Odd Hedge Funds and Rogue Traders

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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Platinum Partners.

Here is Bloomberg's Zeke Faux on one of the world's best-performing hedge funds, Platinum Partners, which has returned about 17 percent a year for the last 13 years, with no down years, by investing in a grab bag of stuff that you'd kind of hope wouldn't work:

Platinum’s specialty is investing in companies that others avoid, such as payday lenders or high-flying Singaporean penny stocks. The firm has never been sanctioned by regulators and even thrived while investing hundreds of millions of dollars in what turned out to be two Ponzi schemes.

Other schemes included finding terminally ill patients to buy variable annuities that paid a bonus when the investor died:

Platinum set up a company called BDL Group to invest in the annuities, eventually putting up more than $56 million, and Nordlicht brought in a friend to oversee the process, the SEC said in an administrative order. A rabbi in Los Angeles found the hospice patients and tricked them into providing their personal information so that BDL could take out annuities with their names, according to the SEC.

A hedge fund researcher says: 

"Even cursory due diligence showed that a number of their dealings ended in death, litigation or handcuffs. Those are the kinds of red flags you can see from outer space."

One basic insight of modern finance is that returns are commensurate with risk, and that any above-market return you get should be attributable to some extra risk factor that you take on. Sometimes the risk is visible as, like, historical volatility; other times it is subtler, like liquidity or reputational risk. The key thing is to know yourself, to know what risks you have, and to make sure that the risks you have are the risks you want. It sounds like these guys are living that dream.

How's Kweku Adoboli doing?

"This prison is like a really rubbish boarding school that you can’t leave," wrote UBS rogue trader Kweku Adoboli to a Financial Times reporter, which seems like a pretty mild way of putting it? His prison letters got worse, though, and now that he's out the U.K. is planning to deport him, which seems gratuitously horrible. I am definitely sympathetic to poor Adoboli, but I am still a little vague on how exactly he decided to became a huge rogue trader. I guess that is how it always goes:

He still seems slow to believe that what he did was truly wrong or unknown to others at UBS, but remains convinced that he had been working to a higher imperative: to make his bosses as much money as possible and lessen the wider pressure on the bank’s traders.

It is hard to fully appreciate that pressure unless you've been there, and Adoboli sure sounds like he was stressed. But, you know. Hiding billions of dollars of losses? A key part of the "making banking boring" theme is about replacing that imperative of making your bosses as much money as possible with the -- much higher, to my way of thinking -- imperative of staying out of prison. 

Health care.

Yesterday Valeant's stock tanked on this rather breathless report from short-selling researcher Citron Research, which on a purely aesthetic basis I found a little unconvincing? Like, the headlines mention both "Enron" and a "Smoking Gun," and usually when a short seller promises Enron and a smoking gun he has neither.

But there are also this longer and more compelling report from Roddy Boyd at the Southern Investigative Reporting Foundation, and this even longer and even more compelling report from John Hempton at Bronte Capital, on related Valeant subjects. Again on a purely aesthetic basis I found them considerably more interesting, and they at least hint at a story of secret ownership, dueling websites, vanished invoices, unlicensed pharmacy dispensing, insurance fraud, channel stuffing, and assorted other badness. Here is more on the effect on drug stocks, and drug mergers. The irony in all this is not lost on critics of Bill Ackman. Here is Valeant's rebuttal which, and I emphasize that I have no real background knowledge here and am evaluating all of these things on a purely aesthetic basis, is terrible. 

Speaking of terrible responses, I haven't really understood Theranos's defense against that crushing Wall Street Journal article? The thrust of the Journal article was that Theranos's miracle pinprick blood tests might not work, and that it does only 15 out of 200+ blood tests on its own proprietary machines. But Theranos Chief Executive Officer Elizabeth Holmes told Bloomberg News that Theranos now uses its own proprietary technology for only one test. Which is ... worse? Like, what does this have to do with anything:

Ms. Holmes now says she is planning to release a 16-page point-by-point rebuttal of the articles, a document that concludes by accusing the articles’ author of having an agenda that considered Theranos “a target to be taken down.”

The rebuttal even dissects the motivations of various people quoted in the articles.

But here is Theranos's actual response, which is considerably more compelling than its previous statements, or than that summary makes it sound. It's mostly about the blood tests, not about the motivations of the people quoted. Still, "the general public was under the impression that Theranos was further along in their development than they currently are," says an analyst, and that seems like a bigger deal than anyone's motivations. 


Here is the sad story of banks that made loans collateralized by taxi medallions, which have cratered in value with the rise of Uber:

Some institutions were known to lend as much as 90% of a medallion’s value during the industry’s heyday, according to people familiar with the matter.

“Because it has been such a golden asset class for so long, the underwriting standards got very loose,” said Alexander Twerdahl, an analyst at Sandler O’Neill + Partners who follows specialty-finance companies.

Values are plunging as prospective passengers—and drivers—are increasingly turning to ride-sharing services including Uber and fellow startup Lyft Inc.

I don't know about "the underwriting standards got very loose," though. Like: These were collateralized loans, collateralized by things that traded in the market and had a fairly knowable value. Now that value has collapsed. Really your underwriting standards have to include stopping to think about the fact that property is a social construct and that all property rights are mediated by rules and norms.

Elsewhere in Uber, Aswath Damodaran looks at the ride-sharing market, getting a value of $23.4 billion for Uber, well behind its quinquagintacorn private-market valuation, and $3.1 billion for Lyft. Tyler Cowen and Izabella Kaminska have further thoughts on the future of Uber and self-driving cars.

Elsewhere in unicorns, here is Fred Wilson on startups with negative gross margins, which are hard to make up on volume. And here is an ancient script from the Indus Valley that features a unicorn.

Motif IPOs.

Here is a story about how JPMorgan "will partner with Motif Investing to give ordinary investors the option to purchase shares in IPOs that are managed by J.P. Morgan." Isn't Motif that company that offers people the ability to invest based on thematic baskets of stocks "reflecting unique industry trends, trading strategies, and personal values," rather than just buying individual stocks? What does investing in a hot IPO have to do with those thematic baskets? There is a whole wave of making-investing-easier-for-regular-people startups that have come up with genuinely novel ideas, but I suppose they might all just evolve to become regular brokerages over time.

Carl Icahn does things.

I forget where I first saw this, but one insightful thing that I've read about Donald Trump is that his appeal comes from the fact that he doesn't act like a billionaire, he acts like a regular guy would act if he one day woke up a billionaire. This appeal is lost on me, since if I had a billion dollars I would not put my name on buildings in big gold letters, or run for president. 

Carl Icahn, on the other hand, is my kind of billionaire. He is clearly having fun with his vast piles of money, and by "having fun" I mean mostly "messing with people." After years of deeply enjoyable messing with companies, and Bill Ackman, he has apparently decided to start messing with politics, and "plans to put $150 million into a new super-PAC that would push for changes to the way U.S. corporations are taxed on their earnings abroad." That is an incredibly specific super-PAC! I have joked about the 2016 election being fought over the Rule 10b-18 safe harbor, but it's almost as unimaginable that it would be fought over international taxation, the focus of Icahn's delightfully Icahn-y letter to Congress. "Not passing this legislation now," he writes (referring to "a Highway Bill that includes international tax reform"), "will be recorded in history as a greater blunder than 'Custer's Last Stand.'" Meanwhile:

“I, for the life of me, don’t even know what he would spend $150 million on,” said Kenneth Kies, a Republican tax lobbyist. “It sounds a little flaky to me, to be honest with you.”

Sure, but flaky in a fun way. He'll find something to do with the money; I'm not worried. Elsewhere, Icahn, like Cato the Elder, seems to mention in every public appearance that Apple should buy back more stock, and he should really have a Latin motto for that. Mali partes emendae sunt? 

People are worried about the debt ceiling.

"Bond investors nervous as US debt default looms," is this Financial Times headline, and it really is amazing that the U.S. might just decide to stop paying its bills for fun. Most of the time countries default because they've run out of money, not just as a political stunt, though I suppose you could characterize Argentina's recent default as an American-made political stunt. "In recent days the yield on four-week US Treasury bills has jumped as default worries depress the price of tradeable federal debt," says the FT, and I am old enough to remember when fears of U.S. default pushed Treasury yields down.

There are, as I may have mentioned, some tricks to avoid default if Congress can't get it together to increase the debt ceiling. Philip Wallach, who wrote a terrific book about the legitimacy of government responses to financial crisis, unsurprisingly does not think that using tricks to get around the debt ceiling would be all that legitimate. He calls the trillion-dollar platinum coin a "zany-but-legal statutory prestidigitation," and refers to me as "a Latin-spewing promoter of super-high coupon bonds." To which I say: Debita impendiorum maximorum vendenda sunt!

People are worried about bond market liquidity.

The big liquidity worry in recent months (years?) has been that bond liquidity has decreased even as more bond holdings are concentrated in mutual funds, which mostly offer their investors daily redemption rights. This, the claim goes, creates a "liquidity mismatch" or "liquidity illusion," where bond-fund investors expect to be able to get their money back instantly, but giving them their money back would actually require massive sales of illiquid bonds, which would be difficult and damaging to the market. That worry might be a bit overstated, and here Bloomberg's Lisa Abramowicz argues that actually mutual funds are probably fine, since their investors have historically been pretty stable and since "many mutual-fund managers have prepared for redemptions by holding bigger cushions of cash and easy-to-trade assets."

But she has a new worry, about hedge funds, which "don’t really know how sticky their money is and haven’t planned for wholesale withdrawals of their clients' money." But hedge funds don't offer daily liquidity! They typically offer quarterly liquidity, with long notice periods and gates to prevent everyone from leaving all at once; if they get big withdrawals they'll have months to sell the underlying bonds. No one expects daily liquidity from their credit hedge fund. Hedge funds have fully solved the liquidity illusion problem. When people worry about bond market liquidity they often just mean that prices might go down.

Elsewhere, people are worried that bond offering documents are too long.

Me yesterday.

I wrote about Igor Oystacher, a guy accused of spoofing really fast, by hand. One popular response was: This was too fast to be legitimate human trading; no one could change his mind that fast. The Commodity Futures Trading Commission case against him alleges 1,316 times when he flipped from being on one side of the market, to being on the other, within an average of about 0.7 seconds. That is faster than I want to think about, but slower than I make decisions in the Bloomberg trading game, which I suppose is about as fast as I can click my mouse. So ... maybe it's possible? It does seem like a stretch, but Oystacher has been quoted saying "If we click quicker than most, it is a skill," so who knows.

Elsewhere in CFTC enforcement, and perhaps in E-mini trading, here's a case against "Colorado Resident Gregory L. Gramalegui, Doing Business as Emini Trading School":

Specifically, the Complaint charges that the Defendant made material, false representations in his solicitations of clients and prospective clients, including that 1) “You can win every day in the markets by following our trading plan”, 2) “The traders who do use our Trading Plans had many LONG winning trades and NO Losing Trades”; and 3) “We make it that easy for the trader to let the profits run.” In reality, as alleged, the Defendant had no basis for making these representations, and his clients lost money using his futures trading system and advisory service.

Things happen.

Obama Administration Draws Up Plan to Help Puerto Rico With Debt. John Thain of CIT Group Will Step Down as Chief Executive. Ex-Porsche CEO: VW Trial Prosecutors Are ‘Helping Hedge Funds.’ European Inquiry Focuses on a Mysterious Starbucks Business. The case against Luxembourg. After Disappointing Results, Yahoo Promises More Focused Strategy. (Focused on what? And: "Yahoo's business now worth less than nothing.") "This is a great time to be poised with ample cash," says Steve Wynn about his art loans at sub-1-percent interest rates. Regulator Raises Red Flag on Auto Lending. Obama SEC nominee Lisa Fairfax blogs. "The New York Stock Exchange is prodding its regulator to make hedge funds reveal which stocks they’re shorting." People are worried about a shortage of line cooks. Carl Mark Force IV got six and a half years in prison. "SPECTRE produced annualised returns of 119% and a multiple of invested capital (MoIC) of 10.5 times." Man bites dog. The Mets won.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

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