Money Stuff

Hedge-Fund Names and Trader Fibs

Also analyst fatigue, M&A oral history, deferred comp and Dow 22,000.

Hedge funds.

One big problem in the hedge fund industry is that every imaginable figure from Greco-Roman mythology has already been pressed into service as a hedge fund name, so what are you going to call your fund? Just opening to a random page in Graves, or even Harrison, will no longer get you a unique name that conveys the seriousness, power and historical heft of your fund. Many other ancient traditions -- Hindu, Egyptian, Norse, Babylonian, Akkadian and of course Elvish -- have also been mined extensively for financial-company names. If you want to name a fund these days, you're pretty much stuck with your street address.

And yet somehow there is a major classical mythology with a goddess of accounting who has never before been used as a hedge fund name. What? Here is a profile of Fahmi Quadir, a 26-year old short-selling protégé of Marc Cohodes, who "expects to raise $200 million at her newly created Safkhet Capital," and who "named her fund for the ancient Egyptian goddess of accounting, math and knowledge." It is honestly flabbergasting that, in decades of hedge-fund history, no one else thought of that first. You should be so embarrassed if you work at Cerberus Capital Management.

Q. What is a cerberus?
A. Cerberus is the mythical three-headed dog who guards the entrance to the underworld.
Q. Hmm, why did you choose that name?
A. I guess it sounded cool?
Q. Do you stand at the gates of the underworld and bark?
A. Almost never, no.
Q. Well what do you do then?
A. Type numbers into spreadsheets and send emails, mostly.
Q. What if I told you that there is a mythological goddess of doing literally that?
A. Huh, that would be a more appropriate name.
Q. There is. Safkhet. Look her up.
A. Cerberus is a sweet three-headed dog though.

The mind reels. Next you will tell me about a Homeric epic whose hero charges a performance fee for managing investments, or a Norse god who wears fleece vests. Anyway congratulations to Quadir for giving her fund the only appropriate mythological name in hedge-fund history. 

Elsewhere: Paul Tudor Jones "saw clients pull about 15 percent of their assets from his main fund in the second quarter," leaving him with "assets at about $3.6 billion, almost half the value a year ago." And: "ETFs Now Have $1 Trillion More Than Hedge Funds."

When can bond traders lie to customers?

Let's say you are a bond portfolio manager, and you buy some XYZ bonds. And then some guy at some hedge fund calls you up and says "hey I see some XYZ bonds traded, were you the buyer?" Obviously he is asking you because that information might be useful to him. If he knows where to find more XYZ bonds, and knows you're a buyer, he might try to "front-run" you (in the loose sense of the phrase) by buying the bonds and then selling them to you at a higher price. Or, conversely, if he knows your fund is experiencing heavy withdrawals, he might want to short those XYZ bonds in the expectation that you'll be forced to dump them soon. Or whatever; the point is, having more information about who is doing what is generally useful in markets.

For you, on the other hand, giving him that information may or may not be useful. If you're desperate to get more XYZ bonds at any price, you should tell him "sure, that was me, you got any more?" If you're looking to buy more quietly and cheaply, though, you may not want him to know what you're up to. Or if your fund is experiencing heavy withdrawals, you don't want to encourage him to short your positions and put further pressure on you.

So what do you say? I think a reasonable thing to say, in those circumstances, would be: "Nope, wasn't me." It's none of his business, right? You didn't buy the bonds from him; he had nothing to do with the trade; he's just some guy trying to get gossip that would be useful to him but possibly harmful to you. You owe him nothing, not even honesty. If you lie to him, and he finds out, and complains, you can reasonably shrug and say "who are you again?" And while some kinds of lying in financial markets are illegal -- lying to people about material facts in order to induce them to do a trade, for instance, is fraud -- lying to random bystanders about trades that don't concern them doesn't seem like a problem. (Not legal advice, though!)

Here's a weird story that goes a little like that, but with one important difference: The person accused of lying was not a bond manager at an investment fund, but a bond trader (Patrick Brennan) at a bank (Morgan Stanley):

His undoing at the bank began when Hutchin Hill, a hedge fund with about $3 billion in assets, noticed someone carried out a trade on a security that it also owned, sparking a decline in the price. The firm determined that Morgan Stanley was involved in the trade and it confronted Brennan, who, according to the people, then misled the client by saying he had nothing to do with it.

It’s unclear what transpired next but after Hutchin Hill complained to his supervisors, Brennan and Morgan Stanley executives agreed to correct the record with the hedge fund, acknowledging the firm’s involvement, one of the people said. Brennan was soon discussing his exit with Morgan Stanley, negotiations that continued as recently as two weeks ago.

Obviously it would be useful for Hutchin Hill to know who is trading bonds that it also owns. On the other hand, whoever was trading those bonds with Morgan Stanley might quite reasonably not want Hutchin Hill to know about it, and might prefer that, if asked, Morgan Stanley would say something like "I have no idea what you are talking about." (I suppose they could live with "I can't talk to you about that," which everyone agrees would have been fine, but which is a more informative response than "no.")

But in the new, post-Litvak world of bond trading, bond traders at banks are really not supposed to lie to their customers. The Jesse Litvak case, and other enforcement actions that have changed the culture of bond trading, involved lying to customers about their own trades, rather than lying to them about random gossip. But even beyond the new tone of enforcement -- and "no one is suggesting that Brennan broke any law" -- lying to customers is now viewed as bad customer service. And now that matters:

It also points to the new reality in debt markets: Once on equal footing with their fund-manager clients, bond traders today have been reduced to mere market makers for the most part, and their employers are loath to cross customers.

Analyst fatigue.

We talked yesterday about a paper finding that research analysts get pretty tired from analyzing more than one stock in a day, and that "forecast accuracy declines over the course of a day as the number of forecasts the analyst has already issued increases." What I did not know is that there is a whole literature about analysts getting tired as the day goes on, and it is fascinating. Here for instance is "Oh What a Beautiful Morning! Diurnal Influences on Executives and Analysts: Evidence from Conference Calls" by Jing Chen, Elizabeth Demers and Baruch Lev:

This study provides novel evidence that expert economic agents’ work-related activities are systematically influenced by the time-of-day. We use archival data derived from time-stamped quarterly earnings conference calls together with linguistic algorithms to measure and track the moods of executives and analysts at different times of the day. The evidence indicates that the tone of conference call discussions deteriorates markedly over the course of the trading day, with both analysts’ and executives’ moods becoming more negative as the day wears on. Capital market pricing tests reveal that the time-of-day-induced negative tone leads to temporary stock mispricings.

Really whose mood doesn't become more negative as the day wears on? "Algorithms," is I suppose the answer, and one effect of these papers is to prepare the way for a future where investing is dominated by robots who don't get exhausted and cranky by 4 p.m.

Also yesterday I mentioned the famous paper about how parole boards issue more favorable decisions right after lunch, and several people pointed out that that's a highly controversial finding. Here is a good critique of it, which focuses on a simple but often-overlooked statistical issue: The effect size is too big. Apparently the judges in the study granted parole 65 percent of the time right after lunch, declining to zero percent by the end of the session. That can't possibly be explained by lunch:

If hunger had an effect on our mental resources of this magnitude, our society would fall into minor chaos every day at 11:45. Or at the very least, our society would have organized itself around this incredibly strong effect of mental depletion. Just like manufacturers take size differences between men and women into account when producing items such as golf clubs or watches, we would stop teaching in the time before lunch, doctors would not schedule surgery, and driving before lunch would be illegal.

M&A oral history.

Given that oral history is the internet's favorite genre, and that mergers and acquisitions are actually pretty exciting, it's a little weird that there aren't more oral histories of M&A deals. No one wants to be quoted at length about deal processes as they're happening, but after a decent amount of time has passed, why not? Anyway here is a Bloomberg 10-year-retrospective oral history of the $49 billion Bell Canada Enterprises Inc. leveraged buyout, which was announced in June 2007, and which fell apart when "the bond market fell out of bed totally" in 2007-2008 and the deal couldn't be financed. There is, as you'd expect, a bit of this:

It was June 10, 2007, a Sunday. I was entertaining a group of friends at the French Laundry, the Napa Valley restaurant, to celebrate my wife’s 50th birthday. I was walking up the steps to go in, and I said: “I’ll just take this call.” There were about 40 accountants and lawyers and us and Citibank on it. I thought it was going to be a half-hour.

The conversation lasted more than three hours. We figured out the debt package and the hedging program, but it ruined my wife’s birthday party. One of her friends felt sorry for me and brought me out a glass of wine. Afterward, Leslie said to me: “How much of an a--hole do you think the serving staff in this restaurant thinks you are, that you brought me here and never showed up?”

Eh, I bet that happens to the French Laundry every week.

Deferred comp.

Employees of Lehman Brothers Inc. had a deferred-compensation plan. Unfortunately for many of them, they deferred their compensation until after Lehman went bankrupt, at which point it became deferred forever. The deferred-compensation plan explicitly said that Lehman's obligations under the plan were subordinated to other creditors, so the deferred comp could only be paid after other creditors were paid back in full. The employees went to the bankruptcy court to say essentially "come on that is mean," but the court was unmoved: Subordinated compensation claims are subordinated claims, and can't get paid back before the senior creditors.

Stephen Lubben writes that this ruling "applies to employees in all sorts of companies," and that "this was the basic trade-off that employees had made decades ago: better tax treatment, in exchange for more risk." But of course it is also a bit of a pre-2008 model for post-2008 financial-industry compensation: The thrust of post-crisis compensation rules has been to defer more compensation for longer, and to take it away if the employee or the bank messes up during the deferral period. Subordinating it, and taking it away in bankruptcy, is a crude but effective way to do that. It's hard to argue that Lehman didn't mess up, and it's fair in a sense that its employees paid the price of that before its creditors did.

Dow 22,000?!?

The Dow Jones Industrial Average closed yesterday at 21,963.92, close enough to 22,000 to inspire several Dow Round Number articles. Honestly 22,000 is barely even a round number; I wonder if they wrote articles about the Dow's move from 210 to 220, back in 1950. But Dow Round Number articles are usually also Dow Is Dumb articles: Since the Dow is a price-weighted index, moves in a few high-priced stocks can have an outsize impact on its overall level. Boeing Co. and Visa Inc., Bloomberg notes, have "alone accounted for more than half of the Dow’s 614-point jump since the start of July," while the Wall Street Journal points out that Boeing accounted for 85 percent of the Dow's gains over the seven trading days through Monday morning, and that Apple Inc.'s results ought to push the Dow over the top today.

But for connoisseurs, a much better Dow milestone is within reach: Dow 22,026.47, which is Dow e^10, a nice round number on an appropriate log scale. There hasn't been a round number like that since Dow e^9 (8,103.08), which we crossed in 1997, and again in 1998, and again in 2002, and again in 2003, and again in 2009.

Blockchain blockchain blockchain.

Here is Aswath Damodaran on "The Crypto Currency Debate: Future of Money or Speculative Hype?

Crypto currencies, with bitcoin and ether leading the pack, have succeeded in financial markets by attracting investors, and in the public discourse by garnering attention, but they have not succeeded (yet) as currencies.

I think that this is obviously true, but I also think that if you are bullish on cryptocurrencies, it is probably for some reason other than "bitcoin is going to replace the dollar as the standard way we buy things online or at the store." If, for instance, bitcoin becomes the standard store of value in much of the world, and if the Ethereum blockchain becomes the standard tool that new businesses use to raise money, then I think that would count as a wild success for cryptocurrency even if people still mostly use dollars to buy sandwiches. Sadly Damodaran, the internet's leading expert on discounted cash flow valuation, does not provide a valuation for bitcoin.

People are worried that people aren't worried enough.

Here you go:

It’s another sign of exuberance in high-yield markets that has veterans like Oaktree Capital Group LLC co-chairman Howard Marks sounding the alarm. Investors are “at it again,” Marks said, funding risky deals and driving valuations so high that prospective returns in most asset classes are “just about the lowest they’ve ever been.” Junk-debt investors are getting only 3.49 percentage points of extra compensation compared with risk-free government debt, close to a post-crisis low. Other deals have softened language that protects creditors’ rights.

People are worried about unicorns.

Here you go:

Analysts and underwriters say that the weak performance of Snap, the largest tech IPO in more than two years, is stoking doubts among late-stage private investors. Such doubts could interrupt the cycle of ever-increasing funding rounds that has underpinned the lofty valuations of many tech startups.

Elsewhere, here is a profile of Patrick and John Collison, the brothers who founded Stripe Inc. And: Conrad the Unicorn wearable balloon costume.

People are worried about stock buybacks.

Here you go:

The most obvious manifestations of the corporate misbehavior that MSV incentivizes are the lavish, stock-based incomes of top corporate executives and the massive distributions of corporate cash to shareholders in the form of stock buybacks, coming on top of already-ample dividends. Indeed, with stock-based pay incentivizing senior executives to do stock buybacks—i.e., having a company repurchase its own shares to give manipulative boosts to its stock price—over the past three decades the stock market has had a negative cash function. On the whole, U.S. business corporations fund the stock market, not vice versa.

People are worried about bond market liquidity.

Here you go:

Among the few constants on Wall Street such as bonus season and empty desks in August add this: with every year that passes, traders are getting more comfortable buying and selling corporate bonds electronically.

Things happen.

How China’s biggest bank became ensnared in a sprawling money laundering probe. Wall Street Regulators Are Set to Rewrite the Volcker Rule. The Great Escape: How Credit Raters Ducked Reform. Were Banks Ever ‘Boring’? Two big distortions: bank incentives for debt financing. Uber drivers gang up to cause surge pricing, research says. SEC Asks Twitter Why It Doesn't Disclose Daily User Number. Etsy’s Painful Lesson: It’s a Retailer, Not a Tech Startup. Jury in Martin Shkreli Fraud Trial Has Questions for the Judge. Trump’s CEO Brain Trust Comes Up Short on Big Ideas for Policies. Cohn Tops Yellen as Fed Chair Guessing-Game Heats Up. Why the Hatchet Men of 3G Spent $10 Million on a Better Oscar Mayer Weiner. "A hemp silk wedding dress, a hemp suit, a 'budquet'—you can crack it from your bouquet to your bowl." Dog anti-vaxxers. Baboon economics. An oral history of the Scaramucci Era

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