Hacienda Hedges and Unicorn Votes
The Hacienda hedge.
Here is a fun Bloomberg Markets story about Mexico's annual oil hedge, where Mexican finance officials go out every year and flood a bunch of banks with orders to hedge the country's oil production. They do a surprisingly good job:
For its part, Mexico has shown a Wall Street-style wizardry in trading oil. It usually makes money on its hedges—sometimes a lot of money, as in 2008-09. From 2001 to 2017, the country made a profit of $2.4 billion; its hedges raked in $14.1 billion in gains and paid out $11.7 billion in fees to banks and brokers.
On the one hand, it is always heartening to see a client make more from Wall Street banks than it pays them in fees. On the other hand ... is it? Mexico is a giant oil producer that has "relied on oil for about a third of its income" in some years. The oil hedges are meant to reduce the volatility of that income:
Hedging is like buying insurance, says Guillermo Ortiz, who was governor of the country’s central bank from 1998 to 2009: "You buy it hoping you won’t need it."
The way you typically think about insurance in daily life is that if you are getting more money from the insurance company than you are paying in premiums, something has gone wrong. You don't want to get your money's worth on term life insurance. Something similar seems to have happened to Mexico. The opening anecdote in the story involves Mexican officials top-ticking the oil market in July 2008, putting on their annual hedge just after oil hit an all-time high. They started that hedging on July 22, when West Texas Intermediate crude was at around $128. They bought puts on 330 million barrels of oil:
Within minutes they began firing off messages to the oil trading desks of Barclays, Goldman Sachs, Morgan Stanley, and Deutsche Bank. Their instructions were to buy “put” options, contracts giving them the right to sell oil at a predetermined future price, at levels ranging from $66.50 to $87 a barrel. The banks receiving the orders had never seen an oil deal this big. The price tag for the options was $1.5 billion.
The puts worked out great. They paid off in December 2009. "Official records tracking the money that landed in Account No. 420127 at state-owned Nacional Financiera bank show the tidy sum Mexico made: $5,084,873,500."
Good work! But "In 2009 oil prices would average less than $55, well below the average price of the options of $70." Mexico's 330 million barrels of puts paid out about $15 per barrel, or $5 billion. But selling oil at $55 per barrel, rather than $128, means that Mexico missed out on $73 per barrel, or $24 billion on 330 million barrels. The hedge was a drop in the barrel, as it were. Wall Street paid Mexico, but Mexico paid the oil market a lot more.
If you started a company, and devoted every waking hour to it for years, and it grew into a big success due to your efforts, and people were clamoring to invest, and you finally agreed to let them invest, and then they came back to you and said "oh by the way we want the right to fire you if we're unhappy for any reason," what would you say? Or: Why would you say yes? What's in it for you? The answer appears to be "nothing," judging by this anecdote about the preparations for Snap Inc.'s initial public offering:
Snap told the dozens of investment bankers at the meeting that it wanted the IPO to include only nonvoting shares, people familiar with the meeting say. No one raised objections or questions about the plan, a sign that the bankers believed few prospective investors would balk.
At a lunch meeting with potential IPO investors in New York in late February, Mr. Spiegel and Snap’s chief financial officer and chief strategy officer were asked mostly about the company’s growth prospects and ability to ward off competition, according to people who went to the meeting.
Yes look this is how it works. If you are an investor, and you don't want companies to issue nonvoting shares, you have to not buy the nonvoting shares. Or at least pipe up about your concerns when you're having lunch with the company. Meekly buying the shares, and then complaining to journalists afterwards, is not an effective substitute.
One simple story to tell here is that globalization and technology have shifted the bargaining power between entrepreneurs and providers of capital. These days, if you want to start a social-media company, you don't need to raise a lot of money from investors to build a factory. You just need a dorm room, and your parents are probably paying for that. And if your social media company is a success, it can go global instantly with near-zero marginal costs. (Yes, I know, this does not exactly describe Snapchat, which is focused on developed economies and which has weirdly enormous costs, but still.) The path to being a gigantic profitable company is paved relatively more with ideas, and less with capital:
Vivek Wadhwa, a distinguished fellow at Carnegie Mellon University’s College of Engineering, says the “winner-take-all” culture in which a few tech companies emerge as hugely profitable from among a far-larger number that fail encourages investors to give tech executives more leeway.
Meanwhile the same forces of globalization and technology mean that there are a lot more people with capital. U.S. tech companies can raise money from China, or the Middle East, rather than limiting themselves to New York and San Francisco. Globalization opens up new markets, which makes good business ideas more valuable, and new sources of capital, which makes those ideas easier to fund.
So winning entrepreneurs are more valuable, while capital is less valuable and less scarce. Of course the bargaining dynamic between the people with ideas and the people with capital has shifted. You'd expect to see some of that playing out in price -- investors paying billions of dollars for unprofitable social-media companies -- but at some level, if you are a young billionaire entrepreneur, you don't really need any more money. You might as well bargain for more power, or more freedom.
One other thing about that Snap IPO meeting. I can't help it, but part of me is a little disappointed in the bankers. Really, none of them complained about the nonvoting stock? When I was a capital-markets banker working on convertible bonds, I would push for standard investor protections even though (1) the company didn't really want them, (2) the company was paying us, and (3) investors wouldn't notice (at least not when they bought the bonds -- they'd notice in a default!). I did that because I thought that the job of the underwriter was to protect the integrity of the capital markets, to be the subject-matter experts who made sure that things worked the way they ought to.
It is tempting to say that underwriters should push back against nonvoting shares, even if investors won't. But it's probably wrong. Giving shareholders voting rights is traditional, but it is not a logical necessity. It's not like the nonvoting shares are a secret. If entrepreneurs want to raise money from investors without giving those investors control, and if the investors want to give the entrepreneurs money without asking for control, why should an investment bank stand in the way? This is generally true for capital-markets gatekeepers; stock-exchange listing standards, for instance, contain lots of corporate governance rules but, in the U.S., do not block companies with dual-class or nonvoting stocks. The gatekeepers help make sure the investors are getting what they want, but they can't make the investors want something else.
In today's stock market, the key gatekeepers might be the index providers, and the fight over nonvoting shares will end up being their problem:
The Council of Institutional Investors, which represents large pension funds and other shareholders, has proposed barring Snap from stock-market indexes such as the S&P 500 because the company’s structure “will undermine the quality and confidence of public shareholders in the market.”
It's an odd role for them. How will they use their power? How should they use it? Should the index be a reflection of the market? Should the index providers give investors what they want? Or should they try to make investors want something better?
What is the equilibrium of all these crowdsourced/do-it-yourself quant trading platforms that I keep reading about? Here's a Wired article about Cloud9Trader and Quantopian and Numerai and Quantiacs:
One model here is that by providing standardized data and algorithm-building tools and capital-introduction services, these platforms will build the next Renaissance Technologies, only in Bangkok instead of East Setauket. Great traders exist, on this theory, and by casting a wide net, you can find them and give them money. The equilibrium is winner-take-all; one or a few algorithms will dominate each platform.
The other model is that these platforms will undermine the advantages that firms like Renaissance have. Market anomalies exist, on this theory, but if you put enough humans and computers up against them, the computers will find them all, and they'll all dissipate. The distributed army of quants will find a lot of trading signals and trade them until they don't work any more, instead of finding a few signals that work forever. The equilibrium is perfect competition; the algorithms will figure everything out until there's no way for anyone -- not even a Quantopian/Numerai/whatever algorithm -- to make outsize returns in the stock market. Obviously neither of these is absolutely true, but the second model strikes me as likely closer to how these platforms will work.
People are worried that people aren't worried enough.
Here you go:
Whether it was the ramifications of Brexit and the U.S. election or even flare-ups of geopolitical turmoil such as this week’s subway blast in Russia that killed several people, very little seems to faze markets these days. That resilience, seen by some as positive, is rightly unnerving to students of market history.
"Nerve is rightly unnerving" would be a good motto for the stock market, or at least for financial journalism.
Index funds and the risk premium.
Here is the always-interesting pseudonymous blogger ("Jesse Livermore") at Philosophical Economics arguing that the rise of efficient index investing should push up stock prices and lower future equity risk premiums:
The takeaway, then, is that as the market develops increasingly cost-effective mechanisms and methodologies for diversifying away the risk in risky investments, the price discounts and excess returns that those investments need to offer, in order to compensate for the costs and risks, comes down. Very few would dispute this point in other economic contexts. Most would agree, for example, that the development of efficient methods of securitization in mortgage lending reduces the cost to lenders of diversifying and therefore provides a basis for reduced borrowing costs for homeowners–that’s its purpose. But when one tries to make the same argument in the context of stocks–that the development of efficient methods to “securitize” them provides a basis for their valuations to increase–people object.
Two broad things that people worry about today are that (1) stock valuations are too high and (2) volatility is too low. The argument that the rise of indexing has (and should have) pushed up valuations directly addresses the first worry. What about the second? Livermore's model is essentially that more efficient diversification makes stock returns -- the returns on the index, anyway -- more bond-like, which should reduce the volatility of the index. And if more investors are indexed, that should also reduce the volatility of individual stocks: You don't have to buy and sell stocks to manage your risks, because you are relying on static diversification to do it for you.
We talk a lot around here about the self-inflicted Wall Street problem of confusing salespeople with fiduciaries: Banks are constantly trying to get customers to treat them as trusted advisers, and then, when they do, and the banks' advice works out terribly for the customers, the banks say "what, we were just arms'-length counterparties, they couldn't have been relying on us for advice." The banks are generally right, in some technical sense, but it is always embarrassing. Anyway here is a story about Navient Corp., the student-loan servicer. "At Navient, our priority is to help each of our 12 million customers successfully manage their loans in a way that works for their individual circumstances," said its chief executive officer (on Medium). But when the Consumer Finance Protection Bureau sued Navient for steering borrowers into forbearance plans that were bad for them, Navient said, nah, just kidding:
Borrowers can’t reasonably rely on America’s largest student loan servicer to counsel them about their many options, Navient said on March 24 in a motion to dismiss the case, because its primary role is, after all, to collect their payments.
“There is no expectation that the servicer will act in the interest of the consumer,” Navient said in response to the litigation filed Jan. 18 by the U.S. Consumer Financial Protection Bureau.
I mean, generically, no, there isn't. But when you keep saying that you will, it does create a little bit of an expectation, no?
Rich Handler and Brian Friedman, respectively the chief executive officer and president of Jefferies Group LLC, really took to heart a story from last year about how Jefferies's parent company Leucadia National Corp. was "No Longer Lovable," and after stewing on it for a year wrote a note to employees and clients with their "Observations On Being 'Unlovable.'" Obviously I want to make fun of this, because investment bank memos about love are the very height of late-capitalist comedy, but it's actually a pretty charming and sensible letter? "It is always OK to be 'unlovable' as long as you don't get a margin call" is good advice for both finance and romance, and this is sweet:
Being “unlovable” is very personal. Whether you are running a company or investing in them, bad results over a period of time can be very unsettling, embarrassing, and humiliating. We are all human beings and for those of us in these positions, we know it is not about the money, power, or glory. It is about pride and not letting the people you care about down. That is why it is so important to have a strong foundation of family and friends that you can always rely on no matter how much you may “stink” lately at work. To family and true friends, regardless of your missteps or failures, you are always “lovable.”
Jefferies, to me, regardless of your missteps or failures, you will always be "lovable."
What's Warren Buffett up to?
Warren Buffett’s face will appear on cans of Cherry Coke in China, an attempt by Coca-Cola Co. to capitalize on its biggest and most famous investor.
The company, which introduced Cherry Coke in the Asian nation on March 10, will offer the Buffett cans for a limited time while supplies last, according to its website. Coca-Cola cited Buffett’s renown in China, where investors have sought to copy his tactics.
Honestly it's a little surprising that Warren Buffett's face isn't on Cherry Coke cans in the U.S. "A Coke is a Coke and no amount of money can get you a better Coke than the one the bum on the corner is drinking," said Andy Warhol, but some amount of money can get you on the Coke.
When Verizon Communications Inc. acquires Yahoo! Inc.'s core internet business and merges it with its AOL business, the combination will be called "Oath," presumably because "Expletive" was a little too on the nose. Actually it seems like it might be called "Oath:," with the colon (though not the comma), to commemorate Yahoo!'s commitment to embarrassing punctuation. They're keeping the exclamation point, but making it smaller and less emphatic. After its next round of mergers -- maybe it'll pick up Twitter? -- they should rename it "Oh."
Here's a story about a Swedish "start-up hub" that "offers to implant its workers and start-up members with microchips the size of grains of rice that function as swipe cards: to open doors, operate printers or buy smoothies with a wave of the hand." "The biggest benefit, I think, is convenience," says the founder.
People are worried about unicorns.
It is not a unicorn, but "Ronco Brands Inc., a gadget maker best known for its late-night commercials peddling the Veg-O-Matic and the Pocket Fisherman," filed to go public this week (at a $110 million valuation), and yes you can get a free rotisserie oven with a qualifying purchase:
Act now, by buying more than $1,000 in shares, and you’ll get a one-time discount of 20% on Ronco.com purchases, the company says on its website. Pony up more than $5,000, and Ronco will kick in one of the countertop rotisserie ovens that account for more than half its revenue.
You could cook a tiny unicorn in there, I suppose. Anyway Ronco also has dual-class stock.
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