gold

In an attempt to demystify the ‘sausage making on wall street’ and provide all investors with the tools to make money in any market, Gary Kaminsky takes readers of ‘Smarter Than the Street: Invest and Make Money in Any Market‘ through 216 pages of his 20 odd year career as a money manager at Neuberger Berman. As a member of Team K, Gary along with his father, brother and several other members routinely outperformed the market and grew their assets under management from approximately $2 billion to just under $13 billion. For example, between June of 2007 and June of 2008, the annualized return on the S&P 500 was 2.88% while equity returns for Team K during the same period were in excess of 11%.

Smarter Than the Street: Invest and Make Money in Any Market begins by outlining Gary’s thesis for a ‘lost generation’ of investors. The ‘lost generation’ are described as investors between the ages of 55 and 70 that have endured not one but two (dot com bubble in 2000 and credit crisis in 2008) crises in the last decade. Gary contends that the extreme volatility of the last decade and the suffering caused by the loss of capital has driven theses investors to exit the equity markets altogether. Building on the ‘lost generation’ thesis, readers are introduced to the impact of this secular shift away from equities, which is a decade of stagnating growth in the economy and the capital markets. While the book is certainly not short of evidence to support these arguments only time will tell whether reality unfolds as Gary envisions it.

Shunning passive investing and rebuking those money managers who are closet indexers, Gary spends the better part of Smarter Than the Street: Invest and Make Money in Any Market detailing the strategies, disciplines and kind of research undertaken at Team K to routinely outperform the markets. Tackling topics like how many stocks one should own, how long a stock should be held, developing a sell discipline to investment strategies that espouse the benefits of taking the other side of the trade (being contrarian) and the consequential changes each investor should be attuned to as it pertains to buy and sell decisions. While there is no lack of tips that beginner and intermediate investors can gain throughout the book, readers should not lose sight of the forest from the trees, which in this case would be recognizing that investing is hard work and that there is no substitute for research and due diligence.

Throughout Smarter Than the Street: Invest and Make Money in Any Market, Gary makes it a point to simplify his points via case studies and examples, making the book a brisk and interesting book to read. Recognizing that retail investors don’t have access to the tools and research of institutional money managers, readers (Americans and Canadians too with a little extrapolation) should find plenty of takeaways to improve not only their investing skills but also their information gathering and trend spotting abilities.

We realize that our review probably doesn’t do the book justice, so we went straight to it’s author and convinced him to do an interview to shed some more light on the book. We had a lot of fun conducting this interview and can attest to Gary being one of the nicest and kindest people we’ve ever spoken to.

Enjoy.

Note: This interview was conducted on November 29, 2010.

Biography: During the last two decades Gary Kaminsky, the former Managing Director, Neuberger Berman, has been one of the Street’s most successful money managers. From 1990 to 1992, he was an analyst at J.R.O. Associates, a New York hedge fund. In 1992 he joined Cowen & Company as a Portfolio Manager in the Private Banking Department and became a Partner in 1996. Assets co-advised by Kaminsky rose from $200 million to $1.3 billion between 1992 and 1999. Cowen & Company was sold to Societe Generale in July 1998. In May of 1999, Kaminsky and his team joined Neuberger Berman LLC. Under his management, ‘Team Kaminsky’ grew from approximately $2 billion under management into $13 billion at the time of his retirement in June 2008.

Gary is a frequent commentator on CNBC where he was an original guest host on CNBC’s signature morning program, “Squawk Box.” He is currently, along with David Faber, the co-host of “The Strategy Session” on CNBC, a daily half hour program that goes inside the minds of dealmakers.

Gary is also the author of the book ‘Smarter Than the Street: Invest and Make Money in Any Market‘.

Q: Can you tell me a little bit about what your responsibilities were at at Team K? I understand that you along with your father and brother and several other team members managed an All Cap Core Separately Managed Account (SMA) - can you elaborate on that?

A: I started out in the hedge fund world and my father was a banker. We teamed up at a predecessor firm Cowen & Company where we were co-managing a private bank. Our primary responsibility was dealing with very wealthy individuals and assisting them to reach their financial objectives, which for the most part was capital preservation and income.

Given these objectives of capital preservation and income, our mandate wasn’t to mimic a mutual fund to fit some sort of style (growth/value/small-cap/mid-cap/large-cap etc.) but primarily to search for certain types of securities from a bottom-up perspective. Our clients would come to us and say we’re not really interested in the performance of thee S&P 500 and we’re not really interested in the overall stock market. We want to grow our principle over time and at the same time we want to generate some income so that we can subsidize our lifestyle. So the All Cap Core strategy was born out of this requirement. Unlike a lot of institutional managers who develop or create a strategy/mandate and then create a portfolio to conform to that mandate/strategy, we chose to name our strategy/mandate the All Cap Core SMA to give us the option to purchase any security as long as we determined that it would meet the objectives of our clients.

Q: So essentially the All Cap Core strategy allowed you to go in any direction that you wanted – correct?

A: Correct. In the last ten years the institutional money management world has become so style box driven, naming our strategy the All Cap Core strategy was a formal way of saying that we could buy any market capitalization, regardless of whether it’s determined to be value or growth. It allowed us to be an institutional money manager, which is what we needed to do when we started to grow the business in 2000 through the institutional channels. But it.

Q: Do you just want to break down what exactly a separately managed account is and how that differs from a mutual fund.

A: To answer that, I’m going to dredge up some history from a few years ago. In the 1999-2001 period, there was a significant amount of criticism geared towards mutual funds for two reasons.

Firstly, we had the mutual fund timing scandals, where a lot of hedge funds were buying and selling mutual funds prior to the close of business, essentially gaming the system.

Secondly, as a result of the technology bubble bursting in 2000, many individuals that invested in mutual funds were literally shocked to find out in 2001 that they could be invested in a fund that was down 30% or 40 % and still had net realized capital gain taxes to pay. It was probably the biggest shock in my 20 some odd years career. When people recognized in 2001 that they could put money in a mutual fund, lose significant money and still have significant capital gains taxes to pay as a result, it was beyond shocking.

As a consequence, the separately managed account business started to grow industry wide because the industry realized that individuals wanted to invest in a managed product but they did not want to have an inherited tax basis.

So the primary difference between a mutual fund and a separately managed account, is that when an individual buys a separately managed account through a sponsor, that sponsor is going to give them the tax basis on the securities that they buy and sell.

While not applicable to Neuberger Berman, for most firms, the separately managed account product mimics the mutual fund in its entirety other than the tax basis.

Q: So the separately managed account product sounds like a better alternative to a mutual fund, why would people even consider a a mutual fund given this alternative?

A: Well, there’s two reasons.

Number one, not all asset managers offered it. For example, one of the most sought after mutual funds at the time, the Legg Mason Value Trust run by Bill Miller, never offered a separately managed alternative. Neither did many of Fidelity’s sector funds. The fact is that it’s more cumbersome and expensive for an asset manager to offer a separately managed product - as there’s more record keeping, higher expenses associated with trading etc. etc. So there’s a lot of good mutual fund companies that don’t even offer the option.

Number two, there is also this idea of daily pricing in a mutual fund. For example, even when the volatility was absolutely crazy in September and October of 2008, an investor could be fairly certain that if they wanted to sell shares of a mutual fund that they could redeem their shares whenever they wanted at the price reflected at the market close.

In a separately managed account, while you could have instantaneous execution, there could arise situations where a significant amount of shares need to be sold and they can’t be sold by the money manager for the next day given the lack of liquidity or other reasons and the investor might not get next day pricing.

For example, if a separately managed account portfolio were faced with a lot of redemption requests and in that portfolio was a company with a billion dollar market-capitalization. There were periods in 2008 where the money manager may make a determination that they don’t want to sell a significant portion of that security because there was very little liquidity. The responsibility then falls upon the SMA sponsor, it may be UBS, it may be Schwab or whoever, to determine if they want to force the sale. The result being that a portfolio could have dramatic changes in valuation from one day to the next because of the liquidity concerns, which in a mutual fund, because they usually own so many more stocks in smaller sizes, is highly unlikely to happen.

I’m just giving you both sides of the extreme.

Q: Thank you for clearing that up. Turning our attention to something a bit more interesting - what are your thoughts are on the market right now and how do you see them?

A: I have been very very surprised in the last week or so that as the European situation has deteriorated, the U.S. equity markets has not felt more of an impact as we did in April or May of this year. I don’t want to get too technical but if you look at what’s happening with bond spreads in Europe, the price to ensure sovereign credits exceeds that of even the worst periods in the financial crisis. Yields on 10 Year Portugal bonds are 7.5%. So I’m very surprised at the lack of impact of the European situation on U.S. equity markets.

Having said that, I believe that since labor day weekend, the major driving factor of the equity markets in the United States in the last 90 days, has been this idea that you can’t fight the Fed, which is the most overused clichés there is.

The equity markets have been unbelievably resilient and it’s been an incredibly difficult market to make any money on the short side. Any hedge that you basically put in place for the last 90 days including buying VIX volatility insurance has not worked. It’s more or less been a one directional move primarily driven by this idea that printing money to buy assets will create asset inflation. So most sophisticated money managers and hedge fund managers who have tried to use historical bias to position their portfolios to create a risk averse portfolio have been completely burned.

So if we end the next 30 days at where we are today, I think the relative underperformance of money managers versus their benchmarks, which is something I pay a lot of attention to, will probably be the largest amount we’ve seen since they measured it in the last two decades.

Q: Going back to your explanation of what’s been driving the equity market and this premise of ‘not fighting the Fed,’ bears a striking similarity to the comments of hedge fund manager of David Tepper of Appaloosa Management when he was on CNBC on September 24, 2010. Given his incredible track record, his comments likely struck a chord with a number of investors and to Mr. Tepper’s credit, the market action has played out pretty much exactly as he called it. However, at some point, people must recognize that the Federal Reserve pumping money into the economy cannot be sustainable and it has to end somewhere so when does that happen and what will be the result?

A: I think there’s three scenarios at which point the Tepper melt up starts to fade away. In no particular those situations are as follows:

1. In an attempt to raise asset prices, inflation gets out of control. I was on NBC’s Today Show [Appeareance Video] a couple of weeks ago in conjunction with ‘Smarter Than the Street‘ and I did some research at the rising food costs at the wholesale level.

Whether it’s canned tuna (price up 25% in last year), eggs (up 30%) coffee (up 12%) or hot dogs (up 20%) at the wholesale level, what’s happening is that in an effort to protect their profit margins, manufacturers, especially in the food space, are passing down their costs. As a result, these costs are then passed on to consumers at the retail level.

If you go back and look at the 1970’s, at some point the Federal Reserve, in an attempt to raise asset prices, will lose control of inflation and that will completely blow up the Tepper melt up theory.

2. I think you always have to try to figure out what’s being priced to the market. I think what’s priced into the market right now is that the Federal Reserve can go through the end of Q1/11 without discussing an exit strategy but I think that if they’re not talking about unwinding a lot of these repos by April 1st, 2011, I think that game is over.

3. Right now, I think the median growth consensus for the GDP of the United States is probably around 2.5% for 2011. So if GDP figures meaningfully start to trend below expectations, then this idea of printing money to inflate asset prices gets thrown out.

Q: If asset inflation is what one is concerned about then the opposite side of that trade would be gold, correct? Should the price appreciation in gold begin accelerating, would it be fair to theorize that equity markets have ended or are close to ending their upward trajectory?

A: I don’t know. I think that the normal correlations between the U.S. Dollar, equity prices, gold and inflation have broken down and I think that is a result of the fact that gold has repositioned itself in portfolios as a safe harbor anchor.

I think the situation with gold is similar to the situation with technology stocks in 2000, where it didn’t matter whether or not you thought you were paying ridiculous multiples for technology stocks, you felt that you had to own it just to participate, i.e. for relative performance. I think the same thing is true with gold now.

If anecdotal evidence counts for anything, in the last 6 months I have not come across an asset manager who has the flexibility to own anything, that doesn’t have at least a 10% position in gold.

Many of the guys on CNBC’s Fast Money have pointed out that this has been the most over-crowded trade (i.e. long gold)) for the bulk of 2010, and it has but the ‘over-crowded’ aspect of it hasn’t made a difference yet.

Q: Daily obituaries are posted by the financial media and trading sentiment is extremely negative towards the greenback. It would appear that nearly everyone is bearish on the greenback. This is an environment not unlike the sentiment towards gold during the late 1990s and early 2000s, when very few people had the foresight to buy gold. Having asked a number of gold investors whether there is a chance that those same people or perhaps an entirely new group are accumulating U.S. Dollar at this moment, the answer I always receive is that there is no way for the U.S. dollar to go but down. Is there any chance or possibility that in the next few years we’ll see the value of the U.S. Dollar at significantly higher levels from today and price of gold at significantly lower levels?

A: Even the biggest gold bugs you talk to, people that have been involved in the gold market for decades like Jean-Marie Eveillard will tell you that the people who come on TV and forecast price targets of 1600 or 1550 have no idea of what the price of gold will be in the future. Nobody knows.

Q: In ‘Smarter Than the Street‘ you talk a lot about fundamental analysis from keeping an eye on social change to economic change but do you pay any attention to technical analysis? Did or do you use it at all?

A: I hope I do mention technical analysis in the chapter on having a sell discipline but at Team K at Neuberger Berman we never made decisions based on technical analysis. We were aware of the technicals because there may be a period where a stock breaks below its 200 day moving average but if you know what’s happening with the company, the technical action might actually be for an irrelevant reason and one could actually utilize that as a buying opportunity.

The traders at Team K would run reports for us and we were obvious and aware of what technical players were doing with the securities that we owned. However, securities were not bought or sold based on technical calls. We were very fortunate in that we were able to develop some of our own internal screens so that we could (and they still utilize it there today) successfully pull back and watch order flows to recognize when the black box quant selling would be over.

A stock that I mention in the book, which also happens to be one of my favorite stocks of all time, is a company called Expeditors International (EXPD:NASDAQ). If you go back and look at the long term chart on Expeditors you are going to notice a number of times where there was a lot of technical selling. However, based on fundamentals, every one of those opportunities would have been a great buying opportunity.

Q: Did you use a lot of screens to find stocks that you would then go out and research further?

A: I think screens were just one tool, not more valuable than anything else. We would get access to a lot of sell side screens and because we couldn’t possibly follow every single company that’s listed – we would for instance, look at a screen at the end of a quarter for companies with the highest distribution growth. Most of the results would be companies that we were already aware of but we might have missed a some things. We also did screens for companies with the largest asset dispositions. As I mentioned in the book about paying close attention to ‘changes’ within companies – we tried to keep a track of companies that were selling assets, buying assets, those that may have done significant debt financings or those that may have restructured their capital structure.

Q: Can you elaborate on the one decision and two decision stock concept a little bit more?

A: Basically when you buy a stock, you’re buying it because you believe it’s going to go up in price.

A two-decision stock is something that you’re buying because you think there’s going to be an event or some sort of change in the future that’s going to rerate the valuation of the company. When that change or event does occur and you determine the stock to be fairly valued, your intention would be to sell it. So not only do you have to get the timing and thesis right when buying that stock but you also have to get it right when selling, making it a two decision stock.

For example, if you had bought BP’s stock at $30 (BP:NYSE), back in March or April of this year when it looked like the company was going out of business, because you felt the selling was overdone and that the valuation was compelling at $30, that would have been your first decision.

Should you have determined that at $45 BP’s stock was fairly valued based on the information available at the time, your call to sell would have been your second decision.

That’s an example of a two decision stock.

A one-decision stock would be a company that can hopefully grow organically forever.

The demand for their service or product is sustainable and pervasive and they should be able to fund their growth strategy from internal cash flow. Once you’ve identified such a company, your only decision (hopefully) would be the decision to buy because you likely never have to think about selling such a company.

Q: You contend in the book that a retail investor can beat the market, so my question is, why are they bailing out of the market?

A: When it comes to equity market returns, retail investors have had a miserable decade. Ten years ago they were convinced that the only way to make money was to put money in an index fund and that active management should be shunned. Not only has putting your money in an index fund for a decade yielded very poor returns but in fact many of those investors that did go the route of index funds have actually lost money.

Let’s say an individual puts some money into the stock market at the beginning of the decade. He or she first endures the dot com crash and then has to live through the subsequent 5 years that are characterized by great volatility. Just as this individual’s portfolio is finally nearing the point where they are breaking even, they get hit by the credit crisis. What’s worse about the credit crisis, is that unlike the dot com bubble which was a valuation issue, the credit crisis caused retail investors to question the trust, honesty and the transparency of the capital markets.

Those investors that didn’t sell in March of 2009 and subsequently stayed in the market through all this massive volatility, were then subject to the ‘flash crash’ on May 6, 2010. The flash crash was an important milestone in that it reminded people who had forgotten what volatility was like.

I think many people who have lived through these massive standard deviation events have simply decided to exit the equity market, on a secular basis. They don’t care that equities may be the best form of asset allocation to keep up with inflation and to grow assets over time. They’re just not interested. I they’d rather re-think their financial future with a fixed-income portfolio with less volatility and more certainty.

Q: We’d like to propose something and get your thoughts on it: we believe that people in general have short memories. This is best demonstrated by way of a sports analogy. People love a champion athlete only as long as he keeps winning, as soon as he loses, their attention shifts to the person who beat the champion. However, if the ex-champion happens to become champion again, people will jump on his/her bandwagon again. Do you not think the same analogy can be applied to the equity markets. Yes, people might shun the markets right now but let’s say something causes the markets to begin accelerating again to the upside, do you not think that people will jump back in, if only to recoup some of their losses?

A: I agree partly with what you’re saying but based on my own channel checks, my own experiences out in the field, the one story that we, Jeff Krames and I, who helped me write ‘Smarter Than the Street‘, felt best epitomized the sentiment among most retail investors was the one relayed to me by the Raymond James broker in Florida.

[Editor’s Note: The story goes something like this: The first of 2 men, who lived in adjacent houses, decided to take his life savings and invest it in the stock market in 1999, figuring that the returns would allow him to retire around 2012. The second man, decided to take his life savings and buy a beautiful boat, so that he could take his family out every weekend for the next decade. Fast forward to 2009, both men got together as the markets had rebounded and compared results. The man who invested in the stock market was still working, had to push back his retirement and to top it all off, he had lost money, since the S&P 500 was about 10% lower than when he put his money into the stock market. The man who bought the boat had an entire decade to enjoy his boat with his family. Since both these men lived in a small community, almost everyone was aware of their differing experiences, making them far more hesitant to put money into the stock markets.]

It’s that type of field surveillance that I would offer up in response to your question and I would say that there are many, many people that are aged between 55 and 70 that have exited the equity market. Those individuals are not coming back. So if they’re aged 55 to 70, I think that they’ve made a determination that for their own financial planning, they don’t want to live through this volatility ever again. I would think, and sociologists would probably agree, that this segment of the population would have a significant influence on the next generation, right?

Now those people between the ages of 55 and 70 that have decided to stay out of the equity markets for their lifetime, have likely had a direct influence (in deterring them from equities) on their children and relatives over the last year, maybe two years. However, I do agree with you that younger individuals will be more willing to change their mindset if they start to see certain good things happen in the equity markets. They may say, ‘I understand why my father or my mother opted to not return to the equity markets but I’m 25 or I’m 30 and I still have a long earning cycle ahead of me, so I’m going to invest in stocks.’So I do agree with you in that aspect.

Q: In ‘Smarter Than the Street: Invest and Make Money in Any Market‘ you mentioned that you saw the subprime crisis coming, so what do you see in your crystal ball for the year?

A: I’ll give you my two predictions for 2011.

1. Driven by slower than anticipated economic growth and a secular shift away from equities (concern for return of capital as opposed to return), I think we will see yields on the 10 year and the 30 year government securities here in the U.S. actually make new historic lows before we get any sustained movement up. I’m in the camp that thinks we could get to a 2% on the 10 year and a 3.25% on the 30 year.

2. My biggest surprise for 2011 pertains to Goldman Sachs (GS:NYSE). After playing defense for much of 2010, Goldman Sachs, is going to re-emerge as the most powerful global investment bank of 2011. They have, for the most part, really been very quiet in 2010, as I said playing defense but I think you’ll see them in re-emerge aggressively as a dominant force in every aspect of the capital markets, equity syndication, debt syndication, M&A advisory etc. etc.

Thank You, Mr. Kaminsky!

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