Thoughts on the Sunday NYT

Again, a few nice things to write about and think about in today's Sunday NYT Business Section.

1. Ben Stein on Regulation - a little off the rails

I always enjoy reading Ben and find his passion and intellect inspiring (even giving him the props in a post I had written about Management Buy-Outs), but his piece today on Hank Paulson and the Committee on Capital Markets Regulation (the "Committee") was some preachy, tiresome stuff. Read below - see what I mean?

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Don’t get me wrong. Powerful people have studies that prove their points, and then they lobby Congress, federal regulators and state legislatures to get what they want. This is how the world works. This is called working the system, dealing with the world as it really is. But is it really right for prominent American executives, amid a host of scandals involving other executives looting their shareholders blind, to have the best and the brightest of academe and the Street lobbying for less accountability to shareholders?

Is there any higher goal at all for management than serving the stockholders openly and honestly? Is “competitiveness” even a meaningful word, compared with honesty and integrity in serving the owners of the company? What can “competitive” mean in this context? Would a hospital be more “competitive” if it didn’t have to take care not to kill its patients when it operated on them?

TOO many of our corporate chiefs are already paid too much. They already have too many layers insulating them from accountability to the law and to their stockholders. Our businesses are plenty competitive if you measure by profits — and how else would we do it? (Long ago, we gave up doing it by how we treat workers, a scale on which we would be in a lot of trouble.)

It’s fine for corporate bosses to be lobbying to keep themselves at the trough. That’s what we expect of them. But Mr. Paulson is sworn to represent all of the people, not just the powers that be on Wall Street. He is way, way too high up the pay scale to be their lackey.

Maybe it’s time for him to back off this committee and start thinking of a legacy that includes law, integrity and responsibility to more than just the chosen few of Wall Street and the corporate boardroom.

I don't know what was in your Wheaties this morning, Ben, but the whole premise of your missive is both insulting to Secretary Paulson and insulting to our intelligence. I, like you, have seen many fascinating and thrilling movies over the past 20 years, including: Portfolio Insurance - The Horror Flick (circa 1987), Private Equity and Junk Bonds - The Beach Party (circa 1985-89), Leveraged Derivatives - They're Not Just for Speculators Any More (1990-95),  Enron, WorldCom, Cendant and Other Space Age-sounding Companies - What's in a Financial Statement? (1999-2001). None of these movies were particularly fun and/or exciting, but we (the financial markets and its denizens) survived. Sh*t happened and people paid. So the whole self-righteous tone really doesn't do you or the issues justice.

The issue to me isn't whether or not regulation is appropriate, but what regulations are appropriate and how these regulations should be administered. I can tell you that a patchwork system - Federal agencies, State and local authorities, private citizens - won't work. Have you run a company of scale, Ben, or spent years operating in the bowels of a regulated institution? It's hard. It's costly. It's bureaucratic. So to ask Hank (and/or the Committee) not to ask the question about the impact of regulations on competitiveness is ludicrous. They're not saying abolish regulation. I think they are trying to determine the right amount of regulation and the right model for adminstering the regulations. Seems pretty sensible to me.

It is clear you have an axe to grind about executive compensation and that is ok. Don't own those companies whose compensation policies you believe are flawed and vote with your feet. But don't tell me that what the Committee is considering or the people they have asked to participate are part of some grand conspiracy to maintain the status quo or to roll back our fantastic regulatory regime. The current system is confusing and it sucks. What we don't want is a phenomenon similar to what we've seen in health care, where litigation overhang and the costs of insuring these risks has crippled the system. We need clear, sensible rules, with equally clear accountability and enforcement mechanisms. And this is not something achievable through a diffuse, patchwork regulatory model. I am happy Secretary Paulson has chosen to get involved in the Committee's mission and to raise its profile - the implications of its findings are potentially far-reaching and could materially benefit both managements and shareholders alike.

2. Paul Lim on Indexing - Hard to Beat

Paul had another sensible and insightful article, this time the value of indexing and how so few active managers have successfully beaten the indexes this year and, in fact, over the previous five years.

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This year through September, only 28.5 percent of actively managed large-capitalization funds — which try to beat the market through stock selection — were able to outpace the S.& P. 500 index of large-cap stocks, according to a new study by S.& P. In the third quarter alone, it was even worse, with only one in five actively managed large-capitalization funds beating the index.

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Over the five years through the end of the third quarter — a span that included both bull and bear markets — only 29.1 percent of large-cap funds managed to beat the S.& P. 500. What’s more, only 16.4 percent of mid-cap funds beat the S.& P. 400 index of mid-cap stocks, and 19.5 percent of small-cap funds outpaced the S.& P. 600 index of small-company shares. “The long term does seem to favor the indexes,” Ms. Pane said.

So does the near term. That’s because corporate earnings are finally expected to decelerate meaningfully over the next several quarters, said Richard Bernstein, chief investment strategist at Merrill Lynch. And in a period of slowing profit growth, stock market leadership typically narrows.

You would think that active fund managers would thrive during such periods — because, in theory, they could select the winning stocks from the market’s losers. But choosing the winners actually becomes that much harder, Mr. Bernstein said.

“In the past few years, when we saw unprecedented breadth in the stock market, it was a stock picker’s paradise,” he said. “Even if you were a poor stock picker, your chances of outperforming the broad market were quite high.”

But as it becomes more difficult to find stocks generating sizable gains, “we’ll begin to uncover who truly has the stock-picking ability out there,” he said.

Wow. I knew the numbers were compelling but not this compelling. I have long believed in creating a portion of my long equity portfolio in an "index-plus" manner, seeking managers and strategies that are specifically geared toward a narrow index base (e.g., a more concentrated portfolio than a broad-based index) with alpha generation via successful model-based algorithms. In fact, I actually seeded a company called Clear Asset Management that does exactly this. And they've done pretty well. Investing for alpha generation is a tough game - and the statistics are hard to escape.

Comments

[Yaser Anwar]

While Mr. Stein raises some valid concerns, he has lost oversight of some key facts:

1) The increase in regulation has led to an exodus of IPOs happening in Europe & Asia, which before would have debuted in the US. Why? Over regulation.

I'm glad that Mr. President G. Bush has given Hank Paulson the go ahead to work out a newer and much better Sarbax.

2) When Mr. Stein puts forth this rhetorical question, "Would a hospital be more “competitive” if it didn’t have to take care not to kill its patients when it operated on them?" I think that is absurd, IMO it's like comparing Apples and Oranges.

No wonder the AMA says the rapidly rising costs of malpractice insurance is causing many doctors to either leave the profession, move to states with cheaper insurance rates or cut back on riskier types of services they provide. (Services which are critical such as Surgery etc.)

Sorry if I was off-topic.