Tuesday, December 23, 2008

Madoff: Need for Trades/Statements from Independent Broker/CIT bonds/Pricing Discrepancy in Aon TCs

One lesson to be learned from the Madoff scandal is that trades and statements need to come from a major brokerage firm independent of the financial advisor.  Then, there would certainly be no easy way to fake the claimed returns.  The WSJ reported today that Madoff  initially had a trading strategy that failed and  thereafter did few if any trades for his clients. WSJ.com  Based on these reports, it appears that his investment strategy was a simple Ponzi scheme that went undetected for almost 30 years involving billions of dollars.  The second main lesson that I would learn from this scandal is that you have to learn to protect yourself.  (for example do not allow the financial advisor to generate their own statements and then also require the trades to go through independent brokerage companies).  Many of the investors with Madoff were steered to him by financial advisors who allegedly exercised due diligence for enormous fees.  I would also say that extraordinary due diligence would have to be exercised when the advisor knows the hedge fund is generating the statements and conducting the trades through a non-independent brokerage company.  It is impossible to believe that any meaningful diligence was exercised by any of them ever.  The primary tip off to me would have been the selection of the accounting firm, followed by returns that were too smooth and consistent, and then the statement themselves.  Really, if you drove up to Madoff's accountants office, knocked on the door, and no one was home at 10 in the morning, what conclusion would you draw?  I have never worried about these issues since I would never allow anyone to manage my money.   As long a I remain mentally competent, I will manage my own portfolio with no assistance or advice from anyone.    

Existing home sales fell by 8.6% in November. November existing home sales fall by 8.6 percent: Financial News - Yahoo! Finance A Larger-Than-Expected Drop in Home Sales - NYTimes.com It would be optimistic to expect a recovery for housing in 2009.   The median sale price plunged 13.2%.  Ultimately, the prices of homes have to have some relation to the ability to pay which means further price erosion is probably necessary. 

CIT received tentative approval to receive 2.33 billion in TARP funds.  NYTimes.com Yahoo! Finance  I am going to check later today to see how this news is impacting the pricing of its short term bonds.  This development has been in the works for weeks but I have not seen yet any significant positive impact, at least in the pricing of what I already own.   I checked my maturity dates for the CIT bonds in my main account and they are: 12/15/09; 3/15/2011 and 12/15/2012.  The one from 2012 is showing a 43 price in my account as of yesterday.  That is the one I am going to check today. 

I am currently inclined to finish adding to my over-weight position in long corporate bonds before making a significant hedge with  TBT.  Until I finish adding to the long corporate position, I will do no more than a 30 share buy of TBT which I have not yet done.  I mentioned earlier that the hedge and the long corporate bond position may both work, provided the long treasury bond starts to fall in price and rise in yield with the spread to comparable long corporate bonds narrowing.  This however would not be my purpose in establishing the TBT position.  The reason why I will do it has more to do with insurance for my long corporate bond position and a way to keep me in it longer that I might ordinarily do as explained earlier.

One of the points that I have made in the past about buying TCs is that a comparison of pricing among those containing the same underlying bond needs to be done prior to making a bid. Pricing in this market can reach epochal irrationality.  I already own two TCs containing a junior subordinated debenture issued by AON (SYMBOL AOC).  One of them is KVW which has a 8% coupon and the other is KTN with a 8.205% coupon.  Another one, DKK,  which I have never owned, has the same underlying AON bond in it and it also has a 8% coupon, just like KVW.  I checked both KVW and DKK prices before buying KVW a few weeks ago, only due to the pricing difference at that time between these TCs which was in favor of KVW at the time.   Now, DKK is priced at 15.9 and KVW at 17.1. This is the link to the DKK prospectus:  http://www.sec.gov/Archives/edgar/data/1071246/000090342304000159/sat_2003-3.txt  This one has as its underlying security the Aon junior debenture maturing in 2027 that has the 8.205% coupon, which is the same one in KTN (but KTN gives you the 8.205% rather than the 8% provided by KVW and DKK).  I have also discussed some of the drawbacks for the underlying security in the Aon TCs.   I am not in the market for another Aon bond since I am already at my limit.   At most, I would consider selling KVW and buying an identical dollar position in DKK if the spread rose some.  I would probably only do that to lower my existing cost position in this Aon bond and preferably at a long term capital gain.  I discussed this arbitrage in a prior post.  That is the way that I play it but others are apparent to me.    

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