Book Review: My Blue Haven (Tax avoidance)

Title: My Blue Haven
By: Alex Doulis

Book has a grim outlook for the next 30 years as boomers use health and pension that will be unfunded due to limited workers supporting the payments.
Gov't is fat and wasteful and will continue to find ways to tax more and more.

Vehicles are available out there to protect / insure against the "move" to more conservative policy as boomers age (largest voting demographic). The insurance policy via trusts/corprations in the "haven islands" without tax will cost approx 2-3k US/year to run.

Fix vs Variable Mortgage strategy

Pick your strategy for locking in
Depending on your financial situation and your aversion to risk, there are several ways to go


LAURA BOBAK - THE CANADIAN PRESS

It's more expensive than ever to buy a home in Canada as record house prices coincide with mortgage rates at five-year highs.

The average sale price in urban markets was $333,524 last month, a 10.2 per cent increase from a year ago and the highest yet recorded by the Canadian Real Estate Association.

Yesterday's data came as the banks jacked up their posted mortgage rates for the fourth time in less than a month, with the popular five-year closed mortgage at 7.44 per cent, up 0.85 percentage point from mid-May. The increases are blamed on higher yields on the bond market, where banks raise the money they lend for mortgages.

However, record prices and rising mortgage rates have not deterred Canadians from buying, as the realtors' association also reported a record volume of sales last month at 42,039 units, an 11.6 per cent increase from a year earlier.

Even with rising rates, the housing market is expected to remain strong, especially in the hot economies of Western Canada.

While long-term mortgage rates have been climbing, the prime lending rate, which defines variable-rate mortgages, has been at six per cent for more than a year - but looks likely to start rising as early as July 10, when the Bank of Canada makes its next rate-setting decision.

That means anybody with a variable-rate mortgage will face increased payments, renewing the question: should I lock in, and if so, when?

Homebuyers researching variable versus fixed rates should start with some introspection: how willing and able are you to assume some risk?

Moshe Milevsky, a finance professor at York University and executive director of the Individual Finance and Insurance Decisions Centre, divides homebuyers into four groups in a paper entitled Mortgage Financing: Should You Still Float?

- The first-time home purchaser, particularly buyers with small downpayments, are the most likely customer for the long-term fixed rate mortgage. "These folks should not be taking any chances with a fluctuating interest rate," Milevsky wrote, noting if the value of the house falls they could be left with "negative equity."

- For the "risk-averse worry wart," Milevsky recommends splitting your mortgage in two halves, with one set at a variable rate and the other locked in.

- The "seasoned veteran," with more equity built up in the home and two incomes, is in a better position to take a risk with a variable rate mortgage, Milevsky says.

- The "financially savvy arbitrageur" can shop around for the best rate with this strategy: get a pre-approved fixed-rate mortgage, guaranteed for up to four months. Then get a floating mortgage with the option to pre-pay the whole thing off without penalty. Follow the Bank of Canada and the bond market. If rates increase, move the mortgage to the bank that you gave the pre-approved rate.

"Otherwise, do nothing and start the process over in a few months," Milevsky wrote. "Understandably, the bank manager might get a bit weary of your constant requests for pre-approval."

Time to take out a little insurance

Time to take out a little insurance
Are you up to speed on securities protection?
Jonathan Chevreau, Financial PostPublished: Monday, June 04, 2007
With stock markets logging new record highs each passing day, advisors may be getting anxious queries from clients concerned about protecting their gains from a nasty stock-market correction.
A timely topic is investment insurance. Consider house insurance, where one pays small annual premiums to protect homes against fire or other disasters. Odds are that nothing will happen to the house but the homeowner doesn't begrudge the premiums that provided peace of mind.
Investment insurance works the same way: You have an equity portfolio for the upside and purchase put options on those securities to ensure the portfolio's value can't fall below a certain level.
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If the market keeps rising, you're happy and don't fret about the premiums spent to achieve peace of mind. If the market tanks, you're protected and relieved your advisor had the foresight to insure your portfolio.
Sadly, not all advisors are knowledgeable enough to do this for clients, or licensed to sell what's required to insure a portfolio. They would do well to read a new book on the topic published by securities lawyer and consultant Robert Goldin.
The first part of Insure Your Investments Against Losses (Bastian Books, Toronto, 2007) looks at techniques for insuring individual securities. It covers the gamut from call options and put options to collars, strangles and straddles. He also looks at strip bonds, futures, principal protected notes, index-linked GICs and other "guaranteed" investments.
Most of the techniques covered require a securities licence -- this book may well motivate those licensed only to sell mutual funds to broaden their focus. Goldin suggests clients looking for such protection dump advisors not qualified to sell options and find ones who are.
The meat of the book is the second half, which looks at how to insure whole portfolios. First it recaps Modern Portfolio Theory, which most advisors view as the foundation of their clients' portfolios. MPT covers such familiar ground as the efficient market, asset allocation, positively and negatively correlated asset classes and alternative investments such as hedge funds, income trusts and precious metals.
However, Goldin does not advocate holding a portfolio of different non-correlated asset classes, or the traditional MPT approach.
Rather than diversifying, he believes in "insurifying."
His term for this is Efficient Portfolio Theory or EPT. With EPT, portfolios consist almost entirely of equity indices, preferably through low-cost exchange-traded funds (ETFs).
By nearly, he means about 96% of the portfolio. The other 3% or 4% is used to buy put options on the indices most reflected in the chosen ETFs.
After assembling such portfolios, you simply insure your investments against losses and sleep soundly at night. "It's that simple," he writes.
For advisors already familiar with options, EPT is a surprisingly simple alternative to other less easily understood alternatives designed to hedge losses. In the book, Goldin says some investment insurance strategies can be performed by do-it-yourself investors while others may require financial advisors "until you feel comfortable implementing them yourself."
Variants of this strategy have been promoted elsewhere. Goldin started to explore the topic when he asked himself why major financial institutions always make money despite the vagaries of the market.
Indeed, finance professor Moshe Milevsky raised similar issues when Manulife Financial unveiled Income Plus. Milevsky said it was possible for investors to "bake their own solution" by combining puts and calls in a retirement collar.
Certified financial planner Fred Kirby, president of B.C.- based Dimensional Investment Planning Inc., is a believer in well-diversified low-cost portfolios of index funds or ETFs. But in a series of client reports on Protecting Your Portfolio, Kirby acknowledged the limitations of Modern Portfolio Theory once a bear market hits.
He found actively managed Canadian equity funds and dividend funds offered better protection than index funds in bear markets.
He also found international equity diversification "fell far short of providing complete safety." It "works when we don't want it to and doesn't when we do."
For clients convinced a market correction is at hand - perhaps because it's the consensus among market timers -- Kirby suggested several steps or half steps investors can take to reduce risks.
They could hedge their bets by selling half their equity positions in tax-deferred accounts and moving the proceeds to cash. Alternatively, they could sell half their registered equities to buy U.S. and Canadian dividend ETFs or mutual funds.
They could also hedge half their equity exposure using a similar approach to Goldin's, although Kirby's suggestions were issued before Goldin published his book.
Thus, for taxable accounts in bear markets, Kirby suggests hedging half a client's equity exposure with a long-term bearishly split strike option index strategy. This locks in a portfolio's value while deferring previously accumulated capital gains otherwise payable in a taxable account.
Kirby cites as an example the SPX mini index [XSP/CBOE], currently trading at 150. For every $30,000 of a U.S.-based S&P500 type of portfolio, investors wishing to hedge half its value simultaneously buy one put contract of XSP December 145 2008 and sell one call contract of XSP December 155 2008 for a net credit of $300 (3 times $100). With the index at 150, the value of each contract is $15,000, effectively protecting half the $30,000 portfolio.
Investors might also consider the new Horizon BetaPro S&P60 Bull and Bear Plus ETFs. The bull version moves in the same direction as the XIUs on the TSX but at double the rate.
Similarly, the bear version is the equivalent of selling the XIUs short, Kirby says, but again at double the rate. American equities can be covered by U.S versions of these funds trading on the Amex: ProShares Ultra S&P500 and UltraShort S&P500.
Kirby hedges only half the equity portion of portfolios because he assumes the first 10% of each move up or down is missed. "Sometimes, the timing of the hedge will be right and will be profitable; other times it will be wrong and there will be an opportunity cost.
But in the long run, it should break even. Its purpose is to decrease portfolio volatility and help keep its value."
jchevreau@nationalpost.com

Using life insurance to your (tax) advantage

It provides some benefits that may be attractive to people in the affluent income group.
Apr 29, 2007 04:30 AM Ellen Roseman

In last week's column, we talked about the way mortgage lenders push you to buy life insurance to cover your loan.
The lender's insurance, while convenient, offers less protection than what you would get with a life insurance policy sold separately.
Here are the main disadvantages of buying mortgage life insurance from a bank, trust company or credit union:
The lender owns the policy and is the beneficiary. With a policy you own personally, you own the policy and choose the beneficiary.
The lender's insurance is not portable. If you switch lenders, you may not be able to get insurance if you have a health problem. But if you own a guaranteed renewable policy, you will never have to provide medical evidence again.
The lender's insurance doesn't decrease in cost, but the coverage shrinks as your mortgage balance declines. With a policy you own personally, the coverage doesn't go down unless you reduce it.
Another problem (not mentioned last week) is post-claim underwriting. This means the insurance is sold to those who may be ineligible for benefits.
Only when someone dies is an assessment done. And the claim may be denied if the death is related to a prediagnosed medical condition.
When you own your life insurance policy, the coverage is underwritten at the time of application. It's almost impossible for the insurance company to get out of paying a death claim after the first couple of years.
So, what kind of life insurance should you buy?
Term insurance is the way to go when you're young. You can protect your spouse and children at a low cost because you're buying only insurance – with no savings or cash value.
It's a no-frills way to insure yourself for a specific period of time. And if you survive to the end of the period, the policy is worthless.
However, a term policy gets more expensive as you get older. You may find the cost prohibitive in your 70s or 80s, if you can get coverage at all.
"The probability of dying increases, so the insurance company must charge more to cover this risk," say financial professors Moshe Milevsky and Aron Gottesman in Insurance Logic: Risk Management Strategies for Canadians.
But why will you need life insurance once your mortgage is paid off and your kids are grown up? What's the point of having it if you have no dependents?
The answer is taxes. Life insurance provides some benefits that may be attractive to people in the higher income groups.
With a permanent (or non-term) policy, part of the premium goes toward pure insurance coverage. Another portion goes toward a savings component to fund future premiums.
This type of coverage also goes under the name of whole life, universal life or level life insurance. The premiums are higher than term premiums for the first part of your life, while term premiums exceed level premiums later on.
"Level, or permanent, insurance is a system whereby you overpay in the early years in order to subsidize the later years," the authors say.
"Since you're overpaying in the early years, the excess over the pure premiums is being invested in a side fund. In some cases, you can actually control where those excess premiums are invested.
"As you age, some of the savings will be depleted to make up for the fact that your annual level premiums are lower than what they should be."
Some people buy life insurance for estate planning. While Canada has no death taxes, your estate will be taxed on the appreciated value of everything you own at the time of death – such as securities and real estate (aside from a principal residence).
Faced with a large tax bill, your survivors may have to liquidate assets.
"In other words," say the authors, "the tax code can force you to sell the very asset that you are paying taxes to inherit. Ugh!"
Besides helping to pay the final tax bill, life insurance can provide tax benefits along the way.
The savings that build up inside a cash-value policy are sheltered from tax. You won't get a tax bill every year for interest, capital gains or dividends earned inside the policy, as you will when you invest in a bank deposit or mutual fund.
Suppose you can defer tax for 30 years. How much would that saving be worth? The authors give an example.
Imagine that you invest $10,000 at 5 per cent interest. If you pay tax each year on the gains at a 50 per cent marginal tax rate, you will have $20,975 at the end of 30 years.
But if the inside build-up is tax-free, you have $43,220 at the end of 30 years – a gain of $33,220. Once you pay a 50 per cent tax on the gain – since you can't escape tax forever – you're left with $26,610.
"Compare the numbers," they write. "You have $5,635 ($26,610 minus $20,975) more from the tax-free inside build-up than from the alternative product.
"This is about 50 per cent of your initial $10,000 investment. Now scale this up to $100,000, or even $500,000, and you get a sense of the magnitude of this benefit.
"You have paid taxes in both cases, so we are not comparing apples to oranges. In the first case, you paid tax continuously; in the second case, you paid it at the end."
You can use this strategy with a large variety of investment funds within a life insurance policy. That's why it's called universal life.
Sometimes, financial advisers urge clients to buy life insurance policies for their newborn children.
Why buy life insurance for children who have no dependents to protect?
Adult children may not contribute to a registered retirement savings plan until they're 30 years old, says Asher Tward, vice-president of estate planning at TriDelta Financial Partners in Toronto.
But they can have investments growing tax-free from birth if their parents buy them a universal life insurance policy.
The policy costs very little at an early age, he says. You'll be doing your kids a favour since they will never have to buy life insurance again – and they won't have to worry about being uninsurable if they develop a medical problem later in their lives.
Next week, we'll provide tips on buying a universal life policy.

Book Highlight: The Sleuth Investor

By: Avner Mandelman (2007)

Lots of foolish money in the market and it is not efficient.
It fails to take physical evidence that is public or that can be sleuthed.
Sleuthing a company is a function of 3 Ps
People (customer, suppliers, internal employees) (Humans)
All will have lots to say if you know how to talk to them
Products (function, who uses, why, etc)
Plant and periphery (location, production, environment)

The ideal company serves a 3 in one where the user (vetter), buyer (decision maker) and check writter is the same person. Ask the question is the customer worth it?

Market Index = mediocraty. Public info can uncover an edge but back it up with sleuthing.

Invest with information that is TRUE, Important, and Exclusive.

Stock selection/analysis should be investigations based
Use star Map to uncover relationship and see the whole picture

Profitable Stocks can fall into Cheapies (Buffet), Goodies (Munger - lasting franchises), Rockets (Momentum, Growth), and Tradies (special situations, speculations).
The First 2 types are most profitable.

Canadian Info Sources
www.Sedar.com
www.sedi.ca

Steady nerves are needed when the bullets start to fly

AVNER MANDELMAN Saturday, July 29, 2006
Five years ago, in August, 2001, Giraffe's monthly letter to clients tried to explain that good stock values often appear in times of war. I claim no prescience, and can no longer remember why I chose that topic. (This was three weeks before Sept. 11.) Maybe it was because our databases were picking so many tech values that the market was disregarding and no one but us was buying and so I felt besieged.
At any rate, I tried to be cute and titled the piece "Valuations in times of bombardment," (you can read that piece on Giraffe's website), then added a true-life example -- which I shall now shamelessly plagiarize before segueing into its relevance today. Here is that example, summarized.
In 1982, a war broke out between Israel, the PLO, some Lebanese militias, and various local drug lords (there's some redundancy here). In the midst of the fiercest bombardment, a scion of an old Lebanese merchant family (related to an economist I knew) decided to buy an office building on Rue Verdun, Beirut's main drag, because the war dropped local real estate valuations to next to nothing. (Worldwide, too, the financial markets were plunging.)
Friends of the guy tried to dissuade him, but to no avail. He plunked down 50 grand in U.S. cash and bought the building. (Even in the midst of war the registry office functioned -- the mark of a fundamentally civilized country.) The seller took the cash and departed to Paris, where he bought a one-room apartment, which over the next 10 to 15 years became $200,000 (U.S.). What of the buyer? He had to suffer through some years of turmoil and rebuilding, but within 20 years his property became worth several millions.
Which brings us to today -- Lebanon is again at war and the stock market is swooning. Does today's war also signify a market bottom? You may recall that Lord Rothschild famously said one should buy when war's cannons boom, and sell when victory's trumpets sound. Is it the same now? I claim no prescience. Instead, let's look at the record of Mideast wars as predictors of market bottoms, or at least abundance of values.
That region has been warlike for the past 5,000 years (as evidenced by weapons found in all layers at archaeological digs), but I suggest we stick to the last generation's wars.
The first Mideast war of modern times, 1967 (one in which I participated), saw the market rise for about a year afterwards, into 1968, before it plunged toward the 1970 bottom. (Curiously, in 1968 Warren Buffett closed his investment partnership, saying he could find nothing to buy.) The next war, 1973 (the Yom Kippur war), preceded a year of market decline before a bottom of sorts was reached in 1974. Then came eight years of sideways movement until August, 1982, when a war similar to the current one broke out in Lebanon -- as per the above example. That time, however, the market made a historic bottom almost concurrently, and did not look back, except for corrections and brief crashes (such as 1987). Then nine years later, in 1991, the first Gulf war took place, when President George Bush senior came to Kuwait's rescue. And again, that was precisely predictive just as the 1982 war was: Gulf 1 broke out on Jan. 17, 1991, and the market bottomed that very same month, with both stocks and bonds (especially junk bonds) taking off, tech stocks zooming, and fresh bull market geniuses born every day.
The next Mideast-related war (or at least warlike event) was Sept. 11, 2001, which Giraffe's letter so eerily preceded. The market plunged for one more week, vacillated, bottomed in October, then rose for six months before plunging again and bottoming a year later, in a complicated year-long bottoming process. There were perhaps a few more unsettling months leading to March, 2003, when the second Gulf war started -- and this was of course yet another historical market bottom that saw the market rise for the next few years.
So what can we say about war's predictive power today? Even those who invest on fundamentals may occasionally find themselves holding on to terrific values, which no one else wants for a while, before they receive their just rewards -- just like that Beirut resident of long ago. Will the bottom now be quick, 1982- and 2001-like? Or an extended one, like 1973-1974?
For all those who invest on fundamentals, this is almost an irrelevant question. You buy when you find a compelling value, and can purchase a dollar for 50 cents, and if it falls to 40 cents, you buy more and wait. But I cannot help but point out that Warren Buffett himself -- the same one who quit the market (for a while) in 1968 -- very recently made a $4-billion acquisition, in Israel, of all places. Therefore, in this case, we do not need to have an opinion, as Mr. Buffett's will suffice: He thinks one of most bombarded regions in the world is now a good place to invest in.
Will he prove as prescient as that Beirut merchant of long ago, in 1982? Time will tell. But it should also tell you that if you find a deep value, do not let present war conditions deter you. Wars come and wars go, but markets always remain.
Avner Mandelman is president and chief investment officer of Giraffe Capital Corp., a Toronto-based money management firm.
amandelman@giraffecapital.com

Don't worry about risk if you know the business's value

AVNER MANDELMAN Saturday, July 1, 2006
On Wednesday night my 15-year-old son won first prize in entrepreneurship in the Greater Toronto Area for a detailed business plan to minimize raccoons' nuisance to a home. Several of his friends won prizes too. It brought to mind how more than a year ago his teacher invited me to speak about "value investing."
The kids were a bright lot, but when I asked how they defined "risk," they used theoretical concepts such as beta, correlation and volatility. Now, I use some math myself, but to a value investor risk is more than math -- it is the difference between price and value. How to explain it? Imagine, I said, that a company's sole asset is a condo building with 10 units, each with a market value of $100,000. The company is publicly traded and there are one million shares outstanding. What's the intrinsic value of the shares? Right: $1 a share, because if you bought all shares you could sell the condos and get this value.
Now assume there's a rumour that deceased raccoons were found inside the building's walls and an expensive renovation is needed. The stock swoons to 75 cents. You hop on the subway to check the building and find only two baby raccoons strolling in the basement, none resident in the walls. The city inspector confirms the building is fine.
So, based on your research, you buy shares, and make money when they climb back to 95 cents. This, I concluded, is what value buyers do. But where's the risk here? It is certainly not in the price volatility.
Finally, one kid piped up: The risk is asbestos in the walls, not raccoons. Exactly, I said. The risk is in ignorance of the facts. But if you check things out, why should you care about the upsy-downsy movement of the stock price?
Which brings me back to the topic of risk, a concept most investors think they know, but may not have thought through. You may be surprised to learn that for certified financial analysts, academics, financial advisers and others who assimilated modern portfolio theory, risk is basically the "squiggliness" of the price line. But is it really? Or is this just the risk of losing sleep?
Take for example Berkshire Hathaway -- Warren Buffett's flagship company. During 1998-2000, the stock fluctuated wildly between $80,000 (U.S.) and $40,000 a share, up and down. At roughly the same time, the stock of a certain mining scam, where local warlords had salted the lab rock samples, was going straight up (because no one had found out about the scam yet). Based on modern portfolio theory, at that period Mr. Buffett's stock would be seen as riskier than the mining scam, because its price wiggled more.
What of the fundamentals? Or underlying assets? About this the theory is silent. Now, this is not an idle point -- most investment portfolios are constructed using the price squiggliness as a surrogate for risk, because economists who won Nobel Prizes define "risk" this way, mathematically. (Indeed, how can you express "dead raccoons in walls" in a mathematical formula?)
But then, if you don't use math, how can you measure risk? Ah. Depends who is doing the measuring. You see, the market is composed of two types of people: agents and principals, and the two see it differently. For the first, it is the risk of losing money; for the second, of losing their job. That's why the first (like Mr. Buffett) usually define risk (and investment) in terms of underlying value, while the second (brokers, advisers) define it in terms of clients' sleeplessness. When you invest your own money based on your own due diligence, if shares you bought at 70 cents drop to 60 cents, you're likely to see a bigger bargain, and perhaps buy more. But if a money manager did it, his clients might yank the account and so force the manager to sell the shares (most likely to a principal investor).
This is something that savvy market pros know and that neophytes take years to learn: Principals make money when agents panic and hand them value bargains. That's why the best money managers (which is what this column is concerned with) often behave like principals -- they buy value and accept price squiggliness (also known as drawdowns) as a fact of life.
Mr. Buffett did not flinch when BH's stock fell significantly in 1999. (Of course, it helped that he controlled the company.) An excellent value manager who appeared in this column noted that 30-per-cent drawdowns are something he'd accept -- and had. (Giraffe, another value investor, had levels of about half that in the past.)
Another excellent money manager who appeared here had taken drawdowns but keeps investing according to value, with a focus on physical due diligence.
What should it mean to you? That if your investments are down after the past few weeks, the best solution to your angst is to measure the value you own, and if it is still ample, ride it out. Just like that condo building -- if you know the value of each unit, some raccoon rumours won't faze you.
But what if you find you don't know the true value of what you own? Then you should either find it out, or invest in something else whose value you do know. Because only deep knowledge of value can both make you money and safeguard your sleep.
Avner Mandelman is president and chief investment officer of Giraffe Capital Corp., a Toronto-based money management firm.
amandelman@giraffecapital.com

How to tell good buys from bad: Talk to people, trust your gut

AVNER MANDELMAN Saturday, June 3, 2006
Two months ago Giraffe put an ad in Report on Business, looking for a research analyst. We asked for a one-page résumé, a half-page letter, and a one-page tech stock pick (or pan). Why the last part? Not because we lack ideas (though you never know where another good one may come from), but because I've found in my past Bay Street incarnations that good analysts, like good magicians, actors, or secret agents, are best picked via a test-audition.
So we published the ad and waited. Over the following few weeks we received many responses, which we culled down to a handful, to be called in for an interview. That's the part I like. (I know it sounds odd coming from a techie, but although I like gizmos, I actually like people more.)
The candidates were a brainy, well educated lot -- professional engineers, possessors of MBAs, CFAs, and other degrees given to those who were taught to deal with the real world via its symbolic echoes. All presented themselves well, and some even gave interesting stock picks (or pans).
But two things were missing: First, nearly all had based their analysis on public, second-hand data -- the kind that everyone else sees also. Very few did primary field research and none thought it important to highlight exclusive information. Instead, the recommendations were rife with data copied from the Web, corporate filings or famous analysts' reports.
It was clear the interviewees saw their role as financial scientists massaging data gathered by others, rather than gatherers of exclusive info themselves. Second, very few spoke of the company's people. The engineers spoke of the gizmos' features; the MBAs spoke of strategies; the CFAs spoke of alphas, betas and financial ratios. All necessary and useful. But what of the people behind them?
Very few candidates spoke of the character of their pick's chief executive officer, the trustworthiness of the chief financial officer, or the high integrity of the company's team when compared to the competition. This lack of people-mention was glaring.
It was as if the possession of degrees made one see the world through concepts only. Or was this because the candidates were trying to sell themselves to Giraffe as investment scientists?
Without saying it explicitly, they seemed to be selling their reasoning power and learned ability to manipulate symbols. This was not a bad proposition, actually, since all were smart and well educated.
But at Giraffe we have a certain reservation about relying on mere smarts and degrees as our main competitive advantages. Other fund managers have smart people also, and if we pitted only our smarts against theirs, our advantage would be small.
What is the best advantage, then? As you probably know by now, in my opinion it is the relentless seeking of primary, important, exclusive information, the kind obtained by talking to people both high and low. Now, I don't want to denigrate our interviewees' academic degrees. After all, I myself have a few.
But in my opinion, relying on formulas can blind a person to the raw commercial world behind them, where real people steal each other's clients, patents and girlfriends, where some act honourably and so may deserve investment dollars, while others don't. How to find out who is who?
I hoped you'd ask. Why, just last week two Enron executives were found guilty after a dozen regular citizens listened to their story in court and said they didn't believe them. No CFAs, no Nobel-prize winning math theories, just normal people using the inbuilt lie detector that every human is born with -- you, me and everyone else.
If the poor fund managers who "invested" in Enron had done the same before and listened to their gut, perhaps some would have stayed away. But then, how many fund managers consider the gut-check proper research? I suspect very few do.
Indeed, several of our interviewees tilted their heads in perplexity like the RCA Victor puppy when I asked whether they had sought primary people data. "Like what kind?" one asked. Like asking ex-employees what they really thought about the company and the CEO; or asking previous colleagues of the CEO whether he was trustworthy. (Enron's chief had issues before.)
Or seeking the CEO's ex-secretary to ask her what she really thought of him. (These are especially valuable sources.)
Only two candidates had done some people checking. One also asked us questions, and listened to the answers. He knew tech, yes, but he spoke of people too. We hired him. Now we'll have to develop his sleuthing ability further. But it isn't hard. He'll only have to talk to people or look them in the eye, then let his inbuilt polygraph tell him whether he trusts them or not. You, too, have such an inbuilt natural device. If you use it more you'll prosper.
Avner Mandelman is president and chief investment officer of Giraffe Capital Corp., a Toronto-based money management firm.

How savvy investors use charts to zero in on fundamentals

AVNER MANDELMAN Saturday, January 27, 2007
Since this column began, I have been recommending that you do more personal due diligence of the companies whose stock you consider. Go out there and sleuth, I said, and you can outperform those who stay at home and rely on the Internet and charts.
That long-ago mention of charts brought a small flurry of e-mails from those who swear by them. One or two even claimed that price charts tell them everything they need to know. "Don't you ever look at charts?" one e-mailer asked.
Well, I do. But not for reasons you might think. Let me give you a few cases, then why it's relevant now.
Years ago, I had travelled to New York to listen to superinvestor Jim Rogers speaking to a class of budding graduate student investors at Columbia University. In that class, Mr. Rogers spoke about sugar. Even though I didn't invest in commodities, the points he made were good for stocks as well, and so they bear repeating.
When he started to invest, Mr. Rogers said, he looked for commodity charts going back 100 years and more, perused them, and marked the bull and bear markets. Then he dug out the history books to see what events that took place at those periods could have influenced supply and demand. That, Mr. Rogers said, is the legitimate way to use charts. Not as a magic trigger that tells you to buy flying-saucer bottoms or sell head-and-shoulder-blades tops, but as a pointer to past fundamentals that may recur today.
For example, in the case of sugar, Mr. Rogers found that nearly every time there was a sizable war, sugar went up. Was it because the population indulged in comfort food to forget the misery? Or did the army buy sugar in bulk for the fighting men's tea (then) or Coke (now)? Hard to say, but the historical fact is clear: In most times of national conflict, sugar's price rose.
So, if you are a commodity trader, this is a powerful fact to keep at the back of your mind, because if you think a current war may last, you would be favourably inclined toward sugar. If you think peace is at hand, you may want to sell it.
Mr. Rogers' use of charts as a pointer to fundamentals was no an aberration on the part of an honest value investor. None other than Warren Buffett did something similar. In a Fortune magazine article from November, 1999, he gently mocked those who forecast the economy in order to forecast the stock market.
The assumption that a good economy brings a rising stock market was bogus, the Sage of Omaha said. Just look at the evidence. Mr. Buffett pointed to two 10-year periods, one with low economic growth, and yet enjoying a wonderful rising market, the other with high economic growth but a stagnant market. The charts were clear. (So what did help markets rise? Why, the Sage said, you must start with cheap valuations and high interest rates, and see rates come down. Then you buy stock by stock-- fundamentally.)
Whereas Mr. Rogers used very long-term charts and data to learn about a commodity's supply-demand fundamentals, and Mr. Buffett used them to make conclusions about the market-economy connection, such tools can also be used for individual stocks. Here are two examples: One from the past, one from the present.
When I was a research director, a mining analyst once forecast that Inco (which was still independent then) would lose a ton of money. Such a loss, he said, only happened three times before in the company's history -- here are the dates. It's such a historic disaster, the analyst said, we must slap a "sell" on the stock.
However, taking a page from Mr. Rogers' book, I asked the analyst to bring me a 40-year stock chart of Inco, then mark the points where those historical losses occurred. As you probably guessed, these proved to have been the best buy points. Please note, the chart was not used to show a "buy" because of moving averages or what have you. It simply showed that a company that survived more than 40 years, and had a reasonable chance to go on surviving, was one you bought when things looked grimmest, because that's when everyone else ran away from the stock the fastest.
Indeed, as every long-term chart would show you, the best times to buy in cyclical industries are when things look most awful. For example, oil and gas, when the Economist had a cover declaring: "The world is awash with oil"; mines, when metal prices sank below production costs; or microchip machinery makers, when such companies lost money in fistfuls and couldn't fill their plants.
That last one in particular is an exercise we have done in Giraffe long ago. We can show that "sell" points for microchip machinery makers coincide accurately with fabrication lines having 100-per-cent capacity utilized. At such times you better sell the stocks, because it can't get much better. Conversely, the best buy points on the charts occur when plants are only 60-per-cent full, all companies are losing sacks of money, and analysts are forecasting further losses.
For instance, a year or so ago, many tech plants were half empty, yet I noted here that the Nasdaq's prospects were rosy. It has since risen nicely. Where is it headed now?
Short term, I have no idea. But over the next year or two, it should be good, because plants of chip machinery producers are not yet 100-per-cent full. When they are, everyone would be euphoric, the Nasdaq's chart would be buoyant -- and I hope I would be smart enough to sell.
Avner Mandelman is president and chief investment officer of Giraffe Capital Corp., a Toronto-based money management firm.
amandelman@giraffecapital.com

To get an investment edge, learn to recognize business stars

AVNER MANDELMAN Saturday, February 10, 2007
Last week I took my son to New York to see the L.A. Lakers play against the Knicks -- it was Dan's 16th birthday, and I had to be in New York anyway on business. So I got two good seats right behind the Knicks' bench through a friend of my buddy Bertie the gold trader, who recently began to trade uranium and enjoyed a good few months, and so was feeling charitable.
What's all that got to do with investments?
The game was the usual American three-ring circus. Madison Square Garden full to the rafters, Wall Streeters wearing baseball hats and chewing gum to show they are down-to-earth, people sporting the jerseys of their favourite players, teenage dancers flipping in the air, and celebs, celebs galore.
Donald Trump walked by, with his son, and his latest wife; Jon Stewart flashed a V sign on the large monitor; Spike Lee sat brooding over some stat sheets, and, of course, the entire teams of the Lakers and the Knicks, gods among men said my son (who knew the names of all, and their stats, and personal and game histories).
Only one player was missing: Kobe Bryant of the Lakers, who had been suspended. With him, the Lakers were bound to win. Without him, they were probably toast. Not crisp. But toast just the same.
And what does all this have to do with sleuthing investment research, you are asking? It just so happens that I have a good memory for faces, and so, as the game was progressing and the camera was flashing more celeb faces on the monitor (Kareem Abdul-Jabbar, and Cyndi Lauper, and a few more godlike folks), I suddenly noted a trio of young men sitting in the middle distance, talking chummily.
They were camouflaged in frayed jeans, non-descript T-shirts, and backward-pointing baseball caps, looking almost like hockey fans, but I recognized two of them as the president and chief financial officer of a Silicon Valley tech company which I'll call here SuperChip.
The company's stock was inexpensive, but its fortunes were in doubt because its marketing team was deficient in what is commonly called animal spirits -- of which, of course, there were lots around us, both on the court and off it. (But not as much as on the next night, when the New York Rangers lost to the Toronto Maple Leafs, a game to which I took my son also. But I digress.)
At any rate, when I noticed the third man in that trio, I sat up and paid attention: He was the vice-president of marketing of SuperChip's main competitor. His face might not have been known to you, nor to most of those who own SuperChip stock, but I had seen him twice before -- first in a conference, the second time when I looked up his company executives' photos on their website.
The fact he was here talking to the top two honchos of his main competitor could mean many things, but the most probable was that SuperChip was trying to recruit him. And if this business star jumped ship, his own company's stock would suffer, and SuperChip's would benefit.
Luckily I recognized the trio's faces, so when I came back to Toronto on Friday I placed some phone calls to Silicon Valley contacts, who soon called back with info I would never have bothered to seek, had I not recognized the business stars' faces. And so, finally, I get to the conclusion: There is more exclusive information in public than you may think -- and it is often related to people.
You see, most investors have been taught in academia (as I have) to analyze companies and stocks via numbers, thus taking people out of the equation. It's as if you tried to forecast whether the Lakers or the Knicks would win by looking only at the teams' and players' stats. (Not that this approach cannot contribute: This is what the Oakland Athletics baseball team did, and what J.P. Ricciardi, who had first helped manage the A's, later did with the Blue Jays.)
Yet often one or two star players, or star executives, can make a big difference: Not only Bill Gates, Steve Jobs, or Kobe Bryant, but also a long list of rising stars one rung below.
Now how can you be expected to recognize all these, you ask? Well. You could probably identify 50 movie and TV celebrities by sight -- just like the crowd in that basketball game could -- yet no celeb has ever made you a dime, and most have probably even cost you, via endorsements. My son surely can recognize most of the NBA players -- he's a sports fan.
Therefore, if you invest, see yourself as a business fan, and pay attention to individual business stars: Follow their careers, learn what they do and how they do it, what they succeed in and where they fail -- and try to remember what they look like. If you do that, you'll often have an edge over those who don't. Sure, you must know the numbers, too, and the industry. But if you can identify a young business-Kobe-Bryant joining -- or quitting -- a company, you may take the money of those who only see a press release. Star talent matters greatly, both in sports, and in business.
And by the way, the Lakers did indeed lose to the Knicks. By five points.
Avner Mandelman is president and chief investment officer of Giraffe Capital Corp., a Toronto-based money management firm.
amandelman@giraffecapital.com

Value play or value trap? Start by looking at the customers

AVNER MANDELMAN - Saturday, February 24, 2007
Value investors can be compared to managers of a shelter for beaten-up stocks. For example, every four or five years cyclical stocks get thwacked by the economy and are then discarded by the roadside. Even a fine tech company may see its main product die while the new one is only beginning to flower, and it, too, is then flung out by respectable investors, who may beat it up within an inch of book value, or even cash per share.
But these are also the times when value investors, perhaps wearing informal jeans and a loose T-shirt saying "Patience & Prudence," can pick up the bruised orphan, feed it, and shelter it in their portfolio where it can heal in peace. Then, two or three years later, its face glowing with financial health, the mended orphan can step out into the Street, where investors in pinstripe will now bid its price skyward. That's when the orphanage manager (value investor) is paid for his patience and troubles.
That, at least, is the theory. Yet there's a problem: Every now and then a bruised orphaned stock does not recover, and either stays in the sick-bed forever, or even succumbs. For a value manager it is thus of critical importance to know what makes one bruised stock an opportunity, while another would stay forever a value trap.
What is the answer? In my experience, eight times out of 10 it is "the quality of the business." Some businesses are good, some businesses are not good, and some are downright lousy.
What of management, you ask? Well, as Warren Buffett put it, when a business with a bad reputation meets a manager with good reputation, the business's reputation stays intact. In other words, even a first-class jockey can't win the derby if he's riding a nag,
What is a good business, then? In the large majority of the cases, a good business is simply one serving good customers. What are such paragons made of? Good customers quickly decide to buy, don't mind paying more, keep coming back, have the money or the authority to buy, pay promptly, and stay loyal. Bad customers are just the opposite.
Now a trade secret: If there's one thing we do really differently at Giraffe, it is analyzing the customer first, before we analyze the company, the product, the technology or the finances.
First of all we ask: Are this company's customers really worth serving? The company, as we see it, is only a mechanism to transfer its customers' money into our clients' pockets. Thus if we deem its customers good, we proceed to analyze the rest. If not, we stop, because you can't make a silk purse out of a porker's rear.
To make it clear how different this mindset really is, here's an example: Years ago, Geac Computer invented one of the first virtual memory processors in the world. The doodad could process vast amounts of data, fast.
And what did Geac's executives do with this? They automated the registered retirement savings plan query process in a trust company's branches. In effect, they aimed to make 6,500 tellers more productive. Was this a worthwhile endeavour? Hah. A teller then made $15,000 a year. (This was a long time ago.)
If the doodad made each teller 10 per cent more productive, it would make the trust company about $1-million. The doodad cost $1-million. Payback was therefore one year.
Sounds good? Hah again. To tinker with the computer systems of a large financial institution, you must get the ear of the chief executive officer. But to make sure it's executed well, the wise CEO (and that one was very wise) must ensure everyone is onside, so the decision goes through seven committees, none of whose members has a bonus incentive.
So why should they decide fast? Indeed, they didn't. Geac sold very few machines, and their cash fast dwindled. They also sold a few others to libraries -- where other committees of bureaucrats took their sweet time making up their minds.
As a result, Geac went bankrupt, and had to be rescued by Ben Webster (at the time Canada's premier venture capitalist), who put in Steve Sadler, who fixed Geac by firing the bad clients and jacking up the prices for the good ones until only those who really appreciated the service remained. Geac's stock zoomed. Why? Because the new jockeys fired the nag customers, and got themselves decent fast horses instead.
As you can see, same product + better customers = richer stockholders. So, if like many beginning investors you try to find value only via the numbers, know that cheap stock price, good balance sheet, even good management, are of course necessary, but are definitely not sufficient.
What you should also check is that the company's customers are indeed worth serving. If they aren't, avoid the stock, no matter how cheap it is.
But if the customers are worthy, and you give the poor beaten stock shelter when it is black and blue because of a temporary problem, when it eventually mends -- probably with the help of its customers -- it would likely repay you for all your kind hospitality.
Avner Mandelman is president and chief investment officer of Giraffe Capital Corp., a Toronto-based money management firm.
amandelman@giraffecapital.com

It's the age-old dilemma. When to sell?

AVNER MANDELMAN
At least once a year I ask money manager friends what rules they use for selling. Often I get a verbal squirm, because although buying well is not easy, at least the criteria are clear, and many investment books detail them: growth, value, yield, neglect, you name it-- even sleuthed physical information now has a book. However, when do you sell?
Warren Buffett said that if you buy well, you never sell. This may work for a genius investor, but for the rest of us some pointers are necessary. Below, then, are six reasons for selling, according to my canvassed friends, plus my commentary.
First and foremost, you sell when management didn't deliver on a major promise, or lied. This one I fully agree with. They promised to develop the fastest widget but instead are making slow widgets in volume. Or they said they'd hire only the best, then promoted the chief executive's cousin who is definitely not Mensa material. They said they'd write off a division, but instead are expanding it. In all these, sell.
The second rule is by fund managers who say you should sell on any disappointment, because, like roaches, when you see one, usually more are coming. For me, however, this is a bit too twitchy.
Not even the best management is perfect, and sometimes minor disappointments should be seen as a chance to add to positions if the long term is still good. I said "if." But how do you know?
My test is -- check with the company's customers. Take them to lunch or drinks and ask. If they are calm, you should be too. If they are twitchy, make ready to sell. What if you don't know any well enough to take them for lunch? Then maybe you shouldn't be in the stock to begin with.
The third rule for selling is a deteriorating balance sheet. Debt, as U.S. newsletter writer Jim Grant once said, is always repaid, either by the borrower or by the lender. So if a company takes on too much debt, most fund managers usually sell, so do I, and so should you.
What of high price? That's the fourth rule, which has two parts. The first is mushier and harder: You should sell when the price has gone way beyond any reasonable valuation, then never look back. And just to make sure you understand how hard this is, here is an example.
Years ago Giraffe bought Novatel GPS at very low single digits, because the company had the best GPS technology and the stock was ridiculously cheap. Then, Oncap took a position by buying NGPS's parent (BAE), and in three years the stock soared to $15 (U.S.). It then traded at such high multiples of fundamentals, that although the company was better than when we had bought it, we had to sell.
The stock flew on to $50 -- at which point Oncap sold too. I couldn't sleep for two weeks. The stock plunged to $15. I slept much better. Bad move. I should've woken up and bought again. Now the stock is at $38 and may one day see $100 -- but it's no longer dead-cheap, so we look for other neglected gems.
Would I have done it differently? Not really. Am I happy about this? Not really; my pride is hurt. But value sellers rub their hurt pride with profit. It helps. You should sell when your value buy soars beyond expensive, then use your profits similarly.
Which brings me to the easier part of the fourth rule: Sell when crazy day traders discover your stock and want to buy it, no matter the price. That's one Giraffe has become sort of an expert on. Because we look for neglected cheap gems, these can languish for a year or two, but then be discovered by Internet day traders, when there can be a melt-up on large volume. To catch such moments our spreadsheets are programmed to "Ping!!" when traded volume reaches a high percentage of a stock's total float.
When a stock of ours soars on such high volume, we sell. We figure that if day traders think they know much more about a stock of ours, social justice dictates that we give it to them. (We often buy the stock back cheaper a few weeks later.)
Even if you don't have a real-time spreadsheet, you should be alert for such a possibility, too. If your stock rises on such huge volume that you feel euphoric -- consider selling. Euphoria should be a trigger for selling just as panic should alert you to a possible buy opportunity.
The fifth rule is more one for money managers than for individual investors, but I mention it nevertheless -- a stock that has risen so much that it is now a too-high portion of the portfolio. As an individual, you can keep a higher portion of your registered retirement savings plan in one stock (though it's not advisable), because you act as a principal.
But when Giraffe, for example, acts as an agent for others, we cannot allow more than a certain percentage of the portfolio in any one stock, because this makes the portfolio too volatile. It's like driving a car -- when you drive alone, you can go faster since you are at the wheel; but when you have passengers, although they know in their heads you're a good driver, their gut is twitchier, so you better go a bit more slowly. You'll get there anyway; no need to make your passengers lose their lunch.
The sixth and last reason for selling is the simplest: Sell when and if you find you have made a mistake. In such a case, don't delay. Admit it, cut your losses, and drive on. Errors in buying are hard enough; no need to complicate them with errors in selling. What matters is the final profit you get to rub on your occasional wounded pride.
Avner Mandelman is president and chief investment officer of Giraffe Capital Corp. and the author of The Sleuth Investor amandelman@giraffecapital.com

Book Highlight: The secret language of Competitive Intelligence

By Leonard M. Fuld
Realities:
Intelligence is an art
The Mind Blinds
Use the right framework to create X ray vision
Internet has own secret language
Role models are great teachers of the "art"

Core Concepts:
Understand and define process (Be the pepperoni)
Early Warning - narrate "scenarios" and map reality against those with plans in place for each one

Internet Concepts:
Mass Info & Noise - Lack standards
Follow transactions to find Intel Gems
Look for what is not said or what is missing
Seek the language of anger/venting
Use blogs/Discussion groups to refine thesis
Track corporate DNA to unmask a competitor
Find the right keywords to mine the web- English vs American english terms
Recognize Cultural bias / pol. bias
Use intelligence filters (AND OR NOT and string expressions together)
Use secret language of search engines to put on x ray lense."filetype: doc" Or ".. pdf"

Masters:
Act on critical intelligence with speed - N. Rothschild
You need less information if you build on past experience - W. Buffett
See you competitors through the eyes of your customers - clearest view of all. - S. Walton and M. Dell
Scan the market from all dimensions, including the political one - Richard Branson
(not just competitor)

Six Degree of separation - you can get most info to what you need in a few phone calls.