Good Hedge Funds and Naughty Banks
Renaissance is having a nice run.
Quanty hedge-fund firm Renaissance Technologies "has staged a comeback after an uneven spell," with mid-teens returns and $7 billion of new investor money over the past year. I feel like you see a lot of this these days:
Some traditional stock pickers say unexpected trading patterns caused by the rush into exchange-traded funds make investing harder for those reliant on fundamental strategies, such as buying underpriced stocks. By contrast, Renaissance’s models rely on signals from a range of inputs, including technical factors related to stock-price movements, helping the firm avoid some issues slowing traditional investors, clients say.
“Technical factors are swamping fundamental analysis lately,” helping Renaissance, says Amanda Haynes-Dale, co-founder of Pan Reliance Capital Advisors, which became a Renaissance client this year.
But this vocabulary is starting to sound outdated. In the olden days, there was a clear difference between "technical" analysis (humans looking at charts) and "fundamental" analysis (humans looking at income statements). But the future model is more like: computers looking at everything. It's not like Renaissance's computers are saying "hmm, yes, head and shoulders pattern, time to sell." They are trying to buy underpriced stocks. It's just that they can draw signals of underpricing -- fundamental ratios, historical correlations, trading patterns, order book information, etc. -- from a lot more sources than most humans. The technical/fundamental distinction collapses a bit; the algorithms use correlation-based signals that encapsulate fundamental relationships.
There is a model in which passive and algorithmic investing has driven up correlations in an anomalous way, making investing harder because stocks don't track their fundamentals anymore. Eventually -- somehow -- this will be fixed and the fundamentals will come back. There is another model in which passive and algorithmic investing is just better at teasing out fundamental relationships than humans are. In this model, it seems a bit silly to think that reading a balance sheet is "fundamental" while using a multi-factor model is not -- and it seems possible that the former might never regain its dominance.
One weird aspect of the Wells Fargo fake accounts scandal is that people seem genuinely offended by all the pressure put on Wells Fargo employees to cross-sell three or eight or 20 new banking products each day. Obviously that pressure led several thousand of them to commit fraud, and obviously Wells Fargo did not do a great job of catching that fraud. But you can imagine a hypothetical world in which Wells Fargo worked its employees to the bone to cross-sell accounts, but had really good methods of checking to make sure all the accounts they opened were real. That would still be a brutal environment for the workers, but it wouldn't lead to millions of fake accounts -- and, because the fake accounts didn't bring in much money, it would be much more profitable for Wells Fargo.
People really are offended by Wells's seeming lack of interest in stopping the fraud once it was discovered. (Here's a Vice article about how Carrie Tolstedt, then Wells Fargo's head of regional banking, was informed about fake accounts in 2006, "five years earlier than the bank has said its board first learned of abuses at its branches.") But I get the sense that they're almost more offended by the culture that led to the abuses. Here is a fascinating Planet Money episode on that culture, which really does sound like a miserable sweatshop.
But it's a little strange to find it scandalous that Wells Fargo employees were required to sell a certain number of products each day, or that if they failed to do they were yelled at or fired. It's a sales job! Their economic value to the bank was that they sold banking products. If they didn't sell enough products, they weren't valuable. You can question Wells Fargo's management methods, which sound horrible, but the basic premise -- that it hired salespeople to sell and then expected them to sell -- seems pretty straightforward.
But we have talked about this before. There is an understandable suspicion of salesmanship in the financial industry. Financial products are hard to understand, and the person selling you that product is always sort of thought of as a fiduciary, even if she isn't one in any legal sense. We want her to be a professional, devoted to doing what's best for you, not to meeting a sales quota. And when we find out that her job didn't look like a thoughtful professional job, but instead like a sweatshop, that in itself is troubling.
Anyway, here are some new revelations that "Wells Fargo & Co. managers pushed bankers to sign up customers for potentially costly overdraft protection that they didn’t always need or realize they were getting." Elsewhere, some nuns condemned Wells Fargo. And "Wells Fargo & Co. Chief Operating Officer Tim Sloan expects to make up lost business with state and local government agencies within a few years."
I linked to it briefly yesterday, but now I have read this BuzzFeed/BBC story about the Royal Bank of Scotland's Global Restructuring Group, and I should say it is very long but also quite ... well, I was going to say "good," but I guess the appropriate praise is "bad." As in, this is bad, don't do this!
The bank’s chairman, Sir Philip Hampton, later had to write to the committee to withdraw the executives’ repeated assertion that GRG was “absolutely not a profit centre”, claiming they had made “an honest mistake”. The RBS Files reveal that both Sach and Sullivan were sent regular updates on GRG’s “profit and loss” performance, which itemised revenues from fees, interest rate hikes, and asset acquisitions that far exceeded its costs. Sach, who told MPs that GRG “does not contribute to the bank’s profits at all”, was responsible for signing off internal documents that described the unit as “a major contributor to the Group’s bottom line”.
GRG was where RBS sent its small-and-medium-sized business borrowers when they were bad, to have their loans worked out or restructured or, frequently, called. It tended to generate large fees for the bank, and large problems for the borrowers, and also conflicts of interest insofar as GRG would often push borrowers to sell off properties and then an RBS affiliate would buy them. (The fees, problems and conflicts were the subject of the parliamentary inquiry at which RBS made that "honest mistake" about GRG's profitability.) Also the determination of which borrowers were bad and needed to be sent to GRG was itself a bit conflicted:
Most startlingly, the trigger list reveals that if the customer came up with “any proposed exit strategy” – meaning they told the bank they wanted to take their business elsewhere – they could be pushed into restructuring.
Yeesh. "Following extensive reviews and investigations, we have not seen any evidence that companies were targeted inappropriately for transfer to GRG," says RBS. One important tension here is that, at the time of a lot of the alleged abuses, RBS was in rough shape and a ward of the U.K. state. Getting it back on sound financial footing -- by reducing exposure to risky assets and boosting profits in a way that didn't involve a lot of risk or balance sheet -- was a priority not only for executives but also for the government. (RBS allegedly told staff that the government had "endorsed and agreed" its GRG plans.) In general, the regulatory priority of making banks safer, better capitalized and more profitable is likely to conflict with the regulatory priority of making them customer-friendly and economically useful. Lending, after all, increases risk and balance sheet usage; charging extra dumb fees, in the short run, is free riskless profit. A bank organized around principles of avoiding risk and increasing capital could end up being a very bad bank indeed.
Yesterday I quoted a marketing professor waxing existential about Twitter -- "users are trying to inject some meaning into an experience that remains rather undefined at this point" -- but today we have, I don't know, whatever this is from Jack Dorsey:
We're only limited by our sense of urgency. Life is short. Every day matters. And the people who use Twitter every day deserve our best. They are why we're here. So let's show them what we're made of and deliver a better Twitter faster than they thought possible. We can do this every day. We can do this!
"Life is short. Existence precedes essence. The struggle itself towards the heights is enough to fill a man's heart. One must imagine Sisyphus happy. Let's ship some product." I could write such good motivational memos for Twitter. Anyway this week Twitter is going to be "the people's news network," though probably not in an orthodox Leninist way.
Also it is still talking with Salesforce.com about being acquired, even though Salesforce's shareholders don't want it to buy Twitter, which makes it the most appropriate possible buyer. The only way to really appreciate Twitter is to use it compulsively while also kind of hating it.
Meanwhile what's Facebook up to?
A new office version of the social network, called Workplace, becomes widely available Monday. It’s meant to help employees collaborate with one another on products, listen to their bosses speak on Facebook Live and post updates on their work in the News Feed. Employers will be charged a monthly fee of $3 per employee for the first 1,000 monthly active users, $2 a head from 1,001 to 10,000 users and $1 per worker beyond that, Facebook said in a statement.
Try injecting some meaning into that!
Here is Steven Rattner on the curious fact that markets, investors, businesspeople and economists all seem to oppose the Republican candidate for president. (Rattner is chairman of Willett Advisors, which invests the personal assets and a family foundation tied to Michael Bloomberg, the majority owner of Bloomberg LP.) Rattner attributes this to the fact that Trump's economic policies seem likely to be disastrous, but I think that's not the entire explanation. Western politics these days are seeing an odd realignment, from left/right to cosmopolitan/nativist axes, and businesspeople and investors tend to be educated cosmopolitans who are often uncomfortable with Donald Trump's nativism, authoritarianism, sexism, ignorance, and racially charged campaigning.
The financial industry is particularly cosmopolitan, so it's strange to watch some of Trump's supporters from that industry publicly try to normalize and excuse his boasting about committing sexual assault as just "stupid" or "salacious." (Carl Icahn: "Over the years I've listened to a lot of salacious talk in locker rooms"; Anthony Scaramucci: "I am not a big fan of the super righteous who think they have never said anything stupid"; Robert Mercer: "We are completely indifferent to Mr. Trump’s locker room braggadocio.") We live in a time when boasting about sexual assault might be acceptable to a major U.S. political party -- and perhaps even to the U.S. electorate -- but not to big business and finance. After Scaramucci's SALT conference this year -- which was sort of an unofficial fundraiser for Trump's campaign, and which featured T. Boone Pickens echoing Trump's call to ban Muslims from entering the U.S. and Karl Rove joking about slavery -- Mary Childs wrote that "as large investors increasingly reward fund companies that show a commitment to diversity, there is a financial incentive to avoid inflammatory and insensitive comments in public." I wonder how popular SALT will be next year.
Elsewhere, Andrew Ross Sorkin notes that many businesses have workplace-conduct rules under which "it is not clear if Mr. Trump would qualify to be hired as a janitor, let alone a senior executive." A Cowen & Co. analyst wrote: "We disagree with many in Washington who describe Trump’s presidential campaign as the electoral equivalent of a dumpster fire because a dumpster fire—by definition—is contained." Warren Buffett seems to pay a lot more in taxes, and give a lot more to charity, than Trump. Carl Icahn closed the Trump Taj Mahal casino yesterday. And "the former lead singer of the band Blink 182 was in recent contact with Hillary Clinton‘s campaign chairman John Podesta about UFOs, newly disclosed emails show."
Blockchain blockchain blockchain.
Izabella Kaminska points out that the economics Nobel Prize awarded to Oliver Hart and Bengt Holmström yesterday for their work on contract theory has some potential implications for "the current hysterical blockchain climate — a climate epitomized by the notion that everyone from central bankers to lawyers will soon be dis-intermediated because of smart-contracts on blockchains." A basic insight of contract theory is that contracts are incomplete: It is costly or impossible, to spell out every possible state of the future, so contracts in the real world always leave some outcomes unspecified, leaving them to be decided later by one party or the other (or a court, or by fiduciary duties, etc.). Judging by the delightfully existential DAO hack, that insight is not fully incorporated in the smart contract world, and if I were a blockchain futurist, I'd be spending a lot of my time thinking about incomplete smart contracts.
People are worried about unicorns.
For a long time, one of the biggest mysteries in the tale of Theranos, the Blood Unicorn (Elasmotherium haimatos), was why no investors had sued it. I mean. You have a company that sold hundreds of millions of dollars worth of stock at a $9 billion valuation, with overwhelmingly positive press about its ability to do lots of medical tests based on a finger-prick blood draw, its state-of-the-art labs and its impressive partnerships with established players. That all turned out to be ... wrong? It disavowed the tests, shut down the labs and lost the partnerships. If you invested at the peak, wouldn't you be mad? And yet no one sued. Were they true believers in Chief Executive Officer Elizabeth Holmes? Did the company always fully and fairly explain its situation and risks to investors, who now have no cause for complaint, even though the media and general public thought for a long time that Theranos was doing a lot better than it actually does? Or were they just too embarrassed even to think about their Theranos investments?
Anyway that streak is over:
One of Theranos Inc.’s biggest financial backers has sued the embattled startup and its founder for allegedly lying to attract its nearly $100 million investment, according to a fund document and people familiar with the matter.
Partner Fund Management LP, a San Francisco-based hedge fund, filed the suit in Delaware Court of Chancery Monday afternoon, a letter to the hedge-fund’s investors says.
"A spokesman for Theranos said 'the suit is without merit and Theranos will fight it vigorously,'" and I am certainly looking forward to that!
People are worried about stock buybacks.
We present evidence that pressure to maximize short-term stock prices and earnings leads banks to increase risk. We start by showing that banks increase risk when they transition from private to public ownership through a public listing or an acquisition. ... We establish that pressure to maximize short-term stock prices helps to explain these findings by showing that the increase in risk is larger for newly public banks that are more focused on short-term stock prices and performance.
This does not exactly fit with the normal "short-term-ism" worrying, which is that, as the authors say, "the stock market induces firms to take less risk because long-term risky projects like R&D lower short-run profitability." (So firms instead buy back stock.) "But in banking," they say, "the easiest way to increase short-run profitability is to take more risk," with lower lending standards or more short-term funding.
Here's how they measure that "the increase in risk is larger for newly public banks that are more focused on short-term stock prices and performance":
To establish the relevance of short-termism, we show first that our risk measures increase more if the bank has a smaller board, fewer insider board members, and better governance according to the measure developed by Gompers, Ishii and Metrick (2003). Thus, the more banks are focused on the stock price, the more risk they take. Second, we find a greater increase in risk for banks owned by institutional investors that turn over their shares more rapidly and by CEOs that trade more actively in the bank’s stock. ... Third, we document that the increase in risk is larger for banks that mention the phrase “short-term” more frequently in their quarterly earnings calls, behavior that has elsewhere been shown to be associated with a focus on short-term earnings management.
That last one is just amusing -- companies that say "short-term" more are focused more on the short term! -- but the first two suggest that measures of good governance and active institutional ownership make a company more focused on the short term. If you want a long-term focus, what you need is entrenched management and supine shareholders.
People are worried about bond market liquidity.
Here's Robin Wigglesworth on the fight over post-trade Treasury reporting, in which banks worry that public disclosure of Treasury trades will be bad for liquidity (because it will tip off the market to the banks' positions and make it harder for them to sell bonds that they've bought), but high-frequency trading firms say that it will be good for liquidity (because it will make the state of the market more visible and allow electronic market makers to make better informed markets). One way to think about it is: Do you want (and can you get) a continuous market, or a chunky one? If your model of the Treasury market is that I sell one bond at 100.05, and then a second later I sell another bond at 100.04, and then a second later a third at 100.03, moving small lots in small price increments over small time increments, then immediate public post-trade disclosure is good: Everyone knows, every second, what the price is, and can make informed trading decisions. If your model is that the last trade was at 100.10, and then I sell a billion bonds at 100.05, then you can see why the dealer who bought those bonds from me doesn't want it to get out that he owns them until he can discreetly move them into the market. High-frequency traders are of course far more continuous than old-school bank traders -- they move faster, and in smaller lots -- so they are naturally more pro-transparency.
Elsewhere: "The market retains that Jekyll and Hyde characteristic, so it’s important to remain aware of that as investors."
Lael Brainard profile. Dueling Payday-Lending Campaigns Deluge CFPB With Comments. Deutsche Bank's Borrowing Premium Doubles From 2015 in Bond Sale. The American Fugitive From the JPMorgan Hack Turns Up in a Russian Cell. Ex-Credit Suisse Banker Wins Dismissal of Rogue Trader Charges. Mean reversion. Online Lending Looks a Little Less Mom and Pop. Samsung to Kill Off Note 7 After Second Round of Battery Fires. Herbalife’s New Ackman Attack: Buy Movie Tickets. "The work of 1985 laureate Franco Modigliani included a highly influential life-cycle savings model, and I recall hearing that Professor Modigliani won by pointing out that people need to save for old age." "It is not a puzzle that informed traders trade and make money. The deep puzzle is why the uninformed trade, when they could do better by indexing." "Better A restaurants use nondisclosure as a countersignal, while worse As and better Bs use disclosure to stand out from the other restaurants." "A millennial librarian who understands cultural cues, and can wink at things." Library apartments. Uses for spreadsheets. Go ahead and curse at work.
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