Money Stuff

Value Investing and CEO Churn

Also structured-notes platforms, employee retention, Martin Shkreli and prolific stock-pickers.

Value investing.

The basic process of value investing is that you go look for stocks that are underpriced relative to their fundamentals, and you buy them, and you wait for everyone else to notice how underpriced they are, and you get tired of waiting, and you go complain to the press about how undervalued your stocks are. Here is an article where some value investors -- at Parnassus Investments, a mutual-fund firm -- complain that their undervalued stocks are still undervalued:

These brainy stock experts are now finding it harder than ever to fulfill their core function: investing in stocks that beat the broader market indexes.

That is largely because a torrent of money has been pouring into machine-driven tracking funds, which allocate money to stocks like Facebook, Apple, Amazon, Netflix and Google’s parent — the so-called Fang stocks — on the basis of how big they have become and where they rank in an index.

For stock pickers, who pride themselves on their ability to zig where others zag by uncovering undervalued gems, such follow-the-crowd investing is anathema — and it is showing up in the numbers.

Well, but! If you pride yourself on your ability to zig where others zag, then a mass epidemic of zagging should make your job easier. If you pride yourself on uncovering undervalued gems, then you should be thrilled that people are ignoring all the gems. (You can buy more!) But of course it doesn't quite work that way. You want the market to mis-price stocks so you can get a good deal, but then you want it to correctly price those stocks, so you can make money, preferably soon. You want the market to be irrational, but not for so long that you become insolvent. "I don’t like calling my clients up every quarter and saying 'Sorry,'" says a Parnassus manager. Being a value investor is in a sense about calling up your clients and saying "Sorry," but for a few quarters, not a lot of quarters.

This is a perennial issue in investing: Everyone is always a contrarian, so everyone always thinks that the market is wrong, and then some of those contrarians are proven correct by events and others aren't. The question, with the modern rise of passive investing, is whether something has fundamentally shifted. In a sense passive investing, herding, "mindless buying of these technology names" -- all of that should make it easier for fundamental investors to spot value. But what if spotting value is no longer rewarded? What if value investing doesn't work any more? What if the rise of indexing has permanently cut the link between corporate fundamentals and stock prices? What if indexing and smart beta are "worse than Marxism" -- what if the function of the market is now to allocate money based on historical correlations rather than on expectations about future cash flows? What if indexing will keep growing for so long that it puts all the value managers out of business before anyone notices their undervalued gems? Honestly, it seems a little far-fetched to me. But if you are an active manager, I can see why you might want to complain about it.


When Marissa Mayer left Yahoo Inc. after making about a quarter of a billion dollars and failing to turn its core business around, a lot of people said mean things about her, to the effect of "that's a lot of money for failing." Then there was a backlash to the backlash, arguing that Mayer did a pretty good job in a hard situation, and that the mean things people said about her were motivated by sexism rather than substance. But it was hard for me to feel sorry for Mayer, because, in Don Draper's words: "That's what the money is for!" If you get paid a quarter of a billion dollars for doing anything, successfully or otherwise, then people are going to criticize how you do it, and if you don't like that, well, you can put on your gold-plated noise-canceling headphones, hop on your private jet, and ignore them.

This is in general how I think about the tradeoff between pay and unpleasantness for public-company chief executive officers. The job should be terrible! That's why you're getting paid so much! If you want a long tenure, a good lifestyle, and the uncritical admiration of everyone you meet, you should be a financial newsletter writer instead. The reason CEOs get paid so much is not that they are unique and irreplaceable talents. Quite the reverse: They're being compensated for being so replaceable, for the risk that some activist will come along, say extremely hurtful things about them, and force them out of a job. 

Anyway, "The bosses of America’s biggest and best-known companies are learning a common lesson this year: The pay is great, but job security has rarely been shakier."

In the first five months of 2017, 13 companies with market values of more than $40 billion installed new CEOs—including American International Group Inc., Ford Motor Co., and Caterpillar Inc.—according to an analysis for The Wall Street Journal by executive-recruitment firm Crist/Kolder Associates. That is more than double the CEO changes at mega-corporations in the same period last year.

This chief executive churn reflects a broader reality for the country’s business elite: An array of challenges—from increasing impatience on Wall Street and in boardrooms to a corporate landscape rapidly transformed by new technologies and rival upstarts—has made the top job tougher and more precarious than just a few years ago, top executives say. Even the biggest companies are vulnerable to shareholder disapproval and competitive forces that their size and stature once helped them fend off.

Part of the premise of high CEO pay is that it is supposed to be linked to performance. This is debatable, but certainly the premise of high CEO precarity is that it is supposed to be linked to performance: You perform, or you're out. I am not sure that that is actually a good way to run a company -- perhaps stability, trust, long-term vision and modest pay are a better combination -- but it is in a sense an obvious way, one with quantifiable results and demonstrable responsiveness to shareholder demands. And so the life of a modern CEO is supposed to be one of constant struggle, solitary, rich, nasty, brutish and short. 


At the most general level, how do you build a technology platform to do a banking thing? One way is to build it inside a bank. This way, you know what clients want and what the bank needs, and you have the right incentives and expertise to build a good product. But then only your bank will use it: If Goldman Sachs Group Inc. builds a platform to trade bonds or whatever, it will have a hard time convincing JPMorgan Chase & Co. to sign up. But this can work; arguably it describes, say, RiskMetrics, or BlackRock Inc.'s Aladdin.

Another way is to build it as part of a bank consortium: You get a bunch of banks to work on the platform together and agree to share it. This will probably be pretty slow. The first, like, 50 meetings of the consortium will be about sharing credit and protecting each bank's rights, not about actually building the thing. No one will want to share their special sauce with their rivals, and the thing may end up feeling compromised. But this can work; arguably it describes, say, the Depository Trust & Clearing Corporation, or the International Swaps and Derivatives Association

A third way is to build it on your own and try to sell it to banks. This can be hard because banks are pretty protective; they like using their own systems and don't always trust upstart outsiders with their data and executions. But this can work; arguably it describes, say, Bloomberg LP (disclosure: where I work). 

A fourth way is to build it on your own and try to displace the banks. This can be hard because the banks are pretty big, and pretty entrenched by regulation; it is easy to say "we will create a brand new financial system that disintermediates incumbent banks" but it doesn't actually happen that often. But this can work; arguably it describes, say, the rise of high-frequency traders as market-makers in the stock market.

I think those are the main ways, and while all of them have worked in the past, none of them are easy. They're worth thinking about when you hear that blockchain, or whatever, is going to revolutionize banking. How? Will a bank build a proprietary blockchain thing and then get other banks to join it? Will a consortium of banks get together and work seamlessly to build a joint blockchain thing? Will an outside technology firm build a blockchain thing and convince a bunch of banks to sign up for it? Will bitcoin or Ethereum just displace banks? Maybe! But all of those paths are pretty difficult, because of how banks are embedded in our financial system, and because of how banks operate culturally.

Anyway here's a story about Simon, a platform that Goldman Sachs (disclosure: where I used to work) built to issue structured notes. It wants other banks to issue structured notes on Simon, but they don't want to, because it is a Goldman Sachs platform. So it "is soliciting investments that would value Simon at about $75 million and lay the groundwork for a spinoff of the business," and it "is talking to several firms about a deal to both invest in Simon and agree to sell products through it."

Employee retention.

Here is a fascinating French employment-law case about ... whether deferred bonuses are legal? "A former Morgan Stanley dealmaker in Paris told an employment tribunal that the lender unfairly withheld $1.5 million in deferred pay a year after he raked in more than $100 million in fees while advising Patrick Drahi on a $23 billion acquisition." I mean, sure, it is unfair that you would earn a bonus one year and not keep all of it just because you left the firm before it fully vested. Certainly I was sad to leave behind unvested equity compensation when I left banking. But banks want to "reward loyalty," as Morgan Stanley's lawyer put it, and regulators want bankers to have skin in the game for the long term, and so they use at-risk deferred compensation.

Everyone knows that -- the banker here, Bernard Mourad, "accessed a website specifically dedicated to the compensation plan where the vesting schedule is 'very clearly mentioned' nearly 100 times and received multiple emails about it" -- and, while there is some grumbling about it, no one really expects it to go away. If anything the regulatory push is to more deferred compensation, and more ways for banks to take it back. On the other hand, I often joke that banks are essentially socialist paradises run for the benefit of their workers, and French employment tribunals might also be socialist paradises run for the benefit of workers, so perhaps this tribunal will undermine the work of the banks and bank regulators and order Morgan Stanley to give Mourad his money. 

Elsewhere, "I'm much more than simply a pitchbook," says one of the "300 financial professionals with six to 10 years of post-MBA experience" surveyed for a recent report on the financial industry, and you'd hope so, six years after an MBA! The survey basically covers all of the millennial stereotypes: Young post-MBAs want "a sense of belonging and value," "an inclusive culture" of "authentic and genuine" values, and companies that are socially engaged. Maybe banks really are doomed?

How's Martin Shkreli doing?

So-so! Prosecutors in his fraud trial were not completely successful in stopping him from making fun of them in public, but they did convince a judge to bar him from making fun of them in or around the courthouse, which he did last week:

"So what happened Friday?" the judge asked. "He walks into a press room and he starts talking about the case?"

Brafman said a reporter with a "vendetta," baited Shkreli. "I hope your honor understands that he’s relatively young." The lawyer apologized to the judge and promised it wouldn’t happen again because a member of the defense team would be with Shkreli at all times.

One of the great English words, especially if you are a lawyer, is "relatively." Relative to what? Shkreli is 34! I suppose he is young relative to, say, his lawyer, but I am not sure that his extreme youth is much of a defense. Anyway the judge told him to knock off the impromptu courthouse press conferences, because of worries that his jurors might hear him. We have talked before about my theory that Shkreli's strategy was to get everyone in America to hate him, so that he can't get a fair trial. That strategy almost worked -- it took forever to find 12 impartial jurors, and his lawyers moved for a mistrial because of all the hate -- but not quite. But there's still time! As Bill Gerath points out by email, you could explain the gag order by assuming that, "having inadvertently left a few New Yorkers who didn't know and despise him, Shkreli is actively trying to instill a personal hatred in the jurors, thus setting up his appeal."

Blockchain blockchain blockchain.

"Bitcoin to $50,000 Is Latest Call From Prolific Stock Picker," and is "prolific" ... what you want ... in a stock picker? Boy, that guy has sure picked a lot of stocks! Were they ... the right stocks? "It doesn't have to be terribly prolific," says Salinger's Esmé. "Just so that it isn't childish and silly." Anyway, right, bitcoin $50,000. Elsewhere: "Former Dogecoin Exchange CEO Faces Fraud Charges."

People are worried that people aren't worried enough.

Yesterday the Federal Reserve released the minutes of last month's Open Market Committee meeting and, of course, "a few participants expressed concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability."

People are worried about unicorns.

"IPO Market Isn’t Quite Back as Many Startups Are Still Holding Out," is the headline here, as bankers and investors encourage the unicorns to get out of the Enchanted Forest while the getting is good:

Given a strong stock market, low volatility and scores of private companies that could be ready for initial offerings, the IPO market should be even busier, some fund managers and bankers say.

“The new-issue market is healthy, so I would have expected we’d have more IPOs given the market environment matched against this backlog of private companies,” said Anthony Kontoleon, global head of equity syndicate at Credit Suisse Group AG.

Elsewhere, a Brooklyn coffee shop is suing Starbucks Corp., claiming that it came up with the idea for the Unicorn Frappuccino first and that Starbucks stole it. If I were responsible for the unicorn frappuccino I'd keep quiet about it but whatever.

Things happen.

Fed Officials Ready to Start Shrinking Portfolio in Months. Fed traditionalists face tough questions over inflation. Barclays Chairman ‘Confident’ London’s Euro-Clearing Hub Is Safe. EU hopes of winning London’s euro trading sunk by undersea cables. Dana Gas Gets U.K. Court Order in $700 Million Islamic Bond Case. "Italian prosecutors have decided to take Morgan Stanley to court over allegations that the U.S. bank caused 2.7 billion euros ($3.1 billion) in losses to the state in relation to derivative transactions." Hobby Lobby Agrees to Forfeit 5,500 Artifacts Smuggled Out of Iraq. PwC at risk of losing bank audit rights in Ukraine. Vantiv Strikes $10 Billion Deal to Buy Worldpay. Manhattan Home Sales Surge as Cuts Bring Prices to Buyers’ Level. "Spiders appear to offload cognitive tasks to their webs, making them one of a number of species with a mind that isn’t fully confined within the head." Jersey Shore Sand Sculpture Mocks Gov. Chris Christie's Viral Beach Outing. "Creamy seafood stews served in bowls made out of hollowed-out loaves of bread are Martin’s true subject, and they’re nearly absent from Game of Thrones on TV." Florida man dons riot gear to remove iguana from toilet.

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