Peter J. de Marigny
is Portfolio Manager of DITMo® Strategies, an Equity Hedge, Aggressive-Income Objective, Buy/Write Portfolio for an Aggressive-Income Objective used as an Enhanced Cash investment vehicle. Pj is also Head of Risk Alternative Strategies for Newport Beach, CA advisor Renovatio Asset Management.
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Jesse Marrus
Jesse Marrus is the Founder and CEO of StreetID, a financial career matchmaking, news and networking site. He has unique insight into the financial services job industry including career advice, employment trends, fund formations, layoffs and hiring developments.
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Rashida Fleet is involved with consulting and working with managers during the fund launch phase. Her work includes; interviewing managers, collecting information for the HedgeCo database and contributing to the HedgeCo News feed.
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Tim Seymour is co-founder and managing partner of Red Star Asset Management, as well as Chief Operating Officer of the $116 million Red Star Double Alpha Fund. » View Tim Seymour
Richard Heller Richard Heller is a partner at the New York City law firm of Thompson Hine LLP. His experience is in the formation of private offerings for hedge funds as well as the formation of registered broker-dealers and RIAs.
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Cameron Hight, CFA, is an investment industry veteran with experience from both buy and sell-side firms, including CIBC, DLJ, Lehman Brothers and Afton Capital. He is currently the Founder and President of Alpha Theory™, a Portfolio Management Platform designed to give fundamental money managers the ability to create their own repeatable discipline to organize the complex process of portfolio management.
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Early last week, real estate circles were sent abuzz by the release of the Standard and Poor’s/Case Schiller national home price index, which revealed that average home prices in the nation’s 20 largest markets experienced a 3% jump in valuations during the second quarter. It marked the first quarterly increase in 3 years for the index, leading some prognosticators to suggest that housing has indeed bottomed out. In fact, CNBC’s Jim Cramer has panned for some time now that housing is bottoming out. However, Cramerica & friends could not be more wrong. Despite this hurried optimism, a variety of factors suggest that the darkest days still loom ahead for the US housing sector.
1. First, we have that pesky figure called “unemployment.” According to the US Department of Labor, 247,000 people lost their jobs in July. While that figure may be beginning to taper down when compared to previous months, any realistic hope for positive job growth will likely wait until 2010, at best. Meanwhile, an extra 200,000 people gave up looking for jobs, most likely as a result of frustration and a lack of hope. While not an earth-shattering figure, bear in mind that millions of Americans, gainfully employed or otherwise, are still receiving mortgage statements in the mail every month. If the recession lingers on, we are likely to see more and more out-of-work homeowners falling behind on or simply walking away from their mortgages.
2. The federal housing credit is due to expire. First-time home buyers are currently eligible for up to $8,000 in credits from the federal government to use towards the purchase of a new home. However, the program ends abruptly on December 1. Roughly 1/3 of all new home purchasers currently take advantage of the credit; thus, when this government subsidy expires, the housing market may find itself in a pickle. Consumers might ride the wave of buyer momentum and continue to scoop up houses, or, more likely, a considerable pool of price-conscious home buyers will decide to delay or abandon entry into the housing market.
3. The effects of ARM resets have yet to be fully realized. As this schedule of adjustable rate mortgage resets illustrates, the US should still see a sizeable chunk of recently-originated ARM mortgages reset in the coming two years (Credit Suisse predicts the total amount could reach $1 trillion). As more and more homeowners see their mortgage payments reset from initial, artificially low teaser rates, the serious threat of foreclosure will remain. Ben Bernanke & Co. has pledged to do its best to keep interest rates low, which should help to mitigate the extent of upward rate resets. Nonetheless, the threat of foreclosure could grow considerably for millions of additional ARM holders as their monthly housing payments rise.
4. Housing inventory data is misleading. Estimates suggest that the US currently has a 6-8 month inventory of homes available for sale, which equates to how long it takes for the average home sitting on the market to sell. In actuality, that figure is much higher. Millions of Americans who in rosier times would sell their homes have taken them temporarily off the market, either continuing to live in them or renting them out. This has created a “shadow” surplus inventory, equating to a surplus backlog of condos and homes. When prices finally do begin to inch back upward, homeowners could very well look to unload their homes en masse, threatening to push prices further south.
5. Pending budget deficits are forcing local governments to raise taxes. As Californians have been made well aware of, the recent recession has forced state, county, and local governments to reign in on spending as tax revenues have evaporated. With continued government bailouts less likely, several states and municipalities are considering measures to recoup such losses, including raising taxes on everything from personal income to water usage and public transportation. This increase in taxation, in the wake of our worst economic struggle since the Great Depression, could easily push even more homeowners beyond their means and out of their homes.
6. Last, access to consumer credit has tightened considerably. Long gone are the days in which just about any John, Jane, or Alberto could lock in a mortgage with little or no down payment and attractive terms. In fact, even if interest rates mimic the artificially low rates encouraged by Alan Greenspan earlier in the decade, home buyers must still navigate a much less-forgiving lending environment. A majority of banks have both reigned in on lending practices and upped their underwriting standards. These efforts, done in an attempt to both deleverage and build up capital reserves, have been passed directly on to the consumer. As a result, home buyers are being forced to shell out larger down payments, undergo more stringent proof-of-income terms, and, in contrast to several years ago, convince the banks that they represent a healthy credit risk. Oh, how times have changed!
Although home prices have recently flirted with the notion of heading north, a multitude of risks still remain. Unemployment, the expiration of home buyer subsidies, ARM resets, a bloated housing inventory, a heightened tax environment, and tightened lending standards should place continued downward pressure on the housing market. While these trends admittedly will not affect all regions of the country equally, they cut to-the-core several of the major themes affecting municipalities across the US. While the recent upswing in prices represents a welcoming change for homeowners, such a price movement is unsustainable. Furthermore, the price weighted Case Schiller Index is disproportionately responsive to changes in prices amongst the most expensive homes in each market. Hence, it is an unreliable indicator of broad market changes in home prices. Lacking any fundamental changes in the consumer landscape, the media pundits and housing bulls will nonetheless pounce at any opportunity to grab the headlines with their ‘bold’ claims of a turnaround in the greater economy and housing. However, taking a quick look around the housing landscape, it’s safe to assume that we aren’t out of the woods quite yet.
Every day, and every minute somewhere on the Web, another statistic that hints at an economic recovery is reported, copied, translated, manipulated and reevaluated. It seems for every positive up tick in economic numbers, there is also a negative. We have been experiencing shaky times for the past 20 months. Every sector is not going to at once join together on an all-knowing graph somewhere and move together as one gradually-rising black arrow.
Stats are meant to give us market indication. “Experts” on the economy make sense of the stats by attaching other positive attributes to them without any solid proof. In social psychology, it is similar to how the halo effect works: If I see Bob Somebody helping an old lady cross a busy intersection, then I automatically believe Bob to be a good person; without having any solid proof. Helping the elderly in dangerous situations is good, I saw Bob do that, so Bob must be good. Similarly, the media tells us recessions are scary and bad, positive things do not happen in recessions; therefore a positive up tick in one sector must mean we are out of the bad recession and into the good recovery. Experts link good news with other good news without any solid proof.
Earlier this month, Newsweek ran a cover that pictured a big red balloon which read “The Recession is Over!” The cover and its related story caused a small uproar that resulted in criticism from President Obama. Although the cover story was meant primarily to sell magazines, the author did make a solid point: “… when economists proclaim a recession over, they’re celebrating a technicality: they mean economic output has stopped contracting.”[1] When the economy stops contracting, it does not simultaneously return to the rising rates we experienced in the years prior to this recession.
The reporting of numbers, percentages, graphs and ratios should only be taken for face value. We use them as indicators, as ways to gauge where we are and the possibilities of where we could be heading. Be aware that we are approaching a period that is sure to be overflowing with economists eager to be the first to accurately predict the recovery by accident. Statistics will punctuate every news story you ingest. A small increase over a quarter is no reason to speculate and sink loads of savings into any financial market. The recovery will come. As we work towards it, I encourage you to stick with the basics. Own stocks that make sense. Consider incorporating alternative investments such as real estate into your portfolio not only because of their soundness, but also because they work as a wonderful hedge against inflation. Pay off debt. Adapt to the times. And, most importantly, focus on those things in your life that you care about the most.
Whether you are looking to invest in commercial property or a new primary residence, the opportunities in the current real-estate downturn are nearly everywhere you look, even Detroit. The pressure to lock in low mortgage rates has many investors champing at the bit. Plus, the approaching December 1st deadline for obtaining the American Recovery and Reinvestment Act tax credit is pushing first-time home buyers off the fence and into the game. But, as investors return to the real-estate market and the inventory of existing homes shrinks, a race to capture the last of the low prices may soon inhibit investors from executing adequate risk management.
With all of the current real-estate investment opportunities, it is crucial to not become blinded by the seductive home prices and appealing tax incentives. Investors with all levels of experience can protect their investments by recognizing and preparing for risk. While some precautions may be required by your lender, such as homeowners insurance, many others are going to be your responsibility. There are three primary ways you can help to prepare yourself for the majority of risks that come bundled with real-estate investing.
First, examine the current market in which you are looking to purchase property. Assess what is available and for what price. Also, what is the current level of buyer interest in the area you are considering? These questions will help you get your bearings within the local market and also increase your negotiation power later on in the process. Only a few cities are investing heavily in improving their infrastructure, but this might help persuade your decision if there are finalized plans for improvements in your considered property’s vicinity. Remember, since real-estate is a long-term investment, it is important to consider the area’s future. With adequate research you can identify some signs that can help you make a wise investment decision.
Second, aim to understand the laws and regulations involved with your considered property. I am not suggesting you become an attorney to make a wise investment, but being well-versed in the legal documents that are involved will behoove you. No matter how seasoned of an investor you are, few things can help you better prepare for risk than understanding the rights and requirements of your property’s regulations.
Third, consider your payment options. When considering your funding options, consider how long you intend to keep the property. The days of no-documentation loans and 100-percent financing loans are behind us, for now. So, thankfully, the trickery exercised by lenders in the middle of the decade should no longer overwhelm you or persuade you into signing something you do not understand. However, it is still crucial to do your homework. Knowing which type of loan you are comfortable with and which is most affordable will help throughout the loan-approval process.
When treating real estate as a long-term investment, it proves to be one of the least-risky options. However, real-estate is still not immune to risk. By taking the precautions mentioned in this article and continuing to be proactive in minimizing risk after you acquire the property, you will allow your investment to work for you. More importantly, you will avoid the tense, nerve-racking roller-coaster ride that comes when you are sideswiped by costly risks you could have prepared for.
Too Old For Risk?
We have all heard the old rule of thumb that states 100 minus your age should be the percentage of your portfolio that is comprised of stocks. This is meant to serve as an attempt to keep your amount of individual stocks manageable. After the recent market meltdown, however, many experts are recommending that even that number may be too high … and major stock funds are adapting.
With the onslaught of baby boomers set to retire, fund managers at major firms have been aiming to develop a stable stock program for older investors. The idea is to keep baby boomers investing in stocks instead of in a safer alternative with lower returns, such as Treasury bills. The various funds have been trying to develop an investment vehicle that combines the stability of T bills with the higher returns offered, sometimes, by stocks.
Older investors are primarily interested in a steady stream of income. Therefore, mutual fund managers have been designing funds that will occasionally hold more bonds to ensure they protect their ability to keep providing an income even in down markets. For example, last year Deutsche Bank created a series of mutual funds aiming to turn volatile stocks into stable investments. Deutsche’s fund managers spent more than a year developing the mutual funds for retirees. However, in the midst of the market meltdown, the fund was forced to abandon all of its stocks for bonds. They were then buckled by poor market performance. Plus, because of a warranty they gave their investors in order to originally entice them, they were then unable to switch back to stocks and had to return their investors’ money.
If an idea is too good to be true, it usually is. A number of mutual funds are aiming to provide stable investments with high returns. Furthermore, they are looking to do so while not tying up the money for years. Alright, so maybe by applying gigantic up-front costs, these fund managers may be on to something. However, they are also attempting to provide investors with the perk of low costs, which renders the creation of such a fund outside of the fundamentals of investing.
While taking on high risk rarely equates to high returns, no risk never translates to high returns. Markets fluctuate and any fund that guarantees high returns all the time cannot survive. Eventually, down markets will affect the fund and the guarantor will be forced to pull the plug or significantly cut returns. Older investors may not have the same appetite for risk that they had in their 20s, but that does not make it any easier to create the world’s first no-risk, stable-income-producing mutual fund.
Come On Risk, I Can Take It
After the recent positive signs presented by stock and bond markets, herds of investors have been lining up to sink their money into what could be the beginning of a rebounding market. Fed up with national performance, many investors have started looking to foreign stock markets for an opportunity. Eager to recoup the massive losses experienced over the last 18 months, investors are anxious to have financial markets, either domestic or foreign, once again work for them. Investors are also impatiently waiting for the bottom of the market to rear its head in order to purchase assets at their lowest possible price. The two schools of behavior have investors opening their arms and welcoming more risk, even if their money has to perform overseas.
Risky emerging-market mutual funds have attracted eager investors in massive swarms. According to Morningstar Inc., investors have dumped $4.9 billion into emerging-markets mutual funds over the first five months of this year, after only pulling out $2.6 billion in all of 2008.[i] While some foreign markets have been on a significant rise as of late, pouring loads of money into any one type of investment still brings about significant risk for investors. Doing so takes investors’ concerns off of their long-term investment goals and they become caught up in chasing short-term performance.
Thanks to positive performance in the stock markets of developing countries, investors are becoming more optimistic about dedicating a larger part of their portfolio to emerging-markets funds. According to The Wall Street Journal:
Not only do investors have a greater appetite for risk these days, they’re also more optimistic about the economic outlook for some of these countries. In China, the world’s third-largest economy, the government’s massive stimulus is starting to take effect. While exports are still down, internal growth is gaining strength. Meanwhile, commodity prices have been on the rise, improving confidence in Brazil and Russia.[ii]
While emerging- markets funds have experienced an average of 33 percent returns, experts are predicting a bumpy ride ahead. Many financial experts are predicting that emerging-markets economies will grow at a faster rate than the U.S. for the next several years. But, the recent rally by investors in emerging-markets funds is not expected to continue for long, which will calm the spike. Therefore, investors should continue to keep a well-balanced portfolio and calm the urge to shift large portions of money into emerging-markets funds in an effort to quickly recoup last year’s losses.
[i] See http://online.wsj.com/article/SB10001424052970204005504574231710838821166.html
Market Watch, with the help of regulatory filings has released an article which indicates that Colony Capital is raising money for an upcoming IPO:
Colony Financial Inc. will be a real estate investment trust managed by a subsidiary of Colony Capital. The new REIT plans to mainly buy, originate and manage commercial mortgage loans and other commercial real estate-related debt investments such as commercial mortgage-backed securities, the company said.
Despite it’s impressive 18-year track record, Colony capital may be best known for its 2008 purchase of the Neverland Ranch from Michael Jackson. The property was bought by Michael Jackson for a total of $22.5 Million.
In reaction to Michael Jackson’s death & the future of the Neverland Ranch, MarketWatch quotes Thomas Barrack, founder of Colony Capital saying:
“We are deeply saddened by yesterday’s tragic news about Michael Jackson,” Barrack said in a statement on Colony’s Web site after Jackson passed away last week. “Over the last year, I have had the opportunity to know and work with this gentle and talented man. We were pleased to help support his return to public life through our acquisition of Neverland Ranch.”
“Neverland itself is now a mythical sanctuary to Michael and we are doing our best to accommodate the throngs of global press and fans arriving there to express their grief,” Barrack added.
