Outperformance and Manipulation
Who had a good year?
Today there are a lot of articles looking back at the best-performing asset managers in 2015, and it is an illuminating and bewildering experience to read them all at once. How did they do it? Well:
- "Her secret is no secret at all: faith in retail companies and the time-tested principles of value investing," writes Matthew Winkler at Bloomberg View about Deena Friedman, the top-performing equity mutual fund manager. (Gabriel Plotkin's Melvin Capital is the top-performing hedge fund identified in this DealBook article; Plotkin is also focused on the consumer industry.)
- "Those who did well defied conventional wisdom," writes Rob Copeland about the top hedge fund managers, including John Armitage of Egerton Capital (bearish on oil) and Lee Ainslie of Maverick Capital (bearish on Apple). (The DealBook article also points out that a lot of "hedge fund hotels," including SunEdison, Williams, Cheniere and Valeant, had terrible years.)
- "Our goal is to pick the safest securities in the market," says Tom Price of the Wells Fargo Short-Term High Yield Bond Fund, the best-performing high-yield fund in 2015 (up 2 percent!), "which has lagged behind the market in each of the previous six years."
- "We took a leap of faith because we knew how much potential there was in e-commerce," says Anindya Chatterjee of the City National Rochdale Emerging Markets Fund, the best-performing emerging-markets stock fund, about his decision to invest in Tencent Holdings "even though it was not clear to him where the company's profit growth would come from."
So betting on the consumer, and betting against the consumer, worked. Following time-tested principles worked, as did defying conventional wisdom. Focusing on safety worked, as did leaps of faith. The thing that didn't work for six years worked in the seventh. Each individual instance of outperformance can be put into its own coherent narrative, can be made to look logical and earned on its own terms. But when you throw them together it's hard to escape the impression of a coin-flipping contest with a song and dance at the end.
One of the great joys of the financial markets circa 2015/2016 is that so many different eras of markets coexist at the same time. In the U.S., we have people who are terrified of hypermodern algorithmic trading that no human can understand, but that algorithmic trading of stocks exists right alongside old-timey used-car-dealer-style voice trading of bonds. We've also got unicorny private markets that are reopening questions (about shareholder rights, employee investing, etc.) that were settled decades ago in public markets. And of course there is bitcoin, which is rapidly reinventing finance from scratch for its own weird purposes.
And meanwhile in China it is just full-on Jesse Livermore all the time, a paradise of pre-Great Depression anything-goes markets where everyone seems to be out to scam everyone else. There is a reason that the U.S. moved away from that system 80 years ago -- it seems sort of exhausting -- but it is fun to read about from a safe distance:
“If you want to make a quick buck from the stock market, you’d better look for stocks with manipulators,” explains Chen Yifeng, a 37-year-old accountant at a state-owned company in Shanghai who has about 100,000 yuan of his personal portfolio invested in local shares. “You just need to pull out faster than them.”
In some ways it is historically anomalous that anyone conceives of any modern stock market as an efficient way to allocate capital to productive endeavors rather than as a pure casino.
Elsewhere: "Traders in China and Hong Kong Paying $920,000 to Settle Insider Trading Case." And here is an article about China's "fast-growing and innovative online finance sector, which offers a glimpse of how the rest of the world may someday handle money but has seen a number of high-profile abuses. "
The blockchain is a cooperative computer database for recording transactions that is supposed to revolutionize the financial industry. One reason for skepticism is that cooperative computer databases for recording transactions are not that much of a novelty. We've had computers for a while. A lot of the stuff that can conveniently move to cooperative computer databases (e.g., stock trading) already has, and the stuff that hasn't probably hasn't for a reason. And that reason is unlikely to be a problem of database architecture that can be solved by using blockchains.
Nathaniel Popper has a skeptical story about Blythe Masters's blockchain company, Digital Asset Holdings, which is having some trouble raising money:
In recent months, the software that Ms. Masters has shown to potential investors allows for the issuance and trading of so-called syndicated loans — large loans broken into pieces and sold to different investors. It can take weeks for trades in this market to go through, a time span that D.A. is trying to shorten.
Investors who have looked at the software, though, say they are not convinced that Ms. Masters’s technology will fix the problems in the loan market, which are attributed as much to human cooperation as to bad software.
On the other hand, though, if the problem you are solving is that syndicated-loan processing takes a long time due to bad software, how big a problem is that? It's a problem, sure, but I am a bit at a loss about how solving it will revolutionize finance. "One of Ms. Masters’s competitors, known as R3, has approached the problem from a different angle and is trying to determine how the banks want to use the blockchain before building specific software," though I wonder how well the banks know the answer themselves.
A big challenge of monetary policy is that its transmission mechanism is the banks, and in the seven years since the U.S. last had non-zero short-term interest rates, the public perception of the banks has changed a bit. Like, monetary policy inevitably involves giving money to banks, and giving money to banks is now inevitably controversial. So here is a Wall Street Journal story about how the Fed's policy of paying interest on reserves -- which it plans to use "as its primary lever for controlling short-term rates" -- could be viewed as a subsidy to the banks (which can borrow reserves at the fed funds rate and get paid the higher interest on excess reserves rate), and particularly to foreign banks.
The Fed is subsidizing both U.S. and foreign banks, said Joseph Gagnon, a former Fed economist now at the Peterson Institute for International Economics, and the latter have a proportionately larger advantage. “I’m surprised it hasn’t gotten more attention,” Mr. Gagnon said.
A Fed spokesman said, “Payment of interest on reserves is a key tool for setting interest rates at levels appropriate for achieving maximum employment and price stability. We treat all banks that operate in the United States the same.”
I'm kind of in the "surprised it hasn't gotten more attention" camp, though on the other hand it is about interest-rate spreads, which naturally resist attention. Elsewhere in interest-rate spreads, "J.P. Morgan to Increase Deposit Rates for Some Big Clients in January." Also: "Larry Summers: Here’s what Bernie Sanders gets wrong – and right – about the Fed."
Jessica Pressler has a story about Wall Street guys spending hundreds of thousands of dollars at strip clubs. In 2007 I guess that would have been a cheery enough story for the Wall Street guys, but the 2015 version is pretty dark. Specifically, it's a story about some former strip club employees who stole a bunch of money from more or less Wall Street-ish guys by luring them out to party, spiking their drinks with MDMA and ketamine, and then running up huge charges on their credit cards. The strip club employees live in a ... strange moral world?
The guys they were targeting were wealthy, she pointed out. “What’s an extra $20,000 to them?” And they weren’t exactly upstanding citizens. “It wasn’t like we pulled them off the street,” she said. “They had history. They’d been to Hustler, they’d been to Rick’s, they’d been to Scores. They all walked in ready to party. And yeah, we slipped an extra one that they didn’t know about. But all of it goes hand in hand — sex, drugs, and rock and roll. You know?”
Hmm yes but as a counterpoint maybe don't drug people in order to exploit them sexually and financially, assume that they will be too ashamed to go to the police, and then blame the victims for their past history of being "ready to party." Elsewhere in Jessica Pressler: "Michael Burry, Real-Life Market Genius From The Big Short, Thinks Another Financial Crisis Is Looming."
People are worried about unicorns.
Here is a story about Wish, which sells cheap stuff ("a $4 watch arrived broken, with one half of the band detached and the minute hand stuttering in place") online, and which has aspirations to be "the second or third trillion-dollar-a-year marketplace." This is the best paragraph:
Facebook’s ad team has been blown away by how much more sophisticated Wish is as an advertiser than literally any other company, according to multiple sources, thanks to the automated way in which it optimizes its ads and its use of every new ad product that Facebook releases. Wish spends around $100 million a year on Facebook ads, other sources say, and was the No. 1 app advertiser on both Facebook and Instagram over the holidays, according to app data startup Sensor Tower.
I used to sell derivatives to corporate clients at an investment bank, and this very specialized use of the term "sophisticated" -- to mean spending a lot of money and using every new product that Facebook comes up with -- is very familiar to me. It sounds flattering, and is meant to, but it is not a term of unmixed approbation.
Elsewhere in unicorns, institutional investors are increasingly buying private companies' common stock in the secondary market (from employees, etc.), creating potential conflicts with those companies' typically preferred-stock venture investors. "It’s a totally new world when sophisticated, well-heeled investors own a lot of common stock," says a lawyer. My bias is, you know, private markets are the new public markets and of course there is institutional secondary trading of common stock, but this really is kind of a weird dynamic. There are not a lot of public companies whose capital structures and boards are dominated by convertible preferred stock.
And it's been a rough year for initial public offerings, with 169 deals for about $30 billion. So the average 2015 IPO raised less than $180 million, or about one-fifth of what Palantir Technologies, the Spy Viginticorn, raised this month in a private offering.
People are worried about bond market liquidity.
"The bond-market exodus is accelerating," says Business Insider, citing a Bank of America report finding that "outflows from high grade accelerated to $3.84bn from $2.52bn" in the week ended December 23, which I suppose suggests that bond-market contagion is slowly spreading from high-yield into higher-grade bonds. And "ETFs to play main role in the next crisis" is the surprisingly confident headline here. Meanwhile: "U.S. Companies Led the World in 2015 Debt Defaults, S&P Says."
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