Riding a Wheelbarrow
I have been mentoring a friend of mine who wanted to take control of his 401k plan and manage his investments rather than choosing from the standard mutual funds that have performed poorly in the past year or so. As I have shown him the mechanics of expanding the choices in his plan and discussed the rudiments of investing, I have shown him some investment plays. I try to explain the risks and potential gains. As his understanding grew, he expressed confidence in my approach by telling the familiar story of the tightrope walker Jean Francois Gravelot, better know as “The Great Blondin” who, upon crossing Niagara Falls in 1860, was about to return and asked the audience “Who believes I can cross back with someone riding in a wheelbarrow?” The audience always believed, but no one would get in, so he pushed his manager across for the show. It’s a story often used to illustrate faith. My friend told me he was getting in my wheelbarrow and was “in” for whatever I was doing. That will give you pause to reflect before making “recommendations.”
Trading strategies
Some of my investment plays are pretty straight-forward, and I gladly explain the rationale, but I still suggest he do his own analysis and not just jump in my wheelbarrow. I have made plenty of trades that didn’t work out so well. I still like to share trading strategies and “insights” (if it is fair to call my view of market opportunities as insight) as a teaching tool for him to explore ever widening opportunities in the market. For example, I like to follow the discount/premium ratios on some closed end funds, and buy them when they are more deeply discounted than usual. As an arbitrage play, this sometimes works well, with short-term appreciation possible as pricing returns toward a norm, sometime very quickly. If the discounted ratio holds, then I am along for the high yield afforded by nature of the discount – there isn’t so much downside risk.
Take your gains
He has become a fan of this strategy, and is learning why rules to take gains when you get them are better than decisions based on emotions of “maybe it will go higher.” I tell him my goal is to sell too soon, rather than too late, since I don’t have any idea how to pick a top (or a bottom). I also tell him that selling a short-term position when it reaches a pre-determined profit is never wrong. It doesn’t matter what was left on the table. Take the gain, and look for the next opportunity. He is fast becoming a believer.
Short selling
Recently I found a fund selling at a 50% premium over its net asset value. I looked back, and historically, the fund has traded between a 10% discount and a 10% premium for years. This recent premium bubble occurred following a strong decline in NAV late last year as selling price has gone back up while NAV has gone flat or slowly continued to decline. It looked like a great opportunity to sell short, but this is not something my friend is ready for. Fortunately, his 401k plan doesn’t support short selling, so I felt I could still explain the play to him as an educational opportunity, without fear that he would jump off the cliff with me. As I explained the risk of short selling – “the most I can make is what I sell it for today, and that is if the fund goes to zero, which it won’t. So, the most I will make is a fraction of what I will sell it for today. However, there is no limit to how much I can lose, because there is no cap on how much the fund can sell for. The price can climb without limits. As his eyes glazed over from trying to think in inverted investment terms and double negatives, I came upon an explanation he would understand. “I am going across the tight rope, but not with a wheelbarrow. I am riding a pogo stick. It is going to be a short ride (get it?) Still want to go with me?” He got it and wished me luck as he walked away from the wheelbarrow.
By the way, that fund went up another 20% in the past week, and I shorted some more because I just can’t see it sustaining the current 65% premium. Anybody else want to ride my pogo stick across Niagra? I am good for about one more bounce. Ooh – look! It just went up some more. (PHK)
One month later, PHK continues to climb. NAV has gone up some, but selling price has gone up more and the premium has been around 70% recently. It still looks unsustainable, but my strategy has been costly so far. Good thing I am riding this one solo!