Hedge-Fund Losses and Boutique Hires

Also governance, the peso, covered interest parity and lots of unicorn news.

How's Bill Ackman doing?

Great, glad you asked, at least by one metric:

He is on pace to record a hefty double-digit loss for investors in his firm, Pershing Square Capital Management, for the second year in a row.

It is a rare accomplishment in hedge funds ...

Okay stop: It is, right? Certainly it is more impressive than recording a hefty double-digit gain for the second year in a row. That happens all the time; anyone can do that. (Ackman himself has done it a bunch of times.) If you run a hedge fund, and you make a lot of money for your investors, they stick around, and you get a chance to do it again. But deep down, you question yourself, your strategy, your relationships. What if the gains were luck? What if those investors don't really care about you; what if they will abandon you at the first sign of trouble? What if they love you only for the money that you're making them, not for yourself? There is only one way to know for sure.

Ackman knows for sure! He has tested his investors' love, and they have passed the test in the most gratifying fashion:

“He didn’t become stupid overnight,” said Mark Baak, a director at Privium, an Amsterdam-based investment firm that manages about $1.4 billion. “His prevailing track record wasn’t luck. Even if he was overrated prior to Valeant, he is still a very good investor.”

To be fair, it is a test of structure as well as love: Pershing Square locks investors up for as long as two years, and has a public permanent-capital vehicle, so even if investor interest flags (and "investors have either withdrawn or announced plans to redeem more than $1 billion" in the last two years), the fund can be relatively stable. 

This sounds like I'm being sarcastic. I am being sarcastic. But I mean it, too. Ackman's success in retaining investors after two big embarrassing down years is proof of his exceptional skills as a hedge fund manager. The only way you can do that is if you have done a lot of things right. You need to have a good structure that matches your investors' capital commitments to your time horizons. You need to have a good track record, so investors believe you can turn it around. You need to have a convincing explanation of your process and strategy and research, so investors believe that you will turn it around, that your current failures -- rather than your past successes -- are the fluke. Your marketing and investor-relations efforts need to be consistently excellent, so that investors' primary feeling is one of loyalty, not anger. You have to ace every aspect of managing a hedge fund.

Except for the one. The one about making money. But that one might be overrated.

You sometimes hear a belief on Wall Street that losing a lot of money is a badge of honor and a proof of competence. It means you were good enough that someone trusted you with that much money, and confident enough to take a lot of risk with that money. Sure you lost it, but what are the odds of that happening twice? What about three times? 

Little banks.

We talked yesterday about the prospects for the rise of a new breed of non-bank investment banks to compete with the current crowd of large heavily regulated universal banks. The new competitors have some advantages. For instance, if you actually want to be an investment banker -- if you are motivated by the idea of being a trusted adviser to corporate clients as they consider big financial decisions -- then you might enjoy working at an advisory boutique. You get to do the investment banking, but without the distraction of being surrounded by bond traders who get paid more and might blow up the firm.

This turns out to be very attractive to a certain type of investment banker, specifically, the ones who worked at Goldman Sachs Group Inc. and who are descended from Sidney J. Weinberg, who "rose from a spittoon cleaner at the firm in the early 1900s to the chief executive who made the bank one of the most powerful on Wall Street." I mean, it's attractive to lots of people, but Weinberg scion Peter Weinberg is a former Goldman partner who co-founded Perella Weinberg Partners, and now John S. Weinberg, who retired from Goldman last year as a vice chairman, is joining Evercore Partners as chairman:

“I am excited because this is an organization that has done an extraordinary job of focusing on clients,” Mr. Weinberg said in a telephone interview.

Mr. Altman added: “We take a very long-term point of view with clients. I don’t know a single banker over my years who better epitomizes that ethos — who isn’t at Evercore — than John.”

The Weinbergs are sort of the mascots of Goldman's notion of itself as a family business, an up-from-the-spittoons place that focuses on the long term and rewards patience and loyalty to clients. And now they are flocking to boutiques.

On the other hand, here's a story about Goldman's continued belief that "being close to the client, staying in touch with the boardroom is what differentiates us." And here is a charming interview with Brad Eichler, the head of investment banking at Stephens Inc., "a family-owned firm in Little Rock, Arkansas":

We try to put ourselves in our client’s shoes and say, “Hey. If this were my business, this is a deal that I would do,” or even more importantly, “This is a deal that I would not do.”

The other big business that the universal banks are in, and that a non-bank could compete with, is sales and trading. That is a more capital-intensive business than boutique investment banking, which really just requires a phone and Excel, but there are competitors. For instance, Citadel is looking into becoming a Treasury primary dealer:

Citadel Securities has capitalised on the pullback of big banks, and a shift towards electronic trading, to establish itself as a major player in the largest government bond market in the world.

Do you think that eventually a Citadel-type trading firm will combine with an Evercore-type banking firm to form a generalist investment bank that is not a regulated bank?


We get alleged-foreign-corrupt-practices stories here in Money Stuff from time to time. Here's a fairly typical one, about how "a mining company run by Glencore PLC in the Democratic Republic of Congo made millions of dollars in undisclosed payments to a company owned by an Israeli businessman accused by U.S. authorities of paying more than $100 million in bribes to Congolese officials." Everyone denies any wrongdoing.

The way a lot of these alleged schemes work -- maybe not the one here -- is that a big company wants to invest in a project in a country that takes let us say a lax view of corruption enforcement. The big company hires a locally connected consultant, who arranges a joint venture between the big company and a local firm that is owned by a nephew of the country's president. The local firm gets a share of the joint venture's profits for its expertise, or for consulting work, or for some other vaguely legitimate-sounding purpose. And then the government gives the joint venture approvals, or mining concessions, or whatever, that it might not have gotten without the involvement of the nephew. But nothing is exactly easy to prove; there are no bags of cash labeled "bribe." Who knows, maybe the president's nephew really performed valuable consulting work and is getting a fair share of the profits.

Elsewhere, here is Matt O'Brien on Donald Trump's refusal to put his business interests into a blind trust and his decision to instead let them be run by his children, who will also serve as informal advisers to his presidency:

Alan Garten, the Trump Organization's general counsel, has offered a defense of what in modern times are these unprecedented conflicts of interest: that they're plenty precedented in other countries. “It's not unusual,” he told the Wall Street Journal, “for people around the world successful in a business to play a role in government.” And he's right. There are a lot of places where this is endemic.

Take Ukraine. For a quarter century, it has been passed back and forth between oligarchs who have treated it like their own personal piggy bank. 

Elsewhere in the U.S. president-elect's business ventures, "the Trump Place apartment complex on Manhattan’s Upper West Side is about to drop the president-elect’s name after an outcry by residents."

Elsewhere in governance, here is Narayana Kocherlakota at Bloomberg View on "How Trump Could Spell Trouble for the Fed." And: "The Next Great Debate at the Fed Will Be All About the 'Monetary Offset.'" And: "Trump Allies Urge Fed to Shrink Balance Sheet as Debt Wall Looms." Here are Ray Dalio's "Reflections on the Trump Presidency, One Week after the Election." Here is Alexandra Scaggs on "Trust, Treasuries and Trump." And here is Bill Gross on Trump:

Not having voted for either establishment party's candidate, I write in amazed, almost amused bewilderment at what American voters have done to themselves.

What is the peso?

The peso is the currency of Mexico, which you can use to buy goods and services in Mexico, or Mexican government bonds for that matter. But it is also a proxy for a whole set of beliefs about the world -- last week, that Donald Trump would be elected president; this week, that he will implement trade policies that will be bad for Mexico; and more generally, that commodity prices will fall or Chinese growth will slow or Venezuela will default or whatever else you've got:

“The peso used to only be a proxy hedge for emerging markets,” says Eduardo Suárez, a strategist at Bank of Nova Scotia in Mexico City. “Now it’s a hedge for everything.”

The peso is the second-most liquid emerging-market currency, trades 24 hours a day, and is increasingly correlated to many other asset classes. So if you want to hedge a bet on some other emerging market, shorting the peso is a natural thing to do. This is annoying for Mexico, and its central bank. Like the dollar, the peso has a role in the global financial system that is separate from its role as a national currency, and that can move prices in non-fundamental ways. Unlike the dollar, though, that role is not especially stabilizing. "It becomes a problem," says an analyst, "when the currency is trapped by that volatility and you’re forced to increase interest rates."

People are worried about covered interest parity.

Here is an important new paper from Stefan Avdjiev, Wenxin Du, Catherine Koch and Hyun Song Shin on "The dollar, bank leverage and the deviation from covered interest parity." The basic story is that when the dollar is stronger, banks lend fewer dollars to international borrowers, and the textbook covered-interest-parity relationship between dollar interest rates, foreign interest rates, and foreign-exchange swap rates breaks down. The deeper story is about bank leverage capacity as the main limit on arbitrage in the financial system, and about the relationship between leverage and the dollar:

The key message of our paper is that the value of the dollar plays the role of a barometer of risk-taking capacity in capital markets. In particular, it is the spot exchange rate of the dollar which plays a crucial role. Deviations from CIP turn on the strength of the dollar; when the dollar strengthens, the deviation from CIP becomes larger. To the extent that CIP deviations turn on the constraints on bank leverage, our results suggest that the strength of the dollar is a key determinant of bank leverage.

"The stronger dollar makes global financial intermediation more expensive" is Tyler Cowen's summary. Here is Izabella Kaminska: "The global hard currency shortage — which let’s face it amounts to a global dollar shortage — stands to become the most significant destabilising force in recent times and the most unanticipated global tail-risk."

People are worried about unicorns.

Okay here is an interview with Tim Draper, one of the leading backers of Theranos, who claims that Chief Executive Officer Elizabeth Holmes is the real victim in Theranos's collapse. Others disagree, but never mind that, look at this:

"People don't want vampires taking gallons of their blood every time they get tested. There is a great opportunity to do a finger-prick blood test, and I think it's fabulous what they've done," he said.

Wait, what? What kind of blood-testing experience has he had? Is that why he invested in Theranos? Holmes came in to pitch, and she said "we can test your blood with just a single finger prick," and he was like "finally! Every time I need my blood tested, I have to go to a spooky castle where an immortal Transylvanian man in a cape bites me in the neck, drinks gallons of my blood, and leaves me exsanguinated, near death and dreaming about bats. Plus he takes forever getting back to me with my test results. A finger prick sounds great, I don't need any more due diligence." Gallons of blood! It's almost like Theranos's investors were not leading biotech experts. Elsewhere: "Walgreens Claims Theranos Voided 11.3% of Test Reports."

In other accursèd-unicorn news, "China's Tech Unicorns Look Increasingly Cursed," as investors in Chinese tech companies are worried about their own bubble that may prove unsustainable if their unicorns go public:

But even as the tech universe's center of gravity seems to be shifting toward Beijing, there's growing skepticism within China about how valid some of the sky-high valuations are. In hotel conference ballrooms and over steaming hot pot dinners, investors and analysts are whispering doubts about startups' ability to maintain such lofty numbers when they try to raise future funding or go public. 

In Canada, though, the unicorn news is chiller: "Canopy Growth becomes Canada's first marijuana unicorn, worth $1 billion." Technically Canopy Growth Corp. is a public company and has been listed on the Toronto Stock Exchange for months, but I am going to allow it because there really ought to be a weed unicorn, anyway. Better than a cursed unicorn, or a vampire unicorn, or the Enchanted Forest's various other supernatural downers.

Finally, the happiest unicorn news: Snap Inc., formerly Snapchat, "has confidentially filed paperwork for an initial public offering that may value the popular messaging platform at as much as $25 billion." "That could provide a boost for the IPO market, which has had a dismal year."

People are worried about stock buybacks.

One objection to stock buybacks is that they are bad for companies, which waste money on their own shares instead of investing in research and development or whatever. But another objection is that they are bad for markets, because they are a form of price manipulation. (In fact, some buyback worriers point out that corporate stock buybacks used to be treated as market manipulation, and argue that they should be treated that way again.) But "price manipulation" is a slippery thing. Any time you buy a lot of stock, you expect your buying to increase the price: Were you buying it because you thought it was undervalued, or because you wanted to make it overvalued? It is hard for an outside observer to know what the right price is, so it's hard to know if your buying is making the price more right (efficiency) or more wrong (manipulation). But Stefan Obernberger and Pascal Busch think they can tell; here are a blog post and related article finding "that share repurchases make prices more efficient":

We find that share repurchases unequivocally decrease the delay with which prices respond to new market-wide information. Further analysis reveals that share repurchases decrease the idiosyncratic risk in stock prices. Therefore, the evidence is not consistent with the notion that share repurchases increase the noise in stock returns as indicated by many commentators. 

People are worried about bond market liquidity.

Federal Reserve Vice Chairman Stanley Fischer spoke at the Brookings Institution "Do We Have a Liquidity Problem Post-Crisis" conference yesterday and gave what I would say is the mainstream governmental view of bond market liquidity, which is: (1) All the evidence points to liquidity being fine, (2) but I know you are worried, (3) but in any case the post-crisis regulations that may have reduced liquidity are not going anywhere, because they have made the overall system safer. "Regulatory changes, even those that may have reduced market liquidity, likely have enhanced financial stability on balance," argues Fischer. 

Elsewhere: "SEC’s White ‘deeply concerned’ about bond market illiquidity."

Airline hotline short fiction!

We talked yesterday about Warren Buffett's claim that he had set up a hotline to call if he was ever tempted to buy airline stocks, and I said that "I would read a short story about Buffett's anti-airline hotline counsellor." You can probably guess what happened next. Here is "13 Years," by Brandon Lawrence. I have mentioned before that I am working on a literary review that will specialize in publishing dystopian fiction about investment management, and this story will fit right in.

Things happen.

Wall Street’s Decade-Long Firing Spree Is Seen Winding Down. Michael Lewis on Danny Kahneman and Amos Tversky. SEC Approves Plan to Create Consolidated Audit Trail. Bank of America Trading Benefits From Trump’s Election Surprise. Firms Flee Mortgage-Backed Bond Business. Court documents allege clashes inside RBS over 2008 toxic assets. SEC Charges Executive With Fraud in HP Acquisition. What's Tommy Belesis up to? Trump’s Effort to Gut Dodd-Frank Law May Spare Whistle-Blowers. TransPerfect Is Threatened by Owners’ Petulance. Fake Content Puts Pressure on Facebook, Google. Twitter Rolls Out New And Long-Awaited Anti-Harassment Tools. Here’s a Chrome Extension That Will Flag Fake-News Sites for You. Wal-Mart Tells Workers: Don’t Download Labor Group’s Chat App. A $900 Billion Oil Treasure Lies Beneath West Texas Desert. Obamacare Startup Oscar Has $45 Million Loss in Three States. Teaching an Algorithm to Understand Right and Wrong. Meet Miles, BP's chatty interactive gas pump aimed at millennials. The most relaxing song in the world. The Love Song of Jeremy the Left-Coiled Snail. Original Space Jam Director Says No Current NBA Star Is Famous Enough to Be in a Reboot. 

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