’s low valuation, we initiated a position on May 29th.

Civeo was spun-off from Oil States International (OIS) on June 2nd. The company provides temporary and long-term accommodations to more than 20,000 workers in the energy industry in Canada, Australia, and the United States. Now that the company is independent, we believe that management, led by Oil States veteran and former CFO Bradley Dodson, will focus on two primary drivers to boost the share price.

The first is to improve its operating results to return its EBITDA to the $400 million level it achieved in 2012 and 2013. In our opinion, the company may accomplish this by 2016.

The second is to convert to a REIT structure, which we expect will increase its multiple to approximately 11.0x EBITDA from its 9.0x spin-off valuation. With this combination of events, we purchased the stock on the spin-off date.

KBR is an engineering and construction company with expertise in the energy markets. The business is cyclical and cost management is crucial, yet KBR has struggled with new orders and cost over-runs over the past few years.

Investors have abandoned the stock. We believe the company is beginning a multi-year transition, led by new CEO Stuart Bradie (June 2014) and new CFO Brian Ferraioli (October 2013). They are currently conducting a top-to-bottom strategic review of the company’s entire operation.

We expect the review will result in cost cutting and margin improvement as well as a new focus on businesses where KBR has a competitive advantage, particularly in gas monetization and hydrocarbons. The company has no debt, holds $1 billion in cash, and is actively buying back stock.

While its backlog is in decline temporarily, we expect large opportunities in gas monetization will materialize starting next year. The company has $3.00+ EPS potential at the mid-point of the cycle, implying an attractive 7.8x P/E in our opinion. We purchased the stock on June 27th.

As long-term investors, we patiently look through temporary set-backs in a company’s transition as long as the overall outlook remains intact. However, if the company’s transition becomes permanently impaired, we will exit that position. This sell discipline drove our sale of Comverse.

This software company was spun-off from Comverse Technologies in late 2012, and was a since-inception holding in our strategy. The spin-off, combined with new management that could focus on pursuing new revenue opportunities and reducing costs, appeared to be a fresh start that would leave the problems of its former parent company behind.

However, Comverse has continued to struggle with producing new orders, particularly in the important Asia Pacific region, and its other efforts to improve operating results also remain off-track. Our analysis of the company’s competitive positioning led us to conclude that the transition had become permanently impaired, and we sold our shares on April 17th.

Our more preferred reason we sell a company is when it successfully completes its transition and its share valuation reaches our price target. We sold Timken and Hillshire Brands for this reason.

The company was being pressured by activist investor Relational Group to spin-off the steel business, allowing the higher-multiple bearing business to be re-valued on a standalone basis.

After a lengthy process, including a non-binding vote by shareholders and management’s hiring of an investment bank, Timken management agreed to pursue a spin-off with a target date of the end of June. As the company successfully completed its transition the stock eventually reached our fair value on both a P/E basis and sum-of-the-parts basis for the two stand-alone businesses, and we sold the stock on June 3rd.

Hillshire Brands Company (HSH), also a since-inception holding in our portfolio, was spun off from food conglomerate Sara Lee Corporation in June, 2012. Hillshire had an under-managed collection of outstanding brands, including Jimmy Dean Sausages, Ball Park Franks, and Hillshire Farms lunch meats.

The new management team began to pursue a three-pronged strategy of rationalizing costs to improve margins, investing in innovation and brand-building, and pursuing acquisitions to drive top-line growth. Hillshire was executing on all three of these strategies.

On May 12th they announced the acquisition of Pinnacle Foods, which would have doubled the size of Hillshire and greatly expanded their product offering. We had a moderately favorable view of this acquisition. However, on May 27th, Pilgrim’s Pride announced an unsolicited offer to buy Hillshire and we sold our shares that day.

DISCLAIMER: The investments discussed are held in client accounts as of July 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.

Aug 8

The 10 investing and personal finance books you should be reading this summer


This Saturday is National Book Lovers Day, so we thought we’d put together a list of beloved and valued books on investing, business and finance — as shared by portfolio managers on Covestor and members of the Covestor senior management team.

Check out the list of ten books below for some recommendations for National Book Lovers Day:

1. The Art of Asset Allocation by David Darst

Selected by Charles Sizemore – CFA, RIA, and manager of the Strategic Growth Allocation portfolio on Covestor

“This is distinctly not a ‘how-to-trade-stocks’ book. As its name implies, it is a guide to building a comprehensive portfolio from the top-down. It is important to remember that, while a savvy stock pick can make you wealthy, studies have shown that more than 90% of your portfolio returns are explained by asset allocation.”

2. Active Portfolio Management by Richard Grinold and Ronald Kahn

Selected by Jane Edmondson – MBA, RIA CEO, and manager of the Mid Cap Quant portfolio on Covestor

“This is the book that many quantitative investment managers consider their ‘handbook.’ I am a strong proponent of active management, but too often, emotional biases and subjectivity can detract from investment performance. The quantitative approaches discussed in this book illustrate how to potentially produce superior returns on a consistent and repeatable basis, while managing risk. These basic principles have helped me manage money for my clients year after year.”

3. Wall Street: How It Works and for Whom by Doug Henwood

Selected by Asheesh Advani – Oxford doctorate, and CEO at Covestor

“This great book is a coherent, although somewhat biased, critique of everything that’s wrong with Wall Street. The good news is that for every abuse of power and every misaligned incentive, there is an opportunity for entrepreneurs and new ventures to provide investors with a better deal.”

Read More

ETFs are from Mars, mutual funds are from Venus


Watch what they do, not what they say.

That’s the thinking of analysts who pay closer attention to money flows than sentiment polls, when they’re trying to get a sense for how investors really feel about the market.

For example, some analysts keep close tabs on inflows and outflows in mutual funds and ETFs to gauge the overall mood of investors.

However, “some curious dichotomies” emerge when it comes to the behavior of mutual-fund and ETF investors, according to ConvergEx Group.

For example, mutual-fund investors have pulled more than $5 billion from U.S. stocks so far this year, while adding nearly $53 billion to bond funds.

Conversely, ETF investors have poured nearly $26 billion into U.S. equities.

So it seems that ETF investors are much more bullish on the stock market than their mutual-fund counterparts. Yet the disparity could be driven more by demographics than bullishness.

“Our heuristic for comparing ETF and mutual fund flows is largely informed by the relative age of the asset owners,” according to ConvergEx.

“Mutual funds were the hot investment product of the 1980s and 1990s; ETFs took over that title in the 2000s and still hold it today,” the analysts wrote in a recent note. “Ask a broker or registered investment advisor how receptive their clients are to ‘new ideas, and they will tell you that the response tends to correlate with age. This is why mutual fund flows tend to skew towards fixed income, and ETFs to equity products. In short, these trends are as much demographic as they are about the capital markets or business cycle.”

So while the S&P 500 continues to climb to new record highs, there appears to be a generational clash between ETF and mutual-fund investors. ETFs are baskets of securities that trade like individual stocks on an exchange. They can be bought and sold during the day, while mutual funds are priced once a day at the close.

“Mutual fund assets still trump ETF balances by +$5.0 trillion to $1.9 trillion,” according to ConvergEx. “Will older investors continue to clip their coupons, or will they cycle back to U.S. equities? Or will their younger investment brethren step up and keep investing in ETFs? Either way, we’ll keep having to follow the money to find out.”

Certainly, this is a theme to watch as the bull market stretches into its fifth year.

At Covestor, some of the portfolios on our investment marketplace invest in ETFs, including diversified portfolios with management fees starting at zero. Covestor clients choose portfolios, and the positions and trades are replicated in their own brokerage accounts.

To learn more about how Covestor works, contact our Client Advisers at or 1.866.825.3005. Or you can try Covestor’s services with a free trial account.

DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. All investments involve risk, the amount of which may vary significantly. Past performance is no guarantee of future results.

What investors may be missing about Finisar


On June 24, Finisar Corporation (FNSR) reported results which showed that revenues were up, but margins were down. Future guidance was conservative. As of July 18, the stock is down more than 30% from its recent high.

In my opinion, any small-cap company that reports disappointing news has a tendency to be sold off quickly. This may be because traders can now continue to short stock until the price finds a bottom. Before a loosening of the old short trading rules by the Securities and Exchange Commission in 2010, a stock could only be shorted on an uptick in most cases.

For the fourth quarter of 2014, FNSR reported its seventh consecutive quarter of revenue growth and annual revenue growth of 23.8%. Fourth-quarter revenue increased by 4.1% over the third quarter and by 25.7% over the fourth quarter of the prior year.

Margins were another story, according to the financial results. The so-called GAAP operating income decreased 7% ($11.5 million) to $21.6 million. Non-GAAP operating income decreased 12.7%  ($7.4 million) to $38.9 million.

Finisar Chief Financial Officer Kurt Adzema cited the impact of a recent acquisition and seasonal telecom price reductions, among other reasons, for the decline in margins in a conference call.

Jerry Rawls, Executive Chairman of FNSR, noted that wireless products lowered the corporate margins but are increasing revenues. The business is profitable and it opens the door for FNSR to create new opportunities with those customers.

The company’s wireless products are older and off-the-shelf, so they don’t require much research and development costs. As Rawls explained in the call:

“This wireless opportunity is large for us and its growing and we expect it to grow even more in Q1, which is why consequently we’re guiding gross margins down in Q1… even though the company is guiding for high growth in revenues. The fourth generation wireless expansion in China …. is hundreds  of thousands of …… new LTE towers.”

In January,  2014, Finisar purchased a German company, u2t Photonics, that fills out the company’s offerings of 100 gigabit products. U2t now has low profit margins, but when their production is transferred to the new China plants within the next year, that may improve things. The 100 gigabyte products are in high demand, have large profit margins and the business is expected to have grow significantly, according to Adzema.

Adzema also pointed out that Finisar is spending heavily on capital expenditures for investments in China, including two new buildings. “Depreciation is going up approximately $2 million a quarter and so obviously that has some impact on gross margins. The first building will be fully occupied by the end of the Q2 and the second building completed in the fall and occupied by the end of Q4,” Adzema said.

I read the details on results and a transcript of the conference call. In my opinion, the company’s explanation of margin pressure is credible. The cost of revenue went up about $21 million to $208 million. The details are not defined, but this could certainly be mostly attributable to product mix in my view.

The operating expenses, including R&D, sales and marketing and other items, went up about $2.8 million. In my opinion, the acquisition of u2t could have contributed to this increase.

FNSR added about $8.3 million of GAAP net income from the sale of a majority owned subsidiary Finisar Korea Ltd. There was a $3,384 charge for “change  in excess and obsolete inventory reserve.”

On the positive side, FNSR is scheduled to complete two new plants in China that will significantly increase capacity and lower costs. Finisar is also developing new, higher-margin products in the “Web 2.0 market,” according to Adzema said.

“We expect it to grow for years to come. The size will depend on the aspirations of each Web 2.0 operators… but they…have plans and dreams for networks that crisscross this country. So it’s pretty amazing in terms of optics.”

In my opinion, the market reaction to the company’s results may be overblown. I believe it is possible that the demand for FNSR products will continue to grow and the stock may trade higher from its recent sell off.\

Photo credit: Brandon O’Connor via Flickr Creative Commons

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DISCLAIMER: The investments discussed are held in client accounts as of June 30, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.

What could derail this rally? Four things investors should watch


Despite the some recent fluctuations, major U.S. stock indices like the S&P 500 Index (SPX) and Dow Jones Industrial Average (DJIA) markets are still setting record highs.

On July 14, Goldman Sachs (GS) revised its year-end target for the S&P 500 to 2,050, up from the previous target of 1,900. Against the backdrop of the U.S. Federal Reserve’s accommodative monetary policy, strong corporate earnings, and improving job markets, individual investors are plowing money back into the U.S. stock markets.

About $100 billion has been added to equity mutual funds and exchange-traded funds in the past year, ten times more than the previous 12 months, according to data compiled by Bloomberg and the Investment Company Institute.

At Julex, our quantitative model still indicates “risk on” and a continued bull market. Although no significant risks are imminent in the market now, investors should be mindful of four things that could derail market rallies.

Rising Interest Rates

After the Fed ends its quantitative easing bond purchases in October, the timing and path of rate increases will present uncertainties in the markets. If the Fed raises interest rates slowly in an orderly fashion like the last tightening cycle, the market rallies may continue for a long while.

Should the Fed raise rates in a hurry to fight potential inflation threat, it will be hard for the market to digest and significant market corrections may occur. We believe that the slow rise in interest rates is more likely scenario, but it will be data dependent. The unemployment rate and inflation rate are the most important data for the Fed to determine the course of action.

Subpar Revenue Growth

With forward P/E of S&P 500 Index at 15.6, which is higher than the ten-year historical average of 13.8, the room for further expansion may be limited. To support the continued bull markets, corporations need to continue growing revenue.

In recent years, corporations have achieved earnings growth by cutting costs. However, with profit margin at historically highs, it becomes hard to expand margin further.

Revenue growth has a lot to do with economic performance. The US economy is doing better, but it’s only growing at a 2% or so annual pace. Robust revenue growth cannot be supported by subpar economic performance. We do think the US economic growth will pick up, but it is still questionable how robust it will be.

Fragile European Banks

Europe still remains a risk to markets. Worries about a major lender in Portugal recently sent U.S. stocks on an early swoon after Banco Espírito Santo International delayed coupon payments relating to some short-term debt securities. On July 18, the lender’s parent company, conglomerate Espírito Santo International SA, filed for creditor protection.

Although the Europe just crawled out of recession, the recovery is still fragile and its banking system is still fragmented, especially in Portugal and Greece.

Middle East Tensions

Rising tensions throughout the Middle East and potentially higher oil prices are also risk factors. Egypt has regressed to military rule, Syria is still mired in a civil war, and the extreme group, ISIS, seizes city after city in Syria and Iraq.

There are more potential disruptions of oil supply here. As oil prices are already creeping higher, any further disruption in production would likely send them higher. Increasing oil and gasoline prices would represent a painful blow for consumers and the global economy. In general, a $10 increase in the price of oil cuts 0.2% to 0.3% from GDP.

Qualitatively and quantitatively, we still believe we are in a continued bull market and “risk on” regime and have our managed portfolios positioned accordingly. The four economic and market factors we are tracking are all point to a positive risk-taking environment (see graph below). However, investors need to be aware of the potential risks in the markets.


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DISCLAIMER: The investments discussed are held in client accounts as of June 30, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.

What Walgreen’s tax-inversion move means for investors


Several recent merger and acquisition (M&A) headlines in the pharmaceutical industry have a common underlying motivation. Consider the following: AbbVie’s courtship of ShirePfizer’s abortive pursuit of AstraZeneca,Salix Pharmaceutical’s acquisition of Cosmo, and Mylan’s purchase of Abbott Laboratories’ generics business.

This wave of proposed deals is partly due to potential tax savings through a mechanism known as a tax inversion. A tax inversion is a transaction through which a US company relocates its headquarters to a lower-tax jurisdiction by merging with a foreign company.

As the pharmaceutical industry consolidates in an effort to reduce costs after years of disappointing drug discovery efforts, many companies seek the added benefit of escaping high US corporate income taxes.

Tax inversions have become more frequent, with 11 transactions completed since 2012 and at least as many currently pending, mostly in the healthcare industry. The large number of deals has attracted political scrutiny, drawing calls from some members of Congress and the White House to curtail the practice.

The optics make for good political fodder: a company undergoing a tax inversion may retain its local operations entirely, but it begins paying taxes to a foreign government instead of the US. Under current law, a US company can redomicile to a foreign jurisdiction as long as foreign shareholders own at least 20% of the combined company. Congressional proposals to raise this threshold to 50% at the end of 2014 have only accelerated inversion attempts this year.

With this backdrop, several activist investors have been pressuring Walgreen Company (WAG) to reconsider the structure of its two-step acquisition of Alliance Boots (BOOT), Europe’s largest drug wholesaler and a leading health-and-beauty franchise.

WAG acquired 45% of Alliance Boots in 2012, and it currently has the option to buy the remaining 55% during a six-month exercise window in early 2015. Although the current structure would not result in a tax inversion, there are several ways WAG could adjust the terms in order to reduce the company’s tax rate close to the 21% rate in the United Kingdom, where most of Alliance Boots’ operations are based. (Alliance Boots is incorporated in Switzerland for other tax reasons).

A June Deutsche Bank report estimated that a tax inversion could save WAG nearly $1 billion in taxes by 2018, increasing EPS by about 15%.

Despite political opposition, WAG management has begun to seriously consider a tax inversion. Though he had previously dismissed the idea, CEO Greg Wasson stated on the company’s most recent conference call that the board is actively evaluating the tax structure of the second-step transaction among other “opportunities below the operating [income] line.”

On the same call, management pulled its previously announced fiscal 2016 operating earnings, cash flow, and net debt targets for the combined company. WAG performance had been running below target earnings, though it was on track to meet the latter two goals.

Analysts initially expressed concern that WAG might be backing away from its previous optimism about the transaction, but management indicated that they remain confident and plan to release new guidance that better reflects the combined company’s capital structure. In my opinion, this is clear evidence that management plans to restructure the second step of the transaction and pursue a tax inversion.

With 240,000 employees, WAG is a large employer sensitive to political issues. Pursuing a tax inversion is far from a certainty, but I believe management’s commentary suggests that it is the most likely outcome. Irrespective of the political consequences, the earnings boost would be a clear boon to shareholders.

So, what does all this mean for the Hedged Value portfolio, which holds a long position in Walgreen? Despite my expectation that WAG will ultimately undergo a tax inversion, that is not why I own it. An inversion could still be derailed by Congress or internal opposition.

I own WAG because I believe the quality of its retail franchise and its earnings power in combination with Alliance Boots are underappreciated by the market and not fully reflected in its current valuation. Through its purchasing consortium with Alliance Boots and AmerisourceBergen (ABC), WAG is the largest generics buyer in the world.

The company may realize significant benefits from reshaping the global pharmaceutical supply chain, continuing to improve the in-store experience, and expanding internationally. While the successful completion of the merger with Alliance Boots and continued smooth integration of the two companies is an important part of the investment thesis, my investment is not predicated on a tax inversion.

One of the perennial challenges of investing with a long time horizon is deciding what to do – if anything – when near-term events independent of the long-term thesis may influence a holding’s share price. WAG presents just such a challenge today. To what extent might other investors’ expectation of an inversion already be reflected in the share price?

If management decides not to heed activists’ recommendations, might they choose to sell and place downward pressure on the share price? Conversely, if a tax inversion is successful, might the share price rise to reflect the increased earnings of the company?

Ultimately, these considerations are secondary to valuation. I believe WAG already trades below the fair value of its earnings power, even without an inversion. If management decides not to pursue an inversion and the share price declines, that could present a buying opportunity. If the inversion takes place, I would view it as a nice bonus.

As a result, Cable Car has not adjusted its position in WAG. We will find out soon — management plans to announce the updated transaction details in late July or August.

Photo credit: Phillip via Flickr Creative Commons

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DISCLAIMER: The investments discussed are held in client accounts as of June 30, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.