A Nosy Client and a New Exchange

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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The Milken fund.

When we talked a while back about Steve Cohen's temporary ban from supervising hedge funds, I pointed out that he had two options to keep his hand in:

  1. He could supervise the people managing his own money; or
  2. He could float lightly around a hedge fund that managed other people's money, but in a non-supervisory way. Like, say, as a large investor with no management role.

Cohen seems to be going with Option 1 until the ban expires in 2018, though there was a bit of a scare that he might be experimenting with Option 2. Michael Milken, whose own securities-industry ban is permanent -- and who, like Cohen, has a lot of money -- seems, awkwardly, to be choosing both options. Here's Option 2:

Executives who have been managing more than $2 billion for Mr. Milken and his family at his family investment office, Silver Rock Financial LLC, have transformed the firm into a hedge fund and are beginning to woo outside investors.

"Mr. Milken won’t help run Silver Rock, nor will he own part of the firm," putting him in the floating-lightly-around category, but it will run "several hundred million dollars" of his money. On the other hand, Milken is perfectly free to kibbitz with the people running his own money. Who also run the hedge fund:

Mr. Milken also has kept close tabs on Silver Rock’s trading. He has shared views on markets with Mr. Meyer and his team, sometimes speaking with them several times a day, the people said. Mr. Milken didn’t dictate moves, but his influence was felt, according to the person close to the matter.

“He’s not a passive client,” said another person. “He’s on the phone saying, ‘What are you buying? What are you selling? Why are you buying that?’ ”

Obviously it is a bit tricky to embrace both options: Does Milken's advice to the hedge fund managers who run his own money constitute involvement in the fund that runs outside money? Where is the line between being a chatty client and helping to manage the fund? I sort of feel like the proper response to this question is a shrug. The guy's allowed to invest his own money, and to ask questions about where it's going; who is he harming if those questions are probing and insightful? But I suppose Silver Rock's lawyers will want to formalize that a bit. Here is Bloomberg Gadfly's Michael Regan.

Like so many active clients, by the way, Milken seems to be hurting the fund's performance:

Silver Rock has focused on junk bonds and distressed loans—markets that Mr. Milken dominated three decades ago—along with stocks. But Silver Rock has run into challenges as the market rallied in recent years, according to someone close to the matter, partly due to Mr. Milken’s insistence on a sizable allocation to cash, due to his worries about expensive stock and bond prices.

I don't know a lot about the structure of this fund, but I personally would be hesitant to pay 2-and-20 fees to invest in a fund that mirrors the preferences of a cautious billionaire who is not the hedge fund manager, does not get incentive fees, and wants "a sizable allocation to cash." That's just me, though; "Silver Rock’s association with Mr. Milken has contributed to at least one large firm’s decision to contact a Silver Rock representative about making an investment."

Market structure.

I missed this the other day, but it looks like IEX will finally get approval from the Securities and Exchange Commission to become a stock exchange. Good for them. We have talked a lot about the controversy over IEX, which is real enough, but for the most part my view has been that IEX should probably get approved because they do seem really nice. I realize that this is not the most sophisticated of market-structure arguments.

Here is Matt Hurd, who is more sophisticated about market structure, and more skeptical of IEX. One of his criticisms is that IEX offers an order type -- called the DPEG -- that lets you "set a limit inside the mid-point so you can use the last-look feature to maintain a passive price near the NBBO that doesn't get adversely selected," making it "a great order type for an HFT." Another is that IEX reports executions to the official consolidated SIP feed without going through IEX's famous magic-shoebox speed bump, creating the possibility for latency arbitrage:

This may not have mattered too much not that long ago when the SIP was as slow as old dog with a limp during a hot day on a rough outback road, but now the SIP may sometimes be a little faster than the 350 microseconds shoebox delay.

All of this strikes me as interesting but non-fatal. U.S. equity market structure is complicated now, and IEX will make it a bit more complicated, but well within the range of complexity that we already accept. The fact that IEX will add complexity is not in itself a reason to turn down its application.

But if down-to-the-microsecond execution efficiency questions matter to you -- that is, if you're a high-frequency trader, or a broker who executes trades for institutions -- then you will need to do a little deep thinking to respond to the new questions raised by IEX as an exchange with protected quotes. Realistically, the high-frequency traders will do that deep thinking quickly, and the brokers will do it more slowly, which means there is a decent chance that institutional investors will find more reasons to complain about being picked off by high-frequency traders in the coming months. That won't be IEX's fault, exactly. (IEX really are nice! And really it's the SEC's fault.) But the basic criticism of high-frequency trading is that it takes money from "real" investors by exploiting a better understanding of market-structure complexity. If that's your view of HFT, then adding market-structure complexity will create more opportunities to take more money from the real investors.

Or not! IEX's added complexity might be minor enough that it won't create any significant new arbitrage opportunities. (Even if the SIP is faster than IEX, for instance, the difference may not be big enough to exploit.) Back when IEX first filed to be an exchange, I asked readers to send me arbitrage opportunities based on IEX's application. I guess I will renew that request: Once IEX is an exchange, if you see high-frequency traders using new, IEX-inspired ways to pick off investors, by all means let me know.

Meanwhile, in the blockchain-hyperbole area of market structure, here's "How blockchain technology can prevent the next financial crisis, disrupt Uber, and give us control of our data." And: "Allianz bets on blockchain for catastrophe bond trading."

Privater equity.

Private equity funds are a way for rich people and institutions to pool their money and buy companies with the help of some smart company-buying professionals, in exchange for fees. But if the rich people and institutions have enough money, they can buy the companies without the pooling, or the help, or the fees:

Over the last few years, a new group of buyers has sprung up: sovereign wealth funds, pension funds and even private families have flexed their deal-making muscles. As interest rates hover near zero (and in many parts of the world, below zero), these investors, with trillions of dollars in their war chests, have taken it on themselves to buy pieces of companies, or in some cases, the whole thing.

Though they'll probably want some help (and will probably have to pay some fees):

The risks are higher, however, especially because some of the newcomers do not have the same internal people who find deals and vet them that a private equity firm or a bank would have.

Some banks are stepping in to fill that void. Last month, Goldman Sachs announced plans to expand its financial sponsors group, which works with private equity firms, to focus more on these emerging buyers.

Bloomberg had an article about this phenomenon last month, with a focus on the family buyers; I said that it seems to represent "a confluence of two trends: First, there is an increasing suspicion of financial intermediaries and the fees that they charge, and second, there is enough inequality and concentration of wealth that now lots of families can go around buying companies just to keep their kids busy." Pooling your money under paid professional management just seems so middle-class. If you have enough money -- as a family or a sovereign wealth fund -- then the real status market is not to invest with private-equity firms, but to compete with them. 

Products.

Apparently more investors are allocating their money based on factors rather than asset classes:

Rather than crude, nominal and sometimes arbitrary allocations to asset classes, factor investing involves breaking down securities into their fundamental drivers and using those to create a more precise, balanced portfolio — at least in theory. For example, corporate bond returns are influenced by both interest rate movements and creditworthiness, and the two factors can move in opposite directions.

That seems inevitable. Honestly why have a financial system if not to constantly move to higher levels of abstraction? Buying stocks was great back when you had to go stand under a buttonwood tree and hand over cash in exchange for share certificates, but now we have computers that will let you buy whatever you want instantly. Surely what you want isn't, like, 100 shares of IBM. (Not investing advice!) It's exposure to some economic trend, to some set of risks and growth opportunities, and if you can find a more precise way to talk about those exposures than just "stocks" and "bonds," you should totally do that.

On the other hand, Vanguard Chief Executive Officer F. William McNabb III thinks there are too many investing products:

“I think the proliferation has gotten out of hand,” he tells a Morningstar conference. “I do worry about some of the new ideas out there.”

He sees the recent growth of new products in some cases slicing up the market too finely.

My own money is mostly in the broadest and most boring Vanguard index funds, so I can't exactly say that I disagree with him, but aesthetically I'm a fan of the slicing. The finer the better!

Optics.

I don't know, there's always a crisis somewhere, and everyone needs a vacation now and then; I don't have a huge problem with this:

Foreign exchange traders at Citigroup, the world’s biggest currencies-dealing bank, are pulling out the stops to prepare for next week’s UK referendum on EU membership and its potentially cataclysmic impact on sterling.

But as rank-and-file workers worked long hours, five of the bank’s most senior currencies executives each took between one and three days out of work around last weekend to drive their sports cars, including some Ferraris, through France.

The five executives, most of them managing directors, declined to cancel their annual “Ferrari Safari” road trip with two former colleagues.

"The optics here are bad," says a Citi person who presumably wasn't invited. But try to see it from those executives' point of view: if the U.K. does pull out of the European Union, it may get a lot harder for them to just pop over to France and drive around in their Ferraris. If not now, when, right?

Elsewhere in stuff banks do in Europe:

UBS has bought a Swiss lakeside villa which once belonged to Congolese dictator Mobutu Sese Seko for 6 million Swiss francs at auction. ... The 700-square-meter property has 16 rooms and 25 toilets and boasts 60,000 square meters surroundings, including a French garden which requires two full-time gardeners to maintain, the current owner told a Swiss newspaper.

The two traditional places for dictators to hide assets offshore are in Swiss banks and real estate, so this a nice synergy. On the other hand: "Shuttered Geneva Offices Show Impact of Lost Banking Secrecy."

Depressing tech stuff.

Here is the story of "How Yahoo derailed Tumblr"; the answer seems to be partly "by being Yahoo":

Top Yahoo executives clashed with Tumblr, or just flat out confused employees. On one occasion, an executive overseeing Karp and his division perplexed employees by saying he thought Tumblr had the potential to "create the next generation PDF," according to multiple sources. 

But I don't know how much of Tumblr's decline is Yahoo's fault, and how much is just the inexorable march of internet trends:

Kyle Bunch, a longtime Tumblr user and head of social at ad agency R/GA, says “the rise of Snapchat” has “forced Tumblr down the priority ladder” for brands. "With so many different platforms and new things emerging and clients coming to us asking, 'How do I do Snapchat better?' or 'Should I be thinking about Medium?' Tumblr has got to find its sweet spot and I just don’t know that it totally has a clear one," he says.

Maybe that's because Yahoo bought Tumblr and demoralized its engineers so they couldn't compete with Snapchat, but my guess is that it's because Snapchat is an entirely different thing and Tumblr wasn't going to compete with it any more than Friendster was. Also, it is just hard to make money off a social network for, like, emo personal blogs and porn. ("Even at its hottest, Tumblr wasn’t the easiest sell for advertisers. At first it was because of content-safety concerns," says an ad guy.)

Meanwhile, Facebook, which certainly knows how to make money off a social network, will just tell you the answer, which is: Make it television.

The amount of text being posted on Facebook is declining, according to one of the company's executives who believes the social network will "probably" be "all video" within the next decade.

And:

On the shift toward video, Mendelsohn said: "The best way to tell stories in this world — where so much information is coming at us — actually is video. It commands so much information in a much quicker period so actually the trend helps us digest more of the information in a quicker way."

I disagree, as I sit here typing into a box on the internet, but you don't need me to tell you that. I guess every mass communications medium eventually devolves into becoming television; why should the internet be any different? And yet the internet isn't just a mass communications medium; it encourages long tails, and I like to think that someone will always be typing into a box somewhere on the internet. Maybe it won't be at Facebook. Maybe it won't even be at Tumblr. But typing into a box is a pretty cool technology. Here is Tim Carmody: "Facebook is wrong, text is deathless."

People are worried about unicorns.

They definitely have an Enchanted Forest in Germany, though I feel like the enchantment there is more of a ... haunting? Like, a witches-eating-orphans enchantment, rather than a frolicking-unicorns enchantment? Anyway here is Die Welt worrying about a unicorn bubble, or in German a "großen Start-up-Blase." (Unicorns in German are "Einhörner," but it seems like the unicorn metaphor has not penetrated Germany sufficiently to call it an "Einhorn-Blase" in the headline.) Meanwhile in China, "Uber rival Didi Chuxing raises $7bn in new capital."

People are worried about stock buybacks.

Not really, but a while back we discussed the question of whether a company can buy itself. It can't, but ever since then people have delighted in sending me examples of companies that sort of have bought themselves, or that sort of own themselves, or whatever. In that vein, Tim McGovern sent me to the Wikipedia page for the Tree That Owns Itself, which, I mean, sure, why not.

People are worried about bond market liquidity.

The worries are pouring in from all over the globe. Here's a Reserve Bank of Australia paper on "Liquidity in Fixed Income Markets," finding that the big changes in dealer inventories and electronic trading "are not as prevalent in Australia as they are in some overseas markets," and that "overall market liquidity across bond and related derivative markets does not appear to have deteriorated." Here's a City of London Corporation research report on "Improving International Access to Credit Markets" that notes that "Concerns are growing about the liquidity of global credit markets and in particular corporate bond markets since mid-2015." Here's a story about a Canadian startup that wants to "disrupt" the "opaque" bond market. And in the U.S., "Federal Deposit Insurance Corp. Chairman Martin Gruenberg said Wednesday that postcrisis regulatory changes alone were not to blame for reduced liquidity in the Treasury market."

Me earlier.

I wrote about the Visium insider trading case. Elsewhere: "Visium Future in Limbo as Gottlieb’s Health-Care Star Is Charged."

Things happen.

Wary Fed Rethinks Pace of Hikes. The restructuring business is booming. China’s Yuan Shudders Despite Beijing’s Campaign to Steady the Currency. China Dumping More Than Treasuries as U.S. Stocks Join Fire Sale. Next frontier for financial advisers: your mobile phone. Goldman Bankers Were ‘Like a Swarm,’ Libya Fund Adviser Says. America’s Dying Shopping Malls Have Billions in Debt Coming Due. China’s Tencent Nears Deal for ‘Clash of Clans’ Maker Supercell. Nick Denton on Gawker's future. Picasso Sculpture in Dispute Goes to Leon Black; Rival Owner to Receive Compensation. A former official in Cristina Fernández de Kirchner's government "was allegedly caught trying to bury bags containing almost $9m dollars in a convent outside Buenos Aires." We'd Be Better Off If Every Human Were As Good As the Top 10 Percent of Humans. Blackstone Co-Founder’s Daughter Debuts Cookbook For People Who Hate The One Percent. Squirrels perplexed by bread-bearing squirrel statue in Montreal park. Happy Bloomsday! Greenpoint dad offers free ironing at bar. A New Yorker parody.

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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