Awkward Hedge Funds and New Exchanges

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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Hedge funds.

This is a sentence about job interviews at a hedge fund. Can you guess which hedge fund?

"In those rare situations, a candidate may find themselves talking about something awkward, like their relationship with their father."

Did you guess Bridgewater? Of course you did, good work. It's from this article about how Bridgewater Associates job applicants "will typically go through around five hours of personality surveys, a verbal logic assessment, and a thorough personal interview" that might sometimes get a little Freudian. Terrific.

It is a time of weird introspection for hedge funds generally. There is, for instance, fee pressure, of an odd kind:

Hedge funds are agreeing to so-called hurdle rates to assuage the sting of underperformance. Some have “hard hurdles,” meaning they must generate typically between 4 and 10 per cent before they are paid, while others must generate a certain percentage above Libor or cash.

“This is here to stay, and in fact it’s going to become more the norm to have these more creative relationships on the fee side,” said Kelsey Deshler, a portfolio manager at Credit Suisse Asset Management.

I gather that there is broad dissatisfaction with performance and fees among hedge fund investors, but it seems odd to express that dissatisfaction by demanding a fixed minimum return before managers can earn fees. Like I know hedge funds are supposed to be uncorrelated with everything, but surely it's harder to break 10 percent returns in a low-rates-everywhere environment than it is in more normal times? Why not just make the fees lower?

Especially when there are hobbyists with computers ready to disrupt the industry:

“If our model is successful there will be no need for hedge funds any more,” says Martin Froehler, an Austrian mathematician who created Quantiacs, one of several online platforms for DIY algo traders. “A smart guy with a laptop will be able to start his own hedge fund. It will be very challenging to the big incumbents. A very simple idea can prove very powerful.”

I don't know, what should you think about the hobbyists? My biases are:

  1. There are probably a lot of opportunities for artificial intelligence to replace human intelligence in a variety of investing functions, just as there are in chess or driving.
  2. Professionals probably have an advantage over amateurs in investing, just like they do in sports or dentistry.

I guess that means I should be bullish on AI-enhanced quantitative hedge funds, but skeptical of do-it-yourself algorithmic-investing platforms like Quantiacs and Quantopian and Numerai and so forth. And yet I find myself a bit more optimistic about the hobbyists. The point of those platforms is a sort of wisdom-of-crowds/tournament model that can quickly allocate capital to the best smart guy with the best (investing algorithm on his) laptop. Like, if I had to choose between investing with a smart guy with a laptop, and investing with a massive hedge fund that requires five hours of personality tests before hiring anyone, I'd take the hedge fund. But if it's the hedge fund versus the sustained number one performer among a thousand smart guys with a thousand laptops, it's a harder choice.

Meanwhile in big-incumbents news:

Billionaire Paul Tudor Jones dismissed about 15 percent of the workforce in a shakeup at his hedge fund that’s reeling from more than $2 billion in investor withdrawals this year.

 And:

Brevan Howard’s master fund was one of the star performers during the credit crisis, but is now on pace for its third straight calendar year of losses. Investors withdrew more than $3 billion from its flagship fund in the first half of this year.

And in non-performance but still awkward news at the big incumbents:

Federal prosecutors have charged a politically connected “fixer” from Gabon with bribing African officials for mining rights while working as consultant for a joint venture involving a U.S. hedge fund.

The hedge fund, which isn’t named in the complaint, is Och-Ziff Capital Management Group LLC, according to people familiar with the matter.

If you hire a politically connected fixer to help out with your African joint venture, you don't want to get e-mails like this:

“You sistematicaly used corruption in Africa to get the assets you have,” Mr. Mebiame wrote, according to an email cited in the complaint. “I have proofs of what I am stating and several witnesses that also feel cheated by your company are ready to testify. But more than that, I have proofs from several bank transfers linking you directly to the corruption.”

Like, man, pick up the phone, you know?

Oh also the Commodity Futures Trading Commission banned Steven A. Cohen from doing any registered commodities trading until 2018. (He can still, like, buy orange juice and stuff; he just can't "act as an officer or employee" of a registered commodity firm. Here is the notice.) Was he ... doing a lot of commodity trading before? This feels like random me-too-ism. The CFTC's penalty conveniently expires when the Securities and Exchange Commission's penalty expires; on the first day of 2018, Cohen can go back to managing outside money and trading commodities and doing whatever else he wants to do. But at least the CFTC has wagged a very stern finger at him.

Happy IEX week!

IEX will start trading as a public stock exchange on Friday:

Once IEX is up and running, the simple — though IEX argues imperfect — report card for its success will be market share. It now trades about 1.6 per cent of the US stock market daily.

Its share is expected to rise because as a formal exchange, brokers are required to route trades to IEX when it has the best bid or offer at any given time.

Ah, but what is time, anyway? There is this weird narrative that I sometimes hear in which IEX's mission is to fundamentally transform U.S. stock trading, to destroy all the other exchanges, and to end up with 100 percent market share because IEX trades stocks The Right Way and everyone else trades them The Wrong Way. It seems to me that IEX is a trading platform that offers some tools and order types and pricing structures that are useful to some investors some of the time, which is why it currently has a 1.6 percent market share, and why that share will probably go up as it offers more tools (like being a public exchange with a protected quote). And because it provides a service that customers want -- and because it is extremely good at marketing that service -- it makes money. ("We have raised a lot of money and we are profitable," says Chief Executive Officer Brad Katsuyama.) And its basic goal is to make its customers happy and acquire more customers and make more money and expand into new lines of business like listings. 

All of this is very normal and obvious and just like any other business, but people tend to think of IEX as a crusade rather than a business, and so they expect something bigger and different from it. (This is obviously to some extent the fault of IEX's outrageously successful marketing, which has somehow gotten people to believe that equity market microstructure is an important issue in their daily lives.) If IEX doesn't completely transform the U.S. stock market, has it failed? I mean, no, obviously not, not if it's profitable and growing and has satisfied customers. 

Elsewhere, here is a profile of Sophia Lee, IEX's general counsel.

Qatalyst.

Here is a profile of George Boutros and Frank Quattrone of tech mergers-and-acquisitions boutique Qatalyst Partners that suggests that they are widely hated by other M&A bankers, and by many acquirers, for their cutthroat behavior. I read it and my first thought was: "This is going to be great for their business." And my second thought was: "What does that say about the investment banking business, that that was my first thought?" Anyway it's this sort of stuff:

Feints and threats go with the territory in M&A. But tales of Qatalyst’s stratagems are legion. Rivals stew over how Boutros and Quattrone wrestle buyers to the table and finagle lucrative deals. They complain Qatalyst plays bidders off each other, bluffs about prices and buyers’ interest, forces tight deadlines to stunt due diligence -- whatever it takes.

Other investment bankers do the same things, of course. It’s just that few seem as adept at it as Qatalyst.

And:

It’s no wonder then that competitors keep trying to pick the firm apart and discern its methods. One major Wall Street bank has gone as far as to disseminate a 10-page presentation laying out its ability to counteract Qatalyst, people with knowledge of the matter said.

Man, that's how you know you're winning. I am a little skeptical of the importance of reputation in repeat-player games like merger advising. There is just a lot of money involved. Like, if you are running an M&A auction, and you're a jerk and mistreat a buyer, is that buyer really going to walk away? It has invested all this time and money in the process, and the actual transaction -- buying a company -- is so huge and important and transformative that it's not going to let some hurt feelings get in the way. (Though the profile does mention one example, where Silver Lake walked away from Shutterfly after "Qatalyst asked the private equity firm to make a final bid before it had finished conducting due diligence.") And then, what, two years later, when you're running an auction involving the same buyer again, the same considerations will still apply. No one goes to their board of directors and says "we decided not to bid for this amazing merger opportunity because Qatalyst were mean to us two years ago."

So the main impact of reputation is that buyers and rivals say mean things about Qatalyst to other sellers, which, if you are a seller, can seem like a pretty strong recommendation. "Buyers hate Qatalyst because it is tricky and gets high prices for sellers? Sounds great!" The incentives here are ... well, they might encourage a strong sense of fiduciary responsibility. But they might also encourage some unpleasantness.

Auditing.

Taylor, Bean & Whitaker was a big mortgage lender that collapsed in a fraud scandal and brought down Colonial Bank, which had provided it with funding. Taylor Bean's bankruptcy trustee is now suing PricewaterhouseCoopers, Colonial's auditor, for failing to catch the fraud. The trustee wants $5.5 billion. That seems ... a little harsh? PwC was just an auditor; its fees were orders of magnitude less than that. "Try as we might, and we tried mightily … we didn't find it," said the former lead auditor. Still this is awkward:

Not only did the firm assign an intern to vet billions of dollars of transactions, he says, but that intern was supervised by someone who said that such duties were “above his pay grade”. In one 2006 document produced by the plaintiffs, the intern — charged with identifying assets pledged as collateral — reports back that she “feels” the collateral is adequate. 

Don't you feel for her? We all have to start somewhere. Anyone who has worked in a high-stakes professional job, in finance or law or accounting or whatever, has had the experience of being thrown into something that they weren't quite qualified for. It's a great learning experience, the standard training mechanism at a lot of these jobs. You muddle through, take your best guess, rely on precedent and instinct. It almost always works out. Sometimes it doesn't!

Helicopters.

Here is a series of notes (one, two, three, four) from Peter Stella on helicopter money. His central point is that, when most people think of "helicopter money," they mean a permanent fiscal expansion financed by an increase in the money supply -- but that in fact you can get the same effect with a permanent fiscal expansion financed by new government bonds:

Many persons believe that when a sovereign prints money it represents a permanent increase in the liabilities of the state that will never be reversed by increased taxes while when a sovereign prints bonds—which are nothing more than promises to pay printed money in the future—they always and everywhere intend to “redeem” those bonds with printed money obtained through tax increases. Although that characterization of the typical sovereign might have been valid in the years prior to the Second World War, it seems archaic, in its extreme form, today. Sovereign debt is today accepted without second thought as a permanent feature of the financial landscape. In contrast, the days of the “monetary base” appear numbered.

Elsewhere in money, "Meet the Man Who’d Revolutionize Money, From the Inside Out." That's Frank Breitenbach, an advocate of "Vollgeld," a Chicago-Plan-ish full-reserve-banking idea. And here is Joseph Stiglitz: "A split euro is the solution for the single currency."

People are worried about unicorns.

Steven Davidoff Solomon worries that when big tech companies acquire their smaller rivals, that is not always great for competition:

Billions of dollars are made in Silicon Valley by selling nascent upstarts to the giants. And the dominant players pay eagerly to remain dominant.

"Where are the antitrust authorities in all of this," he asks, before answering that they're not all that worried because, you know, the barriers to starting a new photo-sharing website aren't all that high.

This misses the point that domination is all about users and views. Those companies with users and page views can dominate, and accumulating those users is everything, something only an infinitesimally small number of companies can find the key to doing.

It seems like a good ecosystem for mid-tier unicorns, though. You don't have to take on Facebook and win. You just have to take on Facebook and worry it enough to shell out a few billion dollars to buy you, and Facebook is an inveterate worrier. 

Speaking of unicorns and antitrust, here are my Bloomberg Gadfly colleagues Shira Ovide and Rani Molla:

The five global giants of ride-hailing have a tangled web of overlapping investors. At least 11 companies or funds have invested in two or more of the biggest startups: Uber and Lyft in the United States, China's Didi Chuxing, Grab in Southeast Asia and India's Ola.

People are worried about stock buybacks.

There aren't enough of them:

Stock buybacks appear to be slowing down, suggesting either corporate America's outlook has dimmed, stock valuations have become prohibitively high or, most optimistically, that companies are starting to listen to investors and put funds toward other uses.

Buybacks announced for the second quarter's earnings season between July 8 and August 15 totaled an average of $1.8 billion a day, the lowest volume in an earnings season since the summer of 2012, according to TrimTabs Investment Research.

Isn't it fun that those possible explanations are opposites? Like either:

  1. Buybacks were a sign that companies had no good investing opportunities, and are slowing down because companies now have better opportunities to invest and grow; or
  2. Buybacks were a sign that companies were undervalued and expecting strong future growth, and are slowing down because they are now overvalued and not expecting to grow much in the future.

Of course if explanation 1 is right, not only should you be buying stock, but the companies should be too. But they aren't, because they are too busy investing in real stuff.

People are worried about bond market liquidity.

Here's Paolo Saguato with "Fixing the Repo Market : The Piece Regulators Missed When Reforming the Financial Markets," and you know by now that repo worries are a subset of bond market liquidity worries. Elsewhere: "Gilts Become Most Actively Traded Bonds in Europe Since Brexit Vote."

Me yesterday.

I wrote about Edwin Chin, the former Goldman Sachs mortgage bond trader who got in trouble with the Securities and Exchange Commission for making up stories about the prices he paid for bonds. One obvious solution to this problem, which several readers pointed out, would be to require public disclosure of transaction prices for mortgage bonds, the way the U.S. does for stock and corporate bond transactions, and for agency mortgage-backed securities, and might one day require for Treasuries. But private mortgage-backed securities don't have that sort of trade reporting. If Chin had to print his purchases and sales -- even with a delay -- then he wouldn't have been able to deceive customers about the size of his markups. Makes sense to me! But so far the regulatory approach has been after-the-fact punishment rather than more disclosure.

Also, in Money Stuff yesterday, we talked about Neuromama, an ... odd ... $35 billion company whose trading was halted by the SEC on suspicion of shenanigans. I said:

We have talked a few times around here about Sarah Meyohas, the artist who manipulated stock prices for art, to "delineate intention" rather than to deceive anyone or make money. (I mean, from the trading. She painted the stock charts, and made money selling the paintings.) Sometimes I hope there are more artists like her out there, founding and marketing and inflating multibillion-dollar companies not because it is profitable to do that, but because it is beautiful. Or at least funny.

It actually turns out that Meyohas herself traded Neuromama stock, back in January, as part of her art project. Here is the painting. The stock went down. Life is imitating art. When reached for comment by e-mail, Meyohas denied being the mastermind behind Neuromama's $35 billion valuation. (Actually she said: "Mastermind, no ..... Muse, yes!") Anyway, today is your lucky day, if you want to own a piece of the Neuromama saga, because that painting is still available for purchase.

Elsewhere, apparently the SEC was thinking about shutting down trading in Neuromama for two years, but just got around to it this week.

Things happen.

Lloyd Blankfein to young people: "Chill out." Barclays Shrinks, but Says Its Core Business Is Stronger. Can Morgan Stanley Keep ValueAct Happy? What to Watch in the Fed Minutes. What is alpha? MetLife lays out strategy in 'too big to fail' court fight. First Republic: Is It Wrong to Build a Bank for Wealthy Clients Only? Company Punished for Severance Agreements That Removed Financial Incentives for Whistleblowing (earlier). Do Banks Extract Information Rents Through Collateral? Deutsche Bank Staffer Aims for Cupcake Supremacy on British TV. Casino magnate Wynn refuses to back Trump presidential campaign. Obamacare’s in Trouble as Insurers Tire of Losing Money. Ford Promises Fleets of Driverless Cars Within Five Years. The Death of Flair. Kegs, Climbing, Kombucha: This Is Co-Working Now. Treasure hunters dig for mysterious Nazi-era train in Poland. The Forgotten Tale of How America Converted Its 1980 Olympic Village Into a Prison. ‘Marathon sex session’ was just final straw for Olympic diving duo. Facebook Fugitive ‘Alive and Well and Living on the Air.’

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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