Hedge-Fund Blues and Digital Dollars

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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Are hedge funds bad?

Isn't the hedge fund business strange? The performance of hedge fund aggregates is pretty underwhelming, the fees are notoriously high, Warren Buffett goes around making fun of them, and even hedge-fund stars like Steve Cohen agree:

Cohen said the industry has “gotten crowded” with too many managers following similar strategies. He said fund firms seem to think they can hire skilled people and “magically” generate returns.

“It’s very hard to maximize returns and maximize assets,” said Cohen, who runs $11 billion Point72 Asset Management. It’s difficult to balance size with carefully managing an organization and delivering good risk-adjusted returns, he added.

So does Neil Chriss of Hutchin Hill:

“Investors are going to vote with their feet,” Chriss said in a Bloomberg Television interview from the Milken conference with Erik Schatzker. “They will redeem the hedge funds that they don’t feel are giving them something that’s worth the fees they’re paying, and that will either force hedge funds out or force them to lower their fees.”

Investors seem to agree too:

"We’ve been reducing our hedge fund investments over the past year or year and a half," Loews Corp. Chief Executive Officer James Tisch said on a conference call Monday, discussing the portfolio at the CNA Financial Corp. insurance unit. "I have a slightly different take on it than Buffett. I would say that the space has become very crowded and returns have been competed away."

"Reducing your fees is your best return on capital," says the chief investment officer of CalSTRS, who is pushing back on hedge-fund fees.

Reading the news, I have to say, I don't get a lot of the opposite perspective. You rarely see people go on TV to wholeheartedly defend the performance and fee structure of the hedge-fund industry as a whole. And yet hedge fund assets under management mostly go up. For all the doubts about the industry expressed by its critics and members and investors, investors basically want more hedge funds.

It is a little bit of a puzzle, no? You can model it sort of like Congress: Everyone hates Congress, but everyone votes for their own congressperson anyway. Perhaps "hedge funds" are bad, but each individual hedge fund is special and lovely to its investors. It is after all an industry built on exceptionalism, on the idea that an outstanding manager can be so valuable that he's worth his 2-and-20 fees. There is something a bit paradoxical about a crowded industry made up exclusively of exceptional individuals, but I suppose it is not logically impossible.

Elsewhere, passive ownership affects activism:

We find that passive mutual fund ownership is associated with significant differences in the goals and tactics of activist campaigns from 2008-2014. We find activists are more likely to pursue changes to corporate control or influence (e.g., via board representation) and to forego more incremental changes to corporate policies (e.g., increased payouts) when a larger share of the target company’s stock is held by passively managed mutual funds. Regarding the tactics of activist campaigns, we find higher passive ownership is associated with increased use of hostile, expensive tactics (e.g., proxy fights) rather than relying on shareholder proposal or exempt solicitation that are “easier, less costly and demand a lower level of commitment from dissidents” (Wilcox 2005).

And how did last year's Sohn Conference picks do?

Blockchains.

Here's a story about a "secret meeting" of bankers in Times Square:

By the end of the day, they had seen something revolutionary: U.S. dollars transformed into pure digital assets, able to be used to execute and settle a trade instantly.

"Dollars transformed into pure digital assets." They had seen something revolutionary: my online checking account. No, I kid, it was a blockchain thing. Look, I get that the point here is less the "dollars transformed into pure digital assets" and more the "instantly." I get that the blockchain may offer real speed and operational advantages over conventional payments technology. But why does everything about blockchain need to be bathed in obfuscation and mysticism?

While cash in a bank account moves electronically all the time today, there’s a distinction between that system and what it means to say money is digital. Electronic payments are really just messages that cash needs to move from one account to another, and this reconciliation is what adds time to the payments process. For customers, moving money between accounts can take days as banks wait for confirmations. Digital dollars, however, are pre-loaded into a system like a blockchain. From there, they can be swapped immediately for an asset.

“Instead of a record or message being moved, it’s the actual asset,” Ludwin said. “The payment and the settlement become the same thing.”

Come on! That is what dollars are! Dollars are an electronic record of dollars! There's no "actual asset." If I wire money from my bank account to yours, no one in the back office is moving a bag of gold doubloons between vaults. It's all electronic anyway. Dollars are digital. The blockchain may be a faster and better way of moving electronic dollars, but it's not like no one thought of making dollars electronic before.

Elsewhere in electronic money: "The Swiss National Bank might seek authority to stop commercial banks converting reserves into cash if its current policy arsenal failed to prevent a major appreciation of the franc, economist Nouriel Roubini's research group said." Elsewhere in fintech: "The growth of peer-to-peer lending platforms and prospects for banks’ disintermediation – hype or real threat?" And: "Wall Street Told to Fear the Machine as Emerging Tech Takes Jobs." And: "Rise of the robots is sparking an investment boom." And: "SoFi offers equity to tempt new partners."

Bitcoins.

Meanwhile, now it seems like the guy who everyone thought was Satoshi Nakamoto, and who announced that he was Satoshi, might not be Satoshi? Some important bitcoiners think Craig Steven Wright is Satoshi, some think he isn't. The trustless decentralized consensus-based cryptographic verification process seems to have broken down a bit. Izabella Kaminska is unimpressed by Wright's proofs of identity. Timothy B. Lee calls Wright's announcement "an elaborate effort at deception." Vice says: "Craig Wright's New Evidence That He Is Satoshi Nakamoto Is Worthless." Tyler Cowen says "p = 0.415," which strikes me as a fitting level of comical precision about uncertainty. It is, after all, bitcoin.

Imagine watching this controversy unfold and being like "oh yes this is a good secure way to store my money." If I need to verify my identity to my bank, I type in my username and password. I don't give interviews to the BBC and the Economist and bring along a famous bank-software developer who got to see my password, but only on a special laptop. We have computer algorithms to verify identity now. Maybe one day bitcoin will too. Anyway, Bloomberg asks what Satoshi, whoever he is, plans to do with his hundreds of millions of dollars' worth of bitcoins. 

Banks.

My model of the post-2008 shakeout in banking has been that it forced banks to get back to their roots: UBS and Credit Suisse have meandered back to wealth management, Wells Fargo to traditional banking, Morgan Stanley to brokerage, and Goldman Sachs to being a classic bond-trading-and-mergers investment bank. This is not a perfect model, but it seems to have served reasonably well, so I am a little perturbed by Goldman's recent emphatic push into retail. There's the Honest Dollar acquisition, and the online savings accounts, and now a push "to partner with small brokerages and wealth management firms to lend money to their clients, many of whom have far less wealth than what's in the typical Goldman private bank account." I realize that securities-based lending seems to be a pretty lucrative business for places with big brokerage organizations. But it is a little strange to see Goldman Sachs look around at the opportunity set in institutional trading and investment banking and say, "meh, let's make small retail loans to other people's customers." What's next, buying E*Trade? (Disclosure: I used to work at Goldman Sachs, and as far as I can tell I have a GSBank savings account with zero dollars in it.)

Elsewhere in banking, "UBS said on Tuesday that its first-quarter profit fell 64 percent compared with a year ago, as investor wariness about the financial markets continued to hurt its wealth management and investment banking businesses," though it beat expectations for new private-banking assets. Here are the earnings release, presentation slides and earnings call remarks. And: "HSBC Holdings PLC said market volatility in the beginning of 2016 crimped its performance as it reported a 18.2% decline in net profit in the first quarter of this year." Here are the earnings release and presentation

Meanwhile, the Bank of China is coming to Bryant Park

Although the building’s 10th floor terrace offers views of the Empire State Building to the east and the World Trade Center to the south, the bank also wanted a respite from Manhattan’s urban jungle. Two large video screens at street level will show calming landscapes, meant as an extension of Bryant Park’s greenery. At other times, the screens will flash scenes of busy Chinese assembly lines, happy Chinese children and bamboo-chomping pandas.

Corporate politics.

Here is a story about how "America Rising, the unofficial research arm of the Republican Party, has launched a for-profit venture aimed at helping companies, trade associations and wealthy individuals push back against detractors and navigate sensitive shareholder or public-policy fights." Here is a story about how "Salesforce’s Marc Benioff Has Kicked Off New Era of Corporate Social Activism." On the one hand, if you are worried about the influence of corporate power on American politics, it's all pretty worrying. On the other hand, that is traditionally a left-ish worry, and many progressives who dislike corporate power can probably find something to like in Marc Benioff's advocacy in favor of gay and transgender rights. In America, these days, it is possible that capitalism is more progressive than democracy. 

Insider trading. 

Here is a strange insider trading case that the Securities and Exchange Commission settled yesterday. According to the complaint, Peter Nunan worked at a company, call it Company A. He heard from a board member of another company, call it Company B, that a third company, Company C, was negotiating to buy Company B. The Company B board member didn't give Nunan this information so that Nunan could trade on it and give him a kickback; nor did he give Nunan the information in secrecy because Nunan was his therapist or whatever. He gave it to him so that Nunan could go to his bosses at Company A and try to get Company A to make a competing bid for Company B. Nunan did take it to his bosses, but Company A never ended up bidding. Company C ended up buying Company B at a big premium, and Nunan -- who had bought Company B stock after being approached, but before the deal was announced -- made about $254,858. (And is now disgorging twice as much, because insider trading doesn't pay.)

The puzzle here is that just trading on material nonpublic information isn't generally illegal; normally you have to have acquired it illicitly. What was the illicit action? The Company B board member wasn't betraying his company in exchange for a kickback; he had a corporate business purpose in approaching Nunan. Nunan wasn't betraying that board member's trust. The SEC's theory is that Nunan was betraying his own company's (Company A's) trust in him, since he had "received the material, nonpublic information about the potential acquisition in the course of his employment, and had a duty not to trade on or otherwise misuse the confidential information for his personal benefit." This is plausible enough, but on the other hand he got the information from an outsider, not from Company A, and Company A never did anything with the information. The answer is probably just that Company C's bid came in the form of a tender offer, and even trading on legitimately acquired material nonpublic information about a tender offer is mostly illegal under Rule 14e-3, but that is a boring answer.

A more fun puzzle might be to work out how close you can get to the facts of this case and still be perfectly legal. For instance: If Nunan had brought the deal to Company A, his bosses passed, he asked them for permission to buy Company B stock in his personal account, and they said okay -- is that legal? Or, he brought the deal to Company A, his bosses didn't want to submit a bid, but they did buy some stock for Company A's account to front-run Company C's bid -- is that legal? Does the answer depend on whether or not Company C's bid was a tender offer? Should it?

Meanwhile, here is a profile of U.S. Attorney Preet Bharara calling him "The Man Who Terrifies Wall Street," which is sort of a strange epithet. Bharara's office has not notably gone after "Wall Street" except for insider trading, and many of his insider-trading victories have been reversed for getting the law wrong. Elsewhere: Cybercrime-as-a-service.

People are worried about unicorns.

The Enchanted Forest is a mystical place that lives in the heart of any child anywhere who has ever dreamed about unicorns, but still there is some geographic segmentation in unicorn worries. In New York, the worry is that it is hard to find any unicorns at all; there is a "scarcity of lucrative paydays — start-ups sold to the public or to other corporations for $1 billion or more." (In the grand tech tradition, New York plans to fix this problem with non-traditional punctuation, launching a ... thing ... called "Tech:NYC.")

In Utah, the worry about unicorns -- yes, they worry about unicorns in Utah -- is that people want to leave at 5 to see their kids:

And while Elkington loves Provo, he does wish one thing was different: His employees, many of whom have young kids, tend to leave at 5 on the dot; many others in the industry in Utah say the same, denoting a healthy work-life balance as one of Utah’s perks. But, for his part, Elkington wishes they’d stay a little later. After all, he argues, InsideSales is competing with the work hours of Silicon Valley.

And in San Francisco, the worry about unicorns is that they might explode. Not in like a metaphorical bubble-popping way (though that too), but I mean, they might actually explode in a fireball, because the latest unicorn craze is pumping gas:

Tap an app, and they'll bring the gas to you, filling up your car while you're at work, eating breakfast, or watching Netflix. Filld, WeFuel, Yoshi, Purple and Booster Fuels have started operating in a few cities including San Francisco, Los Angeles, Palo Alto, Nashville, Tennessee, and Atlanta, Georgia. But officials in some of those cities say that driving around in a pickup truck with hundreds of gallons of gasoline might not be safe.

“It is not permitted,” said Lt. Jonathan Baxter, a spokesman for the San Francisco fire department.

Don't miss the Filld executive who says "You can never ask for permission because no one will give it," which is not even a little bit how that saying goes.

People are worried about bond market liquidity.

The U.S. Treasury Department sat a bunch of people on the couch and listened patiently while they explained their bond-market-liquidity worries, and now you can read them too, if you are so inclined. Technically they are responses to a Treasury "Request for Information on the Evolution of Treasury Market Structure," and if you like bond-market-liquidity stuff they are a rich vein.

They're also of interest if you like equity-market-structure stuff, as the Treasury market is to some extent recapitulating the battles we've seen in the equity markets. Bloomberg's Alexandra Scaggs and Liz McCormick write about a fight in the comment letters over post-trade transparency requirements. Unlike in the equity markets, there is currently no general obligation to publish price and size data for Treasury trades. Dealer banks like Citigroup, which make money by knowing the market, want to keep it that way; electronic trading firms like Citadel and KCG want post-trade transparency requirements so they can compete more effectively as Treasury market makers. Investors are worried about immediate reporting, since it will be harder for them to move in and out of large positions if the market can see their actions in real time. The compromise position seems to involve reporting lags, say of 15 minutes or so, after large trades and trades in off-the-run securities. 

Obviously in the equity markets investors worry that immediate reporting of trades makes it harder for them to move in and out of positions -- because they might be "front-run" by high-frequency traders who see their trades and adjust their prices -- and the highly controversial proposed compromise there is, essentially, a reporting lag of 350 microseconds in trades on IEX. So, sort of similar issues, but at very different scales. 

But there's lots of other cool stuff in the comment letters, too, including proposals to make the Treasury market more liquid by changing the types of bonds Treasury issues. Prudential is pushing a 30-year zero-coupon bond to improve the Strips market, and also has a clever money-making liability-management transaction for Treasury to consider:

Treasury could create a buyback program that buys discounted, less liquid issues in the open market. By buying cheap issues and funding the buybacks with issuance of rich on-the-run securities, the Treasury could enhance liquidity in these issues, while decreasing its borrowing costs. A buyback program could also alleviate some dealer positions that have become balance sheet intensive. Furthermore, dealers could be more likely to buy securities from investors if they know that the Treasury may be an eventual buyer of that security. We believe investors would be willing participants in such a buyback program as it would offer an opportunity to move into more liquid issues. 

The on-the-run/off-the-run arbitrage is a famous trade -- it was involved in the Long-Term Capital Management blowup -- but I suppose it's a lot safer for Treasury to do it. Meanwhile, John Cochrane has a fun proposal to replace all the hundreds of series of Treasury securities with just three securities: A daily-auction floating-rate perpetuity (i.e. an overnight interest rate), a fixed-coupon perpetuity (i.e. a perpetual interest rate), and an indexed perpetuity (i.e. a perpetual inflation-linked index rate). 

Things happen.

Congratulations Leicester City! Robin Wigglesworth and Matthew Yglesias explain Puerto Rico's default. Lew Urges Congress to Act on Puerto Rico to Avoid Bailout. Investors Profiting From U.S. Economic Data Before Release, ECB Study Says. The Super Rich Were the First to Bail During the Financial Crisis. ROIC. Uber enables global e-hailing through Alipay to fend against Lyft/Didi alliance. The Unnamed Beneficiary of an Italian Bank Bailout. China financial regulator clamps down on shadow banking. Facebook's proposed issuance of nonvoting stock challenged in Delaware Chancery Court. Apple stock closed down eight days in a row. 'Burning Man for the 1%': the desert party for the tech elite, with Eric Schmidt in a top hat. Hacker philanthropyWhat’s Up with GCF Repo? Pancake machine. Medieval Fight Club. Boring job. Paw-ternity leave. Prospect Park goats. Firefighters chase fridge-raiding bear from second-floor apartment. Gorillas Make Up 'Little Food Songs' While They Eat.

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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:
James Greiff at jgreiff@bloomberg.net