Active, Passive and Private
Is passive investing bad for active investors?
Here's a post from Josh Brown on that and other questions. Brown on Larry Swedroe:
One of the more interesting ideas he has is that the exodus into passive strategies -- which is usually cited as a reason for active outperformance going forward -- is actually a major negative. This is because, with all the unskilled investors departing, pros will be left to square off against only other pros. The lack of retail punters and their harvestable mistakes cuts off one of the most reliable historical sources of alpha for sharp-eyed managers.
If active investing is a zero-sum game, then raising the average quality of the players will make it harder for any one of them to outperform, and eliminating amateur players will bring down the average performance of the professionals. Of course it's quite plausible to think that active investing is not a zero-sum game, and that investors can actually create value by allocating capital to businesses that deserve it and monitoring managers to make sure that they're good stewards of capital. The question is who will pay for that activity, if passive investors can just free-ride off of it. The old answer, let's assume, was that amateur investors who were bad allocators of capital subsidized the costs of the good professional allocators of capital. The new answer is I guess that the professional allocators all have to outperform the passive indexers, which is ... arithmetically challenging, for one thing (they can't all be above average), but also specifically tough these days. Brown discusses the factors that tend to favor active management (low cash drag, international outperformance, smaller large-caps outperforming mega-caps), none of which are having a great run currently, and the fact that "the 10 most underweight stocks in the S&P 500 by large cap active managers outperformed the 10 most overweight stocks by managers" by 32 percentage points in 2014.
So let's say this is true and you can't get appropriately compensated for allocating capital to businesses in the public equity markets. What would you do about it? You might start allocating capital to private companies, which aren't available to index funds and therefore aren't subject to free-riding. The business of active investing might migrate to the markets that are shielded from passive investing. Public equity markets might stop being the place where businesses go to raise capital, and might function mostly as a reward for the pre-initial-public-offering investors who actually fund businesses and negotiate valuations and monitor managers. IPOs might be less about fund-raising and more about cashing out investors.
This is all very speculative, but "Snapchat Inc. is seeking a new round of funding that would value the company as high as $19 billion, a person with knowledge of the matter said, making it the third-most valuable venture-backed company in the world," and here is Conor Sen on the IPO expectations that that implies.
Annals of fraud.
Clearly someone at the Department of Justice thinks that Steven Hart committed some sort of securities fraud. He maybe did match trades between his firm and his personal fund without permission, or perhaps he insider traded a bit. The Securities and Exchange Commission did an investigation of that stuff, and sent subpoenas to the firm where he worked. But that's not why he's being prosecuted and "faces a maximum sentence of 10 years in prison." No, this is what did it for Steven Hart:
On or about December 8, 2009, an SEC attorney called the Investment Firm to speak with the Investment Firm President regarding the SEC Investigation. STEVEN HART, the defendant, received the phone call and pretended to be another employee of the Investment Firm. The SEC attorney asked HART, who was pretending to be another employee, to relay to the Investment Firm President that the attorney had called and to ask the Investment Firm President to return the call. HART did not relay to the Investment Firm President that an attorney from the SEC had called.
So ... he didn't pass on a phone message. Doesn't seem like that should be a felony, though I guess in a certain light it might look like "obstruction of justice and perjury." But then:
On a second occasion, on or about December 9, 2009, the same SEC attorney again called the Investment Firm in order to speak with the Investment Firm President. STEVEN HART, the defendant, again received the phone call and, on this occasion, pretended to be the Investment Firm President.
He allegedly did this twice, and both times he was ... not that helpful to his case? As pretend-president, he allegedly said things like "the Investment Firm President" (that is, him -- I mean, the guy he was pretending to be) "was aware that HART engaged in improper trading activity, but nevertheless wanted HART to remain an employee of the Investment Firm," or that "HART had traded based on MNPI and that this was a one-time mistake that would not happen again," and I feel like trading on material nonpublic information once is probably enough for the SEC. Anyway, though, apparently it's a felony to impersonate your boss when the SEC calls, who knew.
What is Carl Icahn up to?
I have my biases in Carl Icahn's fight with Wachtell, Lipton, Rosen & Katz over CVR Energy. (Actually I have a lot so let's go through them. I worked at Wachtell Lipton and also at Goldman Sachs, both of whom Carl Icahn is fighting over CVR. At Goldman, I touched a little on CVR Energy matters, though nothing to do with this deal, and I still own a little Goldman restricted stock. I follow Carl Icahn on Twitter.) But the gist of his lawsuit is that he's suing Wachtell Lipton, who were CVR's lawyers in its unsuccessful takeover defense against Icahn, for legal malpractice, claiming that Wachtell did not tell CVR about the fees it had agreed to pay its investment bankers in the engagement letter that it signed. I hope it is not just my biases talking when I say that this seems like a crazy claim. Mergers and acquisitions engagement letters are short, you can actually read them without a lawyer, they are all pretty much the same, and they all say that if the company gets sold then the bank gets a fee. You might quite plausibly argue that this is a dumb system -- CVR agreed to pay its bankers $9 million each for a successful defense, or about $18 million each for a failed defense, so what are the incentives there? -- but it seems unlikely that CVR's directors didn't understand it, or that it was Wachtell's fault if they didn't. But the latest news in this fight is that Icahn is now alleging that the SEC is also interested in this question, and is investigating whether CVR's disclosures of its banking fees were accurate. The SEC tends to take a dimmer view of investment-banking fees that create conflicts of interest than, you know, investment bankers do.
The time to hedge a risk is before it happens.
I mean, it is not particularly helpful for me to tell you that. You have to know what risks will come true. Still this is sort of a funny story about the lag between currency volatility and currency hedging by corporate treasurers: "It generally takes them a while to change hedging policies, so I doubt if this year’s heightened volatility has yet materially affected corporate hedging behaviour," says one consultant. Of course heightened volatility makes hedging more expensive, so if you do decide to hedge now, you'll wish you'd decided to hedge earlier. On the other hand, now is a great time for banks to be selling currency hedging services. Because they're more expensive, for one thing, though that's a minor point. (It's more expensive for banks to manufacture the hedges too.) But the bigger point is that selling hedges in tranquil times is a terrifying business: If all goes well, you'll make a little money, but if things stop being so tranquil, you will take big risks for really not that much profit. When you sell options in more volatile times, at least you know what you're getting into, and can charge appropriately.
Everyone seems to have calmed down a bit since yesterday morning. Here is Steven Englander of Citigroup saying on Bloomberg Television that he expects some sort of six-month delay of reckoning (an "extension" if you're Europe, a "bridge" if you're Greece), followed by, you know, six months of this. So get comfortable. On the other hand Tyler Cowen is betting that Greece will leave the euro and his reasons are worth considering. Particularly:
I do not assume Syriza -- whom I have called The Not Very Serious People -- have a coherent bargaining strategy at all. I take this point from a broader reading of history, where I see that quite often leaders in critical positions simply do not know what they are doing. By no means is that always the case, but it is more often the case than narrative-imposing journalism encourages us to perceive.
But, but, the game theory!
What's the rush?
Here's a story about how Eric Holder "has asked U.S. attorneys involved in reaching mortgage-related civil settlements with big banks to weigh whether 'they think they’re going to be able to successfully bring criminal or civil cases against' individuals and report back within 90 days." This is for conduct that was at least seven or eight years ago, so, I mean, sure, the next 90 days seems like about the right time to wrap that up.
Happy 13F Day.
With the holiday, I forgot about all the Schedule 13Fs, where investment managers disclose what they were up to several months ago, and then it's dutifully reported, and then there's a dutiful hipster backlash of people like me saying ehhh this all happened ages ago. So George Soros bought some Herbalife shares on the dip a while back. Third Point, Omega and Viking Global all bought energy stocks on their dip, while Warren Buffett dumped Exxon Mobile. There's some other stuff, I don't know, here are all of yesterday's 13Fs, go nuts.
Some claims about the HSBC tax story. Some charts. Here's a nasty fight between Chesapeake Energy and its founder Aubrey McClendon over whether he stole trade secrets when he left Chesapeake to start his own company. Here's a somewhat less nasty fight between Perella Weinberg and four of its restructuring bankers over how they quit and/or were fired. BATS will try to IPO again. Systemic Importance Indicators for 33 U.S. Bank Holding Companies: An Overview of Recent Data. Prosecutor asks for Strauss-Kahn acquittal in French sex trial. Should Shakespeare have been a STEM major? "In the book I also very much enjoyed the discussion of the 1946-47 famine in Moldova, which apparently involved a good deal of cannibalism." Congrats Miss P!
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