Friday, September 21, 2007

Berkeley's Haas School's Dubious Move Into "Socially Responsible" Investing

This Tuesday's Wall Street Journal contained an article detailing the University of California, Berkeley's Haas Business School's new program to teach its MBA students about asset management. This will be done via a new, "socially responsible: fund, the $250,000 of initial capital for which was donated by Charlie and Doris Michaels. Mr. Michaels is a Haas alumnus and currently president of Sierra Global Management, to be managed by Haas students.

From the interview with Kellie McElhaney, the faculty member who is director of the Center for Responsible Business at the Haas School, we learn that the intent of the program is to teach MBA and MFE (Masters of Financial Engineering) matriculants about investing.

Just on this information alone, I have grave concerns about the direction Haas is taking business education.

In January, I wrote this post, commenting on an article in the Wall Street Journal regarding the very theme of this new Haas program, "socially responsible investing." It wasn't very pretty. Not at all.

I will cite just three passages from the Journal piece by Jon Entine, a fellow at the American Enterprise Institute, which I also cited in the January post,

"The social investing community also suffers from the hubris that it can separate the good guys from the bad guys. The Times report mentioned that half of the children attending a high school in South Africa suffer from asthma and other respiratory disorders that the Gates Foundation is committed to eradicating. It noted that a nearby refinery that spews out pollutants is owned in part by a foundation-held company, BP. Outrages like this would not happen, the Times suggested, if only the foundation would use socially responsible rating services of firms like the Calvert Group in Bethesda, Md. So much for investigative reporting. Calvert not only invests in BP, it praises the company as an environmental leader. For the record, Calvert added Enron to its approved list in March 2001, just as its ethical house of cards was collapsing, and also owned HealthSouth, ImClone and other ethically-challenged firms.

The dark secret of "social investing" is that it is neither art nor science: It's image and impulse. It reflects perceptions, not performance. Years ago I did a report on the Body Shop, the U.K.-based cosmetic company whose founder, Anita Roddick, was hailed as the Mother Teresa of Capitalism. In the early 1990s, the Body Shop was the world's most popular "socially responsible" investment. It was touted for its natural products, charity, fair trading and integrity. I discovered that Ms. Roddick had stolen the name, concept, product line and even its brochures from the San Francisco-based Body Shop that started seven years before she opened her copycat version. Ms. Roddick fabricated her history; she gave almost no money to charity over the company's first 11 years, and has given meagerly since. The Body Shop's products were made mostly from water and cheap petrochemicals; it had a record of exploiting poor Third World producers; and its franchise system was riddled with mismanagement, which eventually resulted in the company paying more than $500 million to buy out dissidents and diffuse fraud suits. My report sent the company's stock down by more than $600 million -- causing great anguish to social investors -- and contributed to a 10-year tailspin that resulted in its being sold.

It should come as no surprise that a recent Wharton study calculated that funds that layer on ideological screens often perform worse than the general market by about 31 basis points a year, a huge discrepancy. Domini Social Equity Index, considered the gold standard of social index funds, rates a lackluster C- in Business Week's latest ratings. Calvert's Social Index Fund has lost 1.82% since its inception in 2000, ranking it in the bottom 15% of all funds. Now Bill and Melinda Gates are being asked to turn over investment for billions of dollars to these same social researchers?"

Well, at least the kids in the new Haas program don't have such a high hurdle to clear, in order to beat the average "socially responsible" fund's returns.

Seriously, though, Entine's piece suggests that the Haas program is, to be blunt, folly. The very credentialing process by which firms are judged to be "socially responsible" looks to be pure art, and easily fooled, at that.

So how are 10 MBA and MBE students going to outwit the fraudsters who, for a living, fool professional investors on this dimension?

Then there's the "MBE" matriculants.

As I contended in my recent video post, here, the 'financial engineering' degree represents yet another step in the continuing degradation of the MBA into a purely narrow, technical degree, now far removed from the certification of general business management knowledge and capability for which it used to stand.

As Wilbur Ross hilariously commented, cited in this post, from one of his appearances on CNBC this summer,

'When someone mentions two words, financial engineering, you know it's really an attempt to underprice risk.'

Great. Now we have burgeoning degree programs designed explicitly to teach new wunderkinds how to parse, conceal and pass along mis-priced risk.

Haven't we just learned what systemic folly this is in the past two and a half months?

However, perhaps the most chilling part of the Journal article, for me, was these two passages,

"Will this experience give students the skills they need to land jobs with funds that have a social-responsibility focus?

Absolutely. It will give them a competitive advantage over students with just course work on social responsibility or just investment experience. There have been a lot more SRI funds created in recent years, and I see an increasing number of job opportunities out there. What I have yet to see are the traditional investment houses posting jobs for professionals with SRI experience. But I hope I will be able to send more knowledgeable students into the traditional Wall Street firms where they can raise social-responsibility issues from inside the companies.

Does this take corporate social responsibility to a new level in academia?

It definitely will because we'll have data. It may be negative, positive or inconclusive, but there will be data. We in corporate social responsibility are still really in the throes of proving ourselves to other academicians, and the only way we can do that is through research and data."

Reading these two passages, I don't whether to laugh, or cry.

With Entine's piece as background, the 'spread' of this disease to major institutional portfolio managers is likely to depress already-mediocre average returns, for which fund owners pay good money.

To further state that this program will 'prove' anything to anyone is laughable.

Rather than take even $1MM, ten students, dubious criteria for "socially responsibility," and actually buy and/or sell short various equities, wouldn't it be more useful to task these students to rigorous, refereed papers of the sort financial academics write, to attempt to refute research hypotheses concerning "socially responsible" investing and the performance thereof?

With only $100,000 apiece, these students won't impress anyone in the industry with their performance. Believe me, I know. It takes about $25MM before anyone pays serious attention to an investment track record.

However, financial theory is routinely advanced through the use of rigorous theory development, implementation via backtesting, and analysis of the results. Each of ten students formulating different "socially responsibility"-related hypotheses, then testing them over long periods using market data would produce more, and more convincing results, in my opinion, than the Haas' new, tiny investment laboratory.

Thursday, September 20, 2007

Credit Markets: Is Evolution a One-Way Process?

A recent piece in ',' a feature on the back page of the Money & Investing section of the Wall Street Journal, touched on an interesting point.

The notional headline concerned whether investment banks/brokers may be bought by, or merge with, commercial banks. The contention is that banks have certain regulatory and accounting features which happen to allow them to weather the current sub-prime mortgage-sourced credit markets turmoil.

For instance, banks may borrow at the Fed's discount window for liquidity purposes, to avoid selling prime assets to raise cash. Brokers may not do this.

Banks may use their discretion in valuing questionable assets by placing them in an 'investment' account, thereby avoiding the need to mark them to current market value. Brokers must carry all of these types of assets at the best current market value they can deduce, regardless of the loss to the brokerage firm that such valuation may entail.

The column simply addressed the potential for mergers of banks and brokers. Perhaps brokers are merger fodder for commercial banks.

But a larger issue struck me in this piece. Maybe credit markets went too far in their evolution to total market pricing of credit and debt.

Commercial banks seem, after all, to have a few advantages that were unapparent in a consistently up-market.

Could it be that, rather than a uni-directional march toward market pricing and underwriting, credit markets are, in reality, about to swing between extremes? Moving from all-bank balance sheet valuation and warehousing, to heavily market-priced and securitized, and now back toward the original pole of bank-sourced and distributed credit instruments?

It's not something I've read anyone else hypothesizing. Even I just assumed that banks had pretty much become a mere origination platform for credit.

Now, with this latest credit market debacle, the first since really heavily asset securitization of mortgages and corporate loans have kicked in, we are learning that there are market conditions under which non-banks may not be viable for very long, if they originate and/or hold volatile fixed income assets.

It's an interesting phenomenon. Who would have guessed that there was life in the old commercial bank model, yet?

Back in my days at Chase Manhattan, our group's boss, Corporate Planning & Development SVP Gerry Weiss, attempted a number of efforts calculated to move Chase into some sort of arrangement with a US investment bank, in order to, as he put it, so to speak,

'get their management in charge of our assets, with the advantages of our regulatory structure.'

Therefore, it's ironic to me that something like this might happen. Sure, Sandy Weill agglomerated a bunch of different piece parts to form the now-unwieldy Citi bank. But Salomon and Smith Barney are now almost lost inside of it. And the bankers remained in power, as the investment banks they took over had been weakened by various events.

Now, it would be possible to see a Chase or BofA take Bear Stearns, for example.

An interesting development in the quest for a viable, efficient, profitable organizational structure with which to transact fixed income businesses.

Wednesday, September 19, 2007

GE's Immelt To Be Next (Democratic) President's Secretary of Commerce

Last week's Friday Wall Street Journal carried a page-one article extolling GE CEO Jeff Immelt's tackling of global warming with his firm's "ecoimagination" program. A program so important, it even has its own manager- Lorraine Bolsinger.

I won't go into details- you can find the article and read it. But suffice to say, Immelt's got a lot of unhappy power generation customers on his hands. Mostly coal-fired utilities and such.

Even within GE, many are angry at him for pushing to make ecological footprints of the company's businesses on a par with growth and profits.

Let me be just a wee bit cynical here, and suggest what is really going on.

Could Immelt be showcasing himself to be the next (Democratic) President's: Secretary of EPA, Commerce, or (gasp) Treasury?

Perhaps realizing he's already ruined GE in terms of long run growth prospects and lackluster under-performance during his current CEO tenure, he will go green. He can complain that "big business" just does not "get it."

Wouldn't a John Edwards or Hillary Clinton eat that up? Good cover, just like Bob Rubin was for Bill Clinton. A bona fide corporate chieftain joins the eco-camp and demands that business come to heel under the newly-green hobnail boot of the Federal government.

Thereby becoming highly useful cabinet material for a green Democratic President. Or even a moderate Republican.

By pretending to grapple with ecological issues at GE, involving customers, the EPA, talking about carbon caps and trading, etc., he actually benefits from failure to make much headway. He can cite his futile efforts as having given him depth and breadth of experience in the politics of corporate pollution and eco-business, while aspiring to go into 'public service,' where, thanks to his travails at GE, he will now realize the real source of power is to effect corporate eco-change.

Failing to nab the EPA job, which would be a power portfolio in a Democratic administration, Immelt could easily try for Commerce or Treasury, citing Carlos Gutierrez or John Snow as recent precedents.

With his tens of millions of dollars of cash compensation from GE, and much more in deferred compensation, Immelt is well-positioned to leave GE considerably wealthier, personally, than he has made his shareholders. No need for further headaches trying to lift GE out of the dumpster of long term, consistent total return under-performance. Just declare victory, or frustrating eco-defeat, and head off to Washington.

In the wake of Immelt's departure, GE will perhaps fall to a group of private equity firms, newly-emboldened by the Fed's newly-cheap funds, and be split up into its constituent parts. Which, as I have argued in prior posts involving GE, would be a natural and beneficial end to the company, as it is currently structured, in terms of shareholder returns.

Admittedly, it's a wild card scenario. But if something like this happens, you read it here first.

Monday, September 17, 2007

GM's Short-Term Surge

Saturday's Wall Street Journal carried the usual broadbrush coverage of the prior day's equity markets activities.

The headline of this edition's article, however, caught my eye. It read,

"GM Shares Surge 16% on the Week"

Do tell!

My equity portfolio, run according to my proprietary equity strategy, is up just shy of 20%, gross, as of the end of Friday. So GM's performance, while not quite up to my portfolio's, is indeed, well, eye-catching.
As this nearby Yahoo-sourced chart of GM's recent six-month price shows, it's been very choppy.

You would have had to hold GM for just the right period to gain this 16%. Sell to early, and you're out of luck. Buy too late, same thing.
For instance, this chart of the past year of GM's price performance is much less appealing. Over the past twelve months, the stock is up just a little over $2/ share, or less than 10%.

It's a lot like the market dynamics which I profiled in this recent post on the S&P's total ten-year performance tending to be concentrated in just 10 best days of the decade!
For reference, here are the same two GM charts, with the S&P500 Index added.

For the last six months, GM is significantly ahead of the index. Of course, much of this is a result of the past week's speculation on the outcome of the current labor contract negotiations between the firm and the UAW. Prior to that, GM's return had bounced down to 0%. Twice, since August first.

Over the past year, The S&P has outperformed GM for nearly the entire period. In the few days or weeks where GM was on top, it was briefly, and not by much.

Clearly, much of the play in GM's stock has to do with the UAW contract risk.

Hardly a company in which to make a long-term investment, is it?

Thus my continuing emphasis on consistently superior total return outperformance. Attempts to capture short-term, speculation-fueled returns like those of GM are fraught with excessive risk.

Greenspan's Non-Monetary Opinions

I was going to write this post in a few more days, but given all the hoopla surrounding Greenspan's weekend tour of the media, I think I'll post it today.

Let's face it, Alan Greenspan is an economist. He was a Fed chairman. He's a monetary guy.

Why do we care what he thinks about fiscal policy, more than any other economist who is not a sitting Fed member? Granted, Greenspan is a good economist. But we don't need him to tell us that the Republican Congresses of the past few years failed to restrain spending. And that President Bush might have used his veto more than he did.

I already knew this, Alan.

Frankly, who really cares what he thinks about Congress and the Fed?

And, further, why do I care what Greenspan thinks about Iraq? He happens to agree with Bush, and, therefore, with my own views. But I honestly do not care. He wasn't Secretary of Defense. He was Fed Chairman.

Do I look to Don Rumsfeld to remark on the Open Market Committee's actions? I do not.

Now there's even discussion that Greenspan botched the handling of LTCM. Greenspan is on the record as re-writing his reactions to that debacle. He was never as 'pre-emptive' in his own chairmanship as pundits now criticize Bernanke and his Fed for not being now, amidst a credit market turbulence.

Further, as Joe Kernen remarked pointedly this morning on CNBC, Paul Volcker never did what Greenspan is now doing- breaking silence with his retrospective, and forward-looking, views on the Fed, the economy, etc. Kernen noted Greenspan's response to Leslie Stahl, that he 'has to make a living,' as the reason why he's written the book he is now touting on the talk show circuit.

But, as Kernen further observed, Greenspan doesn't need the money. Both he and his wife, Andrea Mitchell, have done very well in private industry- he as an economics consultant, she as an on-air media personality.

I think Greenspan is doing the country, and himself, a great disservice with his book and outspoken second-guessing of current monetary policies. It seems to me to be a lot of hand-wringing and excitement over nothing.