Financial Literacy Grab Bag: 13Fs, a Terrible Short, and a Test

What do 13Fs and shorting stocks have in common? You need to have a high degree of financial literacy in order to use them effectively. Join Gaby Lapera and John Maxfield for a discussion on 13Fs, the perils of shorting stocks, and the overall state of financial literacy in the United States. 

A full transcript follows the video.

 

Gaby Lapera: Hello everyone! Welcome to Industry Focus, financials edition. This is Gaby Lapera with John Maxfield on the phone. This week we're going to be talking about financial literacy and we hope that you are literate too. You probably are because you found this podcast on iTunes. Either that or you're just randomly clicking around the Internet.

So let's get started with this week. This week we're going to start with 13Fs which were due maybe like a week or so ago. 13Fs are an SEC filing with a super long official name. They're formally known as Information Required of Institutional Investment Managers form. So these things come out every quarter and they're required of any institutional investor with over $100 million in qualifying assets and they have to be filed within 45 days of the end of the quarter. So all of them should be in for the third quarter by now.

These things are really super cool because they provide information on what these giant investors have holdings in. Of course, they only work if the firm's reporting honestly which was a huge problem with Bernie Madoff.

John Maxfield: Yeah there are a lot of problems with Bernie Madoff weren't there?

Lapera: There were a lot, but this is one of them.

Maxfield: 13Fs are certainly a huge one. Just to add a little bit more substance to the 13Fs. Let's say you're sitting there as an investor and that you love, I don't know, let's say I don't know Gab, what do you think? Warren Buffet maybe?

Lapera: Sure. Oaktree Capital (OAK). Let's do Oaktree Capital.

Maxfield: Oaktree Capital, a great one run by a guy named Howard Marks. Brilliant, brilliant investment manager. Distress that guy. Not as big into equities but a great choice. In fact Howard Marks is one of the most brilliant. He's got this great, great book titled The Most Important Thing that I honestly believe every investor should read. It's second only probably to, in my opinion, to the Intelligent Investor by Benjamin Graham. But that is a total aside.

Lapera: I had no idea you were such a huge fan, Maxfield.

Maxfield: Yeah. Howard Marks, he's awesome. And what I love about his book, I know we're totally going on a tangent here, but this is actually a valuable enough book that investors should probably take a look at it. It's called The Most Important Thing and it goes through basically I don't know if it's like 20 different things that he calls the most important thing.

And what he realizes is that there is just a number of very equally important things the investors need to keep their eye on. But to get back to 13Fs, so a 13F is like Gaby said. If you're an investor and let's say you love Warren Buffett or Howard Marks or somebody like that, and you want to figure out what they're buying, what they own, things like that.

You go to the 13F because that is where every quarter within 45 days, after the end of a calendar quarter, big institutional money managers must file with the SEC a form that basically says what stocks they own and how much of them they own.

Lapera: Yeah and they're really exciting because like Maxfield said, if you're a really big fan of these guys you can kind of see what their portfolios look like. So I have Oaktree Capital's pulled up right here and it looks like for example their top buys this time was Jazz Pharmaceuticals. Top sells were Allergan, those are both biotech's. I know that we're a financial show but sometimes we talk about other sectors too. And it also has a breakdown of what their sector allocation is.

So most of their stocks are in information technology. It's pretty interesting stuff. You can find this online at whalewisdom.com. Just go Whale Wisdom, search for whatever company you're looking for that has institutional investments -- so that's banks, insurance companies, obviously these capital management firms. It's a pretty helpful tool for investors.

Maxfield: Yeah I find it's a totally helpful tool for investors, but you have to keep it in context, right? Because one of the things you have to keep in mind about 13Fs is that aren't filed until the end of the quarter -- until 45 days after the end of the calendar quarter, right?

So a lot of these investment decisions will have already been you know, they will be stale by a few months by then. Which by that time the valuations and the prices of those investments could change. And the other thing to keep in mind with 13Fs, just as a caveat is that there are procedures that a big institutional money manager can go through to then not actually report specific holdings in a particular quarter. And let me give you an example. So back in 2011 Warren Buffett, I think it was 2011, Warren Buffet went against his long- held belief that he should avoid technology stocks and he invested in IBM.

Well, as he was building that position, if it was straddling two different quarters he's not going to want to come out in the middle of that as he's building that position and say, "Look I'm buying all this billions of dollars worth of IBM." I think he owns something like 8.3% right now, right? Because that would cause the price to skyrocket immediately.

So what he does is he applies with the SEC or Berkshire Hathaway (BRK.A -0.28%) (BRK.B -0.68%) does this, and he says, "Look, let me report this, but let me delay reporting this another quarter so I can build my position first and then let people know." So it's just a good thing to keep in mind for investors that sometimes the data is either stale slightly, or it could not be telling you everything that you think it should be telling you.

Lapera: Absolutely and this goes back to the Motley Fool's general investing philosophy which is that you need to do your research before you buy, right? You can't just depend on other people just to tell you things, right? You really need to make up your own mind.

Maxfield: Exactly.

Lapera: Speaking of buying things and not really knowing what you're doing. There's this guy, I read an article about him. His name is Joe Campbell and he shorted I think it's called KaloBios (NASDAQ: KBIO). It could be Kalo, I'm not sure. Because he thought the stock was going to drop.

Actually Maxfield, do you want to explain what a short is?

Maxfield: So yeah, a short is I mean, typically when the typical investor buys a stock you just buy a stock. And that's called going long because you're buying it and hoping in the long term the price will go up. Shorting it is the exact opposite. It's kind of a complicated thing how it works, but you borrow the stock from somebody else, from your broker, you can sell it immediately and then that way you then later on buy that stock back hoping that its price has fallen. So what you're doing is you're buying low and selling high but kind of in the reverse order. And that's called going short.

Lapera: Right, you're basically betting against the stock.

Maxfield: Right.

Lapera: So anyway this stock instead of dropping, it actually popped because this guy named Martin Shkreli which you guys probably remember from that whole Turing Pharmaceuticals debacle over Daraprim which is a drug that's used to treat malaria and toxoplasmosis in people with compromised immune systems.

Anyway he raised the price like a bajillion dollars and it was like $15 before and he raised it to like $5,000. I have no idea. It was a lot. Do you guys remember this? It was like a, I'm sorry, do you remember this?

Maxfield: Yeah I do, I totally do. I totally do.

Lapera: The one person I'm actually talking to. Anyway, so he bought a heap ton of KaloBios stock. So it was on its way out because they basically announced that they had no more money to develop their cancer drugs. And Shkreli was like, "I'll buy you." And this guy Joe Campbell had shorted like everything he had in his investment fund, he'd shorted KaloBios which is $37,000.

So something about shorts which I think a lot of people don't realize is that, when you buy a stock and you go long, you can only lose the amount that you initially invested. But when you short a stock, there's an unlimited amount that you can lose. So even though he shorted the stock with only $37,000 he lost $106,000 I believe.

Maxfield: Yeah I mean shorting is a dangerous exercise.

Lapera: Well especially in biotech. It's such a volatile sector and it's clear, like this guys says "I was fine and then I went to a meeting and I got back and it was down." So it's clear like he wasn't sitting, or he doesn't have a job where he's sitting around like monitoring what's going on in the biotech field. Like he's just a recreational day trader essentially.

Maxfield: A recreational shorter. And like other people who do things recreationally, and I'm not passing judgment one way or the other on anything, you have to do so very carefully.

Lapera: Right, well especially when so much money is at stake, right? And I mean he thought that, I mean there was no way for them to know that Shkreli was going to do this. But I think the thing that really gets me thought is that he started a GoFundMe to cover the funds that he lost. To cover the $106,445.56 that he lost.

Maxfield: Oh my God, I love it. I love it. I need that, we need to start something like that, Gaby. I haven't lost that much money yet, I probably will at some point in my life, but I'd still like to start a GoFundMe account.

Lapera: Yeah.

Maxfield: Just to kind of tie this in to our 13F discussion, so here you have an investor, he's made this horrible decision, right? Now let's say that this was like a bigger investor, like a David Einhorn or a Carl Icahn or something like that. And you wanted to, you looked at this decision to short a stock and then you decided you'd fall in. You have to keep in mind that even people, let's say this gentleman who made that mistake was a true expert in what he was doing. Even true experts make mistakes, right?

Lapera: Oh yeah, all the time. All the time.

Maxfield: I think it's just a good thing to keep in mind. And let me give, to kind of like a similar story to this that also ties into that 13F, that you have to keep in mind is that sometimes when people buy stocks they have different motivations for doing so -- buy or sell stocks [...] shorting, then maybe immediately apparent, right? So let's say you have a company that is tanking, right? And you want to short it, right? Or you want to buy the shares because you think that they're of value, and you see one of your favorite investment managers accumulating a large stake in that position.

Well, they may be accumulating a large stake in that position for a totally different reason that is actually diametrically opposed to what you're trying to do. Let's say that they're buying up convertible debt, that they're buying up stock, things like that to position themselves to have a large say in a bankruptcy proceeding or to control the company after the bankruptcy proceeding.

We saw a lot of this happen during the financial crisis where you had big institution managers move into stocks that had plummeted, and then you add little retail investors looking, saying "Oh we should move into that too." Not realizing that like, "Oh well the reason they're moving into these is to prepare for after the bankruptcy" which the banker sees really what caught the kind of the followers of those strategies.

Lapera: Yeah, I think that so this guy, there's a quote from him. It says, "I keep it small because I wanted to manage risk. The most I can afford to lose is what I have in the account is $37,000." Which I mean if you knew that that's all he wanted to lose, then you know, shorting is maybe not the way to go for you.

Maxfield: Vegas would be a better way.

Lapera: Exactly. Which kind of leads me actually into my next topic which is a survey that was conducted by Standard & Poor's/Gallup/The World Bank. This is a lot of big names, you can probably trust this study. On financial ...

Maxfield: /the Onion.

Lapera: /the Onion yeah. So it's actually about financial literacy and the survey asked five questions which I am actually going to ask to you, John Maxfield and let's see how you do.

Maxfield: Oh no, no you're not. Oh no. Okay. Alright is this the real deal, so you're going to ask me these questions? And just for listeners I have not prepared the answer to these questions.

Lapera: No, this is a shock to him. Get excited. So are you ready?

Maxfield: Yeah I hope I don't fall into that other category. Okay.

Lapera: Suppose over the next 10 years the prices of the things you buy double. Your income also doubles. Will you be able to buy less than you can buy today, the same as you can buy today, or more than you can buy today?

Maxfield: So your income increases by the same percentage the price increases?

Lapera: Right, and we're not talking about savings or anything. Just literally your income.

Maxfield: Just your income. I would say that you can buy the same.

Lapera: Exactly. Good job.

Maxfield: Okay. Oh my God. I'm very nervous, I want you to know that.

Lapera: Good. Suppose you need to borrow $100. Which is the lower amount to pay back? $105 or $100 plus 3% interest?

Maxfield: $100 plus 3% interest.

Lapera: Correct, excellent! Two for two. You are two for two. Get excited. Alright, we're almost there. Compound interest. Suppose you put money in the bank for 2 years and the bank agrees to add 15% per year to your account. Will the bank add more money to your account second year than it did the first year, or will it add the same amount of money both years?

Maxfield: It will add more and I want that bank account.

Lapera: Yes, I know. Who doesn't want 15% interest?

Maxfield: Because I feel like one basis point on mine.

Lapera: I know, me too. Okay, last question. I guess they're, oh no there is one more question after this, I'm sorry. So suppose you had $100 in a savings account and the bank adds 10% per year to the account. How much money would you have in the account after five years if you did not remove any money from the account? And I'm going to give this to you with multiple-choice answers because I don't want you to have to do math right now.

Maxfield: Okay so let me just make sure, so $100 and they're giving you 10% every year?

Lapera: Right. And how much would you have after 5 years. Can you do the math in your head?

Maxfield: Okay go for it. Give me some multiple choice options and I have a rough idea about what it is. But go on.

Lapera: Less than $150, exactly $150, or more than $150.

Maxfield: You'd have more than $150.

Lapera: Correct.

Maxfield: Okay thank you.

Lapera: No problem. Yeah when I did this the first time, I like sat down and did all the math and I got the correct answer. And then it was multiple choice like that, and I was like oh this is a word I can't say on the air.

Anyway so risk diversification. Suppose you have some money. Is it safer to put your money into one business or investment, or to put your money into multiple businesses or investments?

Maxfield: It's definitely safer just to put your money into multiple investments.

Lapera: Correct. Congratulations you are super financially literate.

Maxfield: Wow, wow.

Lapera: That was it. That was the difficulty level of the questions we're talking about for this survey.

Maxfield: Okay and so you're telling me that ... oh so can you talk about the results.

Lapera: Yeah.

Maxfield: So most people did not pass that? Is that what you said?

Lapera: So most people did, 57% to be exact did. So that is not really the vast majority. And we are ranked actually 14^th in the world for financial literacy. So we didn't do all that great if you think about it.

Maxfield: Yeah. You know here's the interesting thing about financial literacy in the United States specifically. When we talk about financial literacy, it is a really important thing to know, right? I mean I think that that's what we do for living, right? We try to educate people about financial literacy. So obviously we are biased, that is really important thing.

Lapera: That's a good thing you passed that test.

Maxfield: It really is a good thing that I passed that. If it was a more difficult test, I'm afraid I probably wouldn't have. But what's important to keep in mind is that the biggest piece of financial literacy is really about just saving money for retirement, right? This is particularly as pensions have gone out and then we more as individuals largely responsible for our own retirement. So it's saving and then figuring out what to do with your money.

And what's interesting is that when you look at the United States economy, what is it? I think the stat is something like 70% of our economy. Our GDP is a function of consumer purchases, right? And then our savings rate is some abysmal level something like 4% or 2% which is much, much lower than most other developed countries. Well, one of the reasons that our GDP is so healthy historically is because our consumers have spent more money more of their income in a lot of other place. I mean there's other reasons that our GDP is awesome too. We have great natural resources and a variety of other things.

But on a country level, you don't want your people necessarily saving so much. But on the individual level, it is absolutely critical that you not only save, but that you do so early because of, and this kind of relates to a question in that test, because of the power, the time value of money.

Lapera: Of compounding interest.

Maxfield: Another way of putting that is compounding returns. So you know, you want to save, save early, invest that, allow compounding returns to boost your returns multiple-fold over multiple decades.

Lapera: Do you want to know the question that people had the most difficulty with in the United States?

Maxfield: The compounding returns?

Lapera: No the question about interest -- which is less to pay back, $105 or $100 plus 3%.

Maxfield: No kidding?

Lapera: That's the question people had the most trouble with which is crazy if you consider how much for example student debt there is out there or how much credit card debt is. 60% of adults in America have a credit card and they don't understand how interest works which is crazy. If you're not paying off your balance every month, then I mean you're pretty much giving money away.

Maxfield: Yeah and those interest rates are in the 20%.

Lapera: Absolutely.

Maxfield: Yeah. I mean if you don't know how interest works, yeah I mean that would be certainly an important thing that you'd want to get up to ... and it would take you 5 minutes to get up to speed on how it works. But it's certainly an important thing to know.

Lapera: So of the people who have a credit card in the United States only 57% of the people who answered that survey question, answered it correctly which is crazy.

Maxfield: There you go.

Lapera: So anyway I think that's pretty much it. Do you have anything else you want to say?

Maxfield: No I think that you kind of wrapped it up really, really well. I mean yeah people carrying these huge balances on their credit card, they don't know how interest works, I mean it really does fit nicely how that works.

Lapera: Yeah, so financial literacy, kids. It's important. Stay in school. If only schools taught financial literacy that would make it even better. Thank you guys very much for joining us this week. As usual people in the program may have interests in the stocks they talk about, and the Motley Fool may have recommendations for or against. So don't buy or sell stocks based solely on what you hear.

If you have any questions, comments or concerns or you want to quiz us on our financial literacy with your own made-up question please email us at [email protected]. Everyone have a great week and we'll see you all next week. Bye.