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(P&I) My Name Is Bond (James Bond)

May 25, 2014
Mt name is Bond, James Bond. Really?

My name is Bond, James Bond. Really?

Drama. For at least two generations, since the 50’s, pension funds have been trying to enhance their returns above what might be offered by high-grade corporate and government bonds.

Before the 50’s, there weren’t any pension funds, and actuaries generally calculated premiums for insurance policies of all sorts on the assumption that they would be able to obtain a 4% real return on premiums by investing in high-grade corporate and government bonds, and that was pretty much the extent of all their investments except for some real property or ownership interests in real businesses or companies.

That kind of investment doesn’t exist anymore and has seldom existed in the past; could we imagine a world in which our money readily returned 4% plus inflation without substantive risk to our capital?

That is, the “risk” is that we might not be able to get our money back, or get it back when we need it, which we describe as 100% Capital Safety and 100% Liquidity, and if we can’t beat inflation, then that’s just another way of losing our money.

And who would pay for it? Who will give us 4% plus inflation and 100% Capital Safety and 100% Liquidity for the use of our money of which there is a lot around?

S&P 500 Total Real Returns Dr. Who

Figure 1: S&P 500 Total Real Returns
Dr. No & The Seven Year Itch Since 1897

In the pursuit of that who, Dr. Who, so to speak, pension fund managers have sought to “extract” a long-term 8% average return from the capital markets, and they have systematically substituted “volatility risk” for “risk” because they don’t know how to extract an 8% average, and hopefully, a somewhat similar real return from the capital markets in which everybody is trying to do the same thing, if not more.

But they didn’t find Dr. Who. They found Dr. No and Dr. No found them, and the pensioners who depend on those funds for income have had cause to regret that discovery ever since, no less than the pensionees who have to pay for it all; please see Figure 1 on the left.

Nor are the markets to blame. Such complaints as there are, are from “greedy”, “gullible ” or “careless” investors, professionals or not, who prayed for more, but got less. However, when we look at that same market from the original point of view, the point of view of the “price of risk” – we want our capital to be safe, 100% capital safety – and we want our capital to be available to us when we might need it – 100% liquidity – and we want to obtain a hopeful but not necessarily guaranteed return above the rate of inflation – then that same market gives us what we want. Please see Exhibit 1 below.

Exhibit 1: S&P 500 Dr. No – Fundamentals – May 2014

S&P 500 Dr No - Fundamentals - May 2014

S&P 500 Dr No – Fundamentals – May 2014

(B)(N) S&P 500 Dr No - Risk Price Chart - May 2014

Figure 2: (B)(N) S&P 500 Dr No – Risk Price Chart – May 2014

(B)(N) S&P 500 Dr No (ALL) - Risk Price Chart - May 2014

Figure 3: (B)(N) S&P 500 Dr No (ALL) – Risk Price Chart – May

The chart on the left shows the performance of the S&P 500 since 2012, and the market was up $3.5 trillion last year for a gain of +27% and, despite all odds, is up a further $855 billion and +5% so far this year.

The Perpetual Bond™ did even better in that same market, and it was up +48% last year and a further +6% so far this year; please see Figure 3 and the market values for “Dr. No (B)” and Exhibit 1 above for further details, and click on the link (and again to make it larger if required) “(B)(N) S&P 500 Dr. No – Prices & Portfolio – May 2014” for all the details of what we held and when.

And even more importantly, what we didn’t.

The portfolio that pension fund managers have been looking for for fifty years is “Dr. No (ALL)” (please see Figure 3 where it is marked as the thick black line and hard to miss) and it is the “fair market value” of 50% of our money in the “Dr. No (B)” companies and 50% of our money in the “Dr. No (N)” companies, and it returned +10% in 2012, +18% in 2013 and +4% so far this year (plus dividends, of course); that might seem “volatile”, but the primary issue is not to obtain zero returns, or less, for which “Dr. No (ALL)” might need a general collapse of everything that we have and in which money has no value anyway, because it has no value, or the government is (somehow) willing to pay us 4% plus inflation for it.

What makes the “Dr. No (ALL)” portfolio unique is that it puts half our money into stocks that are trading above the price of risk (the (B)-portfolio) and half our money into stocks that are trading below the price of risk (the (N)-portfolio), and the percentage content can be varied depending on whether investors think that we’re in a “bull market” or a “bear market” or they’re doing the old “risk-on/risk-off” routine.

When such investors “take profits”, they need to put their money somewhere, and we can see from Figure 3 that in 2012 they sold companies in the (B)-portfolio and bought companies in the (N)-portfolio, and they did it twice and again in 2013 to a lesser extent, although they could also have bought cash as a money market fund, or also bought more of the (B)-companies even though those, generally, appear to be “high-priced” to “price players” and “profit takers” who are looking for “value”, or “bond players” who are looking for “safety”.

Dr. No (N) Darwin Award

Dr. No (N) Darwin Award

However, if they kept the companies that they bought in the (N)-portfolio, then they got the result “Dr. No (N)” which was down minus (-48%) last year and a further minus (-6%) so far this year; please see Figure 3 above and for further details, Exhibit 1. And those managers are also our nominees for this year’s Darwin Awards and we might hear a lot more about them later.

In contrast, the Perpetual Bond™ only buys and holds the stock of companies for which the ambient stock price appears to be above the price of risk, and, generally, we also need to protect or lock-in its prices with an attentive stop/loss policy because we have no idea what will drive the market on any day, but if after taking profits, the company is still trading above the price of risk, we will generally buy it back, and can even afford more of it. We never buy companies in (N) because those companies are “overvalued” regardless of their price, and they are  further burdened by investor uncertainty.

Please see our Post “(B)(N) The Small-Cap Guy” for another example of “The Separation Theorem” in the less richly endowed S&P TSX Completion Index.

For more applications of these concepts please see our Posts which rely on the Theory of the Firm developed by the author (Goetze 2006) which calibrates The Process to the units of the balance sheet and demonstrates the price of risk as the solution to a Nash Equilibrium between “risk-seeking” and “risk-averse” investors within the demonstrated societal norms of risk aversion and bargaining practice. And for more on The Process, please see our Posts The Food Chain and The Process End-Of-Process.

And for more information on real “risk management” and additional references to the theory and how to read the charts and tables, please see our Post, The RiskWerk Company Glossary; we’ve also profiled hundreds of companies in these Posts and the Search Box (upper right) might help you to find what you’re looking for.

And for more on what risk averse investing has done for us this year, please see our recent Posts on The S&P TSX “Hangdog” Market or The Wall Street Put or specialty markets such as The Dow Transports & Utilities or (B)(N) The Woods Are Burning, or for the real class actionLa Dolce Vita – Let’s Do Prada! and It’s For You, Dear on the smartphone business.

And for more stocks at high prices, The World’s Most Talked About Stocks or Earnings Don’t Matter – NASDAQ 100. And for more on what’s Working in AmericaBig OilShopping in America or Banking in America, to name just a few.

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond
Alpha-smart with 100% Capital Safety and 100% Liquidity
Guaranteed
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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