Investors face two sets of rules for banks’ loan losses

By Huw Jones

LONDON | Mon Feb 25, 2013 11:04am EST

(Reuters) – Investors will have to grapple with two sets of rules for how banks recognize losses on loans after the world’s two main accounting regulators failed to agree a common approach.

At the height of the financial crisis in 2009, the Group of 20 industrial and industrializing nations asked the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) to align their rules to make cross-border comparisons between companies easier.

They specifically requested new rules to force banks to acknowledge impaired loans much sooner, which might allow them to address problems in good time and prevent a repeat of taxpayer bailouts.

IASB Chairman Hans Hoogervorst said on Monday the board’s new impairment rule would be published in early March but alignment with the U.S. equivalent was highly unlikely.

“It’s still a long shot. We are taking a different course,” Hoogervorst told a meeting of the board’s advisory council, and ruling out a shift by the IASB to the U.S. model.

FASB wants all expected losses on a loan to be recognized up front while the IASB, whose rules are used in over 100 countries, thinks there should be an actual deterioration in a loan, such as late payment, before losses have to be recorded.

“The outside world, especially the regulatory community, is growing increasingly restless. I understand that and we are going to finish, whatever it takes,” Hoogervorst, a former Dutch finance minister and markets regulator, said.

“We cannot wait for a magic moment of convergence to come. If we can’t get a joint solution, then so be it.”

In a public consultation of its proposals, the IASB will ask whether a planned January 2015 start date for its new rule is still practical.

IASB officials also said requiring banks to make disclosures to bridge the gap between two different sets of rules could be costly.

INSURANCE CONCERNS

The IASB will also publish in June draft revisions to its insurance contracts accounting rule but seek feedback on only a handful of elements, raising concerns in the industry.

“We believe there are still a lot of important issues. It’s very difficult to have a clear view of how the model proposed will work,” Jacques Le Douit of the European Insurance and Reinsurance Federation told the meeting.

The changes proposed could introduce volatility into financial statements, added Jerry de St. Paer from the Group of North American Insurance Enterprises.

Hoogervorst said the sector had already won several concessions and, despite a decade of deliberation, there was still no accounting rule to show where insurers stood.

Accounting risked failing to flag problems unless the rule was changed in a timely way, he said.

“We have got to get this done. I am much more worried about this than impairment. At least everybody knows the banks are in trouble and they are probably hiding some losses. In insurance, I don’t think we know,” Hoogervorst added.

(Reporting by Huw Jones; Editing by Mark Potter)

Apple signals emerging-market rethink with India push

By Devidutta Tripathy and Harichandan Arakali

NEW DELHI/BANGALORE | Mon Feb 25, 2013 9:44am EST

(Reuters) – As BlackBerry launches the first smartphone from its make-or-break BB10 line in India, one of its most loyal markets, the company faces new competition from a formidable rival that has long had a minimal presence in the country.

More than four years after it started selling iPhones in India, Apple Inc is now aggressively pushing the device through installment payment plans that make it more affordable, a new distribution model and heavy marketing blitz.

“Now your dream phone” at 5,056 rupees ($93), read a recent full front-page ad for an iPhone 5 in the Times of India, referring to the initial payment on a phone priced at $840, or almost two months’ wages for an entry-level software engineer.

The new-found interest in India suggests a subtle strategy shift for Apple, which has moved tentatively in emerging markets and has allowed rivals such as Samsung and BlackBerry to dominate with more affordable smartphones. With the exception of China, all of its Apple stores are in advanced economies.

Apple expanded its India sales effort in the latter half of 2012 by adding two distributors. Previously it sold iPhones only through a few carriers and stores it calls premium resellers.

The result: iPhone shipments to India between October and December nearly tripled to 250,000 units from 90,000 in the previous quarter, according to an estimate by Jessica Kwee, a Singapore-based analyst at consultancy Canalys.

At The MobileStore, an Indian chain owned by the Essar conglomerate, which says it sells 15 percent of the iPhones in the country, iPhone sales tripled between December and January, thanks to a monthly payment scheme launched last month.

“Most people in India can’t afford a dollar-priced phone when the salaries in India are rupee salaries. But the desire is the same,” said Himanshu Chakrawarti, its chief executive.

Apple, the distributors, retailers and banks share the advertising and interest cost of the marketing push, according to Chakrawarti. Carriers like Bharti Airtel Ltd, which also sell the iPhone 5, run separate ads.

India is the world’s No. 2 cellphone market by users, but most Indians cannot afford fancy handsets. Smartphones account for just a tenth of total phone sales. In India, 95 percent of cellphone users have prepaid accounts without a fixed contract. Unlike in the United States, carriers do not subsidize handsets.

Within the smartphone segment, Apple’s Indian market share last quarter was just 5 percent, according to Canalys, meaning its overall penetration is tiny.

Still, industry research firm IDC expects the Indian smartphone market to grow more than five times from about 19 million units last year to 108 million in 2016, which presents a big opportunity.

Samsung Electronics Co Ltd dominates Indian smartphone sales with a 40 percent share, thanks to its wide portfolio of Android devices priced as low as $110. The market has also been flooded by cheaper Android phones from local brands such as Micromax and Lava.

Most smartphones sold in India are much cheaper than the iPhone, said Gartner analyst Anshul Gupta.

“Where the masses are – there, Apple still has a gap.”

‘I LOVE INDIA, BUT…’

Apple helped create the smartphone industry with the iPhone in 2007. But last year Apple lost its lead globally to Samsung whose smartphones, which run on Google Inc’s free Android software, are especially attractive in Asia.

Many in Silicon Valley and Wall Street believe the surest way to penetrate lower-income Asian markets would be with a cheaper iPhone, as has been widely reported but never confirmed. The risk is that a cheap iPhone would cannibalize demand for the premium version and eat into Apple’s peerless margins.

The new monthly payment plan in India goes a long way to expanding the potential market, said Chakrawarti.

“The Apple campaign is not meant for really the regular top-end customer, it is meant to upgrade the 10,000-12,000 handset guy to 45,000 rupees,” he said.

Apple’s main focus for expansion in Asia has been Greater China, including Taiwan and Hong Kong, where revenue grew 60 percent last quarter to $7.3 billion.

Asked last year why Apple had not been as successful in India, Chief Executive Tim Cook said its business in India was growing but the group remained more focused on other markets.

“I love India, but I believe that Apple has some higher potential in the intermediate term in some other countries,” Cook said. “The multi-layer distribution there really adds to the cost of getting products to market,” he said at the time.

Apple, which has partly addressed that by adding distributors, did not respond to an email seeking comment.

Ingram Micro Inc, one of its new distributors, also declined comment. Executives at Redington (India) Ltd, the other distributor, could not immediately be reached.

BlackBerry, which has seen its global market share shrivel to 3.4 percent from 20 percent over the past three years, is making what is seen as a last-ditch effort to save itself with the BB10 series.

The high-end BlackBerry Z10 was launched in India on Monday at 43,490 rupees ($800), close to the 45,500 rupees price tag for an iPhone 5 with 16 gigabytes of memory. Samsung’s Galaxy S3 and Galaxy Note 2, Nokia’s Lumia 920 and two HTC Corp models are the main iPhone rivals.

BlackBerry will target corporate users and consumers in India for the Z10, said Sunil Dutt, India managing director, adding that it will tie-up with banks for installment plans.

Until last year, BlackBerry was the No. 3 smartphone brand in India with market share of more than 10 percent, thanks to a push into the consumer segment with lower-priced phones. Last quarter its share fell to about 5 percent, putting it in fifth place, according to Canalys. Apple was sixth.

(Additional reporting by Aradhana Aravindan in MUMBAI and Poornima Gupta in SAN FRANCISCO; Editing by Tony Munroe, Mark Bendeich and Chris Gallagher)

Inmates go high-tech as startup mania hits San Quentin

By Gerry Shih

SAN QUENTIN, California | Mon Feb 25, 2013 9:08am EST

(Reuters) – One by one, the entrepreneurs, clad in crisp blue jeans and armed with PowerPoint presentations, stood before a roomful of investors and tech bloggers to explain their dreams of changing the world.

For these exuberant times in Silicon Valley, the scene was familiar; the setting, less so.

With the young and ambitious flocking again to northern California to launch Internet companies, there were signs one recent morning that startup mania has taken hold even behind the faded granite walls of California’s most notorious prison.

“Live stream has gone mainstream. Mobile video usage went up and is expected to increase by 28 percent over the next five years,” said Eddie Griffin, who was pitching a music streaming concept called “At the Club” and happens to be finishing a third stint for drug possession at San Quentin State Prison, near San Francisco, after spending the last 15 years behind bars.

Griffin was one of seven San Quentin inmates who presented startup proposals on “Demo Day” as part of the Last Mile program, an entrepreneurship course modeled on startup incubators that take in batches of young companies and provide them courses, informal advice and the seed investments to grow.

According to business news website Xconomy, incubator programs – which it tracks – have tripled in number for each of the past three years, proliferating from Sao Paulo to Stockholm at a pace that has fueled talk in tech circles of an “incubator bubble”.

Last Mile founder Chris Redlitz, a local venture capitalist, says his goal was never to seek out a genuine investment opportunity inside a prison but to educate inmates about tech entrepreneurship and bridge the knowledge gap between Silicon Valley’s wired elite and the rest of the region’s population.

Inmates, after all, are not allowed to run businesses. They do not have access to cellphones — much less Apple Inc’s latest iPhone developer toolkits — and they use computers only under close supervision.

A LOT TO LEARN

After his presentation in San Quentin’s chapel, which received a rousing reception from an audience that included prison warden Kevin R. Chappell, Griffin told a reporter it was unlikely he would launch his startup idea immediately after being released this summer.

“I still have a lot to learn,” said the soft-spoken Detroit native. “I’ve never used a cellphone. Technology is kind of foreign in this environment.”

But to hear the inmates use jargon such as “lean startup” and “minimum viable product” speaks to an unmistakable truth about the Bay Area zeitgeist, where startups, for better or worse, have come to embody upward mobility, ambition, and hustle.

“If they were doing this in the ’80s there may have been a different theme or model,” said Wade Roush, Xconomy’s chief correspondent. “But in this day and age, becoming an entrepreneur or starting a business is a form of self-actuation.”

Situated on prime waterfront land, San Quentin is perhaps California’s most storied prison and home to the state’s only death row. But it has also kept a longstanding progressive reputation, boasting a rare college degree-granting program and vibrant arts courses.

The Last Mile accepted 10 inmates out of 50 applicants for its latest batch. The program, which graduated its first class of inmates last year, meets twice a week to discuss startups and lasts six months, although the most recent class took seven months due to a prison lockdown last year.

Some Last Mile participants, under official supervision, have also joined the online question-and-answer site Quora to respond to questions about prison life or describe what it felt like to commit murder.

The latest batch of startup ideas included a fitness app that would motivate drug addicts to exercise, a cardiovascular health organization, a social network for sufferers of post-traumatic stress disorder, a food waste recycling program, and an e-commerce site for artists in prison.

DIFFERENT PERSPECTIVE

Because the likelihood is not great that these companies will become funded and succeed, Redlitz said he was also working to place the inmates in jobs at tech companies after their release.

Rocketspace, a startup co-working space in downtown San Francisco, has agreed to host an internship. Rally.org, a crowd-funding site that counts Redlitz among its investors, said it hoped to begin a program to seek micro-investments from the public for the inmates’ ideas.

Sitting in the Demo Day audience was John Collison, the 22-year-old co-founder of online payments startup Stripe, who noted some stark differences between the inmates’ proposals and the fashionable startups du jour in Silicon Valley.

“What’s frustrating is that all these companies in the Valley, they’re ideas for the 1 or 10 percent,” Collison said. “You have startups like Uber or Taskrabbit, that’s like, ‘Oh, here’s something to help you find a driver or find someone to clean your house.’ Are they solving real problems?”

The San Quentin inmates “were talking about urban obesity, or PTSD”, Collison said. “It’s a completely different perspective. We actually really need that.”

(Reporting by Gerry Shih; Editing by Dale Hudson)

Analysis: U.S. companies plan to spend, a boost for the economy

By Caroline Valetkevitch

NEW YORK | Fri Feb 22, 2013 3:57pm EST

(Reuters) – U.S. companies’ capital spending plans are holding up, and mostly exceeding Wall Street forecasts, in the face of policy concerns created by arguments in Washington over the fiscal cliff, the debt ceiling and now automatic spending cuts.

Their willingness to spend on new offices, plants and machinery, as well as a pickup in deal making, shows that they are starting to dig into the massive amounts of cash that has been collecting more dust than interest on their balance sheets. That could prove a welcome counterpunch to a softer outlook for spending by consumers and government.

A Thomson Reuters analysis shows that for 2013, more Standard & Poor’s 500 firms are forecasting capital expenditures that exceeded analysts’ expectations than at any time in the past four years. Recent U.S. government data showed a rise in equipment and software spending in the final quarter of 2012.

If companies ratchet up spending, that could help unleash more hiring and extend the early-year rally in stocks, which tend to rise along with business spending.

“Once businesses start spending, that really means not only are they going to be buying goods, but they’re going to be hiring Americans, and those things are really what’s going to be the multiplier that helps to take this recovery and move it into greater expansion mode,” said Burt White, managing director and chief investment officer at LPL Financial in Boston.

Not all the money will be spent on new projects, of course. And the spending plans announced so far are only slightly above last year’s average. But they comfortably exceed the expectations of analysts, whose capex forecasts fell this year.

Part of the reason may have been the dire predictions about the “fiscal cliff” late last year when analysts were putting together their capex forecasts. At least some chief executives, including DuPont’s (DD.N), blamed uncertainty over U.S. government budget and tax policy for a reluctance to invest and hire.

“A number of companies said we’re planning our budget cycle on worst-possible conditions,” said Fred Dickson, chief market strategist, D.A. Davidson & Co. Lake Oswego, Oregon.

That companies have turned more optimistic than analysts heartens investors because it amounts to a vote of confidence in the U.S. economy, which has been hobbled by high unemployment and household debt, and now faces curbs in government spending.

Another sign of confidence is the recent flurry of merger and acquisition activity. The $173 billion in U.S. deals announced so far in 2013 is more than double the volume seen last year at this time, according to Thomson Reuters Deals Intelligence.

After the financial crisis began in 2007, companies slashed expenses and jobs, and they remained diligent about keeping costs down even as the economy exited recession in mid-2009.

Federal Reserve data shows non-financial U.S. companies had $1.7 trillion of liquid assets, or cash, on their books as of the end of the third quarter of 2012.

MOVING OFF THE SIDELINES

The U.S. economy grew at a 2.2 percent clip in 2012 and is expected to slow to 1.9 percent this year as higher payroll taxes and government spending cuts take a bigger bite. Yet even with the economic outlook cloudy, things seem to be changing.

Of the S&P 500 companies that have issued capex guidance so far in 2013, 66 percent have spending plans that exceed analysts’ expectations, the Thomson Reuters analysis showed. That’s up from 57 percent in 2012, 59 percent in 2011, 55 percent in 2010, and 40 percent in 2009.

Those that have issued guidance are expecting to spend $1.59 billion on average in 2013. While that’s only a modest increase from the 2012 average of $1.57 billion, it is above the analysts’ estimates. Those estimates went down, to $1.48 billion in 2013 from $1.51 billion on average in 2012.

The 2013 data is based on 221 companies that have reported, while the 2012 average was based on guidance from 279 firms.

“I think companies are getting a little bit more urgency to actually go ahead and proceed with their plans despite some of the remaining uncertainties around the fiscal cliff,” said Natalie Trunow, chief investment officer of equities at Calvert Investment Management whose firm manages about $13 billion in assets. “They have to remain competitive long term.”

Some large firms, including Apple (AAPL.O), have already announced plans to increase capex, and sectors with the highest percentage of companies exceeding capex estimates so far in 2013 include health care, consumer discretionary and energy, the Thomson Reuters data showed.

To be sure, some expenditures will go toward maintenance of existing equipment rather than new plants, said S&P analyst Howard Silverblatt.

Clearly some will also be overseas. But there has been a surge in investment in oil and gas production in the United States, and there are signs that some manufacturing is returning, thanks to the promise of a cheaper energy supply.

Apple, the biggest U.S. company by market capitalization, said it will spend $10 billion on capital improvements this year, about $2 billion more than last year. It ranked sixth in terms of capex projections for 2013.

Oil and gas producer Chevron (CVX.N) tops the list with about $33.4 billion of capex planned, followed by AT&T (T.N), ConocoPhillips (COP.N), Wal-Mart (WMT.N) and Intel (INTC.O), the Thomson Reuters data showed.

This spending could be crucial at a time when consumer and government spending are likely to decline. A rise in the payroll tax, higher gasoline prices and a delay in tax refunds slowed retail sales in January, a worrisome sign for the year. At the same time, a slate of across-the-board government spending cuts are set to take effect on March 1, barring a deal between the White House and Congress.

PROFIT MARGINS VULNERABLE?

Of course, big capital expenditures can take a toll on earnings. And investors have worried about the effect slower profit growth could have on the stock market, which started 2013 on a tear and briefly notched a five-year high.

Energy and other commodity areas have had big increases in capital spending over the last decade, a trend that could eventually hurt margins, said Vadim Zlotnikov, chief market strategist for AllianceBernstein in New York.

“I expect this very aggressive capital spending to create the type of cost inflation that would make it very difficult for profit margins to expand,” he said.

But John Carey, portfolio manager at Pioneer Investment Management in Boston, said the positives tend to outweigh the negatives. “There’s always a risk when companies invest, but without investment there can’t be any long-term growth.”

(Reporting by Caroline Valetkevitch; Editing by Steven C. Johnson, Daniel Burns, Martin Howell and Tim Dobbyn)

Automakers Shed the Pounds to Meet Fuel Efficiency Standards

Decades of increasing vehicle weight may be coming to an end as cars get more lightweight materials.

By Kevin Bullis on February 20, 2013
Automakers are putting some of their best-selling vehicles on a diet in a race to meet strict new fuel-efficiency regulations that will kick in by the middle of the next decade.

The trend has automakers introducing lighter vehicles and embarking on demonstration projects designed to carve hundreds of kilograms off their most popular vehicles. Last month, for example, GM received major awards for its new Cadillac ATS sedan that weighs 3,315 pounds (1503.7 kilograms), making it one of the lightest vehicles in its class, thanks in large part to an all-aluminium hood, magnesium engine mounts, and other lightweight materials.

“Every automaker we talk to is talking about how they can do more ‘lightweighting,’ ” says Patrick Davis, vehicle technologies program manager at the U.S. Department of Energy’s Vehicle Technologies Office. “Using lightweight materials is a major way the automakers are planning to meet fuel economy standards through 2025.”

As they contemplate the new fuel standards, which require cars to have an average miles-per-gallon rating of 54.5, automakers cannot rely on consumers to buy more hybrid or electric cars, or smaller, more efficient models.

Reducing the weight of conventional cars offers a way to guarantee better fuel efficiency: every 10 percent reduction in weight provides a 6 to 7 percent improvement in fuel economy. Weight savings can lead to further fuel economy improvements by allowing automakers to use smaller, lighter engines and other components. Davis says the DOE’s hope is that all cars will be 35 percent lighter by 2025.

Along with aluminium and magnesium, carmakers are using more carbon fiber. The material is lighter than steel but still absorbs more energy, which can help make lightweight vehicles safe. But it can cost three times as much to make. Oak Ridge National Lab (ORNL), working with Dow and Ford, is developing new precursor materials that, along with improvements to manufacturing, could cut the cost of carbon fiber in half, says Raymond Boeman, a program director at ORNL.

After decades of piling on the pounds, all sorts of cars are becoming lighter. Mazda’s 2014 Mazda6 is 8 percent lighter than the previous model; the chassis is 16 percent lighter, and its bumpers, featuring a novel resin Mazda helped develop, are 20 percent lighter. Jaguar and Volvo both plan to introduce lightweight vehicle platforms—structures that can be used in a wide range of future models—making extensive use of lightweight materials such as boron steel and aluminum.

Automakers are also slimming down their heavy vehicles, which have some of the biggest potential for reducing fuel consumption. Ford has replaced some of the steel in one of its most popular vehicles, the F-150 pickup, with aluminium; and it has partnered with Dow and ORNL in a bid to cut the weight of this vehicle by 750 pounds (340 kilograms) by the end of the decade. The new Range Rover, which went on sale last month, displaced enough steel with aluminum to cut its weight by more than 400 kilograms. The trend has created a boom in the aluminium industry, which expects demand for aluminum in automobiles to grow by 25 percent per year for the next several years.

Even smaller cars aren’t being spared the axe. The back windows of the new Fiat 500L will be made of plastic, making them half as heavy as glass ones. Peugeot, in collaboration with the oil giant Total, is building a demonstration version of its small 208 that is 200 kilograms lighter thanks to composites and plastics. The lighter design could result in a car with half the carbon emissions of its predecessor.

Vehicle lightweighting will also be crucial for more advanced, fuel-efficient cars, such as electric vehicles. This year BMW will introduce the electric i3, which will feature carbon fiber components to cut weight, helping to offset the weight of the battery pack and extend its range. BMW has also teamed up with Toyota to reduce the weight of vehicles through a research program that includes plan to develop fuel cells and advanced batteries; the German carmaker is part of a consortium that’s building an electric car that will weigh only 400 kilograms without its battery.

Davis says that automakers have been increasing their use of lightweight materials for decades (see our story from 1997, “A Practical Road to Lightweight Cars”), but that the weight savings has largely gone toward allowing them to add new features such as airbags and infotainment systems. Now they plan to reduce overall weight and improve fuel consumption. But he says it will take some time for the changes to have an impact on average vehicle weight, as automakers introduce new models a few years apart, and as they wait for volume production and materials advances to bring costs down.

As automakers make their vehicles lighter, they’re also attending to safety concerns. In a recent presentation analyzing the potential impact of larger numbers of lower-weight vehicles, the Insurance Institute for Highway Safety noted that, historically, about twice as many people die in the lightest cars as in the heaviest ones. Better vehicle designs, including safety features that prevent accidents by assisting drivers, will be needed to keep drivers safe (see “Audi Shrinks the Autonomous Car” and “Will Automated Cars Save Fuel?”).

Piggybacking on dealmakers as M&A bounces back

By David Randall

NEW YORK | Wed Feb 20, 2013 11:23am EST

(Reuters) – After a six-year lull, deal making is back with a vengeance. That means investors may need to rethink strategies to profit from increasing numbers of mergers and acquisitions.

Warren Buffett’s Berkshire Hathaway and Brazil’s 3G Capital Partners said on Thursday they would buy ketchup-maker H.J. Heinz for $23 billion, the same day AMR Corp and US Airways agreed to a merger worth $11 billion. These deals came a week after a group of shareholders led by company founder Michael Dell announced plans to take computer maker Dell private in a $24 billion buyout, and Liberty Media announced a $15.75 billion deal for British cable group Virgin Media.

Just in the past 24 hours, shares of Office Depot Inc and smaller rival OfficeMax Inc have soared on rumors that the two are in advanced talks for a merger that could be announced this week.

Deals are up 10.5 percent to $288 billion this year from the same period last year, according to Thomson Reuters data. Last year, global M&A rose just 2 percent to $2.6 trillion.

Analysts do not expect the value of this year’s deals to top the $4 trillion mark, as in 2007, mergers and acquisitions values should nonetheless jump significantly higher, thanks to a combination of low interest rates, high levels of cash on corporate balance sheets, and rising stock prices that give company executives the confidence to take risks. In a slow-growth economy, companies are also seeing it as a quick way to increase profits, and sometimes eliminate competitors, rather than invest in new operations of their own.

“I’m pretty negative about the market in general in 2013, but the one thing that could upset my hypothesis is M&A, because you have the perfect storm of conditions” for a rally, said Uri Landesman, president of New York-based Platinum Partners, with more than $1 billion in assets under management.

Mature companies with declining growth rates and lots of cash look to buy smaller companies to raise their earnings, which could push share prices higher as investors bid up the companies in potential deals, Landesman said. What’s more, cash-rich companies such as Apple have been targeted by activist investors for hoarding their dollars and not creating enough value for shareholders.

Investors who want to focus on mergers and acquisitions have two main options: play it safe with an arbitrage strategy, or make a bet that they can identify the next takeover targets.

MERGER FUNDS

The easiest way to benefit from potential mergers and acquisitions is through an arbitrage mutual fund or exchange-traded fund, analysts said.

These funds buy shares of the target company after an announcement while shorting the purchaser as a hedge in case the deal falls apart. This strategy tends to make money for investors as the spread between the deal price and the current stock price narrows. Investors rarely benefit from the pop in a share price once a deal is initially announced. Instead, this route is more akin to fixed income investing, where earning a positive return is the primary goal.

“People are starting to dip their toes back into the equity markets, and this is one way of doing it while focusing on capital preservation,” said Willis Brucker, an analyst who works on the $616 million Gabelli ABC fund, which charges a fee of 62 cents per $100 invested. The fund, which turns over its portfolio five or six times a year as deals close, also benefits from rising interest rates faster than an intermediate bond fund because there is little inflation risk, he said.

Because of their focus on capital preservation, arbitrage funds tend to underperform the broad stock market. The Gabelli fund’s 4.6 percent annualized return ranks among the top five funds among its 19 peers over the last decade, according to Morningstar, though its performance trails the S&P 500 index by 3.7 percentage points over that time. The fund also underperformed the Vanguard Total Bond Market Index fund by 0.3 percentage points over that span.

Investors could also opt for the IQ Merger Arbitrage ETF. The fund’s assets are only $12 million, giving it a relatively high bid-ask spread of 0.87 percent. Its track record, an annualized 0.1 percent over the last three years, is spotty compared with the broader S&P 500 over the same time.

“The merger concept was just not resonating with investors at all” after the financial crisis, said Adam Patti, the CEO of IndexIQ, the company behind the ETF. The fund, which costs 76 cents per $100 invested, is up 2.1 percent since the start of 2013, compared with a 0.6 percent rise in the average market neutral fund.

BUYING THE TARGETS

Investors looking for potential takeover targets could go to published lists from the likes of Morningstar, which includes Chesapeake Energy Corp, Leap Wireless International, and Kohl’s Corp among its 2013 takeover ideas. Some financial firms publish their own versions as well. UBS includes luxury retailer Burberry Group PLC, information technology company Legrand SA, and grocer Sainsbury PLC on its European “M&A Watch” list.

The downside of this method is that simply appearing on the Morningstar list, which has included more than 70 companies in each of the last two years, often leads to a rally in shares. So if you fail to act the moment the list is released, you may pay more for a stock that fails to attract takeover bids.

For instance, six companies that appeared on the Morningstar list in 2011 saw their stock appreciate by at least 17 percent between the time the list was published and the time they accepted takeover deals.

This year, Kohl’s is up 4 percent since Morningstar published its list January 29, more than double the performance of the S&P 500 over the same time. The company’s strong cash flow and growth potential makes it attractive to private equity investors, Morningstar noted.

A more lucrative bet for investors is to screen for small to midcap companies with cash on their balance sheets and good levels of free cash flow. These are the metrics that private equity investors look for when deciding to make a deal, said Brian Frank, portfolio manager of the $14.9 million Frank Value Fund, who looks for takeover targets as part of his strategy.

“Private equity funds love to borrow money and then have a company pay off that debt, which is very difficult to do if it already has a lot,” he said.

Frank began his position in True Religion Apparel Inc, a $715 million market cap company behind the high-end brand True Religion Jeans, in August.

He was attracted to the company because of the cash on its balance sheet, which at one time amounted to 40 percent of its market cap. In October it announced it was putting itself up for sale and while it has not disclosed any bids, Frank expects True Religion to be acquired for about $35 per share, a 25 percent premium from its current price.

Small-cap fund managers insist they don’t focus on takeover targets alone when buying a stock. Bruce Aronow, a portfolio manager of the $1.2 billion AllianceBernstein Small Cap Growth fund, expects a handful of the roughly 100 companies in his portfolio to be acquired in any given year.

To become part of his portfolio, a company must be growing earnings faster than consensus estimates. That strategy has helped his fund return an annualized 12.5 percent over the last 10 years, or 4.2 percentage points ahead of the S&P 500.

“We like companies that are on their way to becoming large quickly, and those are the companies that tend to get bought out,” Aronow said.

(Reporting By David Randall; Editing by Jennifer Merritt, Lauren Young and Martin Howell.)

Midwestern focus powers top small-cap fund

By David Randall

NEW YORK | Fri Feb 22, 2013 12:15pm EST

(Reuters) – Andrew Adams takes the Wall Street adage “invest in what you know” literally.

Adams, the Minneapolis-based manager of the tiny $62 million Mairs & Power Small Cap fund, invests all but a quarter of his portfolio in companies that are headquartered or do the majority of their businesses in the Upper Midwest. He estimates that there are about 500 small-cap companies that fit the bill in the six-state region that includes Minnesota, Wisconsin, Iowa, Illinois and North and South Dakota, compared with 2,000 companies in the total small-cap universe in the U.S.

“We like to invest in stocks in our backyard, because we know the history better than anyone else,” he said. “To me, it feels like a pretty big pool to fish from.”

It’s a quirky strategy that has nevertheless worked for the fund’s investors. Thanks to gains like a 53 percent jump in Nebraska-based hunting retailer Cabela’s and a 54 percent increase in Minnesota-based business services company Deluxe Corp, Adams’ fund gained 26.8 percent over the last year, making it the best performing small-cap fund among the 1,525 tracked by Lipper. The average fund in the category returned 10.7 percent over the same time frame.

Region alone isn’t enough to get into Adams’ portfolio of 44 stocks, of course. He looks for companies with durable competitive advantages that also have high returns on their invested capital. His portfolio ranges from commercial banks like Wisconsin-based Bank Mutual Corp to chemical makers like Minnesota-based Hawkins Inc. Adams aims to hold on to a company for 5 to 10 years, and emphasizes meeting with company management to get a sense of where the business is headed.

That long-term mentality makes Adams loathe to sell a stock, but he will do so if a company’s shares look extremely overpriced. He sold out of his position in 3-D printing company Stratasys last year, which recently moved its headquarter to Israel from Minnesota after a $1.4 billion merger with competitor Objet. The combined company’s stock is up 92 percent over the last 12 months and trades at 80 times earnings.

“We’re really excited about 3-D printing, but the valuation couldn’t justify holding onto it even assuming above average long-term growth potential,” Adams said.

He used the money from the sale – the stock returned 200 percent for the fund while Adams held it – to buy Minnesota customer parts maker Proto Labs Inc shortly after its February initial public offering. The company makes limited-run plastic or metals parts using 3-D printers and benefits from the 3-D printing trend by servicing commercial orders, while Stratasys focuses more on consumers, Adams said. Its shares are up 57 percent since the IPO and trade at 44 times earnings.

The fund’s Midwestern focus fits the philosophy of privately held Mairs and Power, which was founded in Minneapolis in 1931 and has long had a tilt toward investing in companies in the region. The small-cap fund, launched in 2011, is just the third fund offering from the firm and its first new fund since 1961. Its other funds are the $366 million Mairs and Power Balanced Fund, which is up 15.1 percent over the last year, and the $2.8 billion Mairs and Power Growth fund, which gained 19 percent over the same time period.

Adams’ own background also plays a role: he graduated with both a bachelors and masters in finance from the University of Wisconsin. Prior to Mairs and Power, he co-managed a small-cap fund at US Bancorp Asset Management in Minnesota.

Not every company he buys is headquartered in the Midwest. He bought shares in investment management software company Advent Software, which is based in San Francisco, because he couldn’t find a Midwestern company in the category that offered the same potential. And he recently increased his position in supercomputer maker Cray Inc, which has its headquarters in Seattle but has divisions based in Minnesota and Wisconsin.

Adams believes Cray has the potential to compete with International Business Machines in the so-called “Big Data” business of analyzing large and complex data sets. Already, its customer base includes the Mayo Clinic and the U.S. government. He began buying shares of Cray in February of last year; the company is up nearly 140 percent since then.

Adams also recently increased his position in one of last year’s underperformers, Minneapolis-based biotech Techne Corp. The company, which has fallen 4 percent over the last year, produces antibodies used in gene research.

The company’s shares were downgraded to underperform by Credit Agricole Securities and research firm CLSA in January. CLSA cut its target price to $70 from $77, in part because of the company’s ongoing search for a CEO after former chief executive Thomas Oland retired in November. The company trades at approximately $68 per share and a price to earnings ratio of 22.8.

Adams pins much of the stock’s underperformance to concerns that looming government spending cuts will mean fewer government-financed research studies – and fewer customers for Techne. “This is going to pass, and the long-term thesis is intact,” he said.

Investors in the Mairs and Power Small-Cap fund will pay $1.25 per $100 invested, a fee level that Lipper considers average. The fund yields 0.14 percent.

(Reporting by David Randall; Editing by Jennifer Merritt and Phil Berlowitz)

Avoid the herd mentality on growth vs. value stocks

By John Wasik

CHICAGO | Fri Feb 22, 2013 11:06am EST

(Reuters) – In the mercurial world of stock market trends, predicting whether the market is favoring growth or value styles is an either/or situation.

Sometimes growth stocks, which tend to produce consistently higher earnings, dominate. Then they fall out of favor, as value stocks, bought at bargain prices relative to their potential market value, take the limelight.

The nature of the beast in the growth vs. value tug of war is that when big money managers conclude that growth stocks may be getting overpriced then it is time to look for bargains. Since institutions tend to move in a herd, a switch en masse happens almost simultaneously and billions flow into bargain-priced stocks over a period of months. Sometimes the buying lasts for years.

Indeed, the value shift appears to have gained some ground year-to-date through February 15, as the value ledger of the S&P 500 rose 7.3 percent compared to 5.4 percent for growth stocks, S&P reports.

“We do think that this is a trend that could have legs,” says Todd Rosenbluth, director of Mutual Fund Research for S&P Capital IQ, a market research company based in New York. “But it’s still early in 2013.”

The last major value cycle ran roughly between 2001 and 2008. That was in the wake of the dot-com implosion and recession of 2001, when growth stocks largely crashed and burned after the manic tech-bubble run of 1998 to 2001. In the recovery from the 2008 meltdown, though, growth stocks have largely dominated, as companies rebuilt their earnings streams.

Although you can make money in either market phase, the value cycle might benefit you better because it tends to step away from stocks that can be overvalued and due for declines. Unlike growth stocks near the peak of their popularity, value stocks often offer more upside potential.

Sometimes popular growth stocks like Apple, are burdened with unrealistic upside expectations and any disappointment in news or earnings leads to a sell-off. Since hitting a 52-week high of $705 last September, for example, Apple stock has seen a precipitous decline and has been trading under $500 of late.

While short-term trends can be misleading, some recent evidence points to a value upsurge. Large-cap value funds, according to Lipper, a Thomson Reuters company, gained 17 percent for the one-year period through January 31. That compares with 16.8 percent for the S&P 500 Index and 13.3 percent for large-cap growth funds.

It could be that the recent value returns are driven by heavy weightings in the financial sector, underdogs in recent years that experienced a comeback last year and rose more than 24 percent as a group. Or, maybe the tide is turning and large institutions are making a shift toward value investing.

Although no one really knows when a cycle makes a turn in real time – it is best to make this call through the rear-view mirror – consistently investing in value offers a way to grab bargain-priced stocks with slightly lower volatility and higher dividends than their growth cousins.

HOW TO INVEST

In considering value stocks, it makes sense to diversify across countries and the size of companies: large-, mid- and small caps. Index funds generally give you the broadest array.

For large companies, the Vanguard S&P 500 Value ETF, invests in more than 350 stocks found in the S&P 500 Value Index. The companies in this portfolio may not seem like value stocks, but are mostly household names such as General Electric Co, Exxon Mobil Corp and AT&T Inc.

It is also a good way to own the company run by Warren Buffett, Berkshire Hathaway Inc, which is a living testament to value investing; the fund has a 2.6-percent stake in the company. The Vanguard fund was up nearly 20 percent for the year through January 30.

Vanguard also has a Mid-cap Value ETF that tracks the MSCI US Midcap Value Index and holds companies like Mattel Inc and Seagate Technology PLC. It was up 18 percent over the same period.

For small companies, you will not encounter any brand names, but you may see some greater potential for appreciation. The WisdomTree International SmallCap Dividend ETF focuses on companies across the world that also pay dividends, which is a rarity for companies under $1 billion in market capitalization. The fund returned almost 20 percent over the annual period through January 30. and pays a 3.4 percent yield.

By employing a balanced approach, you could split the difference between growth and value funds – 50 percent each – or simply buy a fund that tracks an index with a larger number of stocks in it. The iShares Russell 3000 Value Index holds 10 percent of its portfolio in small caps, although it is still dominated by mega-caps such as Procter & Gamble Co and Chevron Corp. The fund gained 20 percent for the year through January 30.

(The author is a Reuters columnist and the opinions expressed are his own. For more from John Wasik see link.reuters.com/syk97s)(Follow us @ReutersMoney or here; Editing by Beth Pinsker and Nick Zieminski)

Graphene And The EmergingTechnology of Neural Prostheses

Neural implants are set to be revolutionised by a new type of graphene transistor with a liquid gate, say bio-engineers

The emerging technology of neural prostheses has the power to change what it means to be human. The ability to implant electrodes into the eyes ears, spine or even the brain has the potential to overcome degenerative disease, mend broken bodies and even enhance our senses with superhuman abilities.

But despite numerous trials of electronic devices implanted into the human body, there are still many challenges ahead. The problem is that most of these devices are based on silicon substrates which are hard, rigid and sharp. Those are not normally qualities that sit well with soft tissue.

Consequently, any small movement of these devices can damage nearby tissue and in the worst cases, form scar tissue. What’s more, the hot, wet and salty environment inside the body can damage electronic components, limiting their lifespan.

What’s needed, of course, is a flexible substrate that is also biocompatible with human tissue. Now Lucas Hess and pals at the Technische Universität München in Germany say they’ve found the ideal material–graphene. Today, they outline their plans for graphene-based neural prostheses and the experiments they’ve already done to test its biocompatibility.

Graphene is ideal because carbon “chicken wire” is only a single atom thick and therefore highly flexible. It is also held together by carbon bonds, which are among the most stable known to chemists. That means it should be relatively stable inside the human body.

But graphene has another advantage. Hess and pals have shown how it is possible to use it to make transistors that are gated by the solution in which the transistor sits. In other words, the natural body fluids that surround these prostheses will form an integral part of their operation.

So-called solution-gated transistors are much more sensitive to electronic changes in their environment than conventional silicon devices. “[Graphene-based] devices…far outperform current technologies in terms of their gate sensitivity,” say Hess and co.

These guys have begun to test graphene interfaces with various cells such as retinal ganglion cells, reporting that graphene has excellent biocompatibility.

Of course, working graphene-based neural prostheses are some way in the future.  But Europe recently announced an investment of €1 billion in graphene research over the next ten years. If that doesn’t buy some significant progress in this area, nothing will.

Willow Garage Won’t Do Research Anymore, but It’ll Sell You a Robot

The lab developed key technologies that have advanced personal robotics, but its funding wasn’t sustainable.

By Jessica Leber on February 12, 2013

Willow Garage, a private laboratory that built a popular open-source operating system for robots, as well as the PR2, a capable robot for use by researchers, is rebooting itself. In a blog postpublished yesterday, CEO Steve Cousins said it will move away from developing new research technologies, and would “enter the world of commercial opportunities.”

Founded in 2006 by early Google engineer Scott Hassan to advance the frontiers of robotics, the Menlo Park, California, lab has spun out several companies and created software and hardware now in use around the world.

Because the facility was independent and under little pressure to pursue short-term products, one of its key contributions to the field was making it easier for robotics researchers to share and build on each other’s work. However, its own long-term funding model—beyond Hassan’s personal backing—was never clear (a one-armed PR2 retails for $285,000, and there are fewer than 50 in outside research facilities today).

By last year, Hassan had become CEO of Suitable Technologies, a Willow Garage spinout that is building telepresence robots for stay-at-home office workers (see “Beam Yourself to Work in a Remote-Controlled Body”). Now Willow Garage will attempt to become a self-sustaining company in its own right. “This is an important change to our funding model,” Cousins wrote.

To some, Willow Garage’s timing is perfect if it wants to fulfill its goal of having a wide-ranging impact on the personal robotics field, although there would likely be near-term funding challenges to support its talented pool of researchers and roboticists (see MIT Technology Review’s “35 Innovators Under 35”: Leila Takayama and Brian Gerkey). Autonomous robots have advanced in laboratories to the point where the PR2 can now fold laundry and fetch a soda, and industrial robots can work side by side to assist human factory workers. But the costs of these advanced robots are still relatively high, and the practicalities are clunky.

“I think Willow Garage has a lot of good technology … it’s now really the time to do business. We are really close to the situation we were in with personal computing, when the world switched from expensive mainframes,” says Dmitry Grishin, founder of Grishin Robotics, a $25 million New York investment fund for personal robotics companies. “If you want to make a technology big, you need to bring it to market,” adds Grishin, the cofounder and chairman of the Russian Internet giant Mail.Ru Group.

Willow Garage’s move away from creating open-ended R&D tools is, however, a disappointment to the robotics researchers and companies that use its software.

The Georgia Institute of Technology is, for example, using its PR2 to develop software and user interfaces for robots that could assist elderly people living at home. “They have been a key facilitator of collaborative infrastructure for robotics,” says Henrik Christensen, Georgia Tech’s director of robotics. “We have to figure out how this can be continued.”

Willow Garage wrote that it will “not diminish” its support for the nearly 50 PR2s in use today and was already in the process of transitioning oversight of its Robot Operating System to the Open Source Robotics Foundation.

How Willow Garage will become a self-sustaining business isn’t clear, nor for how long Hassan will continue to support the endeavor. A spokesman declined to comment on its plans beyond the information posted on its blog, other than to emphasize it was not shutting down. Willow Garage’s spinoffs include Suitable Technologies and a company called Industrial Perception, which is developing robots that might autonomously load and unload pallets and shipping containers. Its motto: “Providing robots with the skills they’ll need to succeed in the economy of tomorrow.”