Money Stuff

Snapchat, Indexes and Free Research

Also the "personal benefit" test, orderly liquidation authority, foie gras and Travis Kalanick.


Snap Inc., the initial public offering that everyone likes to complain about, is apparently 10 times oversubscribed and may price above the offering range, because that is the way IPOs work. If you are going to buy a lot of shares in the IPO, you might as well complain to the press that the shares are non-voting and that the business is being eaten by Facebook. If you aren't going to buy it, there's no particular reason to talk about it. This is of course how life works too; imagine how much less everyone would be complaining about Donald Trump if he'd lost.

Of course after the IPO starts trading all those buyers might turn into sellers:

Longer-term shareholders could be in for a bumpy ride, said Allison Bennington, partner and general counsel at ValueAct Capital Management, citing the lack of shareholder voting rights.

Investors who don’t hold sway over management decisions have less incentive to keep holding shares that don’t meet performance targets, she said.

I have heard this model before and I find it a little weird. The idea is roughly:

  1. There is a group of investors -- call them "IPO investors" -- who buy hot IPOs just for the first-day pop. They don't care about governance or long-term performance, and are perfectly happy to buy non-voting shares, since they won't hold them long enough to vote anyway. They are pushing up Snap's IPO price.
  2. There is another group of investors -- call them "real investors" -- who buy shares from the IPO investors after the IPO, and who do care about governance and performance and all that stuff. They will be much less jazzed about buying non-voting shares in a money-losing company. They will push down Snap's post-IPO price.

There is an intuitive appeal to that division, but financial markets work by backwards induction. If the real investors won't buy the shares from the IPO investors because of Snap's unusual governance setup, then there won't be a post-IPO pop. If there won't be a post-IPO pop, then the IPO investors shouldn't buy the shares either. These things can't be predicted with perfect certainty, of course, but you can at least assume that the people buying Snap shares just to flip them think that there will be people who want to buy Snap shares at higher prices to hold on to them. (Also: "At least one new investor indicated it was willing to buy a large chunk of the IPO and not sell it for a year, a rare commitment to make.")

This is why I am often skeptical when people complain about companies issuing dual-class or non-voting shares. If you don't like them, don't buy them! If you pay as much for low- or no-vote shares as you would for regular shares, and then complain about them to the press, you are encouraging companies to issue more of them. (All the complaining, followed by an IPO that prices above the range, just draws attention to the fact that investors will buy non-voting shares.) The answer that real investors don't want non-voting shares, but IPO investors ruin it for everyone by buying whatever comes along and flipping it, doesn't really hold up: Who are the IPO investors flipping to?

But there is a third group of investors. Call them "index investors": index funds, and closet-index-tracking mutual funds, and institutional investors who index their holdings. They can complain about non-voting shares, and genuinely dislike non-voting shares, and have to buy them anyway. (And maybe even wait until after the IPO, when the company is actually added to the index.) If most of the real investors actually turn out to be index investors, then the IPO investors' problem is resolved: They can just flip to the indexers.

We talk a lot around here about the real and imagined drawbacks of index funds: They (allegedly) reduce competition, discourage capital investment, limit market efficiency, etc. This might be another evil to lay at their door: Index funds (and quasi-indexers) advocate for good corporate governance, but they have no choice about what to buy. If companies with dual-class and non-voting shares are included in the index, then index funds will buy them. And the more investors who index, the more (grudging) demand there will be for non-voting shares, and the more companies will issue them. 

Should index funds be illegal?

Speaking of which, here's a paper challenging the empirical papers finding that mutual-fund cross-ownership leads to higher prices:

Specifically, the key explanatory variable in this research – the modified HHI (MHHI) – depends on market shares, which depend on the same underlying factors that drive prices. In econometric terms, market shares and the MHHI are endogenous. Because market shares and the MHHI are likely to be related to factors that affect price that are not included as explanatory variables in the regression equations, the regression estimates from the specifications employed are likely to yield a relationship between the MHHI and price. Under plausible conditions and for reasons not related to common ownership, this relationship is positive. That is, an estimate of this relationship could erroneously suggest a positive relationship between price and common ownership when none exists.

The idea that mutual funds who own every company in an industry will push those companies to raise prices and not compete with each other too hard is plausible without being compelling. It might be in the funds' interests for the companies not to compete, but it's hard to find too many cases of funds explicitly calling for that, or managers explicitly adopting that as a policy on behalf of their shareholders. The theory relies on subtle mechanisms -- and on empirical findings that higher cross-ownership goes with higher prices. If those empirical findings are wrong then, well, maybe index funds shouldn't be illegal.

Anti-gay index funds.

The way mutual funds used to work is:

  1. The manager picks some stocks.
  2. He buys the stocks.

But that has fallen out of fashion, because it is "active management." The new way mutual funds work is:

  1. The manager picks some stocks.
  2. He writes them down in a list.
  3. He calls the list an "index."
  4. He buys the stocks.

This is naturally more efficient than the old way. Ugh, fine, I am being sarcastic, but it actually is more efficient than the old way. For one thing, it probably takes more time and effort to change the index, so the manager ends up trading less (and incurring lower trading costs). For another thing, writing down the list allows you to offer the fund as an exchange-traded fund instead of a traditional open-ended fund, which has some tax and trading-efficiency advantages. Still it sometimes seems a little silly that you can just write down a list of whatever stocks you want and say you're an index fund.

Anyway Inspire Investing is offering some "biblically responsible" ETFs based on its own proprietary indexes, which it generates using its "Inspire Impact Score, a proprietary selection methodology that is designed to assign a score to a particular security based on the security’s alignment with biblical values and the positive impact that company has on the world through various environmental, social and governance criterion." Basically that means that it doesn't invest in "companies like Apple, Starbucks and others that 'take a hardline, activist line' on gay rights." The Inspire large-cap index is up 25.3 percent over the last twelve months, according to Bloomberg data, versus 19.5 percent for the S&P 500, I guess because we are in a period that has been unusually favorable to biblical values? I suspect it will remain a niche product. But five years ago it would have been a niche mutual fund with a manager who analyzed companies to decide if they were too gay-friendly. Now it is a niche ETF with a "proprietary selection methodology" to do the same thing.

Free agent analysts.

We've talked a lot recently about the grim economics of the sell-side research business, which is hardly a business at all: Banks give away research for free in the hopes of drumming up trading business, though that will soon change, at least in Europe. The problem is that if you spend decades giving away a product for free, people start to think that its value is zero. This makes it hard for you to one day show up and ask them to pay millions of dollars for it. Awkward conversations ensue.

Speaking of awkward conversations, yesterday very-recently-former CLSA Ltd. analyst Mike Mayo (he was laid off the day before) showed up for JPMorgan Chase & Co.'s investor day presentation, introducing himself as "Mike Mayo, free agent analyst." Of course he did. Mayo is a famous bank analyst and will soon get another job analyzing banks. ("I'm at the top of my game, and I intend to stay in it," he told the Wall Street Journal.) Best to avoid any interruptions in service by continuing to analyze banks while he's on the beach. It's like the media business: He's working for exposure now, but later he'll work for money.

Still I cannot help thinking about the word "free" in the phrase "free agent analyst." If the banks give the research away for free -- and the analysts do their analyzing for free, even when they don't actually have a job -- then what is the incentive for anyone to pay for it? There is a polite regulatory fiction that analysts are supposed to be motivated solely by intellectual honesty and the thrill of analyzing, with no crass commercial considerations to corrupt their conclusions. What if it's ... true? What if analysts like Mayo just love analyzing banks so much that they'd do it even if they weren't being paid to? (Like Mayo is doing!) That would be noble of them, but also bad for their salaries.

Insider trading.

Well the "personal benefit" test was fun while it lasted, but last week a federal appeals court decided that when a golfer tips his golf buddy about an upcoming merger, their golf friendship alone is sufficient to establish a "personal benefit" to the tipper, and thus to create criminal insider trading liability. (The case involved the Watertown golf course that appears to be the world's leading source of insider stock tips.) This is pretty clearly the correct result under basic principles of insider trading law. But it's also the first step toward cutting back the "personal benefit" test to nothing, so that 10 years from now an aggressive prosecutor can decide that, any time a hedge-fund analyst has a polite conversation with an investor-relations employee at a company, it's a crime. 


There are a couple of financial-regulatory controversies that I may just be incapable of understanding, and one of them is the one about Dodd-Frank's Title II "orderly liquidation authority." Title II gives the government powers to resolve large financial institutions with an out-of-bankruptcy restructuring that basically vaporizes their holding companies and recapitalizes their operating subsidiaries using private money. It's a pre-planned, predictable way to wind up failing banks and avoid ad hoc bailouts like we had in 2008. That much I understand. But the controversy is that people think that it somehow makes the banks "too big to fail," or that it institutionalizes government bailouts. A mechanism to allow big banks to fail, using private money, seems to me like a way to prevent bailouts and make banks not too big to fail. But apparently this view is naive. Anyway Ben Bernanke shares it:

The existence of the OLA option does not institutionalize bailouts of failing financial firms. To the contrary, under the OLA all losses are borne by the private sector, not by taxpayers. Indeed, if no OLA were available, it’s more rather than less likely that some future policymakers would conclude that bailouts were the only viable option to protect the economy.

Food stuff.

Here's an interview with a chef who used to work in the executive kitchen at Morgan Stanley:

“We changed our menu every day. It’s like a secret kitchen,” he says, where “the stainless steel shines like no other stainless steel shines.”

The freedom of a flexible menu allowed Johnson to dive into different territory, including cooking with Iberico pork, foie gras, truffles, and whole animals, breaking them down and using each part while focusing on serving anywhere from 30-50 people each meal.

I don't recall ever seeing foie gras and truffles on the menu at the Goldman Sachs cafeteria, but maybe I just wasn't executive enough. Elsewhere in financial food, Singapore's stock exchange may reintroduce a mid-day trading break, which is good news for local restaurants.

People are worried about unicorns.

The recurring unicorn worry these days is Weird Stuff Happening at Uber, and yesterday's weird stuff was this video of chief executive officer Travis Kalanick embarrassing himself in the back seat of an Uber:

On this particular night in early February—Super Bowl Sunday—Kalanick is perched in the middle seat, flanked by two female friends. Maroon 5’s “Don’t Wanna Know” plays, and Kalanick shimmies. He clutches his smartphone as the three make awkward conversation. The two women ask when his birthday is, and marvel that he’s a Leo. One of his companions appears to say, somewhat inaudibly, that she’s heard that Uber is having a hard year. Kalanick retorts, “I make sure every year is a hard year.” He continues, “That’s kind of how I roll. I make sure every year is a hard year. If it’s easy I’m not pushing hard enough.”

I mean look the takeaway from the video is that Kalanick ended up getting in a fight with the driver over Uber's pricing structure. "The criticism we've received is a stark reminder that I must fundamentally change as a leader and grow up," Kalanick wrote after the video came out. "This is the first time I’ve been willing to admit that I need leadership help and I intend to get it." Fine, great. Honestly I didn't even get to the fight with the driver. Kalanick's shimmying, though, will be etched on my brain forever. And the awkward small talk. They actually talk about the weather! They really do "marvel that he's a Leo"! There are long uncomfortable lulls in which everyone listens real hard to Maroon 5. But I guess that's kind of how Kalanick rolls? He makes sure every conversation is an awkward conversation? If it's easy he's not pushing hard enough? Anyway Uber seems like a really fun place.

Elsewhere in unicorns, "T Rowe Price’s flagship small companies fund has revealed annualised returns of nearly 35 per cent from its private investments," which it has a lot of, because private markets are the new public markets.

Things happen.

Inside Harvard’s Radical Plan to Reverse a Decade of Poor Returns. ‘Inverted’ Model Said to Be Considered for NYSE’s Newest Exchange. US regulator casts eye on banks over interest rate risks. The Top Hedge Funds of 2016 Share Their Best Bets for This Year. Fidelity Buyouts Target Older Staff. Citigroup Said to Be in Talks for Saudi Arabia Banking License. Britain's 50-Pound Note May Be Here to Stay, Says BOE Cashier. "Money is probably the most successful story ever told." Izabella Kaminska: "With blockchain, bank cartels become bank alliances." William Cohan on when investment banks went public. My Bloomberg View colleague Noah Smith on a sovereign robot-wealth fund. London Homeowners Are Desperately Slashing Prices. People are burned out at work. The Trump bump for Bentley sales. Man Robs Same Chase Bank Twice in Same Week, NYPD Says. Rescue horse plays piano at Australian farm. Sea Lions Are Disconcertingly Good At Volleyball.

If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Thanks! 

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

    To contact the editor responsible for this story:
    Philip Gray at

    Before it's here, it's on the Bloomberg Terminal.