SEC Weighs Bringing Back Fractions in Stock Prices
By ANDREW ACKERMAN And TELIS DEMOS

For some stock prices, the new math might look a lot like the old math: Regulators are thinking about bringing back the fraction.

The move would at least partly undo an 11-year-old rule that replaced fractions of a dollar in stock prices, like 1/8 and 1/16, with pennies. The idea of that change was to trim investors’ trading costs: One-cent increments can lead to narrower gaps between the prices at which brokers buy and sell shares—potentially reducing their opportunity to shave off profits.

Those championing the fraction’s return say it would spur securities firms to buy and sell more shares of some companies by making it more profitable for them to do so. Opponents say fractions would increase trading costs for investors with little or no benefit to companies.

Discussions are still in the early stages and it is unclear what the Securities and Exchange Commission will ultimately decide. Furthermore, any change would affect only some smaller companies. “People are increasingly raising this idea with us directly,” SEC Chairman Mary Schapiro said in an interview. “We will look at it, but there are obviously trade-offs.”

The idea will be discussed by the SEC’s staff at a public meeting in coming weeks. That could lead to a pilot test to help the agency learn more about the idea, according to people familiar with the process.

It isn’t clear if the pilot program would apply to companies that fall below a certain market value or trading volume, or whether certain companies would be allowed to choose fractional pricing instead of pennies.

11 Years

The length of time that the rule eliminating fractions for stock prices has been in place.

Arthur Levitt, who oversaw the move to decimal pricing as head of the SEC from 1993 to 2001, said the switch to decimalization “transferred billions of dollars from the pockets of brokers into the pockets of investors.” But he doesn’t object to a pilot testing alternative stock-price increments.

An SEC study this summer said the effect of decimalization on the cost of large transactions is “mixed.”

The move to decimalization was the culmination of an intense debate about the power of market-makers for stocks, such as the specialist traders who worked on the floor of the New York Stock Exchange. Regulators accused several firms of abusing their position to profit by improperly raising the cost of trading.

The push to revert to wider “tick sizes,” as traders call them, comes amid an argument over whether or not decimalization has made markets less welcoming for small companies looking to attract investors to their initial public offerings of stock. Some executives, banks and advisers say that banks do less to drum up investor interest in these shares because of lower profits.

As evidence, people in this camp point to the decline in the number of U.S.-listed company IPOs raising less than $50 million. In the late 1990s there were typically more than 100 such IPOs a year, compared with fewer than 10 so far this year, according to Dealogic.

If you move away from penny pricing, “investment banks will be able to make enough money trading…to write research and re-create the spark in the engine,” said Jeffrey Solomon, chief executive of Cowen & Co., an investment bank focused on smaller companies that is part of Cowen Group Inc.

Others disagree. “If your goal is to lure investors back into the market, raising their transaction costs doesn’t seem like a particularly good way to do it,” said Barbara Roper, director of investor protection at the Consumer Federation of America, a nonprofit consumer advocate.

SEC officials are considering either proposing a rule themselves—or asking the exchanges where stocks are listed, such as those operated by NYSE Euronext, Nasdaq OMX Group Inc. and BATS Global Markets Inc., to propose a rule—for a pilot program to test fractional stock prices, said people familiar with the agency. Some SEC staffers believe the use of different tick sizes in some overseas markets shows that a one-size-fits-all approach isn’t the only way to go, these people said.

The pressure to change how stocks are priced is coming in part from Republican lawmakers, small-company executives, venture-capital firms and banks dealing with small companies, many of whom also backed passage this year of the federal Jumpstart Our Business Startups Act, or JOBS Act. The White House and legislators said that law would spur job creation by making it easier for small companies to raise capital.

The JOBS Act required that the SEC study decimalization. The agency in July reported that there was wide academic agreement that “spreads,” the prices at which investors want to buy and sell stocks, have narrowed since decimalization. But its report said research was inconclusive about the relationship between decimalization and bank-trading profits.

Some on Wall Street share the view that there is no clear link between decimal pricing and bank trading profits. “We wouldn’t look to tick size as a material solution to the bigger problems in the IPO market. That probably has more to do with macro effects than micro effects: a sour economy…and geopolitical uncertainty,” said Jamie Selway, head of liquidity management at ITG Inc., an independent Wall Street brokerage firm that sells computerized trading algorithms and operates a “dark pool,” where stocks can be traded at sub-penny prices.

The SEC’s review urged further study of tick sizes. But JOBS Act advocates have pressed for action on the matter.

“We don’t need more study,” said Christine Jacobs, chief executive of small-cap company Theragenics Corp. and the co-chairman of the SEC’s Advisory Committee on Small and Emerging Companies, which includes venture capitalists, securities lawyers, investment bankers and executives in technology companies.

She said her group is preparing its own proposal to submit to the commission. “We need to find a way to apply the JOBS Act to companies that are already public.”

Corrections & Amplifications
Jeffrey Solomon is chief executive of Cowen & Co. An earlier version of this article incorrectly said he was chief executive of the investment bank’s parent, Cowen Group Inc.

Write to Andrew Ackerman at andrew.ackerman@dowjones.com and Telis Demos at telis.demos@wsj.com

A version of this article appeared October 26, 2012, on page A1 in the U.S. edition of The Wall Street Journal, with the headline: Market Divided Over Fractions.

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– Jeff Thorp

http://online.barrons.com/article/SB50001424053111904571704577404264215025458.html?mod=BOL_hps_mag#text.print

Best 100 Hedge Funds
By ERIC UHLFELDER
As industry assets pass $2 trillion, mortgage specialists surge to the top.
Christian Zugel enjoys high speeds more than most people. A native of Stuttgart, Germany, home to Porsche and Mercedes, the 52-year old fell in love with cars at an early age and today races on the amateur-motor circuit at tracks like Daytona, where he pushes his Porsche Spyder to speeds near 200 miles per hour.

He moves through the financial world at a pretty good clip, too. The former head of high-yield bond trading at JPMorgan, Zugel created Zais Group back in 1997. The asset manager now oversees $6.4 billion from its main office in Red Bank, New Jersey, as well as newer outposts in London and Shanghai. His $418 million Zais Opportunity Fund, which buys portions of collateralized-loan obligations, also has taken the winner’s checkered flag in Barron’s annual ranking of the Top 100 Hedge Funds. The fund returned an average of 78.5% annually to its investors in the three years ending 2011.

“I’m drawn to [racing and investing] out of a desire to excel in challenging environments and to control my own destiny,” says Zugel, who holds a masters degree in economics from the University of Mannheim in Germany. “Both require discipline and consistency, and keen understanding of acceleration and break points.”

THE LAST THREE YEARS have provided a smooth track for hedge managers like Zugel who negotiate the complicated world of fixed-income assets, including asset-backed and mortgage-backed securities. They were at the heart of the credit crisis in 2008 but have recovered strongly since. In the case of asset-backed securities, “they were hammered so excessively that when markets finally normalized, it set the stage for a powerful rebound that has continued to this day,” he says. Zugel’s fund was badly hit in 2008, having lost 73.6%, but survived and has roared back impressively.

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Peter Murphy for Barron’s
Christian Zugel
That financial crisis is fading in the rear-view mirror. Five of Barron’s top seven funds invested in mortgage- or asset-backed securities.

No. 2 on our list is Metacapital Mortgage Opportunities, founded by Deepak Narula, a former head mortgage trader at Lehman Brothers who started his firm in 2001. He created this fund, which has averaged an annual gain of 62% in the last three years, near the height of the turmoil in 2008 just as his one-time employer was imploding.

Most recently, Metacapital has played the unexpected stability in Americans’ mortgage-repayment rates. “Government policy targeted certain homeowners to refinance their mortgages at lower rates,” he explains. That might have sent some prices lower. Narula didn’t believe it would happen. He was right, and Metacapital profited “as payments continued to flow into these securities.”

Another beneficiary of strong mortgage securities markets is 68-year old, former philosophy professor Don Brownstein and his SPM Structured Servicing Holdings fund. The blandly-named $1.7 billion fund, which relies on the research of about a dozen Ph.D.s., has soared by 61.84% per year on average over the last three years. A second Brownstein mortgage vehicle was No. 4 and the $1.4 billion Providence MBS fund ranked seventh among the Top 100.

The best-performing equity-only hedge fund in our ranking was the long-only Cambrian Fund, posting a three-year annualized return of 28.38%.

Some absent from this year’s Top 100 correctly anticipated the meltdown but later strayed into other sorts of investments. Notably missing this year is John Paulson, who’s best known for shorting mortgage-backed securities in 2007, when his Paulson Credit Fund rose close to 600%.

His event-driven Advantage fund made our list the previous four years. It was down 36% last year, sidelining his three-year performance. And Philip Falcone’s Harbinger Capital Partners fund also disappeared from the Top 100 ranking, following his losing bet on LightSquared, the wireless venture that recently filed for Chapter 11. Falcone, too, anticipated the credit crisis, but he’s struggled in its aftermath.

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The declining fortunes of some prominent mortgage bears isn’t the only sign that the effects of 2008′s collapse are receding. HFR, which researches the business, reports that in 2011 hedge-fund assets broke the $2 trillion mark, exceeding the year-end 2007 pre-crisis peak of $1.87 trillion. It had declined as low as $1.4 trillion in 2008. And the number of funds reporting as of first quarter 2012 has now eclipsed the December 2007 level of 7,634, rising to 7,659.

HEDGE FUNDS’ FLEXIBILITY is one reason they’ve proved so durable. Top-performing funds like those of Ray Dalio’s Bridgewater Associates (see story, “Dalio’s World”) or David Tepper’s Palomino fund combine stocks, bonds, currencies, and commodities. Multi-strategy funds, most of which fared poorly when virtually all assets declined in 2008, have seen some of the strongest gains since.

The average three-year annualized returns of Barron’s leading multi-strategy firms soared to 25.71% from last year’s 15.23%, led by the $840 million GLG Market Neutral Fund (No. 14). It has averaged a gain of 35.45% over the last three years. Even Zugel’s seemingly narrow asset-backed fund can spread its bets among many corporate borrowers.

The diversified approach has done well, explains Andrew Redleaf, CEO and manager of the 22nd-ranked Whitebox Multi-Strategy Fund, because it allows managers to exploit the rotation in leading strategies, a particular advantage as different classes have constantly jockeyed for leadership since the markets finally bottomed. “We also have the flexibility to navigate the volatility that’s been part of the recovery,” he adds.

That’s in part the idea behind Bain Capital’s Absolute Return Capital Partners Fund, which seeks relative value and was No. 72 on the Top 100 list with a three-year return of 19.44%. The fund also handles a small ($250,000 to $500,000) part of Republican presidential candidate Mitt Romney’s blind trust as well as a bigger IRA, according to public filings. Of course, Romney retired from the private-equity firm in 1999, and his investments today are spread among a large number of vehicles across many asset classes and managers.

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Top 100 Hedge Funds: 1-50
Although declining to confirm or deny Romney’s passive stake, Jeffrey Woolbert, portfolio manager, explains that in 2004 Bain set out to diversify the firm’s holdings beyond the its private-equity and credit portfolios. The result, he says, is that they “looked to apply the relative value approach to additional esoteric asset classes like currencies, rates, and commodities.” Not only have the returns been strong but assets have jumped to above $2 billion as foundations and pension funds have put money in.

The financial crisis proved the power of Absolute Return’s diversification, says Woolbert. The fund lost just 6% in 2008, and recovered sharply from even that small decline in the first two months of 2009, when equity markets were falling. The fund earned 31% in 2009. “We’re most proud of the fact that we’ve generated returns with negligible co-relation with equities,” says Woolbert.

Barron’s numbers suggest just how important the ability to change lanes is. Our list is dominated by firms that have the freedom to go long or short and to shift among markets. In the last three years, the Top 100′s average annualized hedge fund returns were an impressive 25.55%. This was nearly triple the 9.05% average return of BarclayHedge’s main fund index and nearly double the Standard & Poor’s 500 index’s gain since the end of 2008.

MANY HEDGE FUNDS got a big boost in this year’s ranking because we use a three-year return, which means that 2008, for our ranking purposes, no longer exists. That brought back some names we haven’t seen in awhile. For instance, multi-strategy manager Citadel, which had been off our list since 2007, came in 21st this year with a three-year annualized gain of 29.36%. Another returning member was the event-driven Third Point Offshore Fund, No. 42.

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Top 100 Hedge Funds: 51-100
Making its first appearance on our list is equity long/short Omega Capital Partners fund, managed by respected Wall Street veteran Leon Cooperman, whose offering returned more than 21.57% annually over the past three years.

Nearly making the cut this year were well-known names like Steve Cohen’s SAC Capital International fund and Elliott International. A little further off the mark were D.E. Shaw, Brevan Howard, Cerberus, Farallon, and King Street.

Barron’s hedge-fund ranking highlights what’s possible from this community for investors looking to create a diversified portfolio, possibly securing above-market returns. It isn’t a recommendation to chase last year’s victors. To sidestep funds that benefit from a momentary jump in a certain industry or asset type, we exclude funds that invest in a single country, sector, commodities or narrow asset types. Our minimum fund size is $300 million, to include those vehicles that offer some stability and liquidity. We worked with two hedge-fund database outfits to compile our list, BarclayHedge (barclayhedge.com) and Morningstar (alternativeinvestments.morningstar.com), which sort through thousands of funds to meet our basic criteria. We then contact each of the screen firms to verify their results. With the help of Barron’s contributing editor Erin Arvedlund, we also tapped into additional trusted sources for information, which we have used in gathering data.

SO WHAT WILL THE REST of 2012 look like? Slowing growth, more European debt woes, and an overextended stock-rally have made a number of our leading hedge funds nervous. JPMorgan’s $2 billion trading loss also raised concerns about the state of big financial institutions and regulatory risk. (Funds Nos. 68 and 89, BlueCrest Capital and BlueMountain Credit Alternatives, wouldn’t comment on reports that they were on the profitable side of the bank’s trades.)

But the managers also see opportunities in stocks, bonds and commodities.

Whitebox’s Redleaf sees especially good value in large-cap equities. He points out that in recent years, the trailing price-earnings multiple of small- and mid-cap shares (as measured by the Russell 2000) has widened considerably over the S&P 500′s multiple. Driven by mid- and small-cap stock gains, the multiple of the Russell last week stood at 28.67, versus 13.45 for the S&P 500. At the same time, the spread of price-to-book ratios, (large caps’ are normally bigger) have also narrowed to multi-year lows. Redleaf believes these trends will reverse.

The money manager is optimistic based on positive U.S. fundamentals, supported by strong corporate balance sheets, stable and accessible capital markets, a modest rebound in manufacturing and continued GDP growth.

Bain’s Absolute Return fund has moved into the commodities markets, which now represent about 40% of its total number of bets, an unusually large portion for a macro fund, according to Woolbert. Commodities prices have suffered due to the recent anxiety about the strength of global growth in China, the U.S. and Europe.

As strong as fixed-income performance has been, bonds still hold a lot of opportunities.

Growing restrictions on dealer-capital lending and bank proprietary trading (which JPMorgan’s big loss likely ensures) will accelerate market illiquidity and dislocation, according to GLG Market Neutral manager Steve Roth. He sees significant arbitrage opportunities among various capital securities opened up both by sovereign-debt problems and vulnerable banks, especially in Europe. Distressed-debt specialist Edward Mulé, whose Silver Point Capital fund is No. 54 on our list, agrees that the ongoing deleveraging of financial institutions will offer opportunities to credit investors over the next year.

Any additional central-bank intervention could also generate distortions in sovereign debt that nimble hedge-fund managers can exploit.

As is often the case, many hedge funds will race toward the roadside pile-up, hoping to profitably pick through the debris.

– Additional reporting by Jack Willoughby

E-mail: editors@barrons.com

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A quote I especially liked (and it is one of many) is:

How We View Our Legal Exposures
Our strategy is simple: When we are right, we will fight mightily to ensure a just outcome. When we are not, we will say so.

Many other excerpts are worth repeating, including this one.

But we must take serious action to ensure our success in the decades ahead
While our confidence in the next decade is high, for America to thrive after that, it soon must confront some of the serious issues facing it. We need to redouble our efforts to develop an immigration policy and a real, sustainable energy policy; protect our environment; improve our education and health systems; rebuild our infrastructure for the future; and find solutions for our still-unbalanced trade and capital flows.

The sooner we address these issues, the better – America does not have a divine right to success, and it can’t rely on wishful thinking and its great heritage alone to get the country where it needs to go. But I remain, perhaps naively, optimistic. As Winston Churchill once said, “You can always count on Americans to do the right thing – after they’ve tried everything else.”

On this blog I’ll seek to post thoughts or article which relate to the investment process or other things which we believe are interesting or thought provoking.

Jeff Thorp

This will be an interesting read

Amazing — and it’s less than half of this year’s anticipated budget deficit.