Welcome to the November issue of Condor Monthly! In "From the Portfolio Manager" this month, we share some research on GFI Group. Also, in this month’s "Financial Planning Corner," we will take a look at changes for Medicare Part B in the incoming year and share some observations from the recent Schwab IMPACT conference in Washington D.C.
We would like to take this opportunity to thank all our valued clients for their business. We would also like to extend our gratitude for referring new clients to our firm. It is really appreciated!
From the Portfolio Manager
GFI Group (GFIG)
We review GFI Group, a recent addition to client portfolios.
Business Background
Derivatives are an important and relatively new segment of the financial markets. These instruments are generally used to hedge risk and can be used for equity, fixed income, commodity, currency, and several other underlying asset classes. Seeking to capitalize on this rapidly growing area of the market, Condor Capital has recently initiated a position in GFI Group.
Who They Are
GFIG is an inter-dealer broker of complicated over-the-counter derivative securities. The firm uses both telephonic and electronic trading execution, and provides data and analytics to facilitate trading in everything from currency futures to pulp and paper contracts. GFIG earns brokerage revenue and fees for data and analytic services. The company's clients include major investment banks, insurance companies, and large hedge funds, which generate the majority of revenue.
What They Do
Credit derivatives are GFI's major business. They represent 41% of its brokerage business, which is itself 96% of the company's earnings. The primary focus here is on credit default swaps (CDS). A CDS is a contract in which the buyer pays periodic payments to the seller. In exchange, the seller agrees to make a payment to the buyer of the contract if a specified event occurs with respect to the underlying credit instrument referenced in the contract. Simply put, these contracts offer protection against events such as bankruptcy, failure to pay debt or interest, and debt restructuring. Although it is tough to precisely measure, Citigroup estimates that GFI has the highest market share within this area at about 40% of the total market.
It is important to mention that GFI is an inter-broker dealer serving as an intermediary between major banks. It isn't feasible for one of the major investment banks (Citigroup, JPMorgan, etc.) to break into this market. This is because the buyer and seller of the CDS wish to remain anonymous throughout the negotiation of the contract, since knowing the other party's holdings or desires (and vice-versa) would significantly hamper one's negotiating ability. 
What really sets this firm apart from its peers is its high-technology angle. The majority of derivatives markets are still in their infancy. By nature, these markets are relatively illiquid and usually require a broker intermediary to find a counterparty for a trade. However, as trading volume grows and regulators focus on uniform standards for counterparty risk settlement and back-office processing, liquidity will begin to grow. This is where GFI will shine. GFI is increasing automation like no other competitor and integrating straight-through-processing technologies, which facilitate seamless links with a customer's settlement and risk management operations. Electronic trading systems, such as CreditMatch and GFI FX, now support brokers in 50% of GFI's markets. The quality of its systems has not gone unrecognized by the industry. For example, in November 2003, GFI FX was awarded Euromoney Magazine's award for "Best Interdealer FX options platform." Additionally, GFI Group's credit derivative technology has allowed the company to rank as the #1 credit derivatives broker for 8 straight years in a survey conducted by Risk Magazine.
Fundamentally Strong
GFIG has respectable fundamentals. It has manageable levels of debt and a decent amount of cash on hand. Revenues have been rising faster than expenses, so the company is on its way towards achieving solid economies of scale. The company is committed to margin improvement through economies of scale, decreasing the ratio of compensation relative to expenses, further automation of services, and greater application of leading edge technology.
Attractive Financials
Relative valuation is reasonable given the company's attractive growth prospects. Its PEG ratio is currently 1.31 versus a PEG of 1.53 for ICAP, GFI Group's closest competitor.
Given the company's market leading position in credit derivatives, its recent acquisitions in the energy derivatives market, and its new presence in property derivatives, we firmly believe this company's prospects for growth are being underestimated by the Street.
Financial Planning Corner
Upcoming Hikes for Medicare Part B in 2007
As if the rules and regulations surrounding Medicare aren't confusing enough, there are some important changes for Part B that senior citizens should be aware of starting in 2007. Although most won't complain over the 5.6% increase in the standard premium, which is actually the smallest hike since 2001, others will be paying more depending on their income and tax-filing status. 
Due to a provision in the Medicare Modernization Act of 2003, the thresholds for the higher premiums were set at $80,000 for those filing individually and twice that for married couples. As a result, the additional premiums seniors must pay will depend on how much their income(s) exceed the stated limits, with those individuals earning higher than $200,000 or couples earning more than $400,000 paying the most. Those beneficiaries affected by this new schedule, which will be phased in gradually over the next three years, should expect to be notified by the Social Security Administration.
For more information regarding these changes, please visit the official US government website for people with Medicare at www.medicare.gov.
Did You Know?
In the beginning of this month, several Condor employees had the pleasure of attending Charles Schwab's annual IMPACT conference. This event featured a number of distinguished guest speakers, including former Federal Reserve Chairman Alan Greenspan and entrepreneur Richard Branson, in addition to a bevy of informative education sessions for investment advisors.
One particularly interesting presenter at this year's conference was the firm DALBAR, Inc., which develops standards for, and provides research, ratings, and rankings of intangible factors to the financial services industries. In its presentation of its annual 2006 Quantitative Analysis of Investor Behavior, the company evaluates investor attitudes and behaviors, as well as the historical returns these investors have achieved. This analysis uncovers some shocking statistics.
For example, did you know that over the past 20 years:
- The average individual investor only earned about 4% annually, which was barely ahead of inflation.
- Some investors tried to improve returns by "timing" the market; however, their efforts actually detracted from returns and resulted in negative 2% annualized performance.
- Other investors used a "systematic" approach (i.e. dollar cost averaging into the market), which generally improved returns and resulted in 6% annualized performance.
- All of these results significantly lag the 12% average annual returns of the Standard & Poor's 500 Index, considered one of the broadest measures of the overall stock market.
* Measures returns of investors in equity mutual funds. Source: Bureau of Labor Statistics. Chart courtesy of DALBAR Quantitative Analysis of Investor Behavior 2006 (www.dalbarinc.com)
As evidenced by this chart, the average investor has been unable to capture the full potential offered by the markets due to a variety of behavioral factors, from market timing and unsuccessful investment choices, to a flawed underlying strategy. Please let us know if you have any family or friends who may be getting "average" investor results and could benefit from our investment management services.
