Hedge-Fund Gloom and LBO Memories
I know that benchmarking all hedge funds to broad equity indexes is dumb, but I am nonetheless going to throw it out there that if you are invested in a hedge fund that has returned zero percent year-to-date, you should be pretty satisfied. The S&P 500 is down about 9 percent so far in 2016, so that's 9 percentage points of pure alpha. (I mean, it's not, not at all, but you know what I mean.) One way to generate returns of zero percent is to do literally nothing, and here is an article sort of about that, though it is really about how "a number of hedge-fund managers are playing defense" by holding a lot of cash and generally looking busy while not buying stuff. "Everybody likes buying a bargain, but catching a falling knife is no fun at all," says one of them.
While doing nothing this year has produced above-market returns while also being very relaxing, there are less relaxing ways to get even better results. For instance, if stocks are down, and you are short stocks, then you are up. That has worked particularly well recently:
In the U.S., Markit found, the most hated stocks -- the top 10 percent most costly to short -- underperformed the market by a record 26 percent in 2015. In 2008, they trailed by 19 percent. Those shares are now on track for the worst month ever -- or the best ever, from a short seller’s perspective. Two weeks in, they’re already trailing the market by 6.7 percent.
While the popular shorts are particularly terrible, the popular longs are ... also particularly terrible:
Of the year’s 100 worst-performing companies larger than $1 billion as of Jan. 19, more than half are at least 10 percent owned by hedge funds, and 17 are at least 25 percent owned by such funds.
Popular activist longs are also particularly terrible: "S&P’s US Activist Interest Index, which tracks stocks targeted by activists, is down 18% this year and 31% over the past year." Everything is uniquely terrible. On the other hand: "Even though the U.S. stock market is off to one of the worst starts ever, hedge funds are buying the most equities they have in five years."
Two things that you can generally say about a market top are (1) it is fun and (2) afterwards prices go down. (That's how you know it was a top!) In the stock market, if you get your timing just right, you can have your fun at the top and be out of the market when the prices go down. But if you are a private equity firm taking companies private right up until the music stops, it is possible that you will both remember the top fondly (wasn't it fun, throwing around giant piles of money to buy companies?) and regret holding those companies for the subsequent decade (ugh, why did we throw such a giant pile of money at this company?). Anyway this shouldn't be a huge surprise:
Henry Kravis called it private equity’s golden age. From 2005 to 2007, buyout firms paid fat prices to buy about 20 supersized companies, from Hilton Worldwide Holdings Inc. to Hertz Global Holdings Inc.
Now, a decade later, the results of that debt-fueled spree can be tabulated -- and it’s hardly golden. The mega-deals produced mostly mediocre returns, falling well short of the profits that leveraged buyout shops typically seek, according to separate compilations by Bloomberg and asset manager Hamilton Lane Advisors. In more than half the deals -- each valued at more than $10 billion -- the firms would have been better off if they had put their investors’ money into a stock index fund.
And: "On an annualized basis, the largest deals generated a median 4 percent return," though smaller deals did better. HCA Holdings was the best of the big deals, at a 5.1x equity return; TXU/Energy Future was the worst (and biggest), "the only total equity wipeout of the 19 mega-deals." Here is a chart.
Deutsche Bank pre-announced "a huge yearly loss of 6.7 billion euros ($7.3 billion)," with 5.2 billion euros (1.2 billion in the fourth quarter) of that coming from litigation charges. (Here is the pre-announcement; the actual earnings are next week.) More concerning than the numbers, perhaps, is this:
The bank did not say which of the lawsuits against it or official investigations would cause the charges. The bank has already paid billions in fines and settlements related to accusations that it colluded with other banks to fix benchmark interest rates, and that it violated international sanctions against countries like Iran.
If you've already paid billions of dollars in legal settlements, and you announce billions more, and it's not immediately obvious which of the pending legal issues they relate to, you might have too many legal issues.
Elsewhere, Barclays "unleashed a fresh round of cuts at the investment bank that will eliminate 1,200 jobs worldwide and shut securities operations across Asia," and "the investment bank’s bonus pool for 2015 may be cut by at least 10 percent from the previous year." And here is a ridiculous item from Davos:
A senior global banking leader said he was shocked to discover that eight years after the financial crisis, junior staff are still struggling to take to heart the message from the top about the firm’s culture.
A survey of junior bankers at the firm last year showed they had no idea what the bank’s message about integrity and strategy is, the senior banker, who asked not to be identified, told a gathering of reporters and banking executives at the World Economic Forum in Davos, Switzerland.
Maybe they'd have a better idea of your message about integrity and strategy if you put your name to it?
Here is a story about the feud between Citadel and IEX, which is driven in part by genuine disagreements over questions of market structure and fairness, but also in part by the fact that Citadel founder Ken "Griffin also didn’t like that 'Flash Boys' portrayed Citadel as secretive and he took issue with the book’s negative depiction of firms that pay brokers to execute their customers’ stock trades."
And here is a story about how computers are learning how to invest:
A machine-learning algorithm will autonomously evolve and search for new patterns, adjusting to what works in markets that day, week or year. That means asset managers can use them as a tool to enhance their investment process, perhaps by screening for patterns undetectable by humans, or even to develop strategies and trade by itself.
For Nick Granger, a fund manager at Man AHL, a quant hedge fund, this is the crucial edge. “You see it creating intuitive trading strategies from the bottom up, switching styles according to what works,” he says. “We have been successfully using machine learning for the past few years and are interested in investing in it more.”
The U.S. regulator that polices the complex derivatives markets is struggling to keep its own books in order and has made a material error that its auditor found so significant that it withdrew nearly a decade of its financial opinions, according to documents seen by Reuters.
The Commodity Futures Trading Commission understated liabilities by $194 million in fiscal 2014 and $212 million the following year, the agency's auditor KPMG estimated in the documents. The understatements are the equivalent to more than 75 percent of the CFTC's $250 million annual budget.
It's a little baffling how that's even possible; I would not have expected the CFTC to have a lot in the way of liabilities. The answer has to do with multi-year office leases: "In its annual financial statements, the regulator was only accounting for a year's worth of rent -- and not the full cost of the lease over time." There are probably no lessons here, other than that accounting is hard, and that expertise in spotting other people's financial misdeeds does not necessarily translate into being able to avoid those misdeeds yourself.
Imagine being Howard Schiller. He was the chief financial officer of Valeant until June 2015, stepped down, and then was dragged back into service as interim chief executive officer earlier this month when Valeant's CEO, J. Michael Pearson, was hospitalized for pneumonia. Valeant has had a rough time of it of late, with the Philidor stuff. And now Schiller, who just got there a couple of weeks ago, has to go testify to Congress about Valeant's controversial drug pricing practices. Worst of all, he has to sit next to this guy:
Martin Shkreli, the former drug company CEO charged with securities fraud, has been subpoenaed by a U.S. congressional committee investigating the price of drugs.
Shkreli, a prolific presence on Twitter, didn’t respond to a request for comment, but he did tweet. “House busy whining to healthcare reporters about me appearing for their chit chat next week. Haven’t decided yet. Should I?” Shkreli asked his 40,000 followers on social media. Then, posting a picture of the subpoena, he said: “Found this letter. Looks important.”
His lawyer, Baruch Weiss, declined to comment.
Imagine being that lawyer. The thing about subpoenas is, you're really supposed to go. Do you think Shkreli will tweet about whether or not to show up for court dates in his securities fraud case?
Elsewhere: "CrossFit Promoter Accused of Defrauding Investors Reaches Plea Deal."
Still going on. The Economist: "The data of Davos." John Cassidy: "What Is the Post-Post-Davos Model of the World?" DealBook: "Pope Asks Davos Elite to Remember the Poor," and "Rockefeller Foundation to Take Food-Waste Fight to Davos," and "Davos Participants Seek Out ‘Stardust’ Moments." New York Magazine: "Falling Markets Harshing Billionaires’ Mellow at Davos." Joe Weisenthal: "The Best Place to Network in Davos? The Back of a Bus." Izabella Kaminska: "Blockchain hype storms Davos." The Wall Street Journal: "Tech Companies Bring Battle Over Data to Davos." Reuters: "Actor DiCaprio honored in Davos." Bloomberg: "Trump Is Losing the Davos Primary Among His Fellow Billionaires." As if all that wasn't enough, as Tracy Alloway points out, Davos is worried about bond market liquidity. And here's a robot reading a newspaper. If you get up close to the robot, you can hear it whisper: "The horror! The horror!"
People are worried about unicorns.
After Square's and Twitter's share prices fell yesterday, Forbes ran a widely aggregated article pointing out that Jack Dorsey, the chief executive officer of both companies, was no longer a billionaire. Of course Dorsey is not, himself, a unicorn -- he's a human man -- but he is a serial founder of unicorns, and a parallel CEO of unicorns-made-good, so his own fall below the billion-dollar mark is perhaps ominous. He got better, though: By my quick math, he ended the day with about $1.05 billion worth of stock in the two companies.
Elsewhere: "Europe’s tech start-ups need to scale faster."
If you are worried about short-termism, now there is a long-termism index:
The S&P Long-Term Value Creation Global Index comprises 246 companies that meet criteria for return-on-equity, leverage and other financial factors, as well as a score for corporate governance.
“We are trying to use the index to change corporate behavior,” said Mark Wiseman, chief executive of the Canada Pension Plan Investment Board, in an interview at the World Economic Forum here. Mr. Wiseman said financial markets are too focused on short-term results.
Of course it was launched in Davos. Buybacks don't actually seem to be taken into account one way or another, though. Elsewhere, Adam Davidson ponders the mystery of why "American businesses currently have $1.9 trillion in cash, just sitting around."
People are worried about bond market liquidity.
I mentioned this a few paragraphs back, but it bears repeating: Davos is worried about bond market liquidity. Leonardo DiCaprio's Crystal Award (it seems to really be called that?) was "for his leadership in tackling the climate crisis," but my fondest hope is that next year Davos will give a random celebrity a Crystal Award for leadership in tackling the bond-market-liquidity crisis. I have previously proposed Beyoncé for that role, and why not.
A note on the Einhorn family.
In Money Stuff yesterday, I mentioned some investing advice that David Einhorn got from one of his children, which led me to imagine a hedge fund for that child and name it Einhorn Fils Capital Management. A person familiar with the conversation has informed me that the advice came from Einhorn's daughter, so the "Fils" was inappropriate. Let's call it Einhorn Junior Capital Management. There are important lessons here about gender assumptions, and about not writing in French out of pretentiousness. I apologize to Ms. Einhorn.
Junk-Bond Market Risk Gauge Stages Biggest Jump Since 2009. UBS to Redeem Two Leveraged Exchange-Traded Notes. Treasury Secretary Visits Puerto Rico and Urges Fast Action. Saudi Arabia Said to Ban Betting Against Its Currency. Goldman Sachs makes large donation to pro-EU campaign. Why the Fannie Bet Faces Long Odds. Prat-Gay Said Likely to Meet IMF as Argentina Opens Books. A.F.L.-C.I.O. Seeks to Curb Payouts to Bankers Who Go to Washington. Red-Hot Property Markets Cool as Rich Investors Retrench. Putin 'Probably' Approved Litvinenko Murder, U.K. Judge Says. Ocwen Paying Penalty for Misstated Financial Results. The Debt-Equity Choice When Securities Regulations are Scaled by Equity Values: Evidence from SOX 404. "The planned felicide has greatly upset some cat people, notably Brigitte Bardot, a French former sex goddess, and Morrissey, a miserable British singer." Voxsplaining the Illuminati. Planet Nine. Man braid. Study: Students Studying Abroad Get Drunker, Do New Drugs.
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