Variant Perceptions

Category: psychology

Munger on patience

How many different things has Wesco done since Blue Chip Stamps? We’ve only bought two or three companies and made a few big stock purchases. We’ve probably made a significant decision every two years.

But nobody manages money this way. For one thing, clients won’t want to pay you.

But this is not fun, watching and waiting, for people who have an action bias. Too much action bias is dangerous, especially if you’re already rich.

It takes character to sit there with all that cash and do nothing. I didn’t get to where I am by going after mediocre opportunities.

There are a lot of things we pass on. We have three baskets: in, out and too tough. A lot of stuff goes into the ‘too tough’ basket. We can’t do that if it’s a problem at a Berkshire subsidiary company, but if we don’t own it, we just pass. I don’t know how people cope trying to figure everything out.

We have to have a special insight, or we’ll put it in the ‘too tough’ basket. All of you have to look for a special area of competency and focus on that.

But our theory is that getting a real chance to invest at rates way better than average is not all that easy. I’m not saying it’s not moderately easy to beat the indices by half a percentage point every year, but the moment you seek higher returns, is a very rarified achievement.

The only way we know how to do this is to make relatively few investments of size.

It’s not so bad to have one’s money scattered over three wonderful investments.

Suppose you were a real estate investor with a 1/3 interest in the best apartment complex in town, the best mall, and the best office building. Would you feel like a poor, undiversified investor? No! But as soon as you get into stocks, people feel this way. Partly, people need to justify their fees.

Over many decades, our usual practice is that if something we like goes down, we buy more and more. Sometimes something happens, you realize you’re wrong, and you get out. But if you develop correct confidence in your judgment, buy more and take advantage of stock prices.


Quiet, dignity and grace

A little comic relief after a couple of heavy value investing weeks. As you can imagine not the right attitude. Stop it! stop that! stop it! you’ll kill him!

Vodpod videos no longer available.

Gramercy Capital: it’s alive?

They say that the best investing is dispassionate. Fundamentals improving? buy. Fundamentals deteriorating? sell. No celebrations or funerals, just cold hard facts. I have to recognize though a sense of relief that Gramercy reached a positive settlement for Realty and will soon file its financial statements.

You might wonder why relief and not joy, was not the settlement a positive outcome?

It was. The thesis supposed a complete loss of Gramercy Realty and hinted the possibility of a legal struggle that could have taken months. Instead, the uncertainty has been completely removed with Gramercy receiving $10 million in management fees and at least $3.5 million in incentive fees for administering Realty. We do not know all the details but this is much better than getting nothing.

Even more, if you are following closely the situation you might have heard that CDO 2005 excess interest income is flowing to corporate. In case you miss that important point let me repeat it. CDO 2005 is alive and its cash flow faucet is open, Fitch broke the news a month ago.

Since last review, the CDO exited its reinvestment period. Six assets are no longer in the pool, including four CRE CDO securities sold at a loss; one mezzanine loan paid in full; and one real estate owned (REO) office property, which was exchanged for a performing office loan, as allowed under the transaction documents. While all overcollateralization tests are now passing, as of the June 2011 trustee report, the CDO was previously failing at least one test since March 2010 leading to the diversion of interest payments due on the junior classes to pay down class A-1.

But the investing emphasis in downside protection takes its toll. It’s a life of more question marks than exclamation marks and the feeling when proven right is not the joy of a Young Frankenstein surprised by his creation.

Months of checking and double checking the thesis while being patient creates anticipation with no uncertainty. Actually, the goal in investing is to avoid surprises. Good downside protection analysis should provide as much certainty as possible. And with it, it should bring the death of joy.

What do we get in return? A smirk in the face, a little gloat and relief. Being human I suppose that’s the consequence of enjoying more the process than the outcome.

Earnings Power

I have been receiving lots of questions about the consequence of the Gramercy Realty deed-in-lieu of foreclosure agreement. The following is my best guess of Gramercy’s current earnings power. Please corroborate the numbers as soon as we get the financial statements. There may have been some big changes over the last year … it has been a long time.

NII net of preferred dividends 53M – 63M
CDOs Excess Cash Flow 60M – 70M
Preferred Dividends (7M)
Fees 17M – 20M
CDOs Senior Collateral Management Fees 3.5M
Gramercy Realty Management Fees 10M
Gramercy Realty Incentive Fees 3.5M – 6.5M
SG&A (28M)
FCF pretax 42M – 55M
FCF pretax per share $0.8 – $1.1
Unrestricted Cash 150M

Using the current market multiple for Newcastle Investments NCT, that  is a very similar company to Gramercy, we arrive to a target valuation between $6.6 and $7.7 per share. And I consider NCT very cheap indeed.

Market Cap 392M 160M
Unrestricted Cash 34M 150M
FCF pretax 84M 42M – 55M
FCF multiple 4.3x 4.3x
Price Target $4.9 $6.6 – $7.7

Granted, Newcastle NCT is already paying a dividend of $0.4 per share and we are still waiting to know what Gramercy decides on this issue. At the same time, Gramercy has a better risk profile with a large percentage of its value consisting of cold hard cash and fees.

So the answer to your question readers is yes. Gramercy Capital is cheap and safe.

What’s next?

The answer is simple: here come the catalysts. And it should be an avalanche over the next few months.

  1. Financial Statements: The company already announced that we will have a 10K before the end of September. It will be time to know what has been going on the last year and to finally see the large unrestricted cash consequence of selling the Corporate New York leaseholds … if there are no other large material transaction besides the preferred buybacks and the healing of CDO 2005.
  2. Preferred Share Dividend: including the payment of 12 quarters of arrears. As you can imagine, that by itself make the preferred shares trading at par a very nice opportunity. I hope that after all the Gramercy write-ups you understand why I am looking for more by buying the common.
  3. Common Equity Dividend: Gramercy is in no hurry to reestablish them considering the recent very large accumulated loses and the large pipeline of opportunities in the CRE space. However, considering the experience of similar companies like RAIT Financial RAS and Newcastle Investments NCT, I would not be surprised with a small dividend of around $0.3 per year (30% of FCF) that would permit Gramercy to tap the capital markets in the future for the plenty of available accretive opportunities. Hey, I would not mind that FCF reinvested at 20% ROIs.
  4. Foreclosing Good Collateral:  With lots of cash, two CDOs cash flowing and management fees, there should be no worries about the future and Gramercy can be more aggressive. One way is taking control of cash flowing collateral by using the replacement strategy. Instead of continuing to extend these CDO loans why not take control of the property at great prices. Compared to banks we don’t have regulator pressure to sell them and can receive rent income instead (ie: RAIT Financial RAS). Yes, we can benefit of deed-in-lieu of foreclosures, we are not just on the receiving end.

With Gramercy Realty’s uncertainty resolved and CDO 2005 cash flowing ahead of schedule, two big mysteries were solved. But I start to wonder about the dog that has not barked … what will Gramercy do with all that unrestricted cash?

Gramercy Corporate has not been in the news in any big transaction, except for the curing of CDO 2005, and has not filed an 8K detailing one either. Without financial statements I am in the dark as everyone else but it seems Gramercy has not done much with that cash.


It is not for lack of opportunities or not enough time to close them. For example, competitors have been active over the last year. My impression is that Gramercy is preparing something big but needed to resolve Realty first before committing.

What could that be? I wish I knew but let me throw one possible scenario just for the sake of showing the range of possibilities that open up after the Realty settlement.

What if Gramercy is planning something massive like buying a large part of the dead parrot CDO 2007 bonds?

Let me repeat, this is pure speculation. But I have seen other non agency mREITs buying tranches of their non cash flowing CDOs not because they want to cure them but just because it is good allocation. When an mREIT has other sources of income, like fees and other flowing CDOs, it can take advantage of the acceleration of principal payments for the CDO senior notes.

Gramercy is both a lender and a operator of real estate, and is able to buy its debt at a discount so nothing stops it. And competitors NorthStar Financial NRF and Newcastle Investments NCT have done it too.

It might also explain why the Realty negotiations reached port so soon after a change of Roger Cozzi’s and Tim O’Connor’s incentive package that instead seemed to tip that Gramercy was preparing for a long protracted negotiation. The widening spreads of the last weeks may have provided a large buying opportunity that might have convinced Gramercy to soften a tough negotiation stand. Add that the difficult economic conditions might make difficult a turnaround of Realty … and voila?

After seeing recently buybacks of  flowing CDO bonds at 50% of par, it would not be a shock if senior CDO 2007 bonds are below 40% and that would be great. But I do not know for sure.

What can go wrong?

Gramercy has been in the news lately with the fight over two distressed loans Jameson Inns and Hilton Las Vegas. And more will probably come. However the situation is much different from 2008-2009 when delinquent loans could have compromised the viability of Gramercy. Now Gramercy can negotiate from a position of strength when the worst that can happen with a defaulting loan is a quarter or two of CDOs not cash flowing but in return Gramercy can take control of good properties at bottom prices.

In terms of macro, a Japan type of scenario with interest rates at zero as far as the eyes can see could be positive. Banks with large concentration of CRE loans have been restricted by tough regulators of lending more to the sector, so the conditions have been fantastic for the remaining lenders with 5% plus CRE loans’ yields.

The only bad scenarios that I can foresee at the moment is a 1930s depression or a large capital misallocation. And there is no evidence that we are facing either of those.

Templeton on rational optimism

And now the last principle. Do not be fearful or negative too often. For 100 years optimists have carried the day in U.S. stocks. Even in the dark ’70s many professional money managers made money in stocks, especially those of smaller companies.

There will, of course, be corrections, perhaps even crashes. But, over time, our studies indicate stocks do go up … and up … and up.

Advice that you have probably heard from other greats but few said it better or more often than John Templeton. From the 16 Rules for Investment Success (PS: can someone remind me where did I get this copy to give proper attribution?)


I am having the fun of a lifetime with the BBC Sherlock, so my apologies if you do not like the arrogant and obnoxious new header of the blog. It will stay there for a couple of weeks as an experiment. And any suggestion that this show inspired the most recent banking post is probably right.

PS: I am on the fence on the Asperger or Sociopath debate, it is just a good show

Kahneman and Klein: failing to disagree?

As you have probably noticed, I do not post much on the self control and psychological aspects of investing. There are better places to find that type of information. But given that I am probably the only investor on Earth that reads the McKinsey Quarterly, an unhealthy habit of my management consulting days, it looks that is up to me to give this link to the interview to Daniel Kahneman and Gary Klein (free subscription needed)

It seems that the reason for the interview was a joint article in the September 2009 American Psychology on “Conditions for intuitive expertise: A failure to disagree”. That failure to disagree part I still do not believe. Given that probably most of you are well versed on Prospect Theory, the work of Daniel Kahneman and Amos Tversky on human biases, let ‘s give Gary Klein the mic so that he explains himself why this failure to disagree seems odd. These are the first two introductory paragraphs to his book Sources of Power: How People Make Decisions

During the past twenty-five years, the field of decision making has concentrated on showing the limitations of decision makers – that is, that they are not rational or very competent. Books have been written documenting human limitations and suggesting remedies: training methods to help us think clearly, decision support systems to monitor and guide us, and expert systems that enable computers to make the decisions and avoid altogether the fallible humans.

This book was written to balance the others and takes a different perspective. Here I document human strengths and capabilities that typically have been downplayed or even ignored.

So Klein is the ying to Kahneman’s yang. His book documents the stories of firefighters, pilots, nurses, military leaders, chess players, and other experts in several fields and how they really make decisions. I have a weakness for this point of view, as a chess player it took me years to get rid of Kotov’s analysis tree (that by the way is how computers analyze) and start relying more on intuition and pattern recognition to much improved results. At the same time, I recognize that value investors have plenty of time and do not face the fog of war so their process is more similar to correspondence chess than to competitive chess.

When value investors think of a book by Gladwell they naturally refer to Outliers with its references to unexpected disasters and wild successes. Well, Gladwell cites Klein extensively but in his other book: the book that should not be named. And not surprisingly the citations include stock traders:

Once, out of curiosity, Van Riper and Klein and a group of about a dozen Marine Corp generals flew to the Mercantile Exchange in New York to visit the trading floor. Van Riper thought to himself, I’ve never seen this sort of pandemonium except in a military command post in war – we can learn something from this. After the bell rang at the end of the day, the generals went onto the floor and played trading games. Then they took a group of traders from Wall Street across New York Harbor to the military base on Governor’s Island and played war games on computers. The traders did brilliantly. The war games required them to make decisive, rapid-fire decisions under conditions of high pressure and with limited information, which is, of course, what they did all day at work.

Klein is to a trader what Kahneman is to a value investor. It is a fun interview and with the recent emphasis on the benefits of checklists, even in an intense and time constrained environment as hospitals, you might want to check Klein’s views on that too. Other interesting topics discussed are

  • When to trust intuition
  • The use of experts
  • Management careers favoring overconfidence bias
  • Pre-mortems (you read that right, pre not post)
  • Benefits and problems of checklists
  • Correlated errors in group decisions
  • Balance of reducing chances of error versus gaining insight
  • Quality of meetings
  • and more…

Enjoy: link to the interview to Daniel Kahneman and Gary Klein (free subscription needed)

Alpha Magazine Hall of Fame – The Traders

This is the second part of excerpts from Alpha Magazine Hall of Fame 2008 from interviews with some famous hedge fund managers. In the first part we review the more familiar fundamental investors. Now we go to the more esoteric stuff: macro traders (Louis Bacon, Bruce Kovner, George Soros, Michael Steinhardt and Paul Tudor Jones). I would emphasize a couple of things.

  • There is a lot of hogwash in the macro traders’ camp, but these managers are the best and if we learned something the last few years is the need to understand bubbles and how to ride them
  • I was very surprised with the few mentions of leverage or shorting or risk management. Is it part of the fabric already?
  • Paul Tudor Jones seems like a lot fun and reasonable. Not sure if I want to be a slave of the tape the rest of my life though.

Institutional Investor’s Alpha Magazine – June 200

The Industry

  • The crowded nature of the hedge fund community has changed the character of trading so that you can see waves of risk-taking and derisking coming from the hedge funds themselves – Kovner
  • But a hedge fund is a superior way of running money -or it has been. But as the industry gets bigger and bigger and takes up a larger and larger segment of the market, it renders it more difficult to outperform and to justify the fees – Soros
  • They go for size and are less interested in absolute performance. They are more interested in relative performance – Steinhardt
  • I was very sensitive throughout my career to the idea that the bigger you are, the bigger your risk is – Steinhardt


  • Fundamentals might be good for the first third or first 50 or 60 percent of a move, but the last third of a great bull market is typically a blow-off, whereas the mania runs wild and prices go parabolic – Tudor Jones
  • Many of the successful macro guys today, they’re all kind of in my age range. They came from that period of crazy volatility of the late 70s and early 80s, when the amount of fundamental information available on assets was so limited and the volatility so extreme that one had to be a technician – Tudor Jones
  • I lost my stakes a couple of times which taught me risk control and risk management. Losing those stakes in my early 20s gave me a healthy dose of fear and respect for Mr. Market and hardwired me for some great management tools. Oh, incidentally and by necessity, I became a pretty good fundraiser – Tudor Jones
  • The macro space will be great. I think we’re going into one of those slow or zero-growth periods in the US, which will give us a lot of volatility. – Tudor Jones
  • While I’m a staunch advocate of higher education, there is no training –classroom or otherwise- that can prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market. There’s typically no logic to it; irrationality reigns supreme, and no class can teach what during that brief volatile reign. The only way to learn how to trade during that last, exquisite third of a move is to do it, or, more precisely, live it – a sort of baptism by fire – Tudor Jones


  • He gave me an ongoing tutorial in disassociating oneself from the results of the trade, yet still have passion about it. – Bacon on Tudor Jones mentorship
  • The prevailing paradigm underestimates or disregards the element of uncertainty. I consider myself an insecurity analyst, not a security analyst – Soros
  • I see the younger generation hampered by the need to understand and rationalize why something should go up or down. Usually, by the time that becomes self-evident, the move is already over – Tudor Jones
  • Being a hedge fund manager is particularly suitable for the pursuit of truth – Soros
  • When I got into the business, there was so little information on fundamentals, and what little information one could get was largely imperfect. We learned just to go with the chart. Why work when Mr. Market can do it for you? – Tudor Jones
  • When I was investing, I measured it one way – which was raw performance – Steinhardt


  • The view I started with and embodied in Caxton’s fund was that business cycles were very important and that they occurred all over the world, and it was useful to observe them and to advantage of the opportunities across four different asset classes (equities, fixed income, commodities and currencies) – Kovner
  • When it comes to trading macro, you cannot rely solely on fundamentals; you have to be a tape reader, which is something of a lost art form –Tudor Jones
  • While I spend a significant amount of my time on analytics and collecting fundamental information, at the end of the day, I am a slave to the tape and proud of it. – Tudor Jones
  • One of the most important skills you need is to constantly reinvent where you put resources. Commodities markets were quiet for years, Now they’re very strong – Kovner
  • We feel that we are versatile enough that we can move into a number of different strategies, and if doing that means that we’re global macro, then we’re not going to argue with that label – Bacon
  • The lesson was that picking the right investment will trump any lousy trading around it – Bacon
  • We tend to make top-down, interest-rate-driven investments. We’ve been pretty U.S. and European –centric throughout most of Moore’s history, and we have been pretty closely focused on what happens with the interest rate cycle and the reactions that it drives around the world – Bacon

Munger on personal honesty

The ethos of not fooling yourself is one of the best ethoses you could possibly have. It’s powerful because it’s so rare

Pabrai on checklists

Pakiya Funds is an interesting new blog. I have followed his posts in Seeking Alpha and they are insightful. What else can I say, he recommends Wellcare, Global Ship Lease and Constellation Energy Partners. He MUST be insightful.

He also provides a link to a Mohnish Pabrai pdf on the use of checklists. Recommended

Charlie Munger is famous for saying that investors should use a checklist for selection of companies to invest in. Mohnish Pabrai recently presented on the lesson he learned from the 2008 Credit Crisis and talks about his process for creating his extensive investment checklist.

Munger on envy

Then there’s the chasing of the investment return rabbit. What if you had an investment that you were confident would return 12% per annum. A lot of you wouldn’t like that -especially if you’ve done better- but many would say, “I don’t care if someone else makes money faster.” The idea of caring that someone is making money faster is one of the deadly sins. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun. Why would you want to get on that trolley?