Larry: From the 09/94 issue of WORTH on line:
Muddle through this introduction and you will see that Arakis was one of the high risk, high reward stocks that they comment on at that time, complete with a quote from Lutfur that, "There is no civil war right now" (I wonder what it is that has been going on since that quote). Are we really any closer now than we were in 1994?
94/09-High Risk, High
Reward
Who dares, wins -- and lowers
overall portfolio risk at the
same time. These eight
aggressive plays could return
40 percent a year.
The retreat in stock and bond
markets that marked the first
half of the year has prompted
many investors to rethink
their portfolios. Should I
ditch my risky investments
and batten down the hatches?
Or should I stay put and ride
it out?
On Wall Street, at least, the
conventional wisdom appears
to favor caution: The easy
gains are gone, so this is no
time to be aggressive. Stick
to rock-solid stocks, bonds,
and mutual funds, and avoid
the chancy stuff. At some
point, the market will turn
around. It always does.
Two things trouble us about
this advice. First, as we
pointed out in our last issue
(see "New Strategies for
Tough Markets," the cover
story from Worth's
July/August issue; you'll
find it in the "July/Aug94
Cover Story" file in Worth
Online's software library),
there's a good chance that it
may be some time before the
markets regain their former
vitality. With inflationary
clouds still blowing in from
the horizon, pressure
continues to mount on the
Federal Reserve Board to
further hike interest rates.
Meanwhile, foreign investors
are showing less and less
interest in
dollar-denominated
investments, reducing the
overall demand for U.S.
stocks and bonds.
Second, Wall Street's timid
advice ignores one of the
great paradoxes of investing
-- that conservative
strategies meant to reduce
risk often end up doing just
the opposite.
More than 30 years of
research on building
portfolios that increase
return and lower risk won
Harry Markowitz and William
Sharpe the Nobel prize for
economics in 1990. Among
other things, their work
demonstrated how cautious
investors, in an effort to
get out of risky stocks and
bonds, can end up leaving
entire slices of the
investment pie out of their
portfolios. The result, they
found, typically increased --
rather than limited -- an
investor's exposure to risk.
We all know, for instance,
that the stocks of big
dividend-paying companies,
such as utilities, are
individually less risky than
other types of investments.
Yet a portfolio composed only
of utility stocks can be very
risky indeed. Just since the
beginning of this year, in
fact, the Dow Jones utility
index has lost about 20
percent of its value; a
portfolio composed only of
"safe" utility stocks would
have been hit quite hard.
At the same time, a portfolio
that had invested in the rise
of the yen against the dollar
by buying options in early
January could have earned a
500 percent return by
mid-July. Adding this riskier
investment to a portfolio of
utility stocks would have
produced a much safer
combination than utility
stocks alone.
If the markets remain
stagnant in the months ahead,
the only way for investors to
earn solid returns will be to
increase their portfolio's
exposure to risky asset
classes. This doesn't mean
leaping at the latest fad, or
taking wild chances with big
chunks of the family nest
egg. But it does mean
rethinking the role of risk
in a portfolio.
With this in mind, Worth set
out to identify a number of
alternative investments that
might serve this purpose. At
the beginning of our search,
we assumed investors would
want to keep at least 90
percent of their portfolios
in common stocks and bonds
issued by established
companies or governments. The
remaining 10 percent, though,
could be reserved for
higher-risk investments whose
potential performance
wouldn't correlate closely
with the rest of the
portfolio. This allocation
scheme helped establish our
parameters for risk and
return.
First, since this part of the
portfolio is supposed to help
reduce overall risk, we ruled
out all instruments that come
with an unlimited downside --
such as commodities plays
that can end up losing more
than the size of an
investor's original
investment. If things went
truly sour, we wanted to lose
no more than the 10 percent
of the portfolio set aside
for high-risk investing.
Second, we looked for
investments that require
$50,000 or less to play.
Ideally, we hoped investors
would be able to add more
than one high-risk,
high-reward candidate to a
portfolio, a move that would
provide even better
diversification. For the same
reason, we also wanted to
avoid investment schemes that
eat up huge amounts in
commissions.
Third, we wanted to see
potential for a big payoff.
No sense taking a big risk
for an extra one or two
percentage points in
performance. So we turned to
the professional venture
capitalists' definition of an
investment home run as our
benchmark: Each investment
had to have the potential to
return ten times the original
capital in seven years.
That's an effective annual
return of 40 percent --
enough to make a big
difference in the overall
performance of any investor's
total portfolio.
Fourth, we combed the
landscape for investments in
asset classes that aren't
found in most portfolios.
Adding more stocks, bonds,
and mutual funds wouldn't do
much to improve the
diversification of most of
our readers' portfolios. So
we went looking for
investments in currencies,
real estate partnerships,
venture capital, options, and
other instruments that don't
march in lockstep with
garden-variety bonds and
equities.
Last, we looked for pricing
opportunities. Many of the
individual asset classes
mentioned above made strong
moves this year. When the
move was downward, we checked
to see if lower prices had
eliminated some of the risk
while giving us more upside.
As a well-known French
contrarian adage of the 19th
century says, "Achetez aux
canons, vendez aux clarions."
(Buy on the cannons, sell on
the trumpets.)
We ended up with eight
choices, and our menu is
nothing if not eclectic. We
found ways to earn this kind
of potential annual return by
buying busted real estate
partnerships or shorting the
recently all-powerful
Japanese yen. In the battered
field of emerging markets, we
discovered a way to leverage
Mexican bonds that could
return 50 percent, as well as
a way to bet on the recovery
of the Hong Kong equity
market. In Arakis Energy we
found a company whose
fortunes are closely tied to
international politics and
not the stock market as a
whole. We even turned up two
private deals that give an
investor a way to share in
the kinds of returns earned
by professional venture
capitalists. Finally, we
found a way to transform
bread-and-butter U.S.
Treasury bonds into
high-powered plays on the
course of interest rates that
could produce fivefold
returns on invested capital
-- in just a few months.
These eight plays aren't the
only high-risk, high-reward
deals that the inquiring
investor will be able to
find. And this list isn't
meant to be the end of an
investor's search for that
one big payday. Instead, we
hope that investors will use
it as a guide in thinking
about risk and reward -- in
all probability the least
understood part of investing
-- and attempt to go beyond
these eight examples. Even if
you never put a single dollar
into one of these deals but
instead just use this article
to think about the role of
risk in your portfolio, you
will already have earned a
high return on your
investment.
-- by Scott McMurray
And one of our very own favorites--Arakis--is one of the eight listed as detailed below:
PLAY 3: DRILLING FOR OIL IN
SUDAN --------------- TYPE OF
PLAY: Penny stocks PRICE:
$569 per 100 shares POTENTIAL
UPSIDE: A $5.69 stock could
become a $75 stock in five
years. POTENTIAL DOWNSIDE:
All the oil stays in the
ground. CRUCIAL DUE
DILIGENCE: The civil war
isn't over; will the rebels
play ball?
Is Arakis Energy just another
"story" stock -- you know,
the kind the market has been
hammering lately? Or is it a
real blockbuster in the
making?
Earlier this year, Arakis, a
tiny oil-development company
based in Vancouver, British
Columbia, acquired a license
to develop oil in a
south-central patch of Sudan.
This area is generally
thought to contain at least
300 million barrels of proven
oil reserves. Star stock
picker Lawrence Auriana,
comanager of the $1.2 billion
Kaufmann Fund, believes the
12.2 million-acre area could
ultimately prove to hold 600
million barrels of oil.
Independent international oil
consultant Daniel Johnston,
who first looked at the
potential of this project in
1983, agrees. "If there are
600 million barrels there,"
adds Auriana, whose
small-company growth fund
owns 250,000 shares in
Arakis, "this could be a $75
stock in five years."
Auriana's numbers seem
plausible, especially in
light of the Triton Energy
story. The development of a
single spectacular oil field
in the nation of Colombia --
the largest find in the
Western hemisphere in over a
decade -- propelled the
Triton stock from $4.62 a
share in 1990 to $52.50 a
share in 1991. That field was
bigger, at 2 billion barrels
of proven reserves, but
Triton owned only a 24
percent stake and the
Colombian government was
entitled to half of Triton's
revenue.
Then why was Arakis (listed
as AKSEF on the Nasdaq
small-cap market) trading at
a measly $5.69 a share on
July 18? The answer has to do
with transporting oil out of
Sudan, torn by a bloody and
intractable 11-year-old civil
war. The war pits Muslims in
northern Sudan against
Christians in the south.
Although the fundamentalist
Islamic military government
firmly controls the north,
the south is devastated by
war; more than 1.3 million of
Sudan's people have died as a
result of the fighting and
the accompanying starvation.
The 11 years of war have also
created at least 1.8 million
refugees, according to a U.S.
Committee for Refugees
report. The 1983 census, the
last one done, put the
population at 21 million.
This was why Chevron, which
negotiated the original
concession on the Arakis
field in 1974, threw up its
hands and walked away,
despite spending more than $1
billion developing the huge
finds. In November 1992, as
the civil war dragged on,
Chevron sold the license to
an Islamic entrepreneur, who
sold it to privately held
State Petroleum. On January
25, 1994, State,
headquartered in Calgary,
Alberta, and owned by a group
of Muslim businessmen, signed
a share-exchange agreement
with Arakis that made it a
wholly owned Arakis
subsidiary.
Until that time, Arakis was
developing natural-gas
reserves in southeastern
Kentucky and had no
international oil-exploration
experience. Its revenues for
the eight-month period ended
December 31, 1993, were only
$2,295,478. Investors in
State received 6 million new
shares of Arakis at $2.80 a
share, about 32 percent of
the company.
Arakis officials don't see
the Sudanese war as much of a
problem. In fact, they assert
that it isn't even being
fought. Lutfur Khan, the
president of State Petroleum,
who negotiated the company's
oil-production-sharing
agreement with the Sudanese
government, flatly says,
"There is no civil war right
now." Khan says the
government has entered into a
peace agreement with rebel
Christian forces.
Is this so? U.S. ambassador
Donald Pettersen says in a
telephone interview from
Khartoum, "Of course the
civil war is still going on."
The multilateral peace
negotiations involving
Sudan's neighbors "have not
produced anything yet," he
says, adding that "in the
absence of a negotiated
settlement in which it is
clear how resources will be
allocated in the country, I
don't believe rebel forces
would be agreeable to
exploitation of the oil."
Other experts on the
situation in Sudan, however,
see things differently. "The
Heglig/Muglad area deep in
Southern Kordofan, where the
oil wells are located, is not
affected directly by the
war," says Peter Verney,
editor of London-based Sudan
Update. "A pipeline could be
built without passing through
any area of rebel conflict,
but it would present a target
for sabotage nonetheless."
Oil consultant Johnston notes
that Triton Energy was able
to develop its Colombian
field despite guerrilla
attacks that blew up one oil
rig. A Colombian army
garrison is stationed at the
drill site, and last year
guerrillas averaged one
sabotage attempt per week on
oil operations there.
"Dealing with guerrillas, in
a way, is just another cost
of doing business," says
Johnston. Arakis, meanwhile,
says it is moving ahead full
speed. It projects that it
will be producing 65,000
barrels of oil a day by early
1996.
-- by Andrew Gluck |
