Tuesday, December 31, 2013
It’s truly one of the few pure plays on the Hedge fund businesses. Och-Ziff is structured as a partnership that pays out the lion’s share of its retained earnings to shareholders.
One key reason why I like Och-Ziff is their managers are all about taking on very low risk-adjusted return types of strategies. Here we are talking about pre-announced cash mega merger deals in which there is 2% to 3% arbitrage returned involving a three- or four-month holding period for buying shares now at a discount to the tender value and then cashing them in when due.
The ability to make sense — and money — doing deals like this is one of the beauties of a hedge fund, and it’s something most individual investors just aren’t equipped to do.
Another reason to like Och-Ziff is due to the anticipation of more institutional money flowing into hedge funds from corporate and public pension funds seeking ways to address looming long-term liabilities.
Undoubtedly, some of that money seeking high returns will flow to Och-Ziff, and according to CEO Dan Och, he is “very confident” that the company will be able to capture more than its share of the anticipated money flow into the industry.
Bryan Perry Editor, Cash Machine
The largest AUM are at a Connecticut firm at about 3 times Oz. J.P Morgan’s AUM are about double Oz. Clearly Ozm is not being hampered by its size, and has plenty of room to grow.
When it doubles its amounts under management (Aum) you would think it could double its income. All things being equal (caters paribus). Double income, double payout, less important double payout, double market value. Which just makes compounding more expensive.
Monday, December 30, 2013
A.W. Jones - The Original Hedge Fund
Measuring Market Risk
Jones was light-years ahead of both Wall Street practitioners and the academic community in developing an understanding of market risk as well as the relationship between individual stocks and the market. Before the academic community had codified the Capital Asset Pricing Model (CAPM) with its notion of Alpha and Beta, Jones had developed his own measure of market risk and how individual stocks related to the market. Even more astonishing is that he was actively managing the exposure of a risk-adjusted portfolio with this system.
Jones calculated a metric for each stock called Relative Velocity, which is closely related to the CAPM's Beta (the key difference being the omission of the risk-free rate in the calculation of Velocity). Relative Velocity was the tendency of a stock, based on historical performance, to move with the S&P 500 to a greater or lesser degree. Armed with this metric, the firm could then calculate to what extent its long book and short book were correlated with market moves. What follows below is an excerpt from the 1961 Basic Report to the Limited Partners of the firm, describing in detail the measurement and management of market risk.
From the 1961 Basic Report to the Limited Partners:
ON MEASUREMENT AND REPORTING
This is our post-graduate course. It should be taken by all partners and must be taken by those who wish fully to understand our bi-monthly reports.
In the main body of this communication we described our investment theories and explained at least the basis of our method. It now must be made clear that such a program cannot be put into operation without careful and continuous controls. We have developed methods which provide accurate measurement of the degree of risk being taken at all times as well as a system of allocation by which we determine whether our gains or losses are attributable to stock selection or to the trend of the market. Daily computations using this method enable us to see where we stand and permit us to plan any desirable changes with regard to market risk. In addition we have a moving record of our accomplishments in market or stock-selection judgment.
Different stocks habitually move up and down at different rates of speed, and hedging $1,000 worth of a stodgy stock against $1,000 worth of a fast mover would give no true balance of risk. We must therefore compute the velocity of all our stocks, both long and short, by their past performance, compared with the past performance of a good measure of the market as a whole. For this we use Standard and Poor's 500 Stock Index, which we consider the most scientifically constructed of the several averages. We shall refer to it below merely as the Standard 500.
We measure, for example, the size or amplitude of all the significant swings in the price of Sears Roebuck since 1948 against the corresponding swings in the Standard 500 and find that the average extent of these moves is 80 per cent of the average extent of the moves of the Standard 500. We say therefore that the Relative Velocity of Sears is 80.
By the same measurement (which we have made and which we bring up to date at about two-year intervals for over 2,000 stocks ) we find that the velocity of the stock of General Dynamics is 1.96. Obviously, to buy and sell short, respectively, equal dollar amounts of Sears and General Dynamics would constitute no true hedge. Instead there would have to be more than twice as much of the stable Sears stock as of the volatile Dynamics to cause them to offset each other in market risk.
To illustrate :
This would seem to be no hedge at all, but appearances change when we correct each dollar amount by the respective velocities of the two stocks:
It must be pointed out that relative velocity has nothing directly to do with the desirability of a stock. All a velocity measurement does for us is to measure one aspect of the risk we are taking when we buy it or sell it short. Either Sears or General Dynamics might be a good purchase or a good sale, depending on all the factors that go into stock selection. From here on all the amounts used in the various examples of aggregate stock holdings will be dollar amounts after correction for velocity.
Since the Standard 500 is composed mostly of the big "blue chips," which move slowly, a portfolio of stocks commonly used for investment by us will have an average velocity over 100. Thus a list of typical stocks worth $70,000 to $80,000 in cash, might come to $100,000 after correcting for velocity (cash times velocity in each individual stock.)
Measurement of Results
Let us now take the simplest of cases -- a fund of $100,000 equity or net worth, with $100,000 of long positions and $100,000 of short positions (each position computed in cash times velocity.) Such a fund, being fully hedged, has a market risk of zero and all net gains or losses will be attributable to good or bad stock selection, none to the action of the market.
For six months we maintain this even balance between long and short (this could hardly happen in actual practice,) though we shall certainly make shifts during the period within both the long and short list, thus realizing profits and losses, and then replacing the long stocks sold and the short stocks covered. Every day from the newspaper stock tables we calculate our gains and losses, arriving at a net figure for the long list and a net figure for the short list. These two figures are kept cumulatively and include both unrealized and realized gains and losses. By the end of six months, the following has happened: This is fine as far as it goes. It tells us that we have made $7,000 by good stock selection (since we are fully hedged), but it doesn't tell us how to allocate the gain as between long and short selection—perhaps we should have made more on the long side, in the market rise, or perhaps lost less an the short side. So the following further calculations are necessary:
1) Just to keep pace with the "market" rise of 5%, our long stocks, worth $100,000 should go up by $5,000. But in fact they went up by $9,000. The difference, attributable to good long stock selection, is $4,000.
2) Also to match the rise in the market, our $100,000 worth of short stocks should have gone up, showing us a loss of $5,000. Actually they went up only $2,000, and the difference, due to good short stock selection, is $3000.
3) For a total gain, to account for the net gain shown above, of $7,000.
With an Unhedged Balance
When we are not fully hedged, but have a net-long (as is usually the case) or a net-short balance, the operation has an added complication. Suppose now, still with $100,000 of equity, we are optimistic about the stock market, so we buy stocks worth $130,000 and sell short stocks worth $70,000. We hold this balance (though we may shift individual stocks) for one week, during which time the following happenes:
Our reports go to a good many persons besides yourselves, and because we do not wish to reveal to all who receive them the size of the fund, also in order to indicate more clearly to you the change in your own partnership share, the figures for gains and losses are not stated in dollar amounts but in percentages of our net worth at the beginning of the fiscal year. Therefore if the week's results illustrated above were for the first week of the year, the report for that week would read:
Progress : Since June 1, our fund has gained 2.1% against a gain of 1.0% in the Standard 500. On long stocks we show a gain and on short stocks a loss of 0.4%
These figures are the result of calculations made every day and kept cumulatively for the entire fiscal year. They include both unrealized and realized gains and losses for the period from the beginning of the fiscal year, and are calculated after brokerage expense and transfer taxes on all transactions that have taken place.
The reports take into account dividends received on long stock and dividends paid on short stack. They take into account also, at monthly intervals in our cumulative reckoning, the interest we pay to banks and brokers.
However, the reports overstate the eventual return to you, since they cannot conveniently, and do not, take into account the 20 per cent of realized capital gains paid over to management at the end of the fiscal year. Also, as the year goes on, the reports become more and more unfair in the comparison with the Standard 500 since to the latter should be added a small percentage as dividend yield.
We used to report regularly and we still do report occasionally the amount that we are making in the hedged part of the fund alone. In the example above, the hedged part of the fund is the entire minority, or short list, ($70,000) combined with an offsetting $70,000 of the long list. The entire long list being $130, 000, the hedged part of it is 7/13 of the whole. We now find how much we have made in the hedged part by the following calculation:
We keep this figure cumulatively during the fiscal year, reporting it also as a percentage (in this case 0.9%) of our equity. By a somewhat complicated method we calculate from it what we make on the hedged part of the fund as a percentage of the money actually used in it. This is a gain obtained without risk due to the trend of the stock market, and not to be had by any other form of investment procedure.
The Risk Figure
In the Market Judgment section of the reports you see a number variously called the risk figure, market risk, or percentage of risk in the Standard 500. From the above it is easy to see how this is obtained. Remember that our list of long stocks aggregates $130,000 only after the cash value of each stock in it has been multiplied by its velocity, relative to the Standard 500. This relates our long stocks to the Standard 500, so that $130,000 long gives us a risk on the long side alone (our equity being $100,000) of $130,000 divided by $100,000, or 1.3. Instead of using a decimal fraction we use a percentage and say that our long side risk is 130. By the same reasoning, our short risk, also exactly related to the risk in the "market", or Standard 500, is 0.7, or 70 per cent. Our net-long risk is therefore 60 (130 minus 70), which means that our net-long risk in the stock market is equal to 60 per cent of the risk we would be taking if we had our whole equity exactly invested in the stocks of the Standard 500.
Any minus figure will stand for a net-short balance, in which we gain from a decline in the stock market. At plus 40, say, we would be incurring about the market risk of a widow with half her money in somewhat stodgy, blue-chip common stocks and half in bonds. At plus 100 to 150 we would be taking the risks of a business man with most or all of his capital in more volatile stocks.
Containing, as it does, the velocity measurements of all of our stocks relative to the Standard 500, the risk figure is a very precise measurement of just what we want to measure. It enables us to adjust our position in the market exactly to our outlook for its probable future trend.
A.W. Jones - The Original Hedge Fund
Heirs to A.W. Jones by Chris Mayer Aug 15, 2011.
Last week, in The Daily Reckoning column entitled, Hedge Yourself!, I shared a few highlights from the investment philosophy of Alfred Winslow Jones, the “father of hedged funds.” Today, I’ll share some insights about some very smart guys who manage money in
In 1994, Daniel Och and the Ziff brothers started Och-Ziff Capital Management (NYSE:OZM). They wanted to earn consistent returns with low risk. In a sense, they were heirs to the ideas and techniques of A.W. Jones. And they have done him proud. The success of the OZ Master Fund, the main fund of the company, is one of the best in the business.
Since inception in ’94, the OZ Master Fund returned 14.2%, versus 8.4% for the S&P 500. That’s huge outperformance. Even more impressive is how it did so with a lot less risk. This is the idea of being “hedged.” You can see it in the performance of the fund during down months.
In all but four of the years, the OZ Master Fund actually made money during down months! And even when the fund fell, it fell far less than the market. With performance like that, it is no wonder Och-Ziff today manages $30 billion in assets, mostly institutional money such as endowments, pension funds and the like.
In the world of money, Och-Ziff is known as an alternative asset manager, an option becoming increasingly popular post-crisis. Based on various surveys, institutions are likely to boost their allocations to alternative managers more than threefold from 2009. This is a good tail wind for Och- Ziff. So one catalyst for the stock is growing that $30 billion number.
But what I really like about Och-Ziff is the people and the structure of the company. Successful money manager Martin Sosnoff was once asked how he invested in management teams. What did he look for? He answered: “I am always looking to buy owner-managers who want their stock to go up for solid reasons.”
Och-Ziff has exactly that. Dan Och is CEO and head of the investment committee. Och and his partners own nearly an 80% economic interest in the same assets at OZM shareholders. The firm went public in 2007, and these insiders have a five-year lockup. That means they can’t sell until late 2012. I would expect the partners to cash out some of their stake at that time. They have every incentive to the get the stock price up before then.
Moreover, they eat their own cooking. Of the $30 billion in assets under management, about 9% is money the partners and employees invested themselves. They have every incentive to do well in their funds because a good chunk of it is their own money. Plus, the partners take no salary or bonus. They get paid the way shareholders get paid – through distributions.
Those distributions are fat. Och-Ziff pays out 80-90% of its earnings. In the past three years, distributions per share were $1.42, $0.19 and $0.88. The distributions reflect the performance of the year prior. They took a hit in the financial crisis in 2008, as you can see with the low distribution in 2009. But they have since recovered. For the last 12 months – which includes the first quarter of 2011 – the stock’s paid $1.01 per share, for a near-10% yield!
In 2011, Och-Ziff should earn around $1.50 per share. Take 85% of that and you get $1.28. On $11.25 per share, that’s an 11.3% yield this year. The big dividend is always the last dividend, declared at the end of the year and paid in February. In 2012, the stock could earn $1.80, which would pencil out to yield of 13.6%, based on the current share price.
Key risks? There are always at least a few. One is there is some discussion of raising taxes on publicly traded partnerships. If subject to full corporate taxes, Och-Ziff would suffer a 20-25% drop in net profits. However, this has been bandied about for a while, has gotten lots of press and is at least partially discounted already. Plus, such a rule would likely be phased in over a number of years, softening the blow. The other key risk is what we called “key man” risk in my banking days. If Dan Och got hit by a bus, that would have a big impact on the firm that bears his name.
Let’s see if Och-Ziff meets my CODE criteria:
Cheap? The stock market is a market of secondhand goods and it can help to think about why the shares are for sale at all. The insiders sold a piece of the business to the public at over $30 per share in an IPO in late 2007 (and invested 100% of the proceeds in Och-Ziff funds). Today, OZM is half that. Asset managers typically get valuations of 19 times management fees and 9 times incentive fees. The former fees are valued highly because they are very stable, and the latter less so because they are more volatile. Using the blended 14 times for Och-Ziff gives us a value of about $21 per share on $1.50 in earnings, which seems fair, if conservative. When you consider Och-Ziff has grown assets under management at a 19% clip since 2001, it looks cheaper still. Looked at another way, the stock trades for about 10 times 2011 earnings. A growth stock, yet you are not paying for growth. The high yield offered also protects the downside here.
Owners? Och-Ziff aces this test, which forms a key part of our thesis, as I discuss above.
Disclosures? One of the most transparent companies in the business. It’s also a simple business. Gather assets, get paid. Invest well, get paid. There is little mystery here.
Excellent financial condition? Och-Ziff has few assets of its own, mainly cash, tax assets and some investments. What it has is $30 billion under management, a great brand name in the business and a team of talented and vested insiders. There is little debt, especially compared to its huge cash flows. Och-Ziff is in excellent financial condition.
Asset management is one of the best businesses in the world. It generates a lot of cash and has little need to reinvest that cash in the business. (Hence those fat distributions.)
I like Och-Ziff.
Thursday, December 19, 2013
Monday, December 16, 2013
With pipelines there are two ways we bring in cash. Spot tariffs on pipelines are higher than contracted rates, though they forsake the reliable cash generation that comes along with contract agreements.
Kinder favors the long term contracts that fuel our steady dividends. Ozm’s incentive distribution is more like selling in the spot market. Both companies have a blend. Kinder's Trans Canada pipe is about 80% contract, 20% spot (Contracts sold to committed shippers is 708,000 barrels per day (bpd), Trans Mountain total will be 890,000 bpd).
Ozm contract fees covers more than cost, but incentive fees supply most of the distribution. That means that Kinder can determine its dividends further out. Ozm has to wait until it is actually earned to know how much it will pay out.
Somehow it seems like OZ is out of touch with what Investors want. He thinks if he shows a record of incentive payouts, that Investors will pay for the unearned, uncontracted, evaporatable income payments at greater multiples in the share price. He must think its like a credit card report that gives you more points for a longer payment history.
Insider buying is a clue that both look undervalued from the inside.