Investoid

I was approached by Timothy Sykes, a trader who met with success while he was still in high school, to read a pre-release copy of his book, an An American Hedge Fund. I agreed to read it, not sure of what to expect.

After reading through it, I found that the book is an interesting look at Sykes’ life to date. He made the bulk of his money riding penny stocks during the dot com boom, and subsequently continued to increase his wealth during the bust by shorting the same type of companies he rode on the way up. Eventually Sykes decided to leverage his personal funds into creating a hedge fund. While Sykes goes into detail about how he made his millions, this book is not about the method. It is more of a biography that has some interesting thoughts and lessons for active investors/traders.

For me, the most insightful aspect of his book is how he keeps hammering home the mistakes he made and the psychological traits that were behind his trading decisions. I think this is a crucial aspect for anyone to understand in order to achieve long term success in active investing/trading. Sykes’ no holds barred confessionals made me feel like I’ve learned through his mistakes.

Sykes devotes the last part of the book to his trials and tribulations as a hedge fund manager. He becomes disenchanted with the hurdles that hedge funds face when trying to raise capital, and uses this as motivation to write the book. While I enjoyed reading the ending sequence regarding hedge fund regulations, I thought some more detail would be beneficial (although maybe just an egghead like me wants to know the specifics).

Overall, Sykes has written an engaging book that provides some solid lessons about trading psychology. He has a readable style that makes you want to finish the book as soon as possible.

For more info on Sykes’ new pursuit of investor education on the hedge fund industry, check out his website.

Disclosure: I will be receiving a complimentary copy of the book for my review of his work.

After reading a book review on Capital Ideas over at Canadian Financial DIY’s site, I decided it would be good to write about one of the books I read last year that had a lasting impact on me.

The (Mis)Behavior of Markets is written by Benoit Mandelbrot, a mathematician who is the inventor of fractal theory. Mandelbrot has been applying fractals to many different areas of application, including finance, for over 40 years. While modern financial theory was being written, Mandelbrot was finding issues with the mathematical models used for the derivations and suggested alternatives. While his work was largely ignored during the explosion of mathematical finance, his views have been gaining momentum over the past 10 years or so.

In this book, Mandelbrot provided a non-technical account of what’s wrong with the basic tenets of modern financial theory, namely:

• Asset returns can be modeled with the normal or log-normal distributions, meaning that:
  • returns from separate time periods are independent (ie. no correlation)
  • the mean return is an important number because it can be used as an expected value for future returns
  • it is very unlikely to have extreme returns (ie. 99% of returns should be within 3 standard deviations of the mean)
• Investors have identical knowledge and goals
• Price changes are nearly continuous (as opposed to sporadic changes that cause the price to ‘jump’)

Mandelbrot uses evidence from various financial situations, not the least of which the 1998-2001 bubble/bust era, to demonstrate how these assumptions rarely hold (if ever). By refuting the models that form the basis of modern financial theory (including the Black-Scholes option pricing formula), Mandelbrot sets the stage to offer his own mathematical models that he believes more accurately depict how financial markets work.

I won’t go into any technical detail about fractals (neither does he in the book), but from his modeling he draws some interesting conclusions:

• Markets are way more risky than financial theory suggests (which most people can appreciate - just look at the huge 8.3% decline in China today).
• Bubbles are apt to happen: due to the long term correlation in pricing with his models as well as empirical evidence that trends occur in stocks, bubbles are not only possible but likely from time to time.
• Value metrics are useless: the only appropriate way of determining stock prices is based on estimating what someone will pay for it later, regardless of what is underlying the asset. Thus all value metrics (P/E, etc.) have no ability to assist with investment decisions.
• Market timing is of high importance. Because of the correlation of returns, you need to be able to follow the trends in order to capitalize on them.

Mandelbrot’s views are a fresh take on financial markets from a mathematical perspective, one that has little vested interest in actual investment outcomes. His theories are self-admittedly early in their development, and many young researchers have begun to expand on his basics to more accurately refine the models and re-develop financial theories regarding risk and portfolio construction using them.

It is important to note that fractals are not the only advanced mathematical theory out there that’s looking to supplant the incumbent theories. Chaos theory and nonlinear filtering are two other types of mathematics that look to explain price movements and take advantage of the current use of traditional pricing methods in the markets.

I don’t agree with all his conclusions, because I don’t think his models completely encapsulate investor behaviour, but they are definitely better than the current status quo. I highly recommend that you pick up his book and read it. It provides great insight into what may very well be the future of portfolio management theory and application.

In the past 8 years I’ve used four different brokerages - both for professional and personal purposes. As a result I’ve learned a bit about the what the industry has to offer, but by no means have comprehensive knowledge on how all the brokerages work. I am going to start reviewing about the brokerages I’ve used. I’ll start off with CIBC Investor’s Edge.

I started using CIBC in late 2006 after I received my buyout for my wife’s and my RRSP plans. I was attracted to their offering due to their low cost (free if you meet their account minimum) self-directed accounts, and the fact that it was easy to transfer money into the accounts from our PC Financial bank accounts.

The Investor’s Edge website is fairly functional. Trading is intuitive, although I don’t like how many steps you have to take to get real-time quotes. Like most browser-based trading systems, you must hit refresh to get updated quotes, which is a real pain after you’ve used push-based systems that update when a trade is made or a new bid/ask offer is placed. An auto-refresh feature that can be set to 1-60 seconds would be helpful.

In terms of trading fees, the costs are in line with that other big bank brokerages charge, which means they are relatively high. I’m not planning on doing a lot of trading in my RRSP accounts due to the long term buy & hold strategy I have, so for me trading costs don’t have to be the lowest available.

A big feature of the self-directed accounts is that you get access to some good S&P stock research (mostly for US equities), as well as all of CIBC’s analyst coverage. I’ve found this to be an excellent resource, as I can now get more professional opinion at the touch of a button. I use this in conjunction with what I have available through my TD Waterhouse business trading account to get a more complete picture on stocks I’m analyzing or to identify macro trends.

I have enjoyed CIBC’s customer service as well. I have called them repeatedly over the past few months and have had to wait no more than 2 minutes to get a real person on the phone. In most cases I have had immediate contact with a person, which is a very nice feature. Their staff has been relatively knowledgeable and friendly.

I did have one issue with them recently regarding my Home Buyers Plan withdrawal. I had faxed in my withdrawal application last month and wanted to ensure I would have adequate time to get my funds to our bank. I called back a week later to see how things were progressing and I was under the impression that everything was fine. When nothing had moved another 10 days later, I started to get worried. It turns out that the fax had never been received. Needless to say I was a little miffed, especially since my house closed in 7 days (6 now). When I explained this in a cover letter for my fax, CIBC promptly transferred the funds. While I was frustrated with their error, I appreciated their quick reaction to the situation.

Overall I have enjoyed CIBC’s service and plan on continuing to use them for my RRSP plan.

I just finished watching The Pursuit of Happyness, the story based on Chris Gardner’s life. I was putting off seeing it because I wanted to read the book first, but it’s about four titles down on my bookcase so I probably won’t get around to it for another month or two.

The movie is highly enjoyable, and the message is a positive one about perseverance and belief in oneself. The movie also had some strong messages about personal finance, which had nothing to do with the fact that Gardner was pursuing a career as a stockbroker.

The first message was about investing in an asset for future return. Gardner risked his (and his son’s) entire future on taking a non-paying internship for the prospect (but not a guarantee, in fact only a 5% chance) on a well paying job in the future. Gardner believed in his asset’s fundamentals and saw value, and thus staked everything he had. He essentially made an educated, but risky, value bet.

Lesson: be willing to take chances when you believe you’re right. This is similar to what some retire early champions have done, as one in particular (I can’t remember their name right now) risked his entire portfolio on one stock whom he believed was seriously undervalued.

The second message was about the limits of frugality. When Gardner fell on hard times, he had to skimp on everything (including running away from paying a cab fare). However, when he was rewarded for small successes, he indulged him and his son with a bit of relative luxury.

Lesson: despite having a frugal lifestyle where you’re sacrificing for the future, pay yourself a little bit now. I found this message to be particularly important, since I have stated here and on other blogs that I think it is essential to live for now and the future in balance, not too much in either extreme.

I will be discussing this second message in more detail on Monday, as I describe my personal philosophy on what to do with extra income. In the meantime, if you haven’t seen the movie, go rent it!

I’ve listened to a few episodes of Vanguard’s Plain Talk on Investing. It is a bi-weekly show that covers basic topics for investing and retirement. The shows last 10 – 15 minutes, and usually have a host who interviews an expert from Vanguard or another firm on a particular topic.

I have found the podcasts to be concise and informative, although they are geared towards relative novices. A lot of the advice is specfically for American investors, so while the general principles transfer over, the tax and government program information is not useful for those who live outside of their borders.

For those of you looking to gain an understanding of the fundamentals regarding saving for retirement in a prudent manner, I would suggest you listen to:

• Why investment costs matter
• Achieving financial security fore retirement
• Bond funds: What you need to know
• Basic retirement withdrawal strategies
• The most important decision you can make (it’s about asset allocation)
• How much should I save for retirement

In the saving for retirement podcast, they suggest a minimum 10% saving rate. For the frugal savers out there, they will no doubt argue this is too low, but for many people I think this is a good starting point if they are used to spending 100% of their monthly net income.

Overall, I think it’s worth picking through the episodes to find topics that are of interest and relevance to you, but you don’t need to listen to every podcast.

First of all, I apologize for the lack of posts. I have been very busy recently and hope to write a bit more in the coming week.

I have been listening to the ValueLine Obersver by the Value Guys. They are Wall Street analysts with 25 years experience each. Each week on Friday they release a new podcast which reviews various stocks that are found in the Value Line Investment Survey.

The duo use a combination of fundamental analysis, growth prospects and valuation methodology to review stocks that they are interested in from the newsletter. They typically discuss valuation from a multiples perspective, using EBITDA and free cash flow more often than earnings.

Their podcast is definitely not the most exciting podcast on the block to listen to (don’t expect any Mad Money-style sound effects here), and you have to adjust to their extremely dry humor. Nonetheless, these podcasters provdie you with some expert opinons for free and their analysis is relatively insightful. You won’t get too excited by their stock picks either, but if you’re into value investing then that shouldn’t matter.

With shows running around 30 minutes, I think the Value Line Observer is worth listening to if you have some spare time, although I wouldn’t call it a ‘must listen podcast’. Check one out for yourself next time you’re on your way to work.

After a great few days in Miami, I am now back to my (snowy) home. It was interesting to see the concentration of wealth in Miami’s downtown, and all the development that’s going on (I counted over 20 40-story condominium projects going up). While there may be solid investment opportunities there, Miami seems to be the place to go to spend your wealth, not accumulate it.

A lot of the Canadian finance bloggers have posted several solid book reviews in the past few months. Instead of me treading on their already solid content, I’ve decided to start listening to some podcasts and review their quality (I still may review some of the books I have half-finished once I get around to finishing them).

Now that I’ve received my new phone (which I absolutely love), I am starting to listen to investment podcasts when I have time and duties that I can multitask. I started off with David Bach’s FinishRich minute. For those of you who don’t know David, he’s the author of such novels as the Automatic Millionaire and Start Late, Finish Rich. He has Canadian versions of his books for Canuck-specific information. His full bookology is available here.

It’s a daily podcast that quickly covers personal fianance topics, from real estate investing to stock selection. I’ve listened to about half a dozen of these podcasts, and while the general advice is decent, there is little substance (which I guess is to be expected for a 60 second promo). The biggest issue I have with the FinishRich Minute is that 20 seconds or so is advertising for himself and/or sponsors, leaving even less time for any real value. I find that the one-paragraph messages themselves do not provide enough useful information to be worth the time it takes to download them.

While I find the topics David covers interesting, the brevity of his messages is unappealing to me. Nonetheless, if you want to check out David’s podcast for yourself, you can subscribe to it via iTunes or at his FinishRich site.