Cat Funds and Cooking IPOs
For science, Bloomberg's Dani Burger built an index of companies with "cat" in their names, found that it was up 849,751 percent in a backtest, and shopped the idea to various quants, who gamely made fun of it. Cliff Asness:
“Everything you can sort on can be a factor, but not all factors are interesting. Factors need some economics, theory or intuition even, to be at all interesting to us. Thus the cat factor fails as we have no story for why it should matter at all,” Asness said. “Now, in contrast, we are active traders of the dog and parakeet factors, which are based on hard neo-classical economics married to behavioral finance and machine learning. But the cat factor is just silly.”
"Seems like the tail risks here might be a little high," concludes Burger, a kicker that also backtested extremely well. One real lesson here is that a lot of factor outperformance comes from equal-weighting of teeny stocks. The cat index got most of its outperformance from "the basically untradeable Catskill Litigation Trust, which gained 79,000 percent this year (to trade at one penny)." We talked recently about a paper finding that most efficient-market-hypothesis anomalies seem not to replicate: Many anomalies come from equal-weighting microcap stocks, which allow researchers to find anomalies in data but do not allow actual investors to find actual profits in actual stock trading.
Another lesson is the one about economic intuition. Here's an objection from Goldman Sachs Asset Management:
"It’s very curious, and I appreciate the effort,” said Nicholas Chan, portfolio manager in the firm’s Quantitative Investment Strategies group. “But you came up with an investment idea that doesn’t have economic intuition. When we come up with an investment hypotheses, we’re economists first and statisticians second.”
A lot of people -- including Asness -- tell Burger the same thing, and it is absolutely canonical and sensible. But I wonder if it will seem quaint to the next investing generation, one more reliant on artificial intelligence and machine learning than on economic intuition. There's a great Wired story about AlphaGo, the AI machine that programmers taught to play Go, and how it came up with its counterintuitive but decisive move 37 in its match against Go champion Lee Sedol:
AlphaGo knew—to the extent that it could “know” anything—that the move was a long shot. “It knew that this was a move that professionals would not choose, and yet, as it started to search deeper and deeper, it was able to override that initial guide,” Silver says. AlphaGo had, in a sense, started to think on its own. It was making decisions based not on a set of rules its creators had encoded in its digital DNA but on algorithms it had taught itself. “It really discovered this for itself, through its own process of introspection and analysis.”
AlphaGo's programmers taught it Go intuition, but then it developed its own Go intuition that surpassed their own, and it went and found moves for which there was no (human) Go intuition -- and it won. "We're artificial intelligence programmers first and Go experts second," AlphaGo's programmers might as well have said. The scientific process, not the subject-matter expertise, dominated.
The first stage in investing was that people had economic intuitions and acted on them: "This company seems good, so I'll buy it." Later still, they had economic intuitions, and programmed computers to act on them: "Companies with low valuations are cheap, so I'll have a computer look for them and buy them." The next phase is for the computers to have the intuitions, and act on them, in ways that the humans can understand: "The computer has found a parakeet factor that predicts outperformance, and I can sort of understand the neoclassical and behavioral foundations for the parakeet factor, so I'm letting the computer run with it." But one can imagine a final phase in which the computers have intuitions that are not explicable in human-intuitive ways: "The computer is buying cat stocks. I don't get it. But the computer has a pretty good track record so whatever."
Elsewhere, Jeff Tarrant of Protégé Partners is betting on AI:
“Jeff Bezos picked off the bookstore business. Apple totally picked off the music business and Netflix totally changed television. Now [machine learning] is going to pick off the hedge funds.”
To back up that theory, he is launching a business that will invest solely in start-up investment funds that employ artificial intelligence. Protégé’s new business, dubbed Mov37, will invest in as many as 10 managers through either seeding them or investing directly, and is targeting total investments of up to $1bn.
I wonder if it's named after AlphaGo's move 37. And still elsewhere: "Bots Won’t Just Help Us Buy Stuff. They’ll Help Us Become Better Versions of Ourselves."
Blue Apron IPO.
Meal-kit-delivery service and universal podcast sponsor Blue Apron Holdings, Inc., filed to go public yesterday, with net losses of about $55 million in 2016 and $52 million in the first quarter of 2017. I have a general mental model of the modern financial ecosystem in which companies basically fund their development and expansion with the limitless money available in private markets and then, once they are mature businesses, they go public to make it easier to return money to shareholders. But that model is not universally applicable, and some of the big recent initial public offerings -- Blue Apron, and Snap Inc. before it -- seem to have the more traditional purpose of actually raising money. Blue Apron, at least, seems like it could use the cash.
Also like Snap, Blue Apron is going public with a class of nonvoting stock, though unlike Snap it's selling voting stock in the IPO:
Going public does not mean that Blue Apron’s management is intent on giving up control of the company. The start-up will have three classes of stock: Class A shares that will be sold to the public and will carry one vote per share; Class B shares, which the founders and early investors own, which carry 10 votes per share; and Class C shares, which come with no voting rights and will be used for purposes like acquisitions.
That's the same structure as Facebook Inc. and Alphabet Inc., both of which went public with two classes and added zero-vote stock for acquisitions later. But now that the technology exists, why wouldn't a hot technology company build it in at the time of its IPO? And why wouldn't a hot grocery company that wants to be a technology company build it in at the time of its IPO? Given the more or less complete absence of pushback to Snap's decision to go public with nonvoting stock, it would be a little strange for anyone to go public with a simple one-share-one-vote structure. I mean, there will eventually be a backlash: Shareholders will eventually be deeply disappointed in some ex-unicorn, and realize that they're powerless to change things there, and take out their frustration on the next IPOing unicorn. But until that happens, if you are a founder thinking about going public, why wouldn't you take the opportunity to keep control?
Elsewhere, here is a story about the first Regulation A+ offering that will lead to a listing on the New York Stock Exchange. Well, the NYSE MKT exchange -- NYSE's small-cap exchange -- but still. It's a medical robotics company, Myomo Inc., and it sounds charming, though the overall Regulation A+ world is a little scruffy:
Proponents of the new rules, known as Regulation A+, appear to be “willing to risk a little more fraud if the dollar risk is less,” said David Feldman, an attorney who has championed the rule and is providing legal guidance for several offerings.
Instead of buying a cryptocurrency and keeping those funds on an exchange (or holding the keys in an offline wallet), users put a dollar amount, invest it in "bitcoin", "ether" and "monero" and select the exposure they would like the "portfolio" to have relative to the price fluctuations of each asset.
In this case, there is no bitcoin or monero, only ether in a smart contract that changes its value based on data fed to an oracle that receives its prices from traditional exchanges.
The company offering this -- a Swiss startup called ShapeShift -- will initially be the counterparty to all trades, and will hedge by buying the underlying bitcoins or whatever. (Also it will charge 1 percent per month and 2.4 percent to close out.) Financial derivatives are an obvious early use case for smart contracts: They don't require any action in the real world, just exchanges of cash flows (or cryptocurrency flows), so the whole thing can just happen on the blockchain. On the other hand they are not exactly the most inspiring or world-changing use case. If the upshot of blockchain-based smart contracting platforms is that you can ... buy bitcoins synthetically? ... then that's not that impressive. You could just buy bitcoins directly, on their own blockchain.
Elsewhere here is Izabella Kaminska on blockchain Ponzi schemes and initial coin offerings.
Hamilton Nolan went to the Skybridge Alternatives Conference for some reason, and found it bad, though not as bad as you might have expected him to? The best thing about SALT, it seems to me, is that you don't have to go to SALT, so I don't. But Nolan did, and while the title of his article at Deadspin is "Hell Is Empty And All the Hedge Fund Managers Are At The Bellagio," he seems to have been at least a little bit seduced. For instance, he seems oddly charmed by SALT impresario Anthony Scaramucci, whom he calls "the schmooziest man in the hedge fund world," but who he also thinks is sincere in his concern about wealth inequality. Also he came back from SALT with some investment recommendations for Deadspin readers:
One nifty feature of Wall Street is that unlike in politics or entertainment, where the incentive is for the principals to lie to you for their own gain, the incentive in the investment world is to (more or less) tell the truth for their own gain. By this, I mean that a parade of prominent hedge fund managers will sit on stage loudly lecturing you on what their best investment ideas are, and those ideas are true (more or less), because the more people they can convince to agree with them, the better their investments will perform. For an industry that is built on a foundation of bilking less-savvy people out of their money with outrageous management fees, this is a remarkable dynamic.
You cannot afford to invest in any of these hedge funds. But these people were happy to sit on stage for three days and expound on their biggest bets and convictions about business and economic trends to an audience of their competitors. Do you want to know what the world’s most high-priced investment talent is betting on now? Here, I can tell you:
And he does.
If you work at an investment bank, and your parents are a little disappointed in you, consider printing out this article for them:
I’m a doctor for the National Health Service (NHS) in the UK. I studied medicine at a top school and always wanted to be a medic. Four years into my career I’ve had enough. I think I’ll be of more use to patients working for a healthcare team in an investment bank than as a doctor in a hospital.
Maybe it's best if they stop there, though; the rest of it gets a little weird:
I have my own vision of what a good healthcare system should look like. Built around wearable tech, it should stream live meta data to a cloud-based machine learning system which can detect aberrant patterns.
On the other hand: "Dirty, Dingy Hospitals: Doctors Blame Debt-Fueled Takeovers." I guess it takes all kinds; some bankers make health care better, others make it worse.
Goldman is cool now.
Goldman Sachs Group Inc. Chief Executive Officer Lloyd Blankfein is on Twitter now, moved to tweet by Donald Trump's decision to withdraw from the Paris Agreement on climate change. (Like many CEOs, he's against the withdrawal.) Disclosure: I used to work at Goldman, and as of 8 a.m. this morning I have more Twitter followers than Blankfein, so please do not follow him as I would like to keep it that way.
In other news about Goldman and my strange internet life, yesterday I suggested that the logo for Goldman's Marcus consumer lending business "really should be a sepia-toned portrait of its 19th-century namesake, but with a nose ring. And maybe some equations scrawled on him." And so two readers sent me illustrations of that. Here's one from Rob Terrin on Twitter:
People are worried that people aren't worried enough.
"The CBOE Volatility Index posted its second-lowest monthly average ever in May, according to WSJ Market Data Group, finishing the month with a 10.86 average," despite all the warnings about complacency at the beginning of the month and a brief spike in the VIX in the middle. Markets can remain complacent longer than you can remain interested in this topic, is perhaps the lesson here.
People are worried about bond market liquidity.
Nah, actually, people are very excited about the bond indexing business:
Indexes are increasingly important in the debt market, where there’s less trading than in stocks or futures. Getting into a benchmark often means a company’s bonds are far easier to buy and sell. Given that investors are shifting away from active strategies in favor of just buying whatever’s in an index, these metrics are more attractive to exchanges, which can create new sources of income by introducing futures contracts or ETFs linked to the indexes they own.
The latest is Intercontinental Exchange Inc. buying Bank of America Corp.'s bond index business, days after London Stock Exchange Group Plc bought Citigroup Inc.'s bond index business. I suppose if you are worried about bond market liquidity you might find it interesting that banks are getting out of the bond indexing business and exchanges are getting into it; perhaps that is a sign of the future of the broader bond trading business.
Jeremy Grantham thinks higher valuations are the new normal. In Fight With Buffalo Wild Wings, Activist Investor Mick McGuire Is the Target. JPMorgan settles claims over sale of Good Technology to BlackBerry. After Monte Paschi, Italy's Other Troubled Banks Are in View. Why Whistleblowers Get Paid in the U.S. but Not in Britain. Morgan Stanley is moving some private-wealth brokers into its headquarters. Regulator Bars Ex-Morgan Stanley Broker Who Hid Venezuelan Bond Trades. One of the Oakley Country Club insider traders is on the lam. Altair boss Philip Parker linked to dispute over mother's shares. Antonio Weiss and Simon Johnson on the Financial Stability Oversight Council at Bloomberg View. Job interviews at the gym. Dad overdoses on heroin to teach his addict son a lesson. Nine-year-old Fredericton girl hospitalized after drinking ‘Unicorn Milk’ vaping fluid.
If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Thanks!
To contact the author of this story:
Matt Levine at firstname.lastname@example.org
To contact the editor responsible for this story:
James Greiff at email@example.com