a glimpse at the world map for my superhero setting, Paladin
, specifically focusing on the Middle East.
Much of the history of the Middle East went as we know it in our timeline, even with the addition of Metahumans and advanced technologies since 1945. Israel was established, and Metahuman soldiers fought on both sides, with the Israelis emerging victorious each time; European powers withdrew from the region, etc. A few things go differently, though; for instance, Dubai blossoms into a metropolis much sooner than in our timeline. In general, though, everything went as we might expect, until 1980. That was when World War III (1980-1984)
broke out, and the villainous forces of the New Order
fell upon the Middle East.
Spearheading the New Order’s efforts in the Arabian Peninsula was the S-rank supervillain, Set
. A sociopath with the ability to control sand, Set made his base of operations in the shining city of Dubai, and created a massive sand storm that threatened to swallow the entire region.
Ultimately, Set was defeated by the combined forces of two unlikely heroes: an Israeli superhero named Golem
and a Palestinian superheroine named Simurgh
. The former had the ability to create automatons out of clay, mud and dirt, whilst the latter could take the form of a fiery six-winged bird, as well as transfer her energy into others to enhance their own abilities. They both did their best to fight Set, but in the end the situation required them to not only to work together, but to sacrifice their lives in order to save the Middle East. Simurgh transferred 100% of her power into Golem, who then poured everything he had into a ten-mile-tall colossus of mud and sea water, which he directed to destroy Set. Set, along with the entire city of Dubai, was crushed and buried under half a mile of earth. The Middle East was saved. The war would still rage on for two and a half more years, but without Set, the forces of the New Order were far, far easier to fight.
The lasting legacy of Golem and Simurgh’s sacrifice was a lasting peace between the Israelis and Palestinians, and the creation of the Federal Union of Israel and Palestine
, a secular, bi-national confederation of two peoples united by the sacrifices of each other’s children. Between 1995 and 2006, a colossal bridge covered in solar panels was constructed, connecting the West Bank to Gaza. Today, almost a million people live on the Shalam Bridge
Riyadh was destroyed by Set, killing most of the Saudi Royal Family. When the sand settled, the Saudi Civil War
began, and didn’t end until 1999, with the Treaty of Kuwait City
. The former territory of Saudi Arabia was broken up, with the oil-rich region of Nejd going to the Gulf Alliance
, a confederation of Persian Gulf states, which had occupied Nejd for almost all of the Saudi Civil War. The last remnants of the Saudi Royal Family were put in charge of a revived Kingdom of Saudi Arabia
, based in Jeddah. The Jordanians donated a member of their royal family to sit on the throne of the Kingdom of Hashemite Arabia
, based in Tabuk. And lastly, all involved officially recognized the Free Territory of the Holy Cities
, which was established during World War III by an international group of Muslim superheroes to protect Mecca and Medina first from Set, and then from the Saudi Civil War.
The Gulf Alliance is surprisingly progressive and forward thinking in its own way. As the region hardest-hit by Set’s rampage, it made sense for the governments of Kuwait, Bahrain, Qatar, Oman and the UAE to pool their resources in order to rebuild. Though most of the Middle East has been surprisingly welcoming to alien refugees from the moon (long story), due to the massive regional drop in population brought on by Set’s Storm, the Gulf Alliance has welcomed in the most. Though the Alliance itself is mostly secular, the locals have been rather successful at converting the alien newcomers to Islam. Work is still underway to dig up many of the destroyed oil wells, even as the world is moving towards more and more renewable energy.
As for Saudi Arabia and Hashemite Arabia, the latter is a moderate Arab constitutional monarchy, the former…isn’t. The degree to which it isn’t is kinda shocking, actually. Hashemite Arabia lets their women run for positions in parliament; Saudi Arabia 2.0 doesn’t permit women to leave their homes. Hashemite Arabia is debating abolishing the death penalty; Saudi Arabia doesn’t even have
prisons – they have a waiting list for the guy with the scimitar who beheads people for anything from theft to lying about one’s virginity. Saudi Arabia is also backing North Yemen’s now-radicalized Royal Army (more on that clusterfuck later).
Moving across the Red Sea, we have the Arab Republic of Egypt
, which…well, let’s just say, they have some interesting residents these days. During World War III, Egypt came under siege by the New Order, with the Nile Delta the site of some of the war’s most intense fighting. On one side, the New Order – supervillains, Taurus Group ground and air forces, robots, dinosaurs, African mercenaries, and thousands of undead Nazi soldiers. On the other side, the Allied forces – the Egyptian Army and local Egyptian superheroes, plus some unlikely back-up from the Muslim Brotherhood and
the Israeli Air Force. However, the Allies were losing. Badly. So badly that the Egyptian government activated its covert “Osiris Plan”
See, Taurus Group was able to resurrect the entire Wehrmacht by activating what’s known as a “Charnel Womb” (another long story), which the Nazis created in 1938 through their use of arcane science and mysticism. However, top secret archeological discoveries revealed that the Ancient Egyptians created their own, much more advanced Charnel Womb. Which Egyptian government agents activated. They were then greeted by an undead Metahuman pharaoh by the name of Neherkamun
. Surprisingly reasonable, Neherkamun agreed to aid the Egyptian government. In exchange for some concessions later.
Five days later, hundreds of thousands of skeletons, mummies and zombies rode towards the Cairo war zone, astride skeletal and mummified horses, clad in bronze/crocodile leather armor, wielding swords, spears, axes, AK’s, RPK’s, RPG’s and PKM’s, backed up by lich-sorcerers and animated statues armed with massive clubs and scythes – this undead horde charged into Cairo, Alexandria and Giza, to liberate their once and forever homeland from the forces of evil. The forces of the dead were enough to turn the tide in favor of the Allies. With the New Order defeated in Egypt, the Egyptian Army and their new undead comrades then moved to assist Gaddafi in neighboring Libya.
The Egyptian government held up their end of the bargain with Neherkamun and created the Autonomous Region of the Dead
in 1990, as an autonomous domain for Egypt’s new undead citizenry. The living are permitted to live in the ARD, though at this point, the dead outnumber them in cities like Luxor (renamed Waset), Edfu (Behdet) and Aswan (Swenett). Neherkamun visited Las Vegas in 1996 (when the city was rebuilt following the devastation it suffered during WW3), and was very much impressed; today, the nightlife in Waset, Behdet and Swenett is a strange Ancient Egyptian-themed neon rainforest with very friendly dead people walking around the gentrified necropolis, with street signs in both Arabic and hieroglyphics. In 1999, another autonomous region for the undead was created in the north of the country – the Autonomous Region of Giza
, which has become even more of a tourist-y place than before, now that you can have a friendly conversation with the people who actually built the pyramids. Both autonomous regions have Neherkamun as their constitutional monarch, and all residents of the undead autonomous regions are members of the Egyptian republic.
What are the attitudes of living Egyptians towards their undead countrymen? Surprisingly positive, actually. Sure, some fundamentalists regard them as “spawn of Iblis”, but the undead have been a fairly…secularizing influence on Egypt. Being able to talk with your oldest ancestors brought about a revival of cultural interest in Ancient Egyptian history amongst the Egyptian youth, which pervades. Many undead are still waking up to this day, and they tend to be very, very curious about this new world that they find themselves in – familiar and yet so very strange. It’s not uncommon to see Undead Egyptians visiting Paris, New York, Rio, Tokyo or Moscow, though since most were peasants when they died, most simply remain in Egypt. Some Undead Egyptians have converted to Islam, but the overwhelming majority continue to worship the old gods of the Nile. 2015’s Miss Egypt is the very well-preserved Nefertiti, who became the first undead individual to win such a title.
To the south of Egypt, one can see two grey-ish territories. Before World War III, these were the disputed territories of Bir Tawil and the Hala’ib Triangle. During the war, the New Order made extensive use of combat robots during their invasion of Sudan, Eritrea, Somalia, Djibouti and Ethiopia. However, during the massacre of a village in Sudan in 1983, a simple infantry robot with the designation T9X1109
spontaneously developed sentience and led an uprising within Taurus Group’s mechanical legions in northwest Africa, establishing connections with other “enlightened autonomatons” and “uplifting” those who were not so “enlightened”. T9X1109’s mutiny was mostly successful, and he made an offer to the UN’s Joint Allied Command
; in exchange for withdrawing from the conflict, T9X1109 and his “people” would be allowed to settle these disputed territories as a “homeland” for sentient machines. A neutral “machine homeland”, the Republic of 01001001
(binary for “I”; commonly called “01” or “Zero-One”), was created in 1984. In the years since the end of WW3, many machine intelligences have immigrated to this harsh and bitter desert nation, which is covered in solar panels to provide vital electricity for its approximately ~41,233 intelligences. Increasingly, cyborg transhumanist types have made their “pilgrimage” to Zero-One as well, where they evangelize their strange techno-religion to the human refugees from neighboring war-torn Sudan who’ve been permitted to seek refuge in the mechanical country (this is one reason why Cairo likes Zero-One: it’s a convenient Sudanese refugee sponge of sorts). Zero-One has a strictly pacifistic constitution and possesses no military. Its economy is based mostly on production of batteries.
Saddam Hussein’s regime performed impressively during WW3, and he was able to win over much of the public as a result. But he over-played his hand, and thought he could go back to his old ways. He was wrong, and an idealistic, Western-educated superhero by the name of Ninurta
(real name: Mohammed Al-Doori) led the uprising against Saddam in 2002. His parents fled Iraq for Canada shortly after the Ba’athists came to power in Iraq in 1968, and young Mohammed longed to return to free his homeland. After deposing Saddam, the eagle-headed superhero abolished the Ba’athist regime and replaced it with a secular, democratic government – the Mesopotamian Confederation of Iraq
, with himself as its wise and benevolent dictator. Every office and position in the new Iraq is elected through a multi-party democratic system, with the exception of Ninurta’s position as President. The Federation is divided into six autonomous republics, plus the independent capital district of Baghdad. The six “Mesopotamian Republics” are Babylonia (Sunni Arab majority), Sumeria (Shiite Arab majority), Kurdistan (Kurdish majority), Assyria (Christian Assyrian majority), Sinjar (Yazidi majority) and Akkad (Turkman majority). Under Ninurta’s rule, much has been done to mitigate the country’s historical ethnic tensions and to modernize Iraq. Though most of the time, Ninurta is busy helping to build infrastructure, or assisting the Iraqi Defense Forces with rooting out Islamist or Ba’athist terrorists; there are fundamentalist Muslims who disapprove of Ninurta’s love affair with ancient Mesopotamia or take issue with his atheism, and the Ba’athists are salty that he overthrew Saddam.
To the east of Iraq is the Persian Technate
. In 1979-1980, Iran was a country on the verge of revolution, and between despotic monarchs and totalitarians of both the Islamist and Marxist variety, a low-level Metahuman supergenius by the name of Hamid Mousavi created a fourth option for his beloved Iranian homeland – a secular, scientifically-minded brand of populist technocracy. World War III began shortly after the Iranian Revolution, and amid the chaos, with loyalist and revolutionary forces and third and fourth parties fighting each other and
the New Order, the Iranian Technocratic Revolutionary Army managed to fight its way to be top dog in the Iran Theatre. When all was said and done, Mousavi effectively controlled the country, thanks to his brilliant grasp of strategy and his charismatic brand of “scientific populism”. In 1986, the Iranian Revolution ended, and the Persian Technate was officially recognized by the US and USSR. Today, the Persian Technate is a rationalist, secular regime governed by scientists, engineers, mathematicians. The Technate’s not very democratic, and though they have a lot of fancy doo-dads, the planned economy is kinda mediocre. Following the death of Mousavi in 2010, his successor’s lack of charisma isn’t helping the growing sense of dissatisfaction with the eggheads ruling Iran.
Turkey has not
had a fun time. During World War III, the country was invaded by Taurus Group, backed by Reticulan tripods. Immediately prior to the start of the war, Turkey’s military government was devastated by a string of assassinations carried out by ninjas sent by the Red Hand. To add fuel to the fire, a very young Metahuman in the province of Bayburt experienced a panic attack, unleashing all of its power at once. That glowing blue orb and the “Gulf of Trabzon” you see? That’s the result. The shockwaves resulted in earthquakes across Turkey and tsunamis along the Soviet coastline in the eastern Black Sea, killing upwards of a million people.
Despite all this chaos, the splintered and factionalized Turkish armed forces were able to liberate their homeland from the New Order. Following the end of hostilities in 1984, the National Transitional Council of Turkey
was formed, bringing the three main factions of the Turkish Army together – a secular republican faction, a “theodemocratic” Islamist faction, and a Neo-Ottmanist faction advocating for a constitutional monarchy. Negotiations were tense, with militias and paramilitaries clashing in the streets across Turkey, Turkish and Armenian separatists making their moves, and the Syrians expanding their sphere of influence into Hatay. The Turkish national election of 1995 ended badly
, with violence raging across the country and the military factions breaking away from the NTCT to back their political allies in the streets. The Turkish Civil War
(1995-2001) had begun.
When the dust settled in 2001, a NATO intervention in Turkey resulted in a negotiated ceasefire brokered by the Sentinel Coalition
(which still occupies the Bosporus Straits). The country was now divided into the Republic of Turkey
(“Republican Turkey”, Istanbul), the Islamic Republic of Turkey
(“Islamic Turkey”, Ankara) and the Sultanate of Turkey
(“Ottoman Turkey”, Adana). That last one is a mostly-secular constitutional monarchy headed by Dündar Ali Osman
, the last heir of the old House of Osman. Relations between the “Three Turkeys” have been tense at times, with Islamic Turkey currently in the midst of a military build-up, fearing the growing ties between Republican and Ottoman Turkey.
Istanbul, Ankara and Adana were all forced to recognize the independence of Kurdistan, as well as, more controversially, the Free State of Izmir
Allow me to explain Izmir. At the start of the Turkish Civil War, a giant, tentacled Kaiju by the name of Atlas
took advantage of the chaos in Turkey to take over Izmir and the surrounding area from the Republican and Islamist forces fighting there. A fan of Ayn Rand, Atlas decided to turn Izmir into his own little capitalist utopia. And the people living there decided to go along with the 300-foot beast’s plan. Today, Izmir is a city in the vein of Las Vegas, Singapore and Bangkok – a free market wonderland of Ottoman and Art Deco architecture with its dictator spending most of his time along the bottom of the Gulf of Izmir.
The People’s Republic of Kurdistan
started out as a socialist republic ruled by the PKK (Kurdistan Worker’s Party). Backed by the USSR, Kurdistan made the transition to a multi-party social democracy in 2004.
Meanwhile, in Republican Turkey’s far-eastern provinces the unrecognized and widely-hated “Armenian Republic of Tačkahayastan”
claims authority there. The ART is headed by a pyrokinetic Metahuman and Armenian ultra-nationalist by the name of Azhdahak, who is overseeing a rather ironic campaign of ethnic cleansing against the local Turks. Republican Turkey keeps asking Armenia to do something about the flow of arms that’s obviously coming across their border, to which Armenia shrugs and plays stupid every time. Increasingly, however, more and more Armenians are deciding to agitate in favor of ending the madness, and the Soviets are getting around to tapping Yerevan on the shoulder. North Yemen
is…yeah, pretty much a clusterfuck.
The Mutawakkilite Kingdom
(North Yemen) and the People’s Democratic Republic of Yemen
(South Yemen) put their differences aside to fight against the New Order, and more or less reached a state of détente with the war’s conclusion. This lasted about 30 years.
Around 2010, the failing Mutawakkilite monarchy began experiencing major uprisings by left-wing protestors backed by South Yemen. On the brink of civil war, and with much of the kingdom’s military siding with the protestors, the Yemeni monarchy made the very, very questionable decision to ally with a supervillain by the name of The Claw
. For a while, The Claw was able to keep things under control, though on his watch, North Yemen increasingly became a police state. At the same time, The Claw started to gain his share of odd supporters from the populace. Believing that they could take over the security infrastructure The Claw had built, the Mutawakkilites tried and failed to assassinate him in 2013. Almost immediately afterwards, The Claw staged a coup, backed by his private army of cyborg mercenaries and his following of Yemeni supporters. The Mutawakkilites fled to Saudi Arabia while the Royal Army remained to fight against The Claw’s army, and the left-wing North Yemen Democratic Forces
rose up. The North Yemen Civil War
had begun. South Yemen continued to back the NYDF, but stopped short of committing their forces to the three-way conflict, believing that the Royalists (backed by Saudi Arabia) and The Claw’s forces (backed by nobody) could be easily defeated. South Yemen’s military was actually busy assisting the Soviets and Ethiopians in Somalia during most of the North Yemen Civil War.
Then, in 2014, half of Aden was ripped a series of explosions in the early morning hours. Suicide bombers, whose explosives were traced back to The Claw’s growing transhumanist cult of cyborgs. Though The Claw himself denounced the attack as the actions of a rogue henchmen acting against his orders, South Yemen announced that it would be withdrawing its forces from Somalia to “rectify a previous error in judgement” and invade North Yemen. The Soviet Union and Egypt have both agreed to back South Yemen’s move and have committed troops to backing the NYDF.
So, conclusion? Middle East is a bit of a mixed bag. Some good, some bad, lots of interesting, I suppose.
In his book, You Can Be a Stock Market Genius, Greenblatt talks about using LEAPs to make leveraged bets. The book included his trade in Wells Fargo (WFC, another topic for a future post, I suppose).
But sometimes, stocks get down so cheap that they become priced like options. In the Genius book, the WFC LEAPs were priced at $14 while the stock was at around $77.
Here, we have a hedge fund manager trading less than $3.00/share, which is a typical price for regular options, not even LEAPs. Of course, all stocks are options on the residual value of businesses. But sometimes things are priced for either a large gain or zero, just like an option.
I call this a perpetual option, but that reminds me of those lifetime warranties. Like, who's lifetime? The manufacturer's? The store's? Yours? Nothing is forever, so I guess there really is no such thing as a perpetual option. But anyway...
Och-Ziff IPO'ed in 2007 at $32/share and traded in the mid $20's right before the crisis, then down to below $5.00 during the crisis and back up to the mid-teens. I've been watching this since the IPO and looked at it again when it was trading around $10/share. It's down quite a bit since then. I didn't own it back then but I did take a small bite down at $5.00/share.
I have mentioned other private equity and hedge fund managers here in the past but haven't owned most of them because of the amount of money that seemed to be going into alternatives. I was just worried that the AUM's of all of these alternative managers were going up so quickly that I couldn't imagine them earning the high returns that made everyone rush to them in the first place. Look at the presentation of any of these alternative managers and their AUM growth is just staggering.
Extremely Contrarian We investors walk around and think about all sorts of things; look at store traffic, taste new foods/restaurant concepts, count how many Apple watches people are wearing (I recently biked around the city with my kid (Brooklyn to Central Park, around the park (around the big loop) and all the way downtown back to Brooklyn (30+ miles) and I think I counted two Apple watches that I saw compared to countless iPhones. And this was in the summer so no coats or long sleeves to hide wrists).
And a couple of the things that we tend to think about are, What does everybody absolutely love, and what are they 100% sure of (other than that Hillary will win the election and that the market will crash if Trump wins), and What do people absolutely, 100% hate and don't even want to talk about? In the investing world right now, it seems like the one thing that everybody seems to agree with is that active investing is dead (OK, not completely true because we active investors never really lose faith in it). The data points to it (active managers underperforming for many years, legendary stock pickers too not performing all too well, star hedge funds not doing well etc...). The money flows point to it (cash flowing out of active managers and into passive funds, boom in index funds / ETFs; this reminds me of the 1990's when there were more mutual funds than listed companies. There are probably more ETFs now than listed companies). Sentiment points to it (stars and heroes now are ETF managers, quants etc.).
By the Way Oh, and by the way, in case people say that it is no longer possible due to this or that reason for humans to outperform indices or robots, I would just say that we have seen this before. Things in finance are cyclical and we've seen this movie before.
From the 1985 Berkshire Hathaway Letter, Most institutional investors in the early 1970s, on the other hand, regarded business value as of only minor relevance when they were deciding the prices at which they would buy or sell. This now seems hard to believe. However, these institutions were then under the spell of academics at prestigious business schools who were preaching newly-fashioned theory: the stock market was totally efficient, and therefore calculations of business value -- and even thought, itself -- were of no importance in investment activities. (We are enormously indebted to those academics: what could be more advantageous in an intellectual contest -- whether it be bridge, chess or stock selection than to have opponents who have been taught that thinking is a waste of energy?)
What Do People Hate? So, back to what people absolutely hate. People hate active managers. It's not even stocks that they are not interested in. They hate active managers. Nobody outperforms and their fees are not worth it. What else do they hate? They hate hedge funds. I don't need to write a list here, but you just keep reading one institution after another reducing their exposure to hedge funds. There is a massive shakeout going on now with money leaving hedge funds. Others like Blackstone argues that this is not true; assets are just moving out of mediocre hedge funds and moving into theirs.
This is a theme I will be going back to in later posts, but for now I am just going to look at OZM.
OZM OZM is a well-known hedge fund firm so I won't go into much detail here. To me, it's sort of a conventional equity-oriented hedge fund that runs strategies very typical of pre-Volcker rule Wall Street investment banks; equity long/short, merger arb, convertible arb etc. They have been expanding into credit and real estate with decent results. But a lot of their AUM is still in the conventional equity strategies.
What makes OZM interesting now is that chart from the Pzena Investment report (see here). These charts make it obvious why active managers have had such a hard time. The value spread has just continued to widen since 2004/2005 through now. Cheap stocks get cheaper and expensive stocks get more so. You can see how this sort of environment could be the worst for long/short strategies (and value-oriented long strategies, and even naked short strategies for that matter). Things have just been going the wrong way with no mean reversion.
But if you look at where those charts are now, you can see that it is probably exactly the wrong time to give up on value strategies or value-based long/short strategies; in fact it looks like the best time ever to be looking at these strategies.
Seeing that, does it surprise me that many pension funds are running the other way? Not at all. Many large institutions chase performance and not future potential.
Conceptually speaking, they would rather buy a stock at 80x P/E that has gone up 30%/year in the past five years that is about to tank rather than buy an 8x P/E stock that has gone nowhere in the past five years but is about to take off; they are driven by historic (or recent historic) performance.
OZM Performance Anyway, let's look at the long term performance of OZM. This excludes their credit and real estate funds which are doing much better and are growing AUM.
This is their performance since 1994 through the end of 2015:
OZM fund S&P500 1994 28.50% 5.30% 1995 23.50% 27.40% 1996 27.40% 23.00% 1997 26.70% 33.40% 1998 11.10% 28.60% 1999 18.80% 21.00% 2000 20.60% -9.10% 2001 6.30% -11.90% 2002 -1.60% -22.10% 2003 24.00% 28.70% 2004 11.10% 10.90% 2005 8.80% 4.90% 2006 14.80% 15.80% 2007 11.50% 5.50% 2008 -15.90% -37.00% 2009 23.10% 26.50% 2010 8.50% 15.10% 2011 -0.50% 2.10% 2012 11.60% 16.00% 2013 13.90% 32.40% 2014 5.50% 13.70% 2015 -0.40% 1.40% 5 year avg 5.85% 12.57% 10 year avg 6.69% 7.32% Since 1994 12.05% 8.87% Since 2000 7.59% 5.01% Since 2007 5.14% 6.53%
So they have not been doing too well, but it's really only the last couple of years that don't look too good. Their ten-year return through 2013 was +8.2%/year versus +7.4%/year for the S&P 500 index. It's pretty obvious that their alpha has been declining over time.
For those who want more up-to-date figures, I redid the above table to include figures through September-end 2016. And instead of 5 year and 10 year returns, I use 4.75-year and 9.75-year returns; I thought that would be more comparable than saying 5.75-year and 10.75-year, and I didn't want to dig into quarterly figures to get actual 5 and 10s.
OZM fund S&P500 1994 28.50% 5.30% 1995 23.50% 27.40% 1996 27.40% 23.00% 1997 26.70% 33.40% 1998 11.10% 28.60% 1999 18.80% 21.00% 2000 20.60% -9.10% 2001 6.30% -11.90% 2002 -1.60% -22.10% 2003 24.00% 28.70% 2004 11.10% 10.90% 2005 8.80% 4.90% 2006 14.80% 15.80% 2007 11.50% 5.50% 2008 -15.90% -37.00% 2009 23.10% 26.50% 2010 8.50% 15.10% 2011 -0.50% 2.10% 2012 11.60% 16.00% 2013 13.90% 32.40% 2014 5.50% 13.70% 2015 -0.40% 1.40% 2016* 1.10% 7.80% 4.75 year 6.53% 14.58% 9.75 year 5.48% 6.72% Since 1994 11.68% 8.92% Since 2000 7.29% 5.27% Since 2007 4.82% 6.86%
So over time, they have good outperformance, but much of that is from the early years. As they get bigger, it's not hard to see why their spread would shrink.
They are seriously underperforming in the 4.75 year, but that's because the S&P 500 index was coming off of a big bear market low and OZM didn't lose that much money, so I think that is irrelevant, especially for a long/short fund.
More relevant would be figures from recent market peaks which sort of shows a through-the-cycle performance. Since the market peak in 2000, OZM has outperformed with a gain of +7.3%/year versus +5.3%/year for the S&P, but they have underperformed since the 2007 peak. A lot of this probably has to do with the previous charts about how value spreads have widened throughout this period.
I would actually want to be increasing exposure to this area that hasn't worked well since 2007. Some of this, of course, is due to lower interest rates. Merger arb, for example, is highly dependent on interest rates as are other arbitrage type trades. (The less risk there is, the closer to the short term interest rate the return is going to be.)
One thing that makes me scratch my head, though, in the 3Q 2016 10-Q is the following: OZ Master Fund’s merger arbitrage, convertible and derivative arbitrage, corporate credit and structured credit strategies have each generated strong year-to-date gains through September 30, 2016. In merger arbitrage, certain transactions in which OZ Master Fund participated closed during the third quarter, contributing to the strategy’s year-to-date gross return of +1.3%. Convertible and derivative arbitrage generated a gross return of +0.5% during the third quarter, driven by gains in convertible arbitrage positions, commodity-related volatility, commodity spreads and index volatility spread trades. Year-to-date, convertible and derivative arbitrage has generated a gross return of +1.3%. In OZ Master Fund’s credit-related strategies, widening credit spreads and certain event-driven situations added +0.4% to the gross return within corporate credit during the third quarter, while in structured credit, a +0.9% gross return during the quarter was attributable to the realization of recoveries in certain of our idiosyncratic situations. Year-to-date, the corporate credit and structured credit strategies are each up +1.2% on a gross basis. Gross returns of less than 2% are described as "strong". Hmm... I may be missing something here. Maybe it is 'strong' versus comparable strategies. I don't know. Anyway, moving on...
Greenblatt Genius Strategies Oh yeah, and by the way, OZM is one of the funds that are heavily into the yellow book strategies. Here's a description of their equity long/short strategy: Long/short equity special situations, which consists of fundamental long/short and event-driven investing. Fundamental long/short investing involves analyzing companies and assets to profit where we believe mispricing or undervaluation exists. Event-driven investing attempts to realize gain from corporate events such as spin-offs, recapitalizations and other corporate restructurings, whether company specific or due to industry or economic conditions.
This is still a large part of their book, which is a good thing if you believe that the valuation spreads will mean revert and that Greenblatt's yellow book strategies are still valid.
One thing that may temper returns over time, though, is the AUM level. What you can do with $1 billion in AUM is not the same as when you have $10 billion or $30 billion. I don't think Greenblatt would have had such high returns if he let AUM grow too much.
This seems to be an issue with a lot of hedge funds. Many of the old stars who were able to make insane returns with AUM under $1 billion seem to have much lower returns above that level.
Here is OZM's AUM trend in the past ten years. Some of the lower return may correlate to the higher AUM, not to mention higher AUM at other hedge funds too reducing spreads (and potential profits).
Just to refresh my memory, I grabbed the AUM chart from the OZM prospectus in 2007. Their AUM was under $6 billion until the end of 2003 and then really grew to over $30 billion by 2007.
Their 10-year return through 2003 was 18%/year vs. 10.6%/year for the S&P 500 index.
From the end of 2003 through the end of 2015, OZM's funds returned +7.2%/year versus +7.4%/year for the S&P 500 index. So their alpha basically went from 7.4%/year outperformance to flat.
This is actually not so bad as these types of funds often offered 'equity-like' returns with lower volatility and drawdowns. The long/short nature of OZM funds means that investors achieved the same returns as the S&P 500 index without the full downside exposure. This is exactly what many institutions want, actually.
But still, did their growth in AUM dampen returns? I think there is no doubt about that. These charts showing tremendous AUM growth is the reason why I never owned much of these alternative managers in the past few years I've been watching them.
The question is how much of the lower returns are due to the higher AUM. Of course, some of this AUM growth is in other strategies so not all new AUM is squeezed into the same strategies.
Will OZM ever go back to the returns of the 1990's? I doubt that. First of all, that was a tremendous bull market. Plus, OZM's AUM was much smaller so they had more opportunities to take advantage of yellow book ideas and other strategies.
Boom/Bubble Doesn't Mean It's a Bad Idea By the way, another sort of tangent. Just because there is a big boom or bubble in something doesn't necessarily make that 'something' a bad idea. We had a stock market bubble in the late 1920's that ended badly, but owning parts of businesses never suddenly became a bad idea or anything. It's just that you didn't want to overpay, or buy stocks for the wrong reasons.
We had a boom in the late 1990's in stocks that focused on picking stocks and owning them for the long term as exemplified by the Beardstown Ladies. Of course, the Beardstown Ladies didn't end well (basically a fraud), but owning good stocks for the long haul, I don't think, ever became a bad idea necessarily.
We had a tremendous housing bubble and various real estate bubbles in recent years. But again, owning good, solid assets at reasonable prices for the long haul never became a bad idea despite the occasional bubbles and collapses.
Similarly, hedge funds and alternative assets go through cycles too. I know many value investors are not with me here and will always hate hedge funds (like Buffett), but that's OK.
We've had alternative cycles in the past. Usually the pattern is that there is a bull market in stocks and people rush into stocks. The bull market inevitably ends and people lose money. Institutions not wanting to lose money rush into 'alternative' assets. Eventually, the market turns and they rush back into equities.
I think something similar is happening now, but the cycle seems a bit elongated and, and the low interest rates is having an effect as alternatives are now attracting capital formerly allocated to fixed income. In the past, alternatives seemed more like an equity substitution, risk asset.
Valuation OK, so what is OZM worth?
Well, a simple way of looking at it is that OZM has paid an average of $1.10/year in dividends in the last five years. During the past five years, the funds returned around 6%/year, so it's not an upside outlier in terms of fund performance.
Put a 10x multiple on it and the stock is worth $11/share.
Another way to look at it is that the market is telling you that it is unlikely that OZM will enjoy the success even of the past five years over the next few years. Assuming a scenario of failure (stock price = 0) or back to sort of past five years performance ($11), a $3.00 stock price reflects the odds of failure at 73% and only a 27% chance that OZM gets back to it's past five year average-like performance. Of course, OZM can just sort of keep doing what it's doing and stay at $3.00 for a long time too.
There is a problem with this, though, as the dividends don't reflect equity-based compensation expense; OZM gives out a bunch of RSU's every year.
To adjust for this, let's look at the economic earnings of the past five years including the costs of equity-based compensation.
Equity-based compensation expense not included in economic income is listed below ($000):
2008 102,025 2009 122,461 2010 128,737 2011 128,916 2012 86,006 2013 120,125 2014 104,344 2015 106,565
It's odd that this doesn't seem to correlate to revenues, income or AUM; it's just basically flat all the way through.
If we include this, economic income at OZM averaged around $520 million/year. With fully diluted 520 million shares outstanding, that's around $1.00/share in economic earnings per share that OZM earned on average over the past five years. So that's not too far off from the $1.10/share dividends we used above.
One of the interesting things about investing is when you find alternative ways to value something instead of just the usual price-to-book values, P/E ratios etc.
So how would you value this?
What about adjusting the implied odds from the above. What if we said there's a 50/50 chance of recovery or failure. Let's say recovery is getting back to what it has done over the past five years on average, and failure is a zero on the stock.
50% x $0.00 + 50% x $10.00 = $5.00/share
In that case, OZM is worth $5.00/share, or 70% higher than the current price. You are looking at a 60 cent dollar in that case.
Let's say there is a 70% chance of recovery.
70% x $10.00 + 30% x $0.00 = $7.00/share.
That's 130% higher, or a 40 cent dollar.
By the way, the AUM averaged around $37 billion over the past five years, and remember, their return was around 5.9%/year so these figures aren't based on huge, abnormal returns or anything.
As of the end of September 2016, AUM was $39.3 billion, and this went down to $37 billion as of November 1, 2016. OZM expects continued redemptions towards year-end both due to their Justice Department/SEC settlement and overall industry redemption trends.
The above ignored balance sheet items, but you can deduct $0.60/share, maybe, of negative equity, or more if you think they need more cash on the balance sheet to run their business.
Preferred Shares As for the $400 million settlement amount and preferred shares, the settlement amount is already on the balance sheet as a liability (which was paid out after the September quarter-end). The preferred shares were sold after the quarter ended. They have zero interest for three years so I don't think it impacts the above analysis. You would just add cash on the balance sheet and the preferreds on the liability side.
If you want to deduct the full amount of the settlement of $400 million, you can knock off $0.77/share off the above valuation instead of the $0.60/share.
Earnings Model The problem with these companies is that it's impossible, really, to predict what their AUM is going to be in the future or their performance. Of course, we can guess that if they do well, AUM will increase and vice-versa.
But still, as a sanity check, we should see how things look with various assumptions in terms of valuation.
First of all, let's look at 2015. In the full year to 2015, a year that the OZM funds were down (master fund), they paid a dividend of $0.87. Adjusted economic income was $240 million (economic income reported by OZM less equity-based comp expense) and using the current fully diluted shares outstanding of 520 million, that comes to $0.46/share. OK, it's funny to use current shares outstanding against last year's economic income, but I am trying to use last years' earnings as sort of a 'normalized' figure.
Using these figures from a bad year, OZM is current trading at a 29% dividend yield (using $3.00/share price) and 6.5x adjusted economic income. This would be 8.3x if you added the $0.77/share from the settlement above.
OK, so average AUM was $44 billion in 2015, so even in a bad year, they made tons in management fees. Fine. We'll get to that in a second. AUM is $37 billion as of November 2016, and is probably headed down towards year-end.
2016 Year-to-Date So let's look at how they are doing this year so far. Fund performance-wise, it hasn't been too good, but they do remain profitable. These fund businesses are designed so that their fixed expenses are covered by their management fees. Big bonuses are paid out only when the funds make money.
Anyway, let's look at 2016 so far in terms of economic income.
In the 3Q of 2016, economic income was $57.4 million. Equity-based compensation expense was $18.3 million so adjusted economic income was $39.1 million. Annualize that and you get $156 million. Using 520 million fully diluted shares (share amount used to calculate distributable earnings in the earnings press release), that comes to $0.30/share adjusted economic income. So at $3.00/share, OZM is trading at 10x arguably depressed earnings. (This excludes the FCPA settlement amount). If you include $400 million of the FCPA preferreds (total to be offered eventually), then the P/E would actually be closer to 12.6x.
For the year to date, economic income was $195 million, and equity-based comp expense was $56 million so adjusted economic income was $139 million. Again using 520 million shares, that comes to $0.25/share in adjusted economic earnings per share. Annualize that and you get $0.33/share. So at $3.00/share, OZM is trading at 9x depressed earnings, or 11x including the FCPA preferred.
OK, so maybe this is not really 'depressed'. With still a lot of AUM, it is possible that AUM keeps going down.
AUM was $37 billion in November, but let's say it goes down to $30 billion. That's actually a big dip. But let's say AUM goes down there. And then let's assume 1% management fees, 20% incentive fees, and economic income margin of 50% (averaged 56% in past five years) and the OZM master fund return of 5%.
In this case, economic income would be $300 million. Equity-based comp costs seems steady at around $100 million, so we deduct that to get adjusted economic income. This comes to $200 million.
That comes to around $0.40/share. At $3.00/share, that's 7.5x adjusted economic earnings, or a 13% yield, or 9.4x and 10.6% yield including the FCPA preferreds.
So that's not bad. We are assuming AUM dips to $30 billion and OZM funds only earn 5%/year, and with that assumption the stock is trading at this cheap level.
Things, of course, can get much worse. If performance doesn't improve, AUM will keep going down. You can't really stress test these things as you can just say their returns will never recover and that's that.
On the other hand, any improvement can get you considerable upside.
If assets return to $40 billion and returns average 6% over time, economic income margin goes to 56% (average of past five years), adjust economic income per share is $0.76/share and the stock could be worth $7.60/share for more than a double.
Here's a matrix of possibilities. Skeptics will say, where are the returns below 5% and AUM below $30 billion?!
Well, OK. If returns persist at lower than 5%, it's safe to assume that AUM will go down and this may well end up a zero. That is certainly a possibility. It wouldn't shock many for another hedge fund to shut down.
On the other hand, if things do stabilize, normalize and OZM recovers and does well, there is a lot of upside here. What is interesting to me is that the market is discounting a lot of bad and not pricing in much good. This is when opportunities occur, right?
5% 6% 7% 8% 9% 10% 30,000 $0.45 $0.52 $0.58 $0.65 $0.71 $0.78 35,000 $0.56 $0.64 $0.71 $0.79 $0.86 $0.94 40,000 $0.67 $0.76 $0.84 $0.93 $1.01 $1.10 45,000 $0.78 $0.87 $0.97 $1.07 $1.16 $1.26 50,000 $0.88 $0.99 $1.10 $1.21 $1.32 $1.42 55,000 $0.99 $1.11 $1.23 $1.35 $1.47 $1.58 60,000 $1.10 $1.23 $1.36 $1.49 $1.62 $1.75
The row above is the assumed return of the OZM funds. The left column is the AUM. Assumptions are 1% management fee, 20% incentive fee, 56% economic income margin (excluding equity-based comp expense) and $100 million/year in equity-based comp expense.
It shows you that it doesn't take much for adjusted economic income per share to get back up to closer to $1.00, and can maintain $0.45/share even in a $30 billion AUM and 5% return scenario making the current stock price cheap even under that scenario.
Conclusion Having said all that, there is still a lot of risk here. Low returns and low bonuses can easily make it hard for OZM to keep their best people. But if their best people perform, I assume they do get paid directly for their performance so that shouldn't be too much of an issue.
A lot of the lower returns in recent years is no doubt due to their higher AUM. But it is also probably due to crowding of the hedge fund world and low interest rates leading to an overall lower return environment for all.
If you think these things are highly cyclical, then you can expect interest rates to normalize at some point. Money flowing out of hedge funds should also be good for future returns in these strategies. The part of lower returns at OZM due to higher AUM may not reverse itself, though, if OZM succeeds in maintaining and increasing AUM over time.
But even without the blowout, high returns of the 1990's, OZM can make decent returns over time as seen in the above table.
In any case, unlike a few years ago, the stock prices of many alternative managers are cheap (and I demonstrated how cheap OZM might be here) and institutional money seems to be flowing out of these strategies.
So: OZM is cheap and is in a seemingly universally hated industry Money is flowing out of these strategies, particularly performance chasing institutions (that you would often want to fade) there is a bear market in active managers and bubble in indexing (which may actually increase opportunities for active managers) value spreads are wide and has been widening for years making mean reversion overdue etc. These things make OZM a compelling play on these various themes.
I would treat this more like an option, though. Buy it like you would buy an option, not like you would invest in, say, a Berkshire Hathaway.
There are a lot of paths here to make good money, but there are also plenty of ways to lose. If you look at this like a binary option, it can be pretty interesting!
Posted by kk at 8:11 PM No comments: Links to this post Email This BlogThis! Share to Twitter Share to Facebook Share to Pinterest
Saturday, October 29, 2016 Gotham's New Fund Joel Greenblatt was in Barron's recently. He is one of my favorite investors so maybe it's a good time for another post.
Anyway, this new fund is kind of interesting as I am sort of a tinkerer; this is like the product of some financial tinkering. I don't know if it's the right product for many, but we'll take a look.
But first, let's see what he has to say about the stock market in general.
The Market Greenblatt says that the market is "expensive". The market is in the 21st percentile of expensive in the past 25 years. Either a typo or he misspoke, he is quoted as saying that the market has been more expensive 79% of the time in the past 25 years. Of course, he means the market has been cheaper 79% of the time.
The year forward expected return from this price level is between 2% to 7%, so he figures it averages out to 4% to 6% per year. In the past 25 years, the market has returned 9% to 10%/year so he figures the market is 12% to 13% more expensive than it used to be.
He says: Well, one scenario could be that it drops 12% to 13% tomorrow and future returns would go back to 9% to 10%. Or you could underearn for three years at 4% to 6%. We're still expecting positive returns, just more muted. The intelligent strategy is to buy the cheapest things you can find and short the most expensive.
But... Immediately, bears will say that this 25 year history is based during a period when interest rates went down. The 10 year bond rate was around 8% back in 1991, and is now 1.8%. In terms of valuation, this would have pushed up asset values by 6.2%/year ($1.00 discounted at 8%/year then and $1.00 discounted by 1.8% now).
Declining rates were certainly a factor in stock returns over the past 25 years. Of course, the stock market didn't keep going up as rates kept going down. The P/E ratio of the S&P 500 index at the end of 1990 was around 15x, and now it's 25x according to Shiller's database (raw P/E, not CAPE). So the valuation gain over the 25 years accounted for around 2%/year of the 9-10% return Greenblatt states.
Here are the EPS estimates for the S&P 500 index according to Goldman Sachs:
2016 $105 20.4x 2017 $116 18.5x 2018 $122 17.6x
Earnings estimates are not all that reliable (estimates have been coming down consistently in the past year or so). But since most of 2016 is done, I suppose the $105 figure should be OK to use.
I don't know if it's apples to apples (reported versus operating etc.), but if we assume the 'current' P/E of the market is 20x, then the valuation tailwind accounted for 1.2%/year of the 9-10%. But then of course, even if this was a fair comparison, there is still the aspect of lower interest rates boosting the economy by borrowing future demand (and therefore overstating historical earnings).
In any case, one of the main bearish arguments is that this interest rate tailwind in the past will become a headwind going forward. Just about everyone agrees with that.
But as I have mentioned before, calling turns in interest rates is very hard, Japan being a great example. If you look at interest rates over the past 100 years or more, you see that major turns in trend don't happen all that often; it's been a single trend of declining rates since the 1980/81 peak, basically. What are the chances that you are going to call the next big turn correctly? I would bet against anyone trying. OK, that didn't come out right. I wouldn't necessarily be long the bond market either.
Gotham Index Plus So, back to the topic of Gotham's new fund. It is a fascinating idea. The fund will go long the S&P 500 index, 100% long, and then overlay a 90%/90% long/short portfolio of the S&P 500 stocks based on their valuations.
The built-in leverage alone makes this sort of interesting. Many institutions may have an allocation to the S&P 500 index, and then some allocation to long/short equity hedge funds. The return of the Gotham Index plus would be much higher (when things go well).
I think this sort of thing was popular at some point in the pension world; index plus alpha etc. Except I think a lot of those were institutions replacing their S&P 500 index portfolios with futures positions, and then using the cash raised to buy mortgage securities. Of course, when things turned bad, oops; they took big hits in S&P 500 futures, tried to post cash for the margin call and realized that their mortgage funds weren't liquid (and was worth a lot less than they thought).
Or something like that.
There is risk here too, of course. You are overlaying two risk positions on top of each other. When things turn bad, things can certainly get ugly.
I think Greenblatt's calculation is that when things turn bad, the long/short usually does well. I haven't seen any backtests or anything, so I don't know what the odds of a blowup are.
Expensive stocks tend to be high-beta stocks and cheaper stocks may be lower beta, so in a market correction, the high-beta, expensive names may go down a lot harder.
To some extent, lower valuations may reflect more cyclicality, lower credit risk / lower balance sheet quality too so you have to be a little careful. In a financial crisis-like situation, lower valuation (lower credit quality) can tank and some higher valuation names may hold up (like the FANG-like stocks).
But Greenblatt's screen is not just raw P/E or P/B, but is tied to return on capital, so maybe this is not as much of an issue compared to a pure P/B model.
The argument for this structure is that people can't stay with a strategy if it can't keep up with the market. Here, the market return is built in from the beginning and you just hope for the "Plus" part to kick in. In a long/short portfolio, the beta is netted out to a large extent so can lower potential returns. This fixes that. But there is a cost to that.
In any case, I do think it's a really interesting product, but keep in mind that it is a little riskier than Gotham's other offerings.
Oh, and go read the article on why this new fund is a good idea. Greenblatt is always a great read.
Chipotle (CMG) Well, Chipotle earnings came out and it was predictably horrible. The stock is not cheap so it hasn't been recommendable in a while, but I really like the company. There was a really long article on them recently which was a great read. It didn't really change my view of them all that much. I think they will get a lot of business back, eventually.
The earnings call was OK, but what was depressing about it was that they decided to ditch Shophouse. I don't think any analysts asked about it so it was a given, I guess. I had it a couple of times in DC and liked it and was looking forward to it in NY, but I guess that's not going to happen. As an investor, that was not baked into the cake, I don't think, even though there was probably some hope that the CMG brand can be extended into other categories.
This puts a lot of doubt into that idea. Someone said that brand extensions in restaurants/retail never work, and that has proven to be the case here. I wouldn't get too excited about pizza and burgers either. Burgers are really crowded now and will only get more so.
If CMG has to look to Europe for growth, that is not so great either as the record of U.S. companies expanding into Europe is not good. I would not count on Europe growth.
Anyway, this doesn't mean it's all over for CMG. I think they will come back, but there are some serious headwinds now other than their food poisoning problem; more competition etc. They were the only game in town for a while, but now everyone seemingly wants to become the next Chipotle, so there are a lot of options out there now.
As for Ackman's interest in CMG, I have no idea what his plan is. There is no real estate here as CMG rents all their restaurants, and their restaurants had high 20's operating margins at their peak. I don't know if they will ever get back up there, but it's not like these guys don't know how to run an efficient operation. Maybe Ackman sees SGA opportunities, but pre-crisis, SGA was less than 7%, so there wouldn't be that much of a boost from cutting SGA. Or maybe he thinks it's time for CMG to do what everyone else is doing and go for the franchise model. Who knows? I look forward to seeing what his thoughts are; hopefully some 500 page presentation pops up somewhere...
McDonalds I don't want to turn this into a food blog, but I can't resist mentioning this. I have been a lifelong MCD customer; I have no problem with it. OK, it may not be my first choice of a meal in most cases, but it's fine. And when you have a kid, you tend to go more often that you'd like. But still, it's OK. It is what it is, right?
I like the remodelling that they are doing, and the fact that they have free wifi is great too. But here's a big clustermuck they had with their recent custom burger and kiosk idea. I walked into a MCD without knowing anything about any of this recently. A lady said I can order at the kiosk and I said, no, I'll just go to the counter, thank you.
And I waited 10 minutes or so in line, looking up at the tasty looking special hamburgers on the HD, LCD menu board. It was finally my turn at the cash register and I said I want that tasty looking hamburger up there on the screen. And the lady said, oh, you can only order that at the kiosk. I was like, huh? That was really annoying. So I wait all this time and I can't get what I want; I have to walk all the way back and get in another line again? Come on! At that point, I didn't want any other burger so I just ordered a salad (and the usual for my kid).
OK, so it's my fault, probably. User error. But as a service company, as far as I'm concerned, that was a massive fail on the part of MCD.
OK, Now That I started... And by the way, since I got myself started, let me get these two out too. Yes, I spend too much time at fast food joints. Guilty. But still, here are my two peeves related to two of my favorite fast casual places:
Shake Shack: Being dragged there all the time, I have learned to love the Shack-cago hot dog. Chicken Shack is awesome too, in case you don't want to eat hamburgers all the time. But I can't tell you how often they get take-out and stay wrong. I had a long run where they didn't get it right at all and had to ask for things to be packed to go. It is really annoying and wastes everyone's time.
Chipotle: This hasn't happened to me the last couple of times, but this is the usual conversation that happens to me just about every time I go to Chipotle.
CMG: "Hi, what can we get you today?" (or some such) Me: "Um, I'll have a burrito..." CMG: putting the tortilla in the tortilla warmecooker, "and would you like white rice or brown rice? Me: "White rice is fine" CMG: with tortilla still in the cooker, "and black beans or pinto beans?" Me: "black beans". CMG: laying a sheet of aluminum foil on the counter and placing the tortilla on it, moving over to the rice area, "Was that white rice or brown rice?" Me: "white rice" CMG: sliding over to the beans, "and black beans or pinto beans?". Me: "black".
I can't tell you how many times this exact thing happened to me. If you can't remember what I say, don't ask beforehand! Just ask when we get to whatever you are going to ask me about! This is not rocket science, lol... Incredibly annoying.
Anyway, I still love CMG and will keep eating there.
Oh, and to make things interesting, I decided to post a contact email address in the "about" section of the blog. I will try to respond to every email, but keep in mind I may not look in that email box all the time.
I will try to post more, though. http://brooklyninvestor.blogspot.com/2016/11/perpetual-option-och-ziff-capital.html
(read original with tables)
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