Trading Strategies To Beat Traditional Asset Allocation – by Joseph Hogue, CFA
Article 12 of the 20 part series on SeekingAlpha.com
Jackass Investing “Poor-folio” Award issued to CME Group and its CEO Craig Donohue
The credibility of the U.S. futures industry is based on the trust bestowed on it by the clearing house system. The principal behind this is simple:
1) Brokerage firms are required to be member of a “clearing house.”
2) Those brokerage firms, called “clearing firms” are then able to accept customer money. As a requirement of being a clearing member firm this money is held in a specially segregated account (so that a failure of the clearing firm does not result in a loss of the customer segregated funds).
3) The clearing house in turn stands behind all customer transactions. So the customers are not entering into “principal” transactions with each firm, they are entering into transactions with the clearing house. Again, this is to protect each customer from the failure of any individual clearing firm.
In exchange for this protection the clearing house receives a part of every commission paid on every trade by every customer. But the failure of MF Global shows that this protection was always just an illusion and never really existed. Here’s why.
In the case of MF Global customer funds were illegally comingled with corporate funds, putting customer funds at risk. MF Global made a big bet on European sovereign debt and lost. (Of course if that bet were successful Jon Corzine and his minions would have racked up huge bonuses). Because customer funds were included in that bet, those funds were lost as well. It appears that as much as $630 million was comingled, and potentially lost, in this way. So this is where the clearinghouse system should prove its worth. After all, those customers trades were not made with MF Global, they were made with the clearing house.
But apparently that is not so. In a statement on Tuesday, November 1st, CME Group CEO Craig Donohue suggested that CME Group was not responsible for the lost customer money and that the customers themselves would ultimately be responsible for those losses. “Customers have the risk of other customer losses in the customer segregated pool and there’s always the risk as well that customer funds are not properly protected,” he said.
Huh!?
So that’s how the clearing system works. If there are profits to be had, they get distributed among the clearing house and its members. And if there are losses due to the fraudulent activity of one of those clearing members those losses are to be paid by the customers. Well, guess what, there will be no more customers if that’s really how the system works.
For Donohue to make that statement is completely inexcusable and breaks the bond of trust that has existed between the clearing house and its customers for 150 years. Unfortunately it appears that trust only existed if it produced the potential for profits. Donohue’s comment trades honesty, obligation and integrity for expediency, shortsightedness and a breach of trust and in doing so places a limit on the price of that trust. We now know it is not worth $630 million. When customers start to figure out that the protection money they’ve been paying has not protected them, they will find other venues on which to conduct their business. But maybe that’s how the system works.
Once Craig Donohue and CME Group realize that it will ultimately be far more costly for them to abandon their obligation than to save a few bucks today, they may be forced to “do the right thing.” In a world where doing the right thing is defined as doing what produces the most profit, maybe this will get the attention of Craig Donohue. If not, then the protection they have been offering is no better than that provided by your local gangster.
So due to their abandonment of the core principles of trust in the face of fraud at one of the member firms, I present a Jackass Investing “Poor-folio” Award to Craig Donohue and CME Group.
Article 11 of the 20 part series on SeekingAlpha.com
Article 10 of the 20 part series on SeekingAlpha.com
Halloween Horror! Jackass Investing “Poor-folio” Award to Jon Corzine, as he transforms MF Global from Powerhouse to Poorhouse
MF Global, the brokerage firm headed by ex-Goldman Sachs head honcho and ex-New Jersey Governor, Jon Corzine, filed for chapter 11 bankruptcy protection today. It took Mr. Corzine less than two years to transform MF Global from a futures brokerage powerhouse into a disgraceful poorhouse (read: http://cnnmon.ie/tYDuEi).
The story is both familiar and disturbing, and includes reckless gambling, incompetent credit rating agencies (again!) and unfortunate employees. It started shortly after Mr. Corzine’s appointment as MF Global’s CEO in early 2010 (following his unsuccessful bid for re-election as New Jersey’s Governor). In an interview with Dan Collins of Futures Magazine in December 2010 Mr. Corzine announced,
“I expect that we are on track to move from a broker to a broker/dealer, to an investment bank, and from being a significant participant in futures and options markets and commodities markets to being a full-fledged, quality player in all of the activities that we choose to be involved – including those that historically involve foreign exchange, equities, currencies, advisory and money management over time.” (read: http://bit.ly/sEE7Pk).
Unfortunately, in his attempt at turning Mf Global into a global investment bank on the scale of Goldman Sachs, Mr. Corzine personally steered MF Global into making a $6 billion bet on the sovereign debt of Portugal, Italy, Ireland, Belgium and Spain (every one of the “PIIGS” with the exception of Greece). The old adage, “bulls and bears make money, but pigs get slaughtered,” played out here precisely on cue. A slaughter is what occurred. But I would venture to guess that it affected Mr. Corzine’s reputation more than his pocketbook. I doubt he’s personally in the poorhouse as a result of his reckless gambling. The same can’t be said for many of the hardworking employees of MF Global, who had accumulated stock and stock options acquired through years of hard work (I personally know many of them).
But Mr. Corzine was not alone in bringing down MF Global and destroying the wealth of its investors. The credit rating agencies were also active participants. Less than three months ago Mr. Corzine orchestrated a $325 million bond offering for MF Global that received an investment-grade rating from the ‘big three’ agencies; Moody’s Investors Service, Standard & Poor’s, and Fitch’s. And while Moody’s and Fitch’s did downgrade the debt last week, Standard & Poor’s maintained its investment grade rating until after today’s bankruptcy filing. At least S&P understands the meaning of default! (Do people really pay for this ‘advice’?). For my view on the uselessness of credit ratings agencies and other ‘experts,’ read this complimentary link to my chapter “Myth #13: It’s Best to Follow Expert Advice“.
Taking unnecessary risks is the definition of “Jackass Investing.” The result of Jackass Investing is to turn a “portfolio” into a “Poor-folio.” Because of the precision with which Mr. Corzine followed the script of Jackass Investing that I lay out in my book, I am awarding him this Jackass Investing “Poor-folio” Award. Once again, I’d also award one to each of the credit ratings agencies if I hadn’t already done so. But it’s certainly impressive at how consistently incompetent they continue to be.
UPDATE 11/4/2011
Since I wrote the initial part of this post above, the situation at MF Global has gone from bad to worse. With the disclosure that customer segregated funds were misused, executives of the firm are now likely facing civil, and potentially criminal, charges. In my 30 years of trading I have never seen such a misuse of customer funds, which indicates panic among its top executives, as well as such a bungled process for transferring customer funds. A “Poor-folio” award is too good for these people.
Article 9 of the 20 part series on SeekingAlpha.com
Article 8 of the 20 part series on SeekingAlpha.com
Rewarding Failure: Jackass Investing “Poor-folio” award for Hewlett-Packard
Small business owners understand the need for hard work, integrity and perseverance. If they don’t, they don’t survive, let alone thrive. When I started my investment firm, Brandywine Asset Management, 30 years ago, there were no guarantees. I spent the vast majority of my waking hours researching trading strategies and the legal issues surrounding setting up and marketing a commodity fund, preparing marketing materials, establishing brokerage relationships… the list was almost endless. Fortunately, so was my energy at that time. But one ingredient that wasn’t endless was my bank account. When, after the first year, the business wasn’t yet paying the bills, I borrowed the money off my credit cards (Why and how I got the cards in the first place is another story). Fortunately credit card companies considered me a good credit risk and continued to extend credit as long as I paid their monthly bills on time. In time, with more than 100k owed to the card companies it became clear that I only had one way out, I had to make the business succeed. That was the only way to pay back the debt. (I know, another alternative would have been to renege on my commitment to the card companies, but I never considered that to be an option. I got myself into the situation. It wasn’t the card companies’ responsibility to get me out. It was mine alone).
Fortunately, with continued perseverance, I was able to grow the business and repay my debts. Brandywine thrived and became a highly successful managed futures trading firms. But believe me, I struggled to reach that outcome. I had many opportunities to fail along the way. Over the years I’ve come to recognize that millions of other small business owners can relate to this story. My story is their story.
But that’s not the story in “corporate” America. Unfortunately, corporate America rewards failure. How else can you explain the obscene severance packages doled out to failed executives by huge companies such as Home Depot, KB Homes, Merrill Lynch and most recently, Hewlett-Packard. Many of these companies’ CEOs damaged their companies financially or reputationally (or in the case of Merrill Lynch, actually took their companies to the brink of collapse), and then got paid tens of millions of dollars to go away. In the case of HP, Leo Apotheker mismanaged the company for just eleven months before the Board of Directors (incompetent boards is a topic for another post) showed him the door. But heh, while you’re on your way out, here’s $30 million as a reward for your failure. Huh!?
Apotheker was just the last in a string of HP executives who were rewarded for being fired (er, “resigned”). Just last year then-CEO Mark Hurd left after being accused of a variety of violations of HP’s Standards of Business Conduct, including “misuse of company assets” that was related to his “close personal relationship” with an HP contractor. An investigation uncovered that the contractor was paid yet there was a question about whether her services were actually provided (this behavior is illegal in all states except Nevada). Oops! And how did all this get past the HP Board of Directors the whole time? Oh right, Mr. Hurd was Chairman of the Board. Despite the damage his behavior caused HP, Mr. Hurd was paid $12 million to leave and was also entitled to an additional $53 million that he negotiated away in exchange for being able to take a leadership role at Larry Ellison’s Oracle.
Prior to Mr. Hurd there was Carly Fiorina, who received over $40 million in severance and stock grants for “resigning” in 2005. Look, I generally liked these CEOs (at least Hurd and Fiorina). They were dynamic and assertive. They should have been paid well. But they should have been paid well for the quality of their work and the value they brought to their shareholders, not for the quantity of the messes they left behind.
As a result…
Because of its continued legacy of rewarding failure in both the executive suite and boardroom, I am awarding HP the most recent Jackass Investing “Poor-folio” award.