Levine on Wall Street: Risk Parity and Bond Liquidity

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Valeant tried to be friends with Allergan for a few days.

Remember how Valeant and Pershing Square are suing Allergan, and vice versa, all over the country, because Valeant/Pershing are trying to take over Allergan and Allergan would pretty much do anything to avoid that fate? Well Valeant chief executive Michael Pearson thought he could "take the temperature down" by sending Allergan a nice little note. Honestly sort of a passive-aggressive note; this is perilously close to "I'm sorry if you were offended":

While I recognize that takeover battles can become very heated, it is regrettable that the tone of our public back and forth has become acrimonious at times. I have not appreciated what I believe are baseless attacks on our business model, and I am sure there are things that have not sat well with you.

Anyway, no dice; Allergan actually wrote back to the effect of "baseless attacks? what baseless attacks?":

Far from being “baseless attacks,” Allergan has relied on its knowledge of Valeant, its deep understanding of the pharmaceutical industry and the needs of physicians and patients to express legitimate concerns regarding the sustainability of Valeant’ s business model, its opaque financial disclosures and its ability to successfully manage and invest in market leading franchises of global scale.

So back to the suing and the proxy fight! One much-reported possibility is that Allergan will buy Salix Pharmaceuticals, for cash, without an Allergan shareholder vote, before the December 18 meeting that Pershing Square has called to kick out Allergan's directors. The idea is that an Allergan/Salix combination would prevent Valeant from buying Allergan, frustrating its efforts to present that deal to shareholders at that December 18 meeting. This would lead to another lawsuit, of course. Here is Ronald Barusch on the musical chairs; he concludes that Allergan's directors might do a Salix deal hoping to be thrown off the board in December, and wouldn't you? This deal must be no fun for the board.

Cliff Asness on risk parity.

Here is a good explanation of risk parity, which Asness defines as first deciding an asset allocation balanced by risks, and then levering up the portfolio to get the desired return:

This is not some newfangled idea. Rather, it’s among the earliest and most established ideas in finance. If you have a view on what’s the best risk-adjusted return portfolio and you desire more return, there are only two ways to get there at the asset class level: you can sell low-risk to buy high-risk assets; or you can lever the best unleveraged portfolio. Basic theory favors the latter, which retains the best portfolio, while the former moves away from it.

As an investing strategy, I mean, this is a thing, and you can do it, I don't want to tell you how to invest. But at the very least it's important as a lens to understand other people's investment strategies. Consider, e.g., risk-based capital versus simple leverage ratios for banks: Would you prefer your banks more levered, or just invested in riskier stuff? Or more generally remind yourself that whenever anyone's fretting about increasing leverage somewhere, the alternative might well be increasing unlevered riskiness.

Guess what drug an insider trader was using?

Michael Lucarelli, the guy who insider traded based on information he got in his job at an investor relations agency, pled guilty yesterday. Sounds like his plea was a little bizarre:

Mr. McGinley said that his client was working long hours and using cocaine, which gave him the “zest or the zing to keep on trading as much as he did.” Mr. McGinley said Mr. Lucarelli started using cocaine when he found that medicine for Crohn’s disease did not work.

“He’s not one of these fat cats that we read about,” Mr. McGinley added. “He lived in a fourth-floor walk-up in the East 90s. As a matter of fact, he can’t even pay his bills because the government seized all those gains he made in the stock market.”

Elsewhere, Saba Software falsified some timesheets to manipulate its earnings; it settled with the Securities and Exchange Commission yesterday for a $1.75 million fine, and its former chief executive had to pay back $2.5 million in bonuses to the company because those bonuses were based on the manipulated earnings. The CEO wasn't accused of doing anything wrong, and I suppose that's some point-proving for the SEC: It wants to set the precedent that CEOs who oversee fraud should get their bonuses clawed back, even if they didn't know anything about the fraud.

More on bond illiquidity.

Here is Bloomberg News on life insurance companies that have "almost an insatiable demand for investment product on the long end of the yield curve" and will buy private placements and other illiquid products to meet it, significantly reducing the liquidity premium in investment-grade bonds. Speaking of liquidity premiums! No one seems to know yet what exactly Pimco did to get the Securities and Exchange Commission mad at it, but one possibility is that it just negotiated some aggressive prices on bonds. Remember, it's Pimco, dealers want to be friends with Pimco. Here is the Wall Street Journal on "The Fuzziness Behind Some Funds' Precise Asset Values," and here is Investment News on the chill that the Pimco investigation might cast over other investors. Because you gotta value your bonds somehow, and no way is perfect. And would you be surprised that plaintiffs' lawyers are already rounding up clients despite not knowing what, if anything, Pimco did wrong?

China's stock market is opening up.

"China plans to connect the Shanghai stock exchange to its counterpart in Hong Kong over the next month," allowing foreign investors to trade mainland Chinese stocks directly. Though there will still be restrictions; I liked that "Foreign buyers of Shanghai stocks will not be able to buy shares and sell them on the same day." There will be no high-frequency trading in China. Elsewhere, there are apparently "nearly $10 billion in fraudulent trade-financing deals" in China, and I suppose one needs to know the denominator there. Here's the BIS estimating China bank-intermediated trade finance at $871 billion in 2011, for what that's worth.

Inside the Koch Brothers' Toxic Empire.

It's Rolling Stone on the Koch brothers' businesses, so you kind of know how that's gonna go. The word "contango" crops up. Elsewhere, Gawker endorses Goldman Sachs financial engineering.

Things happen.

Ukraine is investigating the bonds it sold to Russia. Sujeet Indap on David Dayen on Starboard on Olive Garden. Bethany McLean on unlearned lessons of the financial crisis. Fox Business sent a reporter out to chase strangers down the street asking them to cuddle. The new iOS prevents phone calls. Oh hey there's a new BlackBerry with a square screen "the same size as a piece of American cheese." You can target Facebook ads at one person, which is funny if that person is your roommate. If somehow you have not yet read this obituary of the Dowager Duchess of Devonshire, rectify that. The pied-à-terre tax is coming. Turney Duff on tipping. Harvard has a new endowment manager, and a new serenity room. The Situation has deteriorated. If you sell pot, you'll never go bankrupt!

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Toby Harshaw at tharshaw@bloomberg.net