Friday, December 26, 2008

Hookers that still cost too much – some comments on the IMF and Latvia

This blog was early on giving a public cry on the Latvian economy.  I have the Latvian crisis to thank for a lot of my readership – it was about 50 per day until I wrote a post about the looming economic crisis in the Baltics – and illustrated the lack of competitiveness of the Baltic economy by talking about the price of prostitutes.  That single post raised my readership by over 1000 percent - and it has risen - albeit more slowly - ever since.  The post even warranted my first mention in the mainstream media – in the Estonian business press.

I guess it was subject matter.  With some cynicism I suggested that sex tourism was the main Latvian export – and if you wanted to know about the domestic competitiveness then you should look at the price of prostitutes.  The technocratic economists want to talk about “real effective exchange rates” and I just want to talk about the cost of getting laid.  Will the insanely clever PhD students out there (Claus you know I am talking about you) try to model that.  

Anyway if you really are interested in this I suggest you read the original post here…  It is (my opinion) one of the best posts on this blog – so I hope you will not think I am wasting your time.  

That said – the situation was that the Scandinavian banks – most notably Swedbank – had been funding the Latvian (and other Baltic) current account.  This was a fixed exchange rate but in an uncompetitive economy that was not accompanied by the monetary crunch that the theory would suggest because the Scandy banks (especially Swedbank) were acting as the Latvian central bank and borrowing in Euro and lending in Lats.  Locals told me that much of the lending was in Euro not Lats but the effect was the same.  The Latvian current account deficit was sustainable as long as Swedbank was guaranteeing it – and Swedbank kept its credibility.

Unfortunately in a financial crisis – and with management as inept as Swedbank – it is rather tricky to maintain credibility.  When trust in Swedbank eroded either (a) the Lat was about to get devalued massively – smashing up Swedbank either on currency risk or by making it impossible for Latvians to repay their Euro debt or (b) monetary policy – being a fixed exchange rate and an uncompetitive economy was about to re-assert itself and cause a great-depression level event in Latvia.  When Swedbank could not sterlise the current account deficit the Latvian central bank would be forced to do it causing a monetary crunch of massive proportions.

I argued that the other Baltic states were more sustainable than Latvia – Estonia being bad and Lithuania being about as unsustainable as the United States.

Well – if you haven’t been following events – they are playing out rather like my blog post.  Latvia has required an IMF bailout.  Estonia is in a rather nasty recession.  Lithuania is muddling on.  The order predicted in my original post.  

But – not in the scenario of the original post – the IMF has not required a devaluation of the Lat.  Apparently the pressure from the Scandinavian banks was large – and the Scandy governments (presumably political play-things of their banks) are large contributors to the bailout.  They have chosen a bailout with huge domestic contraction but a fixed peg.  The last time the IMF tried that was Argentina and it was eventually a disaster with the peso peg being abandoned anyway.  

There are plenty of raised eyebrows about the decision to keep the peg (see Krugman for instance) but the political economy is obvious…

First – abandonment of the peg is the most rapid way of showing the insolvency of the Scandy banks – and the Scandinavian governments are big contributors to the bailouts and – seemingly – political pawns of their banks.  

The second reason for not abandoning the peg in Latvia is that it would take about 15 seconds to decide the peg is doomed in Estonia as well – and maybe – because a trilogy is three tragedies performed in quick succession – in Lithuania as well.  

Anyway several people I admire (most notably a Fistful of Euros, Alpha Sources and also Krugman) have pointed out the obvious – that the monetary contraction that will happen will result in much lost production and loan failures anyway.  The monetary contraction however comes from the loss of credibility of the real Latvian Central Bank – Swedbank.  Once a real central bank has to give out its foreign exchange it will cause a crunch of gargantuan proportions.  

So – score this for Bronte Capital.  I admit my failures on this blog – and it is Christmas so I should indulge my successes.

As for how the bailout will work – I am with Edward Hugh of Fistful of Euros.  It is Argentina mark 2.  

And do I need evidence?  Well I have spent 15 minutes searching around on the web – and the prostitutes still cost too much (though their price seems to be declining).  If someone with first-hand experience wants to correct me then pop something (anonymously if you wish) in the comments.  

John Hempton

I have resisted pouring more scorn on the totally inept Swedbank – but I should remind people that they purchased a bank in the Ukraine early last year for USD735 million.  The bank had only 10 million of earnings – and most the 735 million was debt assumed.

Next time Swedbank management wants to blow half a billion I have a bridge to sell them in Sydney.  Their title will be just as good as their claim on the Ukraine!

This wouldn’t matter – but Swedbank was funding the Ukrainian current account deficit as well as the Latvian one – and when they stop the crash will be rather nasty. 

Wednesday, December 24, 2008

Santander also caught in the due diligence lie

The numbers are larger than at Bramdean – the lie is the same:

Intensive due diligence is vital to ensuring the integrity and sustainability of the investment process . . . Each investment undergoes lengthy and detailed scrutiny according to clearly defined manager selection criteria.

As the FT points out it was impossible to do due diligence on your Madoff investments because Bernie did not allow it. But Santander claimed they did it as did certain other fund-of-fund businesses.

There is however much bigger consequences to Santander being caught in a lie. Santander – as do almost all English speaking banks – needs to raise money in wholesale markets.

Raising money depends on trust and as Jim Grant has just pointed out (and as this blog has pointed out several times) there is currently a “bear market in trust”.

If the trust in Santander fails then Santander fails. And that would be a very big piece of Bernie Madoff collateral damage.


Monday, December 22, 2008

Bramdean Alternative’s solvency problems

In my last post on Bramdean Asset Management (Nicola Horlick’s business) I suggested to Ms Horlick that she should make a statement to the stock exchange about how Bramdean Alternatives (what the website describes as the “flagship fund”) intends on funding capital calls by the private equity funds that they have invested in.

The problem of course includes that part of the money intended for capital calls was invested in Madoff Securities (via Defender – a Madoff feeder fund).  

No statement from Bradean Alternatives as how they plan to meet capital calls has been made.  In most jurisdictions a listed company has an obligation to keep the market fully informed.  However, failing a statement from Bramdean I thought I might spell the issues out.  

Almost all of this comes from the half yearly management accounts.

First the company has very substantial capital calls.  The half yearly statements detail them:

The Company was 88.8% invested at the end of the second quarter 2008. It has made commitments to sixteen underlying private equity funds and underlying specialty funds amounting to approximately US$224 million and the total amount that has been drawn-down on the commitments made is approximately US$59 million.

This is a very real problem.  The company has obligations to pay capital calls on funds it has already invested in of US165 million.  That is not chump change.

Moreover the most liquid parts of the portfolio – Madoff investments – are suddenly seriously illiquid.  Defender (a Madoff feeder) was specifically earmarked as part of a transitional portfolio – transitional because it was a place-holder for funds intended to meet capital calls.  (Fortunately however - and to give Bramdean some credit - they have raised some cash this year to meet capital calls.) 

Bramdean Asset Management thought that it was perfectly reasonable to overcommit Bramdean Alternatives: 

At 30 June 2008, the Company’s commitments to private equity and specialty funds accounted for 85.3%of its assets, representing an over-commitment of 1.22X, based on the Company’s commitments as a share of total net assets.  Any over-commitment may be managed through the Company’s cash holdings, through redemptions from the Transitional portfolio and through the use of gearing. The Company may gear by up to 25%of its net asset value, but has not employed this facility and had no debt at 30 June 2008.

In particular they thought that they could manage this by selling their “transitional portfolio” (that is Madoff), from cash holding and through the use of gearing.

Now the portfolio is down a lot since June 30.  At June 30 it was 263 million.  By October is was 220 million – and the private equity commitments were thus proportionately larger.  

Moreover they have not done spectacularly well in November and December will have wiped out the Madoff moneys (about 20 million more).  NAV is likely to be below US200 million – and the commitments to illiquid private equity type funds are over 220 million the majority of which has not been called.  Cash was about $50 million.  It will be very difficult to meet calls.

Oh, but in the June report they thought they could borrow the money to meet the capital calls.  That is what it says.  Now Nicola’s much vaunted due diligence process has been exposed as vacuous by Bernie Madoff – and the credit markets have tightened considerably – it is highly unlikely that anyone is going to lend Bramdean Alternatives money secured by the equity interest in a whole lot of 2007 private equity portfolios.  

Nicola Horlick lambasts her critics as sexist – and I admit I did call her a silly silly girl.  But capital calls are not gender specific and the cash drain and resulting insolvency is independent of Nicola’s gender.

I am sorry to say it – but Ms Horlick’s flagship fund looks like toast.  Maybe there is sufficient secondary market in the private equity funds for the fund to survive – but I doubt it.  

Maybe the capital calls will not come.  But I also doubt it.  It is however very hard to tell from the published accounts as the due date for the capital calls is not outlined.  

Moreover if they start testing the market for secondary pieces of funds applied for twelve months ago they will (at best) have to take very considerable write-downs.  The asset value of Bramdean Alternatives hardly reflects current market values on private equity investments made 12 months ago…

I consider this case more than just another piece of Bernie Madoff collateral damage.  It’s a real live case – and resolution is necessary for the restoration of trust to British Capital Markets.

What happens when this finally hits the wall?

It is not enough for the FSA to write off the looming insolvency of Bramdean Alternatives as just another credit crisis meltdown.  Bramdean made some very strong statements about how they do due diligence.  They made them in a prospectus and in annuals.  Here is the statement from the annual.  

The investment process is systematic and disciplined.  Due diligence is at its heart and around 3-4 months are typically spent analysing a potential manager, a process which includes a number of on-site visits with that manager. The process culminates in the provision of a detailed report that is then presented to and discussed at Bramdean’s Investment Committee, where a selection decision will be made on all private equity funds, specialty funds, and transitional investments. That Committee has to approve an investment unanimously before it can proceed. Where required, Bramdean will also conduct legal diligence.

Ongoing monitoring is similarly robust and includes regular reviews of market conditions and their potential effect on the underlying funds and any direct private equity investments. In response to the conclusions drawn from this process, the Investment Committee will decide whether or not to retain an investment.

There is little evidence that the statements are true (though I will take Nicola’s word for it).  Bernie Madoff famously did not let people do due diligence on him, but almost certainly Nicola – with her feminine charms was the exception.  Anyway if the due diligence was not done in the manner advertised – and moneys were raised on that basis then this is not just an unfortunate credit crisis bust but the raising of money on what look like false pretences.  But of course Nicola did the due diligence on Madoff, including several on-site visits and analysis over 3-4 months.

John Hempton

PS.  Nicola said her critics were sexist.  

Nicola wrapped the noose around her neck when she invested with Madoff.  The hangman has now pulled the lever.

It doesn’t matter one iota that the body is a woman and it is delusional to think otherwise.

PPS.  Why did I chose to pick on Nicola?  After all the last time Nicola crossed my consciousness was when she accepted a job at Australians Mutual Provident (AMP) and then did not come.  I am an Australian and Nicola Horlick is hardly a celebrity here.   A distant relative of mine is the chairman of the AMP - so I guess he offered her the job...

I genuinely wasn’t going to post anything.  I wrote the post with no intention of putting it up.  But then she accused her critics of being sexist – and blamed the SEC for the apparent failure to do her own homework.  That invited a response. 

And I wouldn’t have made a second post if she hadn’t changed her website.  

But as I dug I found more and more that is in the public interest.  The financial crisis in Bronte’s view will end when people learn to trust other people in financial markets – and here we had someone who had large – and potentially devastating capital calls trivialising her problems.  

This deserved a little exploration.

Saturday, December 20, 2008

New World Capital Managment - a follow up...

I know my post on New World Capital Managment has nothing compared to recent frauds. But the failure to prosecute reaffirms my doubt in the integrity of financial markets. I am writing this down because restoring trust to financial markets is the key to stopping the second great depression.

The fund was run by Greg Duran under the rubric of “New World Capital Management”. There were other staff such as Tau Ngo, Jill Ballantyne, Kyung Britt and several others – but as far as I can tell these additional people were fictional. (Well one or two of them might be real...)  

Greg Duran is a real person and his career had largely been in the honourable profession of mortgage broking...  I can still find the odd phone number which he answers.

The fund had a fantastic record – with barely a down month and some months up to 66 percent returns.

At one point it was even Barclay’s top rated hedge fund globally – which, given that it was a fraud, says as much about Barclays as it does about New World.

Anyway as explained in the original post I rang their purported auditor. Spicer Jeffries confirmed that New World was a client (perhaps only a prospective client) and indicated that the claimed returns were not audited. To this day I do not understand why Spicer Jeffries did not call the police. The statement “audited by us” is the entire product of an audit firm – and failure to protect that phrase is – at best – sloppy work.

I also emailed the CEO of the purported prime broker and he reported my concerns to Gregory Duran. At best this shows shocking judgement, but my timeline indicates that it is possible that Ikon tipped off Mr Duran that he was being chased – and that Mr Duran took that opportunity to steal the rest of the funds under management. Certainly if I were filing a civil action to recover the money Ikon is a logical defendant. If a class action lawyer wishes to help out – then I will provide the emails and their date stamps.

In my original post I indicated that Gregory Duran had sucked in one New York based fund of funds. The whole rationale for a fund of funds is that they can do thorough due diligence. A fund of funds taken in by a single fraud this blatant should probably not exist. Several funds of funds will of course cease to exist post Madoff...  a fund of funds business in Madoff also should cease to exist.

I did not name the fund of funds that was sucked in as I had no desire to destroy their business. However Holding Capital Group named themselves – suing Gregory Duran to recover their own seed investment (but surprisingly not suing Gregory Duran on behalf of their clients who they also put in the fund).  [Funds of funds businesses in Madoff haven't all come out - but ashen faced silence is probably the best course of action...]

About six weeks after my first post on New World I was contacted by Neville S Hedley – and enforcement attorney at the CFTC. I thought great – the wheels of justice are slow – but at least they are turning. I spent about an hour on the phone with Mr Hedley – and Mr Hedley was familiar with many aspects of the “alleged fraud”. He left his guard down at some point – and just started referring to it as “the fraud”. When questioned on that he just said “well that is pretty indisputable” – possibly the finest judgement I have seen by anyone with any authority on this matter.

I was happy – but not for long. The problem turned out to be that whilst Gregory Duran claimed to trade futures (especially currency futures) to get these returns – there is no evidence that he ever traded anything. Because he did not actually trade Mr Hedley decided that the CFTC had no jurisdiction. Having no jurisdiction he couldn’t actually do anything and dropped the case. 

Mr Hedley said he was going to try and interest the state prosecutors (New Mexico) in the case – and he did so – but state prosecutors it seems couldn’t be bothered. I understand why prosecutors are reluctant to investigate live fraud cases – but this one is dead and the prosecution is an easy scalp.

This is just another appeal to restore integrity to US financial markets. The markets don’t work for lack of trust – and the reasons for that lack of trust are obvious to anyone who looks – this being another example.

John Hempton

Gentle understatement

The Dreier law firm closed down awful fast.  Its website is still up and there is no news on it about the firm’s liquidation.  If you ring 212-328-6111 you get the following beautifully understated message:

You have reached the office of Marc Drier.  At the present time he is not available to take your call.  If you require immediate assistance please dial zero for the operator and ask for Catherine…

The motto of the new era: live fast, die young, leave a pretty website. 

Friday, December 19, 2008

Weather and subprime mortgages

Maybe I am a little harsh on people... strange things happen.  Normal distributions are not normal.  
Paul Kedrosky has a wonderful post on river flows in San Diego.  

The weather flows are even more abnormal than mortgage pools with 30% default rates.  

The world is strange...

John Hempton

Thursday, December 18, 2008

Robust and thorough due diligence is back

Bramdean Asset Management (Nicola Horlick’s business) used to have this line on its website:

Robust and thorough due diligence is at the heart of our firm's investment process. Our detailed manager monitoring programme ensures that our clients' investments are subject to on-going and effective governance.

I pointed out the incongruity between that line and the substantial investment in Bernie Madoff’s fund. 

Within hours “robust and thorough due diligence” was unfashionable – having being dropped from Bramdean’s site.  Nicola Horlick was – consistent with her BBC appearances – insisting that the due diligence failures were the fault of the SEC.  [As anyone with long experience knows the SEC is useless – but Nicola Horlick discovered that only last week.]

Anyway – it appears that “robust and thorough due diligence” is back in fashion.  Bramdean’s site now contains the following paragraphs which are consistent with both the prospectus of Bramdean alternatives and statements made to the stock exchange.  

Robust and thorough due diligence is at the heart of our firm's investment process. Our detailed manager monitoring programme ensures that our clients' investments are subject to on-going and effective governance. Our investment process includes a number of meetings with managers, carrying out on-site visits, as well as off-site analysis. Research reports are prepared for proposed investments and these are presented to the firm's investment committee. That committee has to approve all investments.

We report transparently and regularly to our clients and investors. In regard to Bramdean Alternatives Limited we produce a monthly Factsheet in addition to our regulatory reports which are prepared at the half-year and full-year end. We provide details about the portfolio, the asset allocation and the geographical allocation on, which is updated every month following the release of the month-end net asset value.

Anyway lets examine what that due diligence entailed.  There were two holdings in the Bramdean Alternatives accounts that were described completely differently.  These were Rye Select and Defender.

Here is how the last Bramdean Alternatives annual report described Rye:

Rye Select Broad Market XL portfolio Ltd
Strategy Derivative Arbitrage
Fund size US$330 million
Portfolio Weighting 3.49%

The Fund was launched in September 2006, although the manager has many decades of experience in executing the underlying strategy. The Fund is a relative value fund which specialises in derivative arbitrage and index trades.

The Rye Select portfolio is a three-times leveraged version of a very conservative split-strike strategy – which consists of the purchase of a basket of equities, the purchase of a put option and the sale of a call option. The strategy has provided steady incremental profits for the portfolio over the period. During the months that the manager felt there were no sufficient investments to take advantage of, it remained in cash.  The cost of leverage normally outweighed the interest from the capital during these months.

And here is how Bramdean Alternatives described Defender Ltd

Defender Ltd.
Strategy Relative Value
Fund size US$382 million
Portfolio Weighting 4.18%

This Fund was established in May 2007 and the manager, Reliance Management BVI Ltd., currently employs, via its subsidiaries and affiliates, 17 employees with two key principals: Linda Wayman and David Whitehead.

The majority of the Fund’s assets are traded by Bernard L. Madoff Securities LLC, based on a trading authorisation agreement with the Fund. Madoff Securities is a leading international market-maker in all of the S&P 500 stocks. Madoff Securities is also a leader in the U.S. ‘third market’ which trades U.S. listed equities away from the exchange floor.  Based on the trading authorisation with the Fund, Madoff Securities implements a strategy that consists of a long position in a basket of S&P 100 shares and an index option strategy against these shares (bull spread). Madoff Securities will only enter into this trade if it believes that it can profit.  Otherwise, the money is invested in U.S. Treasury-bills.
The Company invests in this low-risk, high-liquidity fund as a vehicle to provide short-term liquidity to fund private equity capital calls. The Fund is continuing to contribute steady monthly returns for the portfolio as intended.

Now it turns out that both of these funds were Madoff feeder funds and had their capital almost exclusively with Madoff.  In other words they were essentially identical – though Rye may have been levered to Madoff.  

The descriptions given by Bramdean/Horlick are wildly different.  Did Nicola Horlick and her much vaunted investment committee know that these two funds were identical?  Or did they fail even that part of the due diligence?  There should be reports on both funds.  Nicola has told the stock exchange that the process is “systematic and disciplined” and that reports are prepared on all managers.  

If those reports did not identify that the manager was the same then Nicola’s organisation is grotesquely incompetent.  And if the reports were not prepared then Nicola has committed criminal fraud by telling the stock exchange that they were prepared and raising money based on her vaunted due diligence process.

I can’t see an alternative to incompetence or fraud – and when faced with that choice I usually pick incompetence – but hey – this is superwoman.  And who would have though that she was incompetent?

Liquidity needs of the private investments

There is a second problem here – which is the annual report clearly states:

The Company invests in this low-risk, high-liquidity fund [Defender] as a vehicle to provide short-term liquidity to fund private equity capital calls. 

The Defender moneys are now gone down the Madoff Ponzi.  It is incumbent on Bramdean Alternatives to inform the market as to how they now intend to fund private equity capital calls. 

They may have other resources – indeed they hold cash.  But a disclosure to the stock exchange is required.  

Did Nicola Horlick’s due diligence allow Bramdean Alternatives to get fleeced on a day-to-day basis by Madoff feeders?

One thing about the Rye reporting puzzles me.  Madoff never reported a down period.  A levered Madoff fund always made money until the ponzi was exposed.  But Bramdean Alternatives reports that there were periods where the fund did not cover its cost of leverage.  

This is strange… did Nicola Horlick allow her clients to be fleeced on the monthly returns by Rye or some other intermediary?  If so what does that say about her due diligence?  She could of course do due diligence on Rye…

Bronte’s view

Every day that Bramdean remains licensed (FSA register number: 410624) is a day that brings discredit to the British Capital Markets.  Removing Nicola’s licence is in my view a no-brainer.  Either fraud or incompetence is demonstrated here.

Further the reports into Rye and Defender – both of which were prepared after “systematic and disciplined” due diligence should be made public.

Failure to make those reports public brings further discredit to the British capital markets because it makes it appear as if Nicola Horlick has been able to raise money based on fraudulent statements about the nature of her due diligence processes.

If the reports do not exist then Nicola Horlick should be charged with fraud.

John Hempton

One correction...

The Rye Select Broadmarket XL fund is a three times levered version of the Rye Select fund.  Here are the stated returns of the Rye Select fund:

A three times levered version of that would produce negative returns in some months - for instance in October when the stated "return" was 0.05 percent.  

I also have a copy of the offering document for the three times levered fund.  It never mentions the name Madoff.  Perhaps - and I am speculating here - that is why Bramdean never mentioned Madoff.  


Wednesday, December 17, 2008

Criminal charges for Nicola Horlick now?

Note:  I have edited this post.  I put a question mark in the title.  Nicola almost certainly has the reports into Madoff that her due diligence process claims she has.  In which case the due diligene was grotesquely sloppy - but at least done - and she has therefore not misled the market as to the nature of her due diligence process.

I think - for the removal of any doubt - she should release them publicly.  

If she does not have them she leaves herself vulnerable to a fraud charge.  It should be a simple thing to release them.  I urge release of these reports.  

Nicola Horlick has decided that due diligence is passé.  The website of Bramdean Asset Management used to contain the following paragraph.

Robust and thorough due diligence is at the heart of our firm's investment process. Our detailed manager monitoring programme ensures that our clients' investments are subject to on-going and effective governance.

That paragraph has now been removed as detailed here – and on Naked Shorts.

But is worse.  Bramdean Alternatives is a listed company – and its annual reports are statements to the stock exchange.

Bramdean Alternatives annual report contains the following statement about how investments are chosen.

The investment process is systematic and disciplined.  Due diligence is at its heart and around 3-4 months are typically spent analysing a potential manager, a process which includes a number of on-site visits with that manager. The process culminates in the provision of a detailed report that is then presented to and discussed at Bramdean’s Investment Committee, where a selection decision will be made on all private equity funds, specialty funds, and transitional investments. That Committee has to approve an investment unanimously before it can proceed. Where required, Bramdean will also conduct legal diligence.

Ongoing monitoring is similarly robust and includes regular reviews of market conditions and their potential effect on the underlying funds and any direct private equity investments. In response to the conclusions drawn from this process, the Investment Committee will decide whether or not to retain an investment.

Ok – it is time for Nicola to come clean.  According to Nicola 3-4 months was spent analysing the Madoff investment and a number of on-site visits were made.  There was a detailed report presented at the Investment Committee.  

Release that report now.  Go on.

Otherwise we have to conclude that such a report does not exist and Nicola is the CEO of a company making false statements.

If the UK regulators are as diligent as Nicola demands US regulators be, and that report does not exist, then it is prison time for Nicola.

But Nicola is an honourable girl.  Go on - release the report.

Tuesday, December 16, 2008

Nicola Horlick is a silly silly girl

One of the things about the web is that it has a level of permanence.  You put stuff out and you have to live with it.  

Only a few hours ago – and preserved for posterity here the website of Bramdean Asset Management said this:

Robust and thorough due diligence is at the heart of our firm's investment process. Our detailed manager monitoring programme ensures that our clients' investments are subject to on-going and effective governance.

I pointed out the incongruity between this statement and losses in Bernie Madoff’s ponzi scheme only a few hours ago – and the offending paragraph has rapidly been removed from Nicola Horlick’s site.

Google however saves the day.  Here is a picture of Google’s cache of the site.  Note the offending paragraph.

And here is how the site as it currently appears with the paragraph removed.

So now Nicola we know your organisation was incompetent in its due diligence.  This should be the death knell for a fund of funds business.

You are now proven to be deceitful hiding website content when it is inconvenient.  Publicly exposed deceit should also be the death knell of any financial business.

And you are incompetent as you try to cover your tracks.

Lawyers note this.  Any sensible jury would see this behaviour as an admission of guilt.  

Nicola – you were never worth the trust people put in you.  You have now proven it.

If your business is not dead before this deceit it most certainly is after.

John Hempton

My delayed Nicola Horlick post

Oh dear

I deliberately did not post on Nicola Horlick and her investment in Bernie Madoff’s giant ponzi scheme because I thought I might be transgressing on some gender issues.  I wrote the post – and I never put it up.  

But this blatant piece of garbage self defence has spurred me to action.  She thinks that we are being sexist singling her out.  

I will just put up the original post.  You decide...

Your chance to see Superwoman naked

Warren Buffett famously said that when the tide goes out you can see who is swimming naked. As a surf lifesaver I can tell you that Buffett’s pithy remark is not literally true. And nor is the title of this post – so the perverted can stop reading now.

Ok, so you are still with me. I didn’t think too many of my readers would admit their perversion…

Anyway Nicola Horlick is London’s famous superwoman – an attractive articulate woman who has juggled several high profile jobs, five children and a messy divorce all in the glare of London’s insatiable gossip press. When I was younger I looked at my career and wondered how she did it.  I also wondered how she generated all those headlines.

Ms Horlick has now started her own business – a fund-of-funds known as Bramdean Asset Management. Bramdean and Nicola of course know their job – as their website says:

Robust and thorough due diligence is at the heart of our firm's investment process. Our detailed manager monitoring programme ensures that our clients' investments are subject to on-going and effective governance.

Good – we got that. And it is not boilerplate. Due diligence is actually not that hard a lot of the time. And if you don’t do it you will wind up with a Greg Duran or a Bernie Madoff.

Pregnant pause…

What… Nicola did get a Bernie Madoff – and for almost 10 percent of her funds under management. 

This can’t be happening. She is superwoman after all. After all there were warning bells and Jim Vos nailed it.

Now here is the question: does a fund-of-funds which correctly lists due diligence as the core function deserve to exist if it invested with Bernie Madoff?

I think not.

Superwoman is metaphorically naked.

I think Nicola would have preferred run literally naked through Piccadilly Circus than have this happen to her and her clients. It would have helped News Corp sell papers too.

As for her business. It is over.   She tied the rope around her neck when she invested with Madoff. And the hangman has pulled the lever. For the junior staff – it is time to pack up shop and find a real career.

The Bramdean website says that it is uncertain as to what the value of Madoff funds are. Who are they kidding – Naked Shorts has that answer.

As for the value of a fund-of-funds business with Madoff in the portfolio? Well that is fast approaching the same answer.

John Hempton

One correction - the loss to Bernie Madoff was in the alternatives portfolio only.  In otherwords almost 10% of the money allowed to be invested in hedge funds was invested with Madoff.

Monday, December 15, 2008

Bronte Capital calls for a new French Revolution

Credit Agricole SA is a bank which obsesses me – and on which I have lost some loot.

The problem is that it is a bank with very good bits and very bad bits. And the good bits are excellent (and mostly outside Paris) – and the bad bits are atrocious.

Charlie Munger observed that if you mix turds with raisins you still have turds.  Charlie was right and it shows in Credit Agricole SA’s stock price.

The bank is controlled by a bunch of regional mutual banks who – for reasons that are not apparent to me – have never got around to closing the bad bits.  Those regional mutuals are in turn controlled by five million voting mutual certificate holders – a reasonable proportion of French households.

The super-bad bit is their investment bank. It’s a mathematical finance type investment bank in the French mould. As has been noticed by more than a few people – the market recently has not been too kind to mathematical finance.

I just want to extract the results – quarterly – for just investment banking business.  Please click for detail...

These numbers really deserve looking at. The first observation is that revenue can go very strongly negative at an investment bank. That is nothing that Lehman et al have not discovered before – but the trading revenue was negative for several quarters in a row. You might conclude the traders were not much better as traders than say the average French farmer.

The second thing is that the costs line doesn’t seem to move much. Now when I was young and naïve – say 2006 – I thought the investment banks would have a very rough trot – but that the staff would take a fair bit of it in the hip-pocket. The argument being that the very high salaries were at risk – and you could at least assume that when time got rough for an investment bank the staff would be paid salary without bonus. Capital risks were lower than it would appear because at least variable expense would go close to zero.

Now I read lots of stories about how children are getting less allowance due to the credit crisis. Such stories always seem to wind up high in big-media’s “most read” and “most emailed” lists. And that is only because we – dear readers – are doing it to our own kids.

And if it is good enough for our kids it is surely good enough for our investment banker!

Anyway – it is noted that Wall Street bonuses remain stubbornly high – but this is France with all its equality and fraternity. And they can’t control this crap either.

But with numbers like these – if the investment bank were not owned by the rich French parent (Credit Agricole SA) then it would be bust – and the children (sorry investment bankers) would be out on the street.

But bust is better than it would have been in 1792. In those days – faced with a class as egregiously and hypocritically greedy as investment bankers they would have set up the guillotine in the Place de la Concorde and we would be treated to the public spectacle of mass beheadings.

These days of course it is easier. The French farmers and middle class all have a vote – its their mutual share. Executing a vote may be less grizzly than executing investment bankers – but it might be just as effective (though somewhat less theatrical).

Now how do you organise a new French Revolution?

John Hempton

Sunday, December 14, 2008

By no means the scale of Madoff

This is one of then first posts I made on this blog... in light of the issues that have been exposed in the last week I thought I would repeat it.

A similar check on Madoff would have exposed him as questionable (has anyone ever heard of the auditor?)

I argued that any fund of funds that got suckered into a single fraud as per the one detailed below did not deserve to exist. I guess we are about to get the test of that... but a test I would prefer not to have. The original post is here.


Forgive me for a non-stock post. But it will cover the dubious goings on off Wall Street - and is fun.

A while back I went looking for a new name for a fund. In passing I came accross New World Capital Management - the most intriguing hedge fund you have never heard of. The fund was run by someone who called themselves Greg Duran - and who hailed from New Mexico.

Their record was unbelieveable. Below I have extracted from their marketing materials the records for their two funds. The equities fund monthly return is below:

The return for the multi-curreny fund is below:

In both cases you should click for more detail - just to show how truly extraordinary these returns are. In July 2007 the multi-currency fund claims to have scored a 66% month.

The first cockroach

It is sometimes said there is never just one cockroach. But the first cockroach I found was a doozy. The annual returns in this table are not consistent with the monthly returns!

In particular the monthly returns in the 2007 currency fund compound to more then the stated annual return. Similar mathematical errors exist throughout their documentation.

Some due diligence

Given the very attractive returns listed I figured maybe I could give up the game altogether and put my money with Mr Duran. But of course I would need to do some due diligence.

Mr Duran made this fairly easy. His literature listed (for the currency fund) the Prime Broker as Ikon Global Markets, the auditor as Spicer Jeffries LLC, the legal council as Pillsbury Winthrop Shaw Pittman.

As a basic due diligence I thought that I would approach these firms. In particular the auditor is expected to stand behind the accounts that they sign - so they would be good people to approach.

The Prime Broker's less than Prime response

The Prime Broker's (reasonable) response is repeated below:

Mr. Hempton:

Thank you for contacting us regarding this situation. As per our privacy rules, we cannot disclose details regarding client’s of the firm unless directed by the client. IKON is a prime broker for FX trading and acts as a counterparty for FX trades. In this capacity, we do not endorse, verify or audit the returns or claims of any client (individual or fund). If the fund is rated, then you can research their results through the rating agency. You can also ask to speak to their auditor, legal advisor or request further information. I am sorry we cannot be for further assistance and I recommend that you do thorough research and due diligence before you select any money manager.

Thank You

Diwakar Jagannath

Managing Director/CEO


99 Wall Street, 11th floor

New York, NY 10005

What Ikon did next however staggers me. They contacted Greg Duran - and I received an indignant email from New World. [If it is a fraud - why tip-off the perpetrator? Confidentiality applied to the customer but not to me.]

The auditor

The auditor was at least polite - but at first had never heard of New World. It turns out that a partner had discussions with Duran about becoming his auditor - but that no appointment had been made and Spicer Jeffries had never audited any New World accounts. [This was despite New World literature asserting that Spicer Jeffries had conducted such audits.]

I would have assumed that an auditor would want to protect the integrity of the statement "audited by us" and called the police. No such luck. I think they were interested in protecting a potential client.

Further conversation with Greg Duran

As Duran now knew I had contacted his Prime Broker he might as well know that I had contacted his auditor as well. This led to the following fascinating exchange:

I started the fund in 2005 with myself and two small investors. We built up a track record up till April of 2007, when we launched the fund LP. We started taking clients accounts in November of 2007. In November of 2007, we hired on Spicer Jeffries to do our audits. Because it is an LP, we have a choice of whether to do an audit at the end of the 2008 or do an audit now. We are in the midst of getting feedback from our current investor base to determine if they want to wait to do the audit or, if they want to do it now. The investor pool has to decide since they are paying for the audit. Now, we started a relationship with Dranger Capital, whom is our CTA and who also gave us notice to the contact you had with IKON's Manager so that they can speak on our behalf.

The plot is thickening here. Note this email has him starting the fund in 2005. He gives (above) records for the 2003 and 2004 years. Peculiar.

Does the fund exist?

This is a good question. Greg Duran seems to exist. Indeed he was often good for a quote in the Santa Fe New Mexican - by a journalist called Bob Quick - who seemed to put his stories out that way. Here is an example where Greg Duran is seen (in January this year) backing the solidity of Thornburg Mortgage. (He got that wrong.)

Indeed Quick quotes Duran more than once. Lazyness is the nicest explanation I have - though I rang Bob Quick up and suggested to him that - just perhaps - Greg Duran was the local story. There was no follow up.

Who was suckered?

I do not know how many people were suckered by New World - but one New York based fund-of-hedge-funds gave him money. They were kind of embarrassed when I spelt out the problems. I do not know whether they have recovered some or all of their funds.

Duran quite quickly realised I was doing a proper due-diligence - and he realised that maybe New World was not a "good fit [for me]". I do not know anyone else who was suckered.

Their website has now gone dead. The phone number that they gave me now rings through to someone called "Dranger Capital". Dranger Capital might be a legitimate operation - but they woud hate to know that the number of New World is being forwarded to them.


I didn't just tip off Bob Quick. I went to journalists with some leading publications. I copied full details to the SEC and to the New Mexico AG.

Nothing seems to have happened.


Due diligence - just a little digging - will save you most errors.

Obvious frauds are not prosecuted. (This was an obvious fraud - and the authorities were told.)

Just because it is not prosecuted doesn't mean its not fraudulent. If you can't verify you should not put your money there.


The website may be gone. The phone may ring to a new venture. But you can still see their logo here.

Full disclosure: this is for amusement only. Had the fund checked out I would have given them some money. But it didn't check out and that was that.

My main interest here is how easy it appears to get away with it. Unless that is changed then the capital markets will remain unsafe and deserve lower valuations.

Thursday, December 11, 2008

A post-script: climate change from the left and another plea for investments...

I think it is fairly obvious that nuclear is part of the solution to climate change.  

The impression I get is that some on the right think of climate change as some kind of left-wing conspiracy to get a government controlled economy implemented on basis of scientific fraud.  (I know I shouldn't focus on the wing-nuts - but the wing-nuts are everywhere.)  

But the left has also had to suck it up.  I know a few people who have changed their mind about nuclear - but I have seen very little rational debate about nukes on the left.  

But politics is not the purpose of this blog... investing is...


The investing idea I had however was that if the governement was going to restrict investment in certain carbon emitting activities those who had protected investments in place would win big-time because they had competition restricted.   Don't invest in the solution - invest in the problem!  (As Charlie Munger says: "invert - always invert.")

The right investment in Europe was not windmills but big nasty polluters.  That may wind up being more general.

And if I did that the right might think I was some kind of "greenhouse believing socialist fruit-loop" and the left might think I was a sell-out.

Hey - if I get it right I make a lot of lucre.  And that is my cynical purpose...


I have a few unethical investments in my day.  I am a liberal with a large stock holding in News Corp.  You should hear me cheer Fox News.  I have owned tobacco companies in Indonesia.   And those were companies that chopped down rainforest to get timber to smoke-cure their cancer-causing drug of addiction.

If the right investment is a polluter in China whose western competition go away then I am all-too-happy to make the unethical investment.  

I just want ideas guys - not debate on politics.  


Wednesday, December 10, 2008

Conservatives, climate change and investing

I didn’t mean to start a debate by the religious fanatics of climate change. And I will not do so here. But I will state my position and I do want to talk about the investing implications of climate change.

My position on the political and practical debate (and on the science on which I have limited expertise)

Conservatives have had a funny set of positions on climate change. First they argued that it didn’t exist. That seems to have fallen by the wayside. There is little factual doubt that the world is warmer than it was say 50 years ago. In Australia – where the climate is doing quite strange things – popular opinion says the strange things (sustained drought) are caused by greenhouse effects. I have my doubts about that…

Then conservatives argued that the observed warming was not caused by human driven changes in the CO2 in the environment. That is possible – but I am happy to accept that it is highly likely that humans have caused it. I am far less convinced by the human cause step than the existence step – but I still think that the bet on climate change is having human causes is pretty strong.

It is not clear what conservatives are going to argue next. Starting by arguing with the preponderance of scientific opinion doesn’t bode well…

I was always more impressed by Charlie Munger’s view – which was intellectually honest – and did not start by denying the science. His view – which I believe arguable – is that climate change is real, is caused by humans but that it is essentially unstoppable at any reasonable cost (you simply can’t administer any plausible program to reduce greenhouse gas emissions). He then argues that the cost of the world being marginally warmer are not too high.

I really have no idea at that point. I do not know how big the cost of the world being a few degrees warmer will be and I have no idea whether a system to ameliorate climate change is even practically possible. I have some idea how you would design quotas and taxes to try ameliorate greenhouse emissions and I personally think it worth trying, however I am very unsure as to whether it would be successful.

More generally I think the conservatives without strong relevant scientific skills and who start by denying the preponderance of scientific opinion do themselves disfavour. If they lose the scientific debate they look stupid – and just as importantly – they deny the fundamental intellectual strength of conservatism.

The appeal of conservatism as an ideology is that it is based on a practical observation about the world – decentralised market systems work pretty well on the whole and governments stuff up lots of things. That observation – loosely stated – is grounded in fact. Nobody is responsible for the distribution of bread in New York or Sydney – but it works very well. Someone was responsible for the distribution of bread in Stalingrad and it worked dreadfully. The appeal of conservatism in this regard is that the core part of the ideology is based on observable fact.

I do not understand why conservatives want to latch onto very minority scientific positions (which are probably wrong) on climate change or onto positions which are completely scientifically untenable on evolution (six days, recent origin).

Conservatives have a perfectly defensible ideology – why give up the intellectual high ground for obscurantism? It is not my ideology – but when the facts suggest that I am wrong I am very happy to retreat. If you are not happy to retreat then you count yourself out of serious discussion.

But this is a practical investing blog

I think we can assume (on the strong balance of probability) that CO2 emissions cause global warming. I am not sure we can assume that something effective will be done about it – or even that it is possible within a modern global economy do to anything effective about it. But there is a good probability that governments will try.

How they try is going to dramatically change the investment horizon – and it might do so in strange ways. For instance in Europe greenhouse gas quotas were given to large carbon emitters – and for a while the way to make money was to buy the company with the worst emissions problem. Why? Because the quotas were worth more than the industrial base they had to shut.

I do not want to provoke a debate about whether the human caused greenhouse effect is real – I think that is pretty likely – but this blog is entirely unlikely to contribute in any meaningful way to the debate. I am not a relevantly trained scientist and nor are most my readers.

What I do want to provoke is a debate about how the governmental reaction to greenhouse will change the investment horizon. I may not like it – but if the incentives are for me to buy the ugliest most polluting industry because it is a beneficiary of government action then I will do it. I will not let ideology get in the way of investing. That would be even more stupid than believing in six day creationism – because the belief in creationism is largely personally harmless – but letting ideology get in the way of investment decisions is personally costly.

So this is a plea: let us discuss what really matters to my clients and my readers – which is how do we make some filthy lucre from all of this – rather than argue about science about which we can make little contribution.

And just to make sure the discussion is focussed I am going to break this blog’s policy on censorship of comments. I will censor any comment on the science of greenhouse unless it has an investing implication. I will however let through any comment with investing implications generally or discussions on the practicality of things governments might (try to) do to ameliorate greenhouse gas emissions.

John Hempton

Tuesday, December 9, 2008

Is this the seriously smart money?

It pains me to say anything nice about Exxon Mobile management.  They are the most notorious climate change sceptics for instance, something I rank along with believing that the world was created in six days about 6000 years ago.  

The belief might be politically convenient for Exxon, just as it might be politically convenient for some conservative politicians – but otherwise it dumb and possibly dangerous.

But – putting my politics aside I am going to say something really nice about Exxon.  They look a lot smarter than me – and a lot smarter than most of the rest of us.

Remember the super-spike in oil.  Remember how it was going to remain high forever.  It was only a few months ago.

You would think that Exxon believed it too – and ramped up their capital expenditure to take advantage of the super-cycle boom to come.

You would think…

But you would be wrong.  

Here are the capital expenditure numbers for the company by year in millions:

2002 11,437
2003 12,859
2004 11,986
2005 13,839
2006 15,462
2007 15,837

Now anyone who followed this industry knows that the cost of building new plants, pipes and drilling new holes skyrocketed during this period – so the physical amount of capex done by Exxon probably reduced during this period.  It reduced whilst the cash flow from operations went from 21 billion to 52 billion.  

Sure capex went up a little in the first nine months of this year but even that increase was disciplined.  

The conclusion you have to come to is that Exxon did not drink the kool-aid.  They were at the centre of one of the biggest booms out there – and they were not sucked in.

So – if you want to know who the smart money were – look no further.

John Hempton

PS.  There is another hypothesis consistent with the data – one which paints Exxon in a very poor light.  The alternative hypothesis is that they did little capex because they did not have worthwhile projects to do – that is that their reserves are stuffed.  I see little evidence for that hypothesis but hope to entertain it in the comments.

However I should note that I know so little that it is entirely possible that the PS bear case is correct.  Knowledgeable comments much appreciated.  


Sunday, December 7, 2008

Weekend edition: iphones and Galileo

The comments have proved to my satisfaction that the effect noted here is an artifact of the lens and not a crescent of Venus.  So the discussion here is faulty.  

Thanks to the person who put up the comment.  The issue is that there are simply too many pixels in Venus...

However I am left perplexed as to why Venus pixelated as a crescent - with the lit side tilted towards the sun (as you would expect) and Jupiter and the Moon look like circles (the moon) or squares (Jupiter).  If someone is able to give a good optical explanation I would appreciate it.  

Meanwhile I will try to replicate the Brad Delong picture with a mobile phone camera and a 10 megapixel SLR.  



Brad Delong has a photo on his blog taken with an iphone of the moon, Jupiter and Venus.

It is impressive – and through it – looking at the individual pixels – you can tell that Venus is a crescent.

Now all Galileo did – which marks him as one of the greatest minds of all time – was look at Jupiter through a simple telescope and plot the four moons (I have never been able to resolve more than four moons).  And if you do this regularly – certainly every evening for two or three weeks – you will come to the conclusion that the moons circle Jupiter.  Galileo’s letter to the Prince of Venice is here and an English translation of the text attached to the diagrams is here.

Galileo did not distinguish between the moons and stars – the notion that the sun was just another star far out in the uncharted backwaters fo the unfashionable western spiral arm of the galaxy was beyond him.  But he did work out that the “Medici Stars” revolved around Jupiter and that was a major challenge to the authorities.

The second great Galileo experiment was to work out that Venus revolved around the sun – and for that he took observations in the morning and the evening for considerable time – observing the crescent shapes.  

And Brad Delong has shown you can do that with an iphone.

Here is Brad’s image

 – and here is an expansion of the pixels of Venus.

When technology that good is easily available the excuses for basic scientific ignorance are becoming thinner and thinner.

Now to take the eight year old out with an iphone and teach him some real science!  There are few excuses...

John Hempton

Friday, December 5, 2008

The bull in the china shop

Well I am relieved.  It has been my contention that Sheila Bair is the bull in the china shop.  She confiscated Washington Mutual because it might cause a problem for her agency.  There is little evidence that WaMu was illiquid or insolvent at the time – and indeed if the losses were only what JP Morgan has assumed then the bond holders (which she wiped out) would have received considerable value – probably par.  

There is plenty of evidence she made these mistakes all on her own and she should resign.

Press reports indicate that Geithner wants her gone.  Geithner is no political hack wanting to get rid of the Republican.  He just wants to get rid of the dangerous and irresponsible bull in the china shop.

Some press indications are that Sheila Bair will be hard to remove.  She is a statutory appointment after all – and her position will survive a change in government.  And if she puts up a fight she will be even more destabilising.

A change in administration is the perfect opportunity for Sheila to resign.  Then she can do it without disgrace.  But my contention is that every day Sheila is in the position is another day added to the end of the financial crisis.  She, more than anyone, makes it clear that intermediate funding in banks is insecure – and fixing that perception is the first and most important thing needed to make this crisis go away.

So Sheila, you are going to be asked to resign anyway.  Please make it quick, give your successor time to undo the damage you did and help get this crisis over with.  

John Hempton

Tuesday, December 2, 2008

Great interviews in finance

Sorry - YouTube has mangled the video and the sound is stuffed.  I can't seem to fix.  

Mish alerted me that Land America had filed bankruptcy.  Its a company I used to follow - but I never shorted.  

This is a gem - an interview from only 18 months ago.

The money quote: "the United States real estate economy is the envy of the world... the ability to create value out of real estate by taking mortgages and securitising them..."

And this was the seemingly boring business of title insurance!

Monday, December 1, 2008

Goodbye Tanta - I will miss you...

Doris Dungey (Tanta) - a really competent blogger in the mortgage area has died at an unfortunately young age.  

I am not much into obits...  I would rather praise the living when they can enjoy it.

But I will give you one blog post - an absolute gem which shows the quality of the woman:

John Hempton

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.