Coin Flips, Mergers and Bonuses

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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How's the coin flipping contest going?

S&P Dow Jones Indices released its annual SPIVA Scorecard (for "S&P Indices Versus Active") last week and it is a predictably ugly thing. It goes like this:

The S&P 500® had its third straight year of double-digit gains in 2014, returning 13.69% (returns were 32.39% in 2013 and 16% in 2012). Based on data as of Dec. 31, 2014, 86.44% of large-cap fund managers underperformed the benchmark over a one-year period. This figure is equally unfavorable when viewed over longer-term investment horizons. Over 5- and 10-year periods, respectively, 88.65% and 82.07% of large-cap managers failed to deliver incremental returns over the benchmark.

Mid-cap and small-cap managers do a bit better but still below their benchmarks on average, etc., you get the idea. In addition to being rare, outperformance looks random: Jeff Sommer points out that, out of of 2,862 broad active domestic stock funds that were in the top quartile of performance for the 12 months ending in March 2010, zero managed to be in the top quartile in all of the five succeeding 12-month periods. (Barring miraculous outperformance in the next two weeks.) 

Here is Brad DeLong on market efficiency, noting that (1) "Markets are efficient" and (2) "Investors pay a fortune to money managers who make losing trades relative to any reasonable diversified-index benchmark" are sort of inconsistent propositions:

(2) necessarily entails that investors are making huge and expensive mistakes in who they trust with their money — and thus also, presumably, making huge and expensive mistakes when they trade on their own. (2) necessarily entails that money managers are also making huge and expensive trading mistakes. For that and for (1) to be true simultaneously requires that these trading and advisor-picking mistakes somehow exert no pressure on prices.

I think you can get to active-management underperformance based just on fees and frictional costs, without "huge and expensive trading mistakes," but that doesn't mean he's wrong conceptually: If markets are so good at pricing things, why do they seem to over-price active management?

Happy de-merger Monday.

The big construction-materials merger between Holcim Ltd. and Lafarge SA is in doubt over "the financial terms and governance structure" of the deal. Part of this is a people dispute -- "Holcim’s board is pushing for a candidate other than Lafarge Chief Executive Bruno Lafont to lead the combined company," after previously agreeing to let Lafarge pick the CEO, because they don't think he can extract all the promised synergies -- but a big part is financial. The companies had agreed to a one-to-one exchange ratio, but Holcim is now pushing for 0.875 to 1, since Swiss Holcim has outperformed French Lafarge since the deal was signed, due to both operational and currency factors: "The stronger franc has made Holcim’s franc-denominated shares worth more in euros, the currency in which Lafarge shares trade." The result of the Swiss National Bank's decision to un-cap the franc was, generically, to make Swiss things more expensive to other Europeans, and one of those Swiss things that is now more expensive is a giant Swiss construction company.

Elsewhere in M&A news, Valeant is planning to raise its offer for Salix to "more than $160 a share," perhaps "close to $170 a share," nominally a bit less than Endo's cash-and-stock topping bid but with rather more certainty (and cash). "To finance the increased offer, Valeant is turning to top shareholders, including Pershing Square, the hedge fund run by William A. Ackman," and at this point aren't you rooting for Bill Ackman to finance an acquisition by Valeant? He just seems so eager.

Also, we talked earlier this month about the fact that the U.S. crackdown on tax inversions (i.e., fake foreign takeovers of U.S. companies to reduce taxes) has led to a rise in real foreign takeovers of U.S. companies; here is some data ("Since the crackdown, there have been $156bn of inbound cross-border US deals announced, compared with $106bn in the same period last year and $81bn a year earlier"). And the Federal Trade Commission might be getting more lenient on mergers that it wants to contest on antitrust grounds: "Under new rules released late Friday, if the FTC doesn’t win an injunction from a federal judge it will suspend in-house trial proceedings upon request by the merging entities."

Bonuses.

Here is a calculation that Wall Street bonuses -- "the bonus pool paid to securities industries employees in New York City" -- were "roughly double the total earnings of all Americans who work full time at the federal minimum wage." There are about 167,800 people getting the bonuses, and about 1.03 million getting full-time minimum wage, which means that ballpark Wall Street bonuses are 12 times minimum wage. If the average bonus is half of total comp, a ratio I just made up, then that means that "Wall Street" pays, on average, 24 times minimum wage, or like $174 an hour, pre-tax. This is obviously not very scientific but that number seems plausible.

Elsewhere, here is a criticism of awarding bonuses as a roughly fixed percentage of revenue rather than of profit:

This year, bonus payouts will amount to a whopping 170% of the profits reported by New York stock exchange member firms – profits that continue to be eroded by legal settlements and regulatory expenses. Back in 2009, that figure was slightly more than 36% of profits, and it has crept steadily higher.

This is I think an example of the word "bonus" being confusing. Given that people -- and legal settlements! -- are a bank's main expenses, it would be sort of weird to pay them a fixed percentage of profits, right? It would be weird for any business to pay all of its employees out of profits rather than revenue. But when you call it a "bonus," sure, it does sound odd when it's bigger than net income.

Admitting, denying, disqualifying, waiving.

When the Securities and Exchange Commission settles cases with companies, sometimes those companies admit guilt, agree to a statement of facts, and pay a bunch of money; other times, they just admit to the facts and pay the money, but do not admit guilt. I just do not find this distinction at all interesting or important. (There are sometimes legal consequences -- like, if third parties are suing you, admitting guilt makes it harder to fight them -- but even that isn't very interesting.) Is this something wrong with me? Everyone else seems to think it's a big deal. Here is Gretchen Morgenson on the current state of play at the SEC, and I just lack the gene to understand it.

And here is Mary Jo White, chair of the SEC, on why the SEC frequently waives its automatic-disqualification provisions, another topic that I find irritatingly symbolic:

Rigorous enforcement against entities engaged in wrongdoing, including large financial institutions, is critical for the protection of investors and the fairness of our markets, both in fact and appearance.  And, at the SEC, we have many enforcement tools at our disposal which we can and do use vigorously to address and deter conduct by financial institutions that violate the federal securities laws.

Disqualifications, with their accompanying grant of authority and discretion to provide exemptions or waivers, serve a very different purpose.  Disqualifications guard against future participation in certain capital market activities by entities or individuals whose misconduct suggests that they cannot be relied upon to conduct those activities in compliance with the law and in a manner that will protect investors and our markets.

So that makes sense, but I still don't understand why, in that case, the disqualifications have to be automatic. Or, I mean, they're not; I don't understand why they have to be called "automatic."

Elsewhere, the Justice Department "is seeking about $1 billion each from global banks being investigated for manipulation of currency markets," plus guilty pleas from several of them, because I guess the guilty plea is the new admission of guilt in terms of symbolic importance.

Sovereign debt.

"Ukraine’s biggest creditor has formed a bloc and hired advisers to prepare for tough talks with Kiev." The biggest creditor is Franklin Templeton, which owns some $7 billion of Ukraine bonds; the advisers are led by Blackstone (soon to be PJT Partners) and Weil Gotshal, and the "tough talks with Kiev" will be made a lot tougher by the tough talk of Moscow: Russia owns $3 billion of Ukraine debt and "has indicated that it is unwilling to restructure," while Ukraine's finance minister "stressed in last week’s conference call that there would be no special treatment for any creditors, including Russia." As for the private creditors, "the bondholder group was unwilling to accept outright haircuts" and thinks that Ukraine is seeking too much debt relief. "There are a myriad of what the IMF calls 'exceptionally high risks' to the program"; sounds about right! Elsewhere, a majority of Germans are sick of Greece and want it to leave the euro. And I guess it's time for U.S. debt ceiling nonsense again?

Paul Ceglia is amazing.

Somehow I missed this news when it happened last week, but it has lost none of its charm. Paul Ceglia is a guy who once sued Mark Zuckerberg, claiming that he owned half of Facebook based on a 2003 contract. That lawsuit went poorly because, among other reasons, Ceglia's own lawyers concluded that he had forged the contract. He was arrested for fraud and scheduled to go on trial this May, and was on house arrest with an ankle bracelet. Until last week, when marshals "forced their way into" his house and "found Ceglia’s ankle bracelet hanging from the ceiling-mounted, motorized device" that he had built "to keep the bracelet in motion using a stick connected to a motor that would rotate or swing the bracelet." Ceglia, of course, was not hanging from the ceiling-mounted, motorized device along with his bracelet: He was long gone, along with "his wife, two sons and the family dog." Man! With that level of ingenuity and technical skill, he really should have just invented Facebook.

Man buys yacht.

This is a good disclosure, from Marcus C. Blackmore, the chairman of Blackmores Ltd., "Australia’s leading natural health brand":

Source: ASX Company Announcements

Things happen.

"So we don't make the, like, bat-winged angel sword of fiery doom." "The Total Return EPS Index models what EPS would have been if the dividend payout ratio had been 0% at all times in history, with all dividend cash flows instead used to repurchase shares (or acquire or merge with existing companies)." "Detractors consider her a blight on Etsy’s hipster cred." "A man who has spent seven years as finance director of one of the world’s biggest companies decides to go on an extended vacation with his wife." "The application of the concept to tourists potentially opens up a new whole kind of business: sadistic tourism." "Is Scarborough, Ontario the dining capital of the world?" "To take something recognizably bad, whether pizza or bulky fleece sweatshirts, and try to pass it off as avant-garde self-expression is an incredibly defeatist gesture, one both aware of and happy with its futility." "Yes, I’m focusing on goat heads specifically." "When asked if he liked being pope, Francis told the interviewer that he doesn’t mind." 

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:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net