Cogitator

Vigorish.wordpress.com

In Arbitrage, Benjamin Graham, Security Analysis on November 25, 2008 at 2:20 am

Vigorish.wordpress.com is a private forum detailing arbitrage and hedging opportunities in equities, bonds, derivatives and convertible securities. I am not certain of how to proceed with the blog; however due both to technical matters and my desire to keep opportunities “close to the vest,” I do want to limit the audience to 35 individuals. Candidates will be selected based on the quality of their ideas (submitted to me via email).

oswaldshot

Wild Card: Well forget about EMH, would you agree a lot more riskless opportunities exist now than say…back in 2006?
How highly efficient can this market really be right now?

Deep Throat: Riskless is very relative. The tricky part of a market like the one we have is figuring out which deals are fairly priced. Ok, that’s the tricky part of every market. But my point is that you might be more easily become overly excited in a market like this than in a much calmer market, when perhaps people with the tiny amount of capital that we have are more likely to blow their wad on stuff that’s not worth it.

In other words, look at those people on google finance who invested in Freddie and Fannie, thinking it was a riskless opportunities. Obviously, we’re not that dumb… but it’s all relative.

Cogitator: No, [REDACTED]. As I understand the English language, riskless means “without risk.” And the [REDACTED] arbitrage truly is without risk; you short sell 3.3682 shares per [REDACTED], and exercising the [REDACTED] gives you 3.3682 shares back. It’s like selling 10 apples at $1 each and getting those identical apples back for a price of only $0.93. It yielded a riskless 7% return today.

How could an investment in Fannie Mac riskless? Any directional bet is by its terms riskier than an arbitrage. Granted, the Volkswagen/Porsche incident demonstrates the risk of this technique, but that is a peculiar case. If you buy and short sell economically equivalent securities (of the same issuer) at a substantial spread (say, 30% or more), the risks should be nil.

The market is efficient most of the time for virtually all participants. However, Ackman makes a very good point: not everyone has permanent capital (capital not subject to redemption). A great deal of Buffett’s success is due to having steady access to capital at times when the rest of the world does not.

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Pershing Square Q3 2008 Investor Letter

In Bill Ackman, Insurance, Security Analysis on November 15, 2008 at 11:44 pm

These are extraordinary times particularly for active participants in the capital markets.  While I do not normally choose to write about macro and regulatory events, I thought it would be useful for you to understand how we think about recent events and their impact on our portfolio.

We are currently witnessing the greatest deleveraging event in history.  What began as a credit bubble bursting has now spread to the equity markets as banks, investment banks, hedge funds, structured products, mutual funds, pension funds, endowments and other leveraged and unleveraged market participants have been forced to liquidate assets by their counterparties, leverage providers, redeeming clients, and as a result of downgrades, other debts or other commitments that need to be funded.

These actions have led to forced and indiscriminate selling in security markets around the world, which in turn has caused other investors to panic or simply to sell, to get out of the way of other forced sellers.

As a fund which is generally substantially more long than short, we have also suffered large mark-to-market declines in our long investments.  Year to date, however, our performance has substantially exceeded that of the broader equity markets, which at this writing have seen a more than 34% decline.  Our outperformance is largely due to large gains on our investments in Longs Drugs and Wachovia Corporation as well as profits on our credit default swap and other short exposures.  Our market losses have been further mitigated because we operate unleveraged and have substantial cash balances.  Currently, we have cash and near-cash (Longs Drugs and Wachovia/Wells Fargo long/short) equal to approximately 39% of our capital.

When, you might ask, will the selling end?  While I don’t proclaim to be a market prognosticator, I will make a few observations.  Unlike the deleveraging that takes place when banks and other financial institutions sell assets to meet regulatory requirements, which is typically a longer term process, the forced deleveraging that is now taking place in the equity markets is being implemented largely by the prime brokerage firms and margin account managers at broker dealers around the world.  Prime brokers are not known to be laggardly in their approach to liquidating an account that no longer meets margin requirements.  This is likely to be even more true in the current environment.  As such, it may be reasonable to conclude that the forced liquidation that is now taking place may not be a prolonged process.

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Target Corporation (TGT): Deep Value Case Study

In Bill Ackman, Security Analysis on October 31, 2008 at 12:37 am

Deep Throat: I don’t really like Target, which Derek said to look into. Retail’s gonna be hit the hardest during the recession, and I don’t know that Target enjoys the same economic or brand advantages Walmart has.

Cogitator: The problem with your reasoning is that (1) recessionary effects may already be accounted for in the stock price and (2) Walmart has no smart activist investor to push the price toward intrinsic value. I have explained the first point many times. A company is worth the sum of its cash flows from now until the end of the world discounted to the present—thus value neither declines in a recession nor increases in a boom. The public’s constant exposure to the news (with all of its poor reasoning) assures that they will never understand this simple principle. [REDACTED], your employment with [REDACTED] may put you in an even worse position.

Target was recently selling below its real estate value, let alone its earning power. It is essentially in the same situation as Sears Holdings, except that the earning power is more predictable.

Ultimately the problem with your comments is that they are all qualitative. It is surprising to hear this from someone with a quantitative bent. You can take it as an axiom that the most salient thoughts (as most qualitative thoughts are) tend to be factored into the stock price.

http://www.valueinvestingcongress.com/landing/p09/pershing/target.php

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