Thursday, March 21, 2013

Promising yield: Roddy Boyd on Brookfield Asset Management

Perhaps the easiest financial product to sell is one that offers safety plus a high yield. Of course the product may only offer the illusion of safety plus a high yield (safety plus a high yield being rather hard to obtain). But that won't stop it selling well. Often very well.

Bernie Madoff - apart from being a degenerate wart was the best salesman of hedge funds in the history of the business. No legitimate hedge fund has ever raised $10 billion let alone $50 billion without a huge sales force. Madoff managed that. The cumulative money raised by authentic financial geniuses (Buffett or even Loeb, Einhorn et al) is a small fraction of what Bernie raised. I can assure you as someone running a completely legitimate operation we have raised less in three years than Bernie raised on many days.

In money management what sells is the illusion of certainty... a fund manager who tells the truth (the truth being that he may be wrong at any time) is a more-difficult sale but a better investment.

High yields plus the illusion of certainty make my ears prick up. And it is common enough. In Australia there were two large businesses that sold unit trusts of some description to the public which housed "safe" assets like tollways and airports. These "safe" assets were levered to the point that they were not very safe any more but the leverage and - to some extent distributions paid out of capital - gave them yield.

The managers of these trusts were Macquarie Bank and Babcock and Brown.

In some instances the story was simple. Assets were revalued, borrowings were made against those revaluations and distributions were paid.

Macquarie Bank is still with us - partly saved by the Government guarantee of bank funding and partly saved by having some real and profitable businesses. Macquarie is - like many investment banks - a shadow of its former self. But it is still a real and powerful operation.

Babcock and Brown has gone to meet its maker though a surprising number of ex-B&B staffers are very wealthy.

The investors in the unit trusts mostly did not fare so well. Still some trusts survived - and ex-ante it was hard to tell the Ponzis from the merely over-levered from the well managed. Even ex-post it is hard to tell Ponzis from over-levered - and nobody has been charged with anything criminal anyway.

Often compared to Macquarie and Babcock was the Canadian operation of wheeler-dealers known as Brookfield Asset Management. Unlike Macquarie and Babcock Brookfield is still with us - and largely unimpaired. Its unit holders are not yet angry let-alone resigned to their losses. [Babcock structure unit holders are well past the "resigned" state now...]

But the formula seems remarkably similar (and similar to some MLPs). The formula - find an asset that is fairly stable - not riskless but low risk - and sell a structure based on that asset to mostly a pensioner-needing income investor set. The yield is made possible by either leveraging the asset with debt or endless capital raises.

In all the nasty cases (and in some less nasty cases) the wheeler-dealers did considerably better the holders of the investment vehicles. Pay was not commensurate with long term performance.

Anyway I spent a lot of time (often wasted) picking apart Macquarie structures before the bust. I should have been picking apart Babcock structures because Babcock performed far worse than Macqaurie.

I never got around to picking apart Brookfield because it was so darn complicated. Just breathtakingly complex.

But that doesn't mean it is not worth the effort. If you want to understand what it was like to try and understand Babcock or Macquarie before the denouement you can.

And you do not have to make much of an effort. Roddy Boyd (bless his hard-working soul) has done much of the work for you. And put it online.

Go read it.

The investment required is not large. But reading Roddy is low risk. And this time I can promise you a high yield.



But What do I Know? said...

The push to sell MLP's to retail clients is on in full force here in the US--so much so that they are running out of traditional MLP assets/companies and trying to legislate new ones. Of course it will end badly but Mr. Bernanke doesn't care. . .

Anonymous said...

Quite timely, seen the carnage in the MLP market in the last few days?.

Anonymous said...

Hi John,

Are you suggesting BAM is a short sale candidate?

I read Roddy's report. I also read Brookfield's response (link below). I do not see the issue. Brookfield addressed all of his concerns/questions, yet he still published the research report. I heard he was also involved with the Fairfax smear campaign years back that proved baseless.

While "infrastructure" investments might be a fad, I do not see how this makes Brookfield a bad company.

Thanks, Matt T.

Sambo said...

Hi John,

Very interesting post; seems worthy of some digging.

As I recall from your epic Fannie Mae, Freddie Mac posts a while back (long time reader here), I recall that there will be no recovery for holders of the prefs, let alone the common. I assume that the large swings in the common are just punters punting around in the equity on news flow without regard to this.

I once bought puts on GM after it went BK but still traded (ie the old worthless entity - not Motors Liquidation, which has been a fun ride to date - you might want to blog about the deal certain hedge funds got - which is now being litigated. The value of Motors depends on the outcome). Anyway...

Oddly the original GM post-bk still traded even after the company put out a press release warning investors that the equity was worthless. I'm always amazed how a stock will still trade in the US post-bk even when bonds are trading at 50% of par. I'm seeing this now with OSGIQ (I own puts), which is dancing around wildly. If this was in Australia or many other jurisdictions, the stock would be halted. Not so in the US it seems.

Eventually, the orignal GM wound down to close to zero and the puts were a double, but it took some time and was volatile in the interim.

Is my understanding correct regarding there being no equity recovery possibility for the Fanny and Freddie common (as a result of the Treasury changing the rules mid-game)?


Anonymous said...

Interestingly I noticed the collapse of the Australian fund LM Mortgage recently.

Al said...

Roddy Boyd should have held back on this release until he found more meat. The complexity of the company, and the income + fair value adjustments model, may disguise something, but this article doesn't get into much substantive analysis. Deferred, smoothed, or otherwise conveniently adjusted fair values are not sufficient justification for a short, as USB and WFC have proven. Companies with real money generation can ride out the bumps. The assets have to be hugely out of whack, ala Olympus, or supported by unstable financing, ala ALD.

Tom said...

Some of those retail MLP investors are going to be quite surprised to receive their K-1s ... *after* they have already filed their tax returns.

Anonymous said...

Roddy should write about Soul Pattinons/Brickworks next - clearly a 'pyramidal control' structure.

abee crombie said...

new reader here John

interesting post. I remember working in an office next to a babcock and brown. They were rolling in it for a while.

Some canadians have been calling Brookfield a scam for many years but with today's search for yield and assets I doubt it will stop now.

Wheather or not Brookfield is a ponzi or just very complicated, clearly the managers there are not working for the S/h but more interested in themselves.

Thanks for the heads up!

Anonymous said...

Brookfield owns some of the best infrastructure assets in my country (Chile). They also have a guaranteed minimum revenue and the risk is far less than the one in neighboring countries so they are highly levered... I heard a infra manager at a local ibank that the equity these companies posted when applying to concessions was fake... infinite unlevered IRR is pretty nice. That way infra investors can achieve ROE's (over they faked equity) over 80% for 30 years... doesn't sound too bad neither... I have no idea how much they spent in kickbacks though...

Albert Adam said...

At one stage or another, every man woman or child will be faced with the issue of Wealth Management. Given that its influence pervades our society, its influence on western cinema has not been given proper recognition. Crossing many cultural barriers it still draws remarks such as 'I wouldn't touch it with a barge pole' and 'i'd rather eat wasps' from so called 'babies', obviously.

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