Selling T3

Guest Post by James Wheeldon of http://www.jameswheeldon.net/

The Commonwealth Government is about to embark on a $20 million advertising campaign to encourage retail investors to pick up Telstra shares in the “T3″ third tranche of its privatization.
It is generally accepted that the best investment strategy for retail investors is to pick a widely diversified basket of investments and hold them for a long time.

I wonder if the T3 advertising campaign will explain to the mum and dad investors who are the targets of the campaign how investing in a single stock (Telstra) in one of the riskiest sectors (telecommunications) of the stock market forms part of a diversified investment portfolio? Considering John Howard’s record of not leveling with the Australian people about Telstra, I think it’s unlikely that retail investors will be able to rely on the federal government’s advertising campaign for responsible or reliable advice.

Let me be blunt. Buying individual stocks as opposed to investing in a diversified bundle of stocks and other investments is a mug’s game. Investing anything more than a small proportion of one’s investment assets in a single stock is a bad idea, unless you know enough about that stock and the business it operates to be able to explain why that stock will perform better than the market as a whole. If you can’t give that explanation, then consider investing in an index fund that tracks the market as a whole.

Anybody who is thinking of buying T3 should ask themselves (at least) the following questions:
“¢ Do I understand how Telstra makes money?
“¢ Do I understand how it’s going to make money in two/five/ten years’ time?
“¢ Have I read Telstra’s financial statements, and did they make sense to me?
“¢ Do I understand the difference between Telstra’s wholesale and retail business?
“¢ Do I understand the costs and risks involved in fibre rollout?
“¢ Do I understand how competition from wireless and voice/video over internet will affect Telstra’s business?
“¢ Do I understand the regulatory burden on Telstra?
“¢ Do I understand Telstra’s dividend policy, and am I confident the policy is sustainable?
“¢ Do I understand Telstra’s governance and am I confident that the relationship between management and the federal government won’t act as a drag on its operations and financial performance?

If you can answer those questions, and if on the basis of those answers you are confident that Telstra will outperform the market as a whole, then and only then should you consider investing in T3. Otherwise, put your hard-earned in a low fee diversified fund and let it grow.

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42 Responses to Selling T3

  1. Jc says:

    James

    I don’t think your assessment of the riskiness of telstra to the market is accurate.

    Telstra right now have an implied volatility for 3 months call options at 18%
    BHP on the other hand is at 25%. ….. both at the money call options.
    This suggests that Bhp is a far riskier investment than Telstra

  2. taust says:

    Nick;

    given to a practical degree efficient markets can you explain to me why once you go to a diversfied group of stocks and allowing for the occassional dud (risk) the return would be any higher than putting your money in the bank.

  3. taust,

    I didn’t write the post. But in response to your question, the answer is that I can’t explain it. No-one can. But the return on stocks is around 5-6% higher on average than the return in the bank. If we really had efficient markets then, at least according to some theorists the margin should be around 0.5%.

    And we’re geting closer to an explanation via behavioural finance and the statistics of rare events. And probably a few other things. Quiggin knows the literature much better than me – he’s a world authority on it. Go ask in this Weekend’s Weekend Reflections.

  4. Chris Lloyd says:

    I am not aware of any theoretical return margin between equities and treasury bonds. I have certainly never heard 0.5% as a benchmark. Probably JC can give a clear answer. Also JC, I think that the Wheeldon is mainly arguing that the government should not be encouraging ordinary citizens to invest in individual stocks at all. Though I take your point that Telstra is not necessarily the most risky single investment, single investments are risky by nature.

  5. JC –

    My point is not that Telstra is more or less risky than any other individual stock. It may turn out to be a great buy. My point is that the “mum and dad” investors who don’t understand what implied volatility means or know what a call option is are better off investing in something that tracks the market as a whole than in trying to guess which individual stock is going to outperform the rest.

    I was making a couple of really basic general points about investing – i.e., don’t put all your eggs in one basket, and don’t pick stocks unless you know enough to be confident that the stocks you are picking will outperform the market.

    You sound like you know what you are talking about – you are probably not going to be swayed one way or another by the govt’s ad campaign. And I bet if you buy TLS in T3 it won’t be the only investment you hold.

    On the other hand, there are a lot of people who don’t know jack about markets and don’t know why you should hold a diversified portfolio but who think that if the govt is telling them to buy Telstra then it must be a good idea.

    The government is directly targetting “mum and dad” investors with their ad campaign for T3. I think that’s irresponsible.

    James Wheeldon
    jameswheeldon.net

  6. Chris Lloyd says:

    I am pretty sure you must be wrong about the 0.5% Nick. I don’t think there is any benchmark premium for a given level of risk. The extra return depends on the amount of risk and the ratio of these two does tend to be empirically consistent across a range of similar stocks

  7. Jc says:

    Chris
    I am not an investor so I really don’t know all that much about how one splits up assets for investment purposes.

    We always need to be wary of past history though. Depending on timing it would have been better to put money in the bank than hold a bunch of stocks from the time of the depression to about 1960 I think. And the Dow Jones remained almost stationary from the 60 to 1982 or so. This is a long time.

    I think James nails it on the head though. If you’re going to be focusing on a few stocks do it like Warren Buffet. That is make sure you know those stocks inside out and hold them forever. I think he says you need to treat them like you would a business and avoid worrying about what the economy is doing. Good advice it seems.

    I think james is right tough, Telstra is a risky bet for anyone as no one really knows where that business is heading.I recall Nick writing some stuff about setting up a voice over the internet phone system and I thougt at the time that sort of thing kills Telstra land line business.
    Movie on demand in High defintion is already reaching US makets so it could eventually put a negative spin on Foxtel as they really suck compared to the offerings in the US market.

    This business is too fast moving and I think Telstra is not that fast on its feet ans may die the death of a thousand cuts.

  8. Jc says:

    Movie on demand in High defintion i

    Should read movies on demand in HD over the web……..

  9. Lance Kelly says:

    Why invest in stocks at all when one can earn 30% per over ten days or 44% on 12 days with little effort?

  10. Jc says:

    Because you can’t Lance and it’s dishoesnt to advertise such rates of return on unsuspecting people.
    If such rates of return were possible, you wouldn’t be advertising them as you would be taking advantage of them and living in Bermuda.

  11. Jeez – it’s pretty hard not to be misunderstood around here. (Mind you, maybe I’m doing the misunderstanding.) Just to clarify what I tried to say,

    Firstly I agree with James’ point – people should not be encouraged to take a punt on Telstra. They should be encouraged to take out a balanced portfolio.

    Secondly it depends what models you use obviously, but at least from memory when I read up on some of this stuff standard models of risk aversion lead one to the view that, given all the opportunities for managing risk – with diversification of various kinds – and given plausible parameterisation of actual risk aversion, one would expect the equity premium to be way way lower than the 6 odd percent it is.

    Here’s Wikipedia on it.

    The puzzle arises as the observed difference in returns implies an implausibly high level of risk aversion. That is, economists predict the difference in returns between these two investments should be much smaller than 6 percentage points. To quantify the level of risk aversion implied, investors would have to be indifferent between a bet with a 50 percent chance of $50,000 or $100,000 and a certain payoff of $51,209 (Benartzi and Thaler, 1995).

    I’m happy to be proved wrong on this – and in fact tried to go have a squiz at Quiggin and Grant’s recent paper – but it’s not up on his site and my journal access doesn’t extend to ‘economists voice‘ (and I thought it was going to be a freeby when it was launched!)

  12. Jc says:

    Nick
    I’m not sure if such a premium exists in reality. The question always gets back to the issue of timing. If you had bought US stocks in 1982 when the dow was 700 the decision would look brilliant.But what if you had ploughed into the Nasdaq at 5200 in 2000?

    You got to ask why did the people examining the equity premium not take into account the global stock markets since say 1850 when records are available and more reliable. If they did they would have found a much lower return. Global equity returns look nowhere near as good over that time…… some of the markets were completely wiped out…. the Russian market in 1917 being a good example.

  13. Lance Kelly says:

    Well as a small investor I do earn 44% return on original after 12 days. Whether you think it is illegal or not it is happening and people are earning.

  14. Jc says:

    First of all it’s illegal in OZ to be advertising investments without authorized documentation and not having proper licence. Do you?

    Secondly, if you’re earning a return of 44% why are you telling us for?
    It’s a 1320% pa without compounding, Lance. Is it possible, sure it is, about as possible as snow in north Queensland in January.

    Just by the by, I looked at your site and couldn’t make head or tail of what it is you are trying to flog. What is it: a pyramid scheme of some sort right? If it is make sure you’ve got that one way ticket to Honduras handy, Dude. It will come in handy when it comes crashing down.

  15. The numbers in the article I’ve just looked up in the JEL go back to 1880 odd and there’s not much trend either way. I doubt going back further does much, but feel free to quote chapter and verse. Regarding the wiping out of the stock market, bond markets go the same way and (I think) do so more often than stock markets. If you were to go through a quick hyperinflation what paper would you be rather holding?

  16. Jc says:

    Did another quick look at your site. V stocks, Lance. Cute name.

    oh and the 12% referral commission doesn’t sound like a pyramid scheme to me. Yea right.

    Lance, why not do the right thing and grow a conscience. Little people who are unsophisticated believe that swill and lose money. Why take them for a ride? Don’t try and take them for a ride. It’s wrong.

  17. Jc says:

    Good point on bonds getting whacked too.
    I saw this analysis in one of James Grant’s books some while ago.

    If there was hyerinflation: I wouldn’t want to own any paper, i guess. Just gold and land…etc.

  18. Jc says:

    james Grant
    Money of the mind
    “Borrowing and lending in America from the civle war to Mike Milken”

    the book missed the tech mania….. Funny that.

    If you want I look for the relevant part and summarize it.

  19. Jc says:

    Without looking at it yet, nick. my recall is that bonds had a marginally better time of it. The reason was that foreign bond holders have historically got their money back…. Russia for instance may not have defaulted on it international bond obligations. I think bond default is a no no, whereas nationalizing industry is ok.

  20. taust says:

    One possible explanation that I remember being raised at some time was that (except when you purchase market index) one buys individual stocks. You take the wins and losses on these stocks.

    An index is composed of different stocks over time. In particular bankrupts disappear from the index. Thus the return earned from the index will exceed that from actual purchase of the stocks making up the index.

    Anyone know if there is explanatory truth to this idea and if it has significant effect?

    By the way have posted my original question in weekend reflections.

  21. JC, my understanding is that the Russians defaulted on their bonds.

  22. Bring Back EP at LP says:

    I would baulk about investing in a company whose only strategy seems to be getting looser regulation so it can get monopoly profits.
    It has no hope.

  23. Jc says:

    Thanks Nick
    I thought they met their obligations on international bonds. Guess I was wrong. I used to always recall reading when i was younger that the Soviets had never defaulted on debt. I guess that doesn’t mean they didn’t default on Tsarist paper.

    In any event though:

    My comment didn’t just take into account nationalizations and expropriations etc. In other words there have been far more corporate failures round the world than government bond defaults, which forms the basis of the risk free rate of return

    Homer:
    That’s a conclusion that does not follow from the premise…..How do you get a monopoly from less regulation?

  24. Bring Back EP at LP says:

    less regulation means more ability to rip off consumers.

    It is only through more regulation you can make market forces work where a monopoly exists. look at any economics text book in the micro-economics section dealing with monopoly!

  25. Bring Back EP at LP says:

    JC,
    it was the reason why Long Term Capital Management went essentially belly up.

    Any company that controls the market wants more controls is as far as I can determine what Sol and his amigos want to do and the ACCC quite obviously will not let them and nor should they.

    The government obviously had this in mind when they wanted the biggest price it could get. Telstra is only a good bet if it is allowed to control the market.
    If it isn’t it seems to me it is going nowhere fast

  26. Jc says:

    Homer
    Long term capital went under becasue they were running leverage of 80:1 and the bond market collapsed particularly italian BTPs. they had an enormous position in italian government bonds and what they thought was relatively risk free was not.Of course they were “arbitraging” many other bond markets as well.

    they weren’t trying to corner the market in any way. Stop making things up , homes.

    You can’t have a monoply position unless it is government sanctioned through regulation. Anyway why is a fast moving, ever changing industry like telco suddenly the preserve of the government and regulations. We are much better off if the Government had no hole to dig in this industry.

    Ever looked at the telco laws and regs. they are a complete mess and no one can really make sense of them.

  27. Bring Back EP at LP says:

    JC, have a look at European Financial Mgmt Vol 6, 277 p277-300 for the authorative version on what went wrong

  28. JC,

    I also heard that the Soviets bought up Tsarist consuls at some stage – I think the 1980s. They were not being honoured so they could buy them for a song. Then they announced they’d honour them! Made a big (paper) capital gain! I’m not sure how much of this is true, but I picked it up somewhere a long time ago.

  29. One thing that occurre to me while reading the post that has not been picked up. If it is back risk management to hold a large amount of a particular stock why are you not calling for the government to unload its Telstra holdings? If

    Buying individual stocks

  30. Andrew, there’s some validity in your point, but only a bit. The Government is much much bigger than an individual shareholder, and much more inherently diversified. But agree that’s only a partial argument for govt holding telstra. Personally I go some of the way with Quiggin’s argument against selling Govt Business Enterprises, but there’s no harm in taking the argument seriously.

    If Govt is a more efficient bearer of equity risk than private holders of equity (which Quiggin argues and I accept) then it should invest more in equities (though up to what point is unclear). But there are lots of other principles at stake. viz

    1. Govts should not generally involve themselves in the running of business enterprises
    2. Govts should consider involving themselves if this improves efficiency – which it may if there are natural monopoloy or other eggregious market failurs.

    Anyway, this is a whole new area of debate. Perhaps worth another post at some time.

  31. Jc says:

    Homes

    I witnessed it go wrong, our firm was one those called up on the weekend by the NY FED to figure a way out. We had a US$500 mill line of credit to them. Not my area though.

    They never tried to corner the market, they couldn’t and they weren’t that stupid. What they did, that was really silly, was to think that arbitrage existed when it didn’t. They were playing spreads in a huge way.

    I forget now, but they were playing EU convergence trades in a massive way. At one stage there were no bids for Italian govies when the bottom fell out of the global bond markets. Trust me, they weren’t trying to monopolize any market. They were just greedy little pigs who ended up understanding that no one is ever bigger than the market.

    Good save by the Fed though, it was a very impressive operation.

    Nick

    That’s funny if it’s true. What’s even funnier is if there was such long term Tsarist paper out in the market.

  32. JC – well it was ‘in the market’ only by virtue of being in numismatic collections I suspect.

  33. Sacha says:

    James Wheeldon – jeez – you just want to spoil the fed govts game don’t you?

  34. Jc says:

    Nick
    I gave it some thought, these days my long term memory serves me jsut a litle better than my short term one.

    I recall something about those bonds. It was some time before the Soviet Union broke up and they wanted to do a bond issue.. the commies did. Apparantly it was the first time they had ever tried going to the Euro markets to raise money on a sovereign basis. They were about to do the deal and the investment bankers found out that they were in legal jeopardy with the issue as the result of the Tsar bonds they defaulted on.
    It meant that if anyone hadn’t used the old bonds as toilet paper they were legally entitled to ask a court to escrow the funds and get paid on the proceeds. That’s why they came into the market and bought the bonds… in order to get them out of the market. Funny, but to the best of my knowledge close to the real story.

  35. Yes, that sounds like the story. My undersanding is that they bought them up at a song while their intentions were unclear to the ‘market’.

  36. Bring Back EP at LP says:

    JC,

    It was the Russian situation that caused everything to go pear-shaped for Long Term Capital Management.

  37. Jc says:

    Homes

    Not sure about that. Long term cap happened in 1994 if I remember. Russia went down the toilet in the later 90’s … 1997/1998? I think.

    Are you talking about Russia crisis?

  38. Bring Back EP at LP says:

    JC,

    The default set off all the problems that Long Term were to encounter and were thought to be impossible to happen.

  39. Bring Back EP at LP says:

    JC,

    The default set off all the problems that Long Term were to encounter and were thought to be impossible to happen.

  40. Jc says:

    Homer
    Long term cap was in 1994. Russia defaulted in 1997/1998. They’re unrelated.

  41. JC,

    LTCM folded in 1998. Their computer models failed to include the potential of sovereign default and, yes, it was Russia’s default that took them down.

    http://en.wikipedia.org/wiki/Long_term_capital_management

    (My old law firm in New York City (Skadden, Arps) hosted Alan Greenspan and the rest of the Fed over a brutal weekend to organise the bailout.)

    James

  42. Jc says:

    Sorry Guys,

    you’re right. I thought it went under after the bond market fall in 1994. My mistake.God, time flies.

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