What's wrong with CDO?

I was reading sixth edition of Security Analysis by Ben Graham and David L Dodd and in 1934 they provided the answer to this question. Here is what they said about investing in Fixed Income Securities:


I. Safety is measured not by specific lien or other contractual rights, but by the ability of the issuer to meet all of its obligations.

II. This ability should be measured under conditions of depression rather than prosperity.

III. Deficient Safety cannot be compensated for by an abnormally high coupon rate.

IV. The selection of all bonds for investment should be subject to rules of exclusion and to specific quantitative tests corresponding to those prescribed by statue to govern investments of savings banks.


In first point above

Safety not measured by lien but by abilty to pay

they further explain:

The basic difference confronts us at the very beginning. In the past the primary emphasis was laid upon the specific security, i.e., the character and supposed value of the property on which the bonds hold a lien. From our standpoint this consideration is quite secondary; the dominant element must be the strength and soundness of the obligor enterprise. There is here a clearcut distinction between two points of view. On the one hand the bond is regarded as a claim against property; on the other hand, as a claim against a business.

The older view was logical enough in its origin and purpose. It desired to make the bondholder independent of the risks of the business by giving him ample security on hich to levy in the event that the enterprise proved a failure. If the business became unable to pay his claim, he could take over the mortgaged property and pay himself out of that. This arrangement would be excellent if it worked, but in practice it rarely proves to be feasible. For this there are three reasons:

1. The shrinkage of property values when the business fails.
2. The difficulty of asserting the bondholders’ supposed legal rights.
3. The delays and other disadvantages incident to a receivership.

How to invest in India

India is a developing country and economy is growing at approximately 8%. The Indian stock market though volatile, is booming. If you live in USA and want to invest in India, you can invest in either INP, EPI or PIN. INP is an ETN (Exchange Traded Notes)whereas EPI and PIN are both ETFs (Exchange Traded Funds). EPI and PIN are relatively new (inception in March 2008) and INP has been there for long time.

The basic difference between ETF and ETN is, after creation ETF is placed with the trust and usually the company which created it acts as the adviser. If the adviser goes bankrupt then the trust replaces the adviser with someone else and your money is safe. ETN on the other hand, are the bonds issues by a company. So if the issuing company goes bankrupt then you are basically standing in line with other creditors to recover your money. So before investing in ETN, read the terms and conditions very carefully.

I have not got a chance to compare the three so I can not basically tell which one is better for investment.

More on it later....

Can Accenture grow

Accenture is considered a power house by many investors. I was reading a magzine last year and one of the most influential mutual fund manager described Accenture as consulting and outsourcing power house who thought that accenture's share at $41 was a bargain. Now after an year, its share are struggling at $34. Last year was difficult and most of the companies saw correction. But what about the future. Can accenture grow and deliver superior result to boost its share price?

I really doubt it. Accenture has grown really rapidly in India. I myself saw that growth. In Dec 2002, I went to Accenture India office for an interview for the position of software engineer. The office was still under construction in Bangalore and only staff they had was HR. I was among the first 30 people who joined Accenture Bangalore in Jan 2003. By the end of Feb 2003 Accenture had more than 3,000 employees and by the end of 2003 the number was probably more than 10,000. In Jan, 2003 there was no project and we spent most of our time playing games in office or in cafeteria. By March 2003, Accenture was competing with established Indian companies like Infy and TCS. It now has 5 offices in Banglaore, 1 in Mumbai and probably few in Chennai.

So you see, it has already grown in India and growing beyond this point is difficult. In recent years, most of the growth came from India. So it probably can not sustain current growth rate in future, unless it grows in some other area in some other country like China or Philippines. Though Accenture is really good at spotting opportunities and grabbing them. I really doubt that in near future it can grow as
fast as it has grown in past.

I got some more information from Accenture form 10K item 7 Management Discussion and Analysis:

Revenues before reimbursements for fiscal 2007 were $19.70 billion, compared with $16.65 billion for fiscal 2006, an increase of 18% in U.S. dollars and 13% in local currency. Revenues before reimbursements for the fourth quarter of fiscal 2007 were $5.11 billion, compared with $3.97 billion for the fourth quarter of fiscal 2006, an increase of 29% in U.S. dollars and 23% in local currency. Consulting revenues before reimbursements for fiscal 2007 were $11.86 billion, compared with $9.89 billion for fiscal 2006, an increase of 20% in U.S. dollars and 15% in local currency. For the fourth quarter of fiscal 2007, consulting revenues before reimbursements were $3.04 billion, compared with $2.19 billion for the fourth quarter of fiscal 2006, an increase of 38% in U.S. dollars and 32% in local currency. Outsourcing revenues before reimbursements for fiscal 2007 were $7.84 billion, compared with $6.75 billion for fiscal 2006, an increase of 16% in U.S. dollars and 12% in local currency. Outsourcing revenues before reimbursements for the fourth quarter of fiscal 2007 were $2.07 billion, compared with $1.77 billion for the fourth quarter of fiscal 2006, an increase of 17% in U.S. dollars and 12% in local currency.


Outsourcing contracts typically have longer terms than consulting contracts and generally have lower gross margins than consulting contracts, particularly in the first year. Long-term relationships with many of our clients continue to contribute to our success in growing our outsourcing business. Consistent with broader market trends, our recently signed outsourcing contracts are of shorter duration and therefore of smaller initial total contract value than they have been in the past. Despite this, our average annualized revenue per contract is steady. Long-term, complex outsourcing contracts, including their consulting components, require ongoing review of their terms and scope of work, in light of our clients’ evolving business needs and our performance expectations. Should the size or number of modifications to these arrangements increase, as our business continues to grow and these contracts evolve, we may experience increased variability in expected cash flows, revenues and profitability. As we are a global company, our revenues are denominated in multiple currencies and may be significantly affected by currency exchange-rate fluctuations. During the majority of fiscal 2006, the weakening of various currencies versus the U.S. dollar resulted in an unfavorable currency translation and decreased our reported revenues, operating expenses and operating income. During the majority of fiscal 2007, the U.S. dollar weakened against many currencies, resulting in favorable currency translation and greater reported U.S. dollar revenues, operating expenses and operating income compared to the same period in the prior year. If this trend continues in fiscal 2008, our U.S. dollar revenue growth will be higher than our growth in local currency. In the future, if the U.S. dollar strengthens against other currencies, our U.S. dollar revenue growth may be lower than our growth in local currency.

Bear Stern's Bailout

This Friday, Fed lent the money to Bear Stern to avoid Bear from falling down disorderly. Was this a right move? Should Fed bail out financial institutions which willingly made subprime mortgage loans and invented complex financial instruments to fool the investors? They knew in advance that these were bad loans, people won't be able to pay them back. And, to fool the investors and avoid the risk, they created CDO and sold it to pension funds, municipalities and other naive investors. Now think about the people who invested their life's earning into securities. Municipality workers who will lose their jobs because of these CDOs. Shouldn't financial institutions be held responsible for this?

I don't know what you think, but in my opinion this certainly is a bad move by Fed. Why? Because this tells investors that financial institutions instead of getting punished for such actions, get bailed out. There is no punishment for cheating investors. As an investor I will not trust any of the future complex financial instruments banks come out with. Though those instruments might be good. But what's the guarantee that they are good? And if they are bad who is gonna suffer? Bank or me? Obviously based on what is happening right now, I will assume that it will be me, not the guy who told me that this instrument was as secure as Treasury Security and provides me higher return.

In my opinion Fed should not bail out Bear Stern or any other financial institution. It is a free market and there is a direct relationship between risk and reward. Also, financial institutions needs to be held responsible for their action. People invest their hard earned money with banks and they need to feel secure that banks are not lending it to someone who can not pay it back. This will be a lesson for all other financial institutions that if they do not act responsibly, they will no longer exist. Before inventing complex instruments to fool the investors, they need to think not twice but at least ten time.

If you read this post, drop your comments. I would like to read your thoughts.