Archive for October, 2010

Charlie Munger The Psychology Of Human Misjudgment

October 21 2010 | 2:09 am PDT

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The Wisdom of Steinberg

October 20 2010 | 4:00 am PDT

I got to interview some very interesting people as an Editor for Trader Monthly.

Some, like Jeremy Siegel and Michael Steinhardt, were for background information. Others became the subject of the article such as the case in John Del Vecchio in Pain Spotting.

In this case of the article below, I spoke with Jono Steinberg about his new firm WisdomTree and how he put the deal together to launch the firm. Regardless of the topic, I had a chance to learn a lot from some of the best minds in the investment community.

Almost 2 years after to the day, I had a chance to interview his wife Maria Bartiromo for her book The 10 Laws of Enduring Success which I reviewed for The Huffington Post.

This article was originally published in the June/July 2008 issue of Trader Monthly. It was edited by Rich Blake.

The Wisdom of Steinberg

Aided by two industry legends, Jonathan Steinberg transformed an ailing publishing business into an ETF juggernaut

By Michael Martin

As the bear market of 2001 — 2002 wore on, hobbling his personal-finance publishing company, Jonathan “Jono” Steinberg found himself fascinated with the potential implications of a growing but at the time overlooked securities market: exchange — traded funds. Gazing across the financial spectrum, Steinberg sold approximately 8,000 mutual funds and 5,000 hedge funds. ETF’s by contrast numbered just 100.

What if, thought Steinberg — who had never run a money management company before, just a struggling magazine called Individual Investor — someone built a company that invested solely in ETFs?

Low-cost, alpha-generating portfolios swirling in his head, Steinberg set out to transition his company (also called Individual Investor), wallowing in pink-sheet peril. “At one time our stock was trading — I’m serious — at one cent per share,” he recalls.

With a mere $93,000 in market cap remaining, Steinberg began to create a new business. Tapping hedge fund legend Michael Steinhardt as the primary backer and noted Wharton finance department professor Jeremy Siegel as his senior adviser, Steinberg launched a firm called WisdomTree. His goal: to become the Fidelity of ETF’s. His niche: dividend-weighted funds, as opposed to cap-weighted.

“When Jonathan was making his presentation, I stopped him in the middle and told him ‘Okay, I believe, I want to be part of this,’ Siegel says.”

Now, with more than 40 ETF’s and some $4.5 billion in assets, New York-based WisdomTree is well on its way to becoming a major force in financial services, with widespread distribution among CFP’s and brokers. Interestingly, professional traders have embraced the WisdomTree ETFs, which are distinct baskets of stocks grouped an array of sectors, flavors and styles. This industry following stems from these ETF’s extraordinarily tight spreads (.01) and robust liquidity. The wider the spreads, as far as ETF players are concerned, the more difficult it is to get trades done, because market makers will won’t take on the sellers inventory without extracting a shave and a haircut. The tight spreads reflect WisdomTree’s dividend-weighted approach; companies that make up each basket are selected and weighted based on the premise that cash dividends, not stock price alone, provide the more heuristic measure.

Steinberg was able to land Steinhardt and Siegel only after he spent the better part of two years pitching his idea to would-be backers, most of whom passed. Those who wanted in advocated a 2/20 structure, which ran counter to Steinberg’s vision of a sophisticated asset allocation approach for the little guy: low-cost, long-term Alpha generation.

To say Steinberg wished to avoid the lure of beefy hedge fund fee structures is not to imply he wasn’t out to make money. But he was also out to make a market and to cut his own path, having lived largely in the shadow of both his celebrity wife CNBC’s Maria Bartiromo, and his father, Saul, the well-known corporate raider.

As a child, Steinberg was always immersed in the world of deals. “I can remember being 5 years old and listening to my dad on the phone,” he says.” I grew up with finance.”

After attending Wharton, Steinberg did a stint as an analyst at Bear Stearns before launching Individual Investor in 1999 as the country’s personal-finance wave crested. Around this time, he hit it off with Bartiromo, one of its columnists. But the magazine was toast after the tech-bubble burst, publishing its final issue in July 2001.

By then, though, Steinberg was already planning his ETF-fueled reconstitution; he had renamed his company Index Development Partners. What he needed was backers — and he needed them fast. His colleagues, such as research chief Luciana Siracusano, had not been paid in months.

“I was a few weeks away from complete financial failure,” Steinberg admits. “I would have had nothing left.”

He met Steinhardt through a mutual friend. Apart from some minor similarities they had both gone to Wharton; their last names begin with the same five letters — Steinberg was coming to Steinhardt like a bolt from the blue. The hedge fund legend was deep in retirement and focused on giving away his Wall Street fortune to charity. He wasn’t especially interested in angel investing.

“If I met 140 guys, Steinhardt was, like, 138 on the list,” Steinberg says. “Michael was entirely skeptical — I had a failed media company to my credit.”

“I was skeptical,” Steinhardt confirms. “But he had a passion that really impressed me. I thought, ‘Well, if his math is right, then “yes”, he has something here.'”

Running out of time, money and sanity, Steinberg needed a break, and he was about to get one: Steinhardt saw something in the dividend-weighted investment strategy for an ETF. But he wanted back tests, and he wanted someone of stature to vouch for the model. Someone like, say, Jeremy Siegel.

It was the spring of 2003. As fate would have it, Siegel had dividend-paying stocks on the brain. He’d just been in Waco Texas, with President Bush, advising him along with some other economists and financial figures, about a proposed dividend tax cut. Not long after that, sensing a sea change coming, Siegel began to do his own back tests on dividend-paying stocks. But he didn’t get far; the modeling was tedious and complicated.

But Steinberg had completed back tests, and when he met with Siegel at Wharton in mid-2003, it was an immediate fill. With Siegel on board, Steinberg went back to close the sale with Steinhardt.

Having flirted with extinction, Steinberg’s company was not licked yet. No one was aware of the intellectual property the company had stored up, though, or its ETF plan.

In November 2004, Steinberg persuaded Steinhart to buy stock then trading at around $0.03 share, at $0.16 per share; months later, Steinhardt bought more, for a total investment of $7 million. The company changed its name to WisdomTree in September 2005; Steinhart became chairman of the board.

Today, WisdomTree has about 40 staffers. Siegel is it senior investment strategy advisor. Also on board as senior advisor is Arthur Levitt, the former head of the SEC.

WisdomTrees assets have skyrocketed, growing from zilch in June 2006 to $4.5 billion today. The company recently launched an institutional separate account platform, for which the minimum buy-in is $25 million.

“It’s very exciting right now looking back,” Steinberg says. “I remember how tough it was, all the rejection.” It was an experience, he insists he wouldn’t trade for anything.


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Benoit Mandelbrot (1924- 2010)

October 18 2010 | 7:00 am PDT

I have read The Misbehavior of Markets: A Fractal View of Financial Turbulenceabout 100 times, so naturally I was sad to hear of his passing.

“Brokers often advise their clients to buy and hold. Focus on the average annual increases in stock prices, they say. Do not to “time the market,” seeking the golden moment to buy or sell. But this is wishful thinking. What matters is the particular, not the average. Some of the most successful investors are those who did, in fact, get the timing right. In the space of just two turbulent weeks in 1992, George Soros famously profited about $2 billion by betting against the British pound.

Now, very few of us are in that league, but we can in our modest weight take cognizance of concentration. Suppose big news has inflated the stock price by 40% in a week, more than twice its normal volatility. What are the odds that, anytime soon, get another 40% run will occur? Not impossible, of course, but certainly not large. A prudent investor would do as the Wall Street pros: Take a profit.”

Quote taken from The Misbehavior of Markets: A Fractal View of Financial Turbulence.

Benoit Mandelbrot died last week at the age of 85.

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Meaningful Reader Feedback

October 17 2010 | 11:46 pm PDT

I get a lot of nice emails from readers and I should probably post more of them. Here is one I got in the past week.

“I want to say I really enjoy your site and that it continues to be an intricate part of my education. My favorite are the podcasts and videos. I must have listened to the podcasts with Mr. Sperandeo, Mr. Ritholtz and Ms. Raschke and watched the videos with Mr. Dunn about a thousand times each.

This material, along with other sites and books ranging from trading to history to philosophy, led me to test trading theory for myself. After extensive work here, I decided to launch my own fund which is launching Jan 2011. Thank you again for your help. Go Yanks.”

Michael M. — MartinKronicle reader

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Managing Risk Is Managing Your Track Record

October 11 2010 | 4:00 am PDT

(click to enlarge)

The grain market has been literally and figuratively on fire these past 2 trading sessions. As I’m writing this, December Corn is up 45 cents – and this is after being up 30 cents on Friday. That’s 75 cents or almost $4,000 per contract.

(click to enlarge)

November Soybeans are up 47 now after being up 70 cents on Friday. That’s over $5,000 per contract.

How much of these gains are you willing to take?

Over the last few weeks I’ve written about managing portfolio heat and I created a tutorial video on trading gold.

When you are out marketing your track record, allocators will ask how you handled this period in time. Telling them “I just followed my rules” is too general and you won’t build any trust with this statement. You need to break it down for them.

Another answer is “I saw unanticipated gains that came to me as a gift in a matter of a few days. I felt this was an outlier event that didn’t show it’s head in my hypothetical backtesting. I took some gains and MOST IMPORTANTLY I cut the risk and the volatility to my portfolio.”

When the market is on one side of the trade, everyone will be heading for the door at the same time. But if you are just starting out (5 years or less of a track record) managing risk is as much about managing your track record than for someone such as Bill Dunn for example. He already has everyone’s trust. You don’t. You need to earn it. And to put that into perspective, it will take 10 to 15 years before anyone is going to know whether your trading results are random or based upon skill.

Look at it from another point of view: You had gigantic gains overnight. You waited for an X-day low to get out and watched the gains recede faster than your hairline? Explain that to a client. They are not going to care about your rules when you’ve let gains slip through your fingers.

In circumstance like these, you have to pick a spot where you’ll be emotionally and financially stable by offsetting some of the risk. Sell some contracts and move a stop up to protect the majority of the unrealized gains. You can get back in. Most of the guys who made kajillions during gold’s big move in 1979 were catching large chunks of the move. That means they were in and out of gold WHILE IT WAS TRENDING.

Ed Seykota used to say, “your stop is the point at which you are willing to transfer the risk to someone else.” What is that spot for you?

Make sure to join our email list on the home page and to Follow me on Twitter.

In order to get a feel for using options in turbulent times, listen to my interview with Larry Shover, author of Trading Options in Turbulent Markets.

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