Happy Hedge Funds and Frightened Lenders

Also China, student lending, bond market liquidity, e-mail scams, etc.

Hedge funds hedge.

Some hedge funds had a good month, with equities long-short funds run by former SAC Capital employees doing particularly well. Jason Karp's Tourbillon Capital Partners, Aaron Cowen's Suvretta Capital Management, and Gabriel Plotkin's Melvin Capital are all up on the year. Various non-SAC-alum funds are also doing well, although "the average hedge fund, as measured by the HFR Index, is down about 1 percent," and the S&P is down 5.3 percent. One possible advantage of the recent market volatility might be that it will make it harder to talk about hedge funds as a unitary asset class with an undifferentiated strategy and similar, sub-market returns. That has never been especially accurate, but it seems to have been especially inaccurate recently. 

And here is John Authers on the post-crisis growth in hedge funds:

As Don Steinbrugge, an industry veteran who analyses the sector for Agecroft Partners in Virginia, puts it: “As long as the expected return is higher for hedge funds than fixed income, we will continue to see money shift from fixed income to hedge funds.”

He adds: “Since most of the new flows into hedge funds are coming from fixed income portfolios, many institutional investors in the short term will be happy if their hedge fund portfolio outperforms their fixed income portfolio, validating the decision they made.”

Consider that when you read comparisons of hedge fund performance to the S&P 500, as you did in the first paragraph of this newsletter. Elsewhere, Lee Cooperman thinks that "systemic/technical investors" are partly responsible for the crash. "A Pyrrhic Victory for Active Stock Pickers." And "Why University Endowments are Large and Risky." 

How're things in China?

The big parade happened, and if your theory was that China's government was propping up stocks in anticipation of the parade, then I guess that is a bearish signal? (Or not, I mean, maybe private capital was just waiting until after the parade to come back in; market timing is hard.) Also perhaps bearish is the fact that China's interventions, and its search for people to blame for the crash, "are damaging China’s credibility as a legitimate investment market." And that is causing foreign investors to pull back:

“In the first half of the year, there were an enormous amount of investment products being developed to invest in A-shares. That has reversed completely on its head,” said Effie Vasilopoulos, a co-leader of law firm Sidley Austin LLP’s investment funds practice in Asia.

"We are required to use more gentle wording in reports and our opinion should not be too strong," says one Chinese stock analyst. And here is the story of China Galaxy Securities, a Hong Kong investment bank that issued a research note on its own stock, rating it a buy. I suppose there would be regulatory troubles if it rated itself a sell.

Student loans and capital structure.

Here's a good Mike Konczal post on college costs, student loans and educational subsidies. Konczal writes about New York Fed research finding that Pell Grants have only a modest effect on tuition, while "for every dollar in increased student loan availability colleges increased the sticker price of their tuition 65 cents." He notes that Pell Grants are an actual tuition subsidy, but don't seem to increase tuition. Loan availability does, though, which is weird, because the Modigliani-Miller theorem predicts that things shouldn't cost more just because you borrow to finance them. One of my core beliefs about finance is that nobody believes in Modigliani-Miller, and Konczal's conclusion is that it doesn't hold in education finance because that market is not complete. Which is worrying:

I read this research as implicitly concluding that the cost of higher education is low relative to where it would be if markets were “complete.” By complete I mean a situation in which students have perfect access to borrow against future outcomes. Students can’t do this now due to financial market imperfections, which is why the government provides student lending. But as finance does a better job of providing students with these options, or the government reworks markets to create these conditions, say in the form of human capital contracts, we are talking about a widespread increase in tuition.

People are worried about bond market liquidity.

But yesterday's Wall Street Journal article about how banks "are now just glorified order takers" and did not take much market risk in the last few weeks is the flip side of that. Maybe the Volcker Rule and stricter capital regulation have made it harder for banks to smooth volatility in bond markets, though, again, there does not seem to be much evidence of that in the bond markets. But those regulations also do seem to have made it harder for banks to lose a ton of money in volatile markets, which was after all the purpose of the regulations. On the other hand, some banks have managed to do it anyway; I'm looking at you, Goldman and Jefferies (fine, not a bank). More to the point, the rules have made it harder for banks to make money on market volatility, which after all is where a market making business is supposed to shine. Arguably -- in an ideal world -- market-making is a bit countercyclical; if you are a bank, your loans lose value in a crash, but you make up for it with more market-making income in volatile markets. If banks aren't making money on volatility now, maybe that's bad for their stability. Maybe.

I realize that this is a pretty tenuous bond-market liquidity section. Here, have an article about the "Sudden Dry Spell for Bond Sales." 

Watch out for scams.

The Federal Bureau of Investigation is warning companies about e-mail scams, which "hit more than 7,000 U.S. companies, which lost more than $740 million," between October 2013 and August 2015. Those scams are what they sound like: An employee gets an e-mail telling him to wire money to a scammer, and he does, because, you know, it said it in an e-mail:

The accountant for a U.S. company recently received an e-mail from her chief executive, who was on vacation out of the country, requesting a transfer of funds on a time-sensitive acquisition that required completion by the end of the day. The CEO said a lawyer would contact the accountant to provide further details.

“It was not unusual for me to receive e-mails requesting a transfer of funds,” the accountant later wrote, and when she was contacted by the lawyer via e-mail, she noted the appropriate letter of authorization—including her CEO’s signature over the company’s seal—and followed the instructions to wire more than $737,000 to a bank in China.

Oops, no, it was fake. The FBI has things to say about how the scammers have become increasingly sophisticated, leading to their growing success. Another contributing factor might be that no one ever wants to talk on the phone any more, making it less likely that anyone will ever pick up the phone to verify e-mailed transfer instructions.

In other regulatory news, here's a Securities and Exchange Commission action against a collateralized debt obligation manager for allegedly keeping restructuring fees instead of passing them on to clients. Here's SEC Commissioner Luis Aguilar calling for reforms to the SEC's waiver process; he does not seem to like my idea of just getting rid of it. And here is a story about how prosecutors and regulators search for suspicious phrases and acronyms in traders' electronic communications:

Evasion techniques can get creative. Raj Rajaratnam, the fund manager convicted in 2011 of insider trading, would write “fon” instead of “phone.” Prosecutors said they suspected the intentional misspelling was meant to distract the all-seeing electronic Javert of Control-F.

Oh I will take the other side of that. In my experience powerful middle-aged men in finance, like texting teens, love using abbreviated misspellings. It makes them feel young and potent and alive, plus it's faster to type, though of course slower for the recipient to read.

Loan officers are people too.

Economics is great:

We study the impact of emotions on real-world decisions made by loan officers by analyzing the loan conditions of loans granted immediately after a bank branch robbery. We find significant differences in conditions of the loans granted after a robbery compared to changes in loan conditions that occur contemporaneously at unaffected branches. In general loan officers seem to adopt so-called avoidance behaviour. In accordance with the literature on post-traumatic stress their avoidance behavior is halved within two weeks after the robbery and the effect further varies depending on the presence of a firearm during the robbery.

The data is from Colombia, and "avoidance" is pretty literal: 

In general loan officers seem to adopt so-called avoidance behavior: they decrease at once the likelihood of having contact with the client by lengthening the maturity of the loan contract and by demanding more collateral thereby reducing the probability of loan non-performance (and dealings with the client) prior to maturity.

This can be good for borrowers:

Further consistent with avoidance behavior is our finding that loan officers end up granting loans with ceteris paribus slightly softer loan conditions, possibly reflecting a reduced willingness to spend face-to-face bargaining time with applicants (Mosk (2013)). Loans at once carry a somewhat lower interest rate and a higher loan amount: the interest rate drops by 30 basis points (bps), for a mean interest rate of 17.2 percent, and the loan amount increases by 34 Million COP, for a mean loan amount of 928 million COP. 

In other SSRN paper news, here's a study of "performance persistence of star sell-side analysts."

Things happen.

It's a bummer to ring the closing bell on a bad day for the market. Cheniere Energy's Sabine Pass liquefied natural gas terminal in a Louisiana bayou. Market calls for US and Europe to end derivatives dispute. Texas Teachers in London. Felix Salmon on Cooper Union. "Joining Clemson’s investing club was my main catalyst for leaving school." Vettery. Do some work on a boulder. Australia urgent plea to shear overgrown sheep. "Tell me, Socrates, must the player always play, play, play?"

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    Matt Levine at mlevine51@bloomberg.net

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