| Programming note: Money Stuff will be off tomorrow, back on Monday. Direct indexing Well sure: A strategy blurring the lines between benchmark-hugging and stock picking is attracting choosy investors. Those who appreciate the lower costs and simplicity of passive investing can make their own edits to a benchmark with an approach called direct indexing. Rather than owning an exchange-traded fund or mutual fund that tracks a gauge like the S&P 500, the strategy allows you to buy shares of the companies in an index, while tailoring the portfolio to your needs. ... These strategies are revamping separately managed accounts, products that can be used to create bespoke portfolios, traditionally for institutional investors or high-net-worth clients. And developments such as zero-commission trading and brokerage Charles Schwab Corp.'s offer to transact fractional shares have made it cheaper and easier to run tailored pools than ever before, paving the way for direct indexing to reach more customers. The accounts can be used in various ways: an Apple Inc. staffer who already owns company stock via benefits could reduce further exposure in their portfolios, for example. An ethically minded investor who wants to steer clear of a company that's not doing enough to combat climate change could use direct indexing to avoid that firm but still track the rest of the market. … Direct-index strategies typically charge about 0.15-0.35%, according to data from Bloomberg Intelligence. Conceptually, the way you invested fifty years ago was that you went to a broker and told him what stocks you wanted to buy, and he bought them for you. The way you invest now is that you go to an asset manager and tell it what stocks you don't want to buy, and it buys the rest for you. This strikes me as completely correct! There are thousands of stocks and you only have the time and attention to make, like, five decisions, tops. Also even those probably won't be particularly good decisions. Choosing five stocks not to buy and then buying the rest will probably get you close to the return of the average investor, which is fine; choosing five stocks to buy and then skipping the rest is pretty much a gamble. (Notably "the best-performing 4% of listed companies explain the net gain for the entire US stock market since 1926," and your odds of hitting them with just five shots are low.) In a way this demonstrates the intellectual triumph of the passive indexing revolution even more than actual low-cost index funds do. The message of direct indexing is that, for most investors, active investing should start from the premise of indexing—that you should own the whole market, weighted by market cap—and delete from there, rather than starting from a blank page and adding stocks. Or rather, the message is that the "blank page," for investors, is owning the market portfolio, that the actual decisions that investors make are choices to deviate from the market portfolio. The default is the index. One other thing I should mention about direct indexing. We talk about a lot around here, often under the semi-joking headline "Are index funds illegal," about whether common ownership of multiple companies in the same industry by large institutional investors reduces competition and creates an antitrust problem. That headline is semi-joking because (1) the problem is not really about index funds—it's about common ownership by diversified institutional investors—and no one really thinks index funds should be illegal, but also (2) some of the proposed solutions to the problem really do call for, um, banning index funds as they currently exist? One question that people sometimes have is, if in some hard-to-imagine universe regulators really did ban index funds, what would happen? And I suspect that the answer is, if index funds (and broadly diversified mutual funds generally) became illegal, then the alternative would be something like direct indexing: Instead of selling a million customers shares in a big mutual fund that owns 10% of every company, asset managers (or brokers) will sell each customer a separate portfolio that owns 0.00001% of every company. The actual ownership of companies won't change, and neither will the overlapping common ownership of multiple companies in each industry, but the form of that ownership will change, from big funds that can be treated as single entities (even though they hold shares on behalf of dispersed investors) to the individual investors themselves. (I am not sure that this would solve the possible antitrust problem—all the companies still have common owners!—but I'm not sure it wouldn't either; aggregation of all of those people's ownership under a single investment manager probably does matter for corporate decisions.) Once you have good enough tools—fractional shares, zero-commission trading, etc.—to let everyone own all the stocks directly, and once it is broadly accepted that owning all the stocks is the normal way to invest, then it becomes less important for people to own all the stocks through funds. The ultimate triumph of indexing could be the elimination of index funds. Private markets are the new public markets I've been saying that for years now, but there is some possibility that it was a historical blip and 2019 would mark the end of it. You know the idea: Companies can now get really big, become household names, raise billions of dollars, provide liquidity to founders and early investors, etc., all without ever doing an initial public offering; the IPO, once an essential milestone for a growing company, is now an afterthought. But two important things happened in 2019. One is that a lot of the biggest tech unicorns—particularly Uber Technologies Inc., the poster unicorn for the private-is-the-new-public boom—actually went public. "All the big famous tech companies are private these days" is no longer all that true. The other is that some of the biggest tech unicorns—including Uber, but especially including WeWork—had pretty disappointing IPOs (or, in WeWork's case, a totally failed IPO), which might cause private investors to re-evaluate their willingness to pump billions of dollars into pre-IPO companies at high valuations. Perhaps the old model, in which a company that wanted to raise billions of dollars from investors at an 11-digit valuation had to go public, file audited financial statements, and generally submit to the discipline of the public markets, had some benefits. Nah it's fine: Investors are planning to pour billions more dollars into later stage tech start-ups, even as Japan's SoftBank reels from a succession of faltering bets. Stephen Schwarzman's Blackstone plans to raise between $3bn and $4bn for its first growth equity fund led by former General Atlantic executive Jon Korngold, people familiar with the discussions said. Tiger Global Management, the New York-based group managing close to $11bn in hedge funds, last week revealed it would try to raise $3.75bn for its next private investment fund in January, according to a document seen by the Financial Times. The venture capital firms Lightspeed Venture Partners, an early investor in Snap, and Peter Thiel's Founders Fund are also seeking to raise funds for backing private companies that are nearing initial public offerings or takeovers, people familiar with their plans said. The pace of fundraising will test the demand of large investors, such as pensions and sovereign wealth funds, that have looked to capitalise on a rising tide of private start-up valuations. I think the basic idea here is that, for the most part, if you are an entrepreneur or a chief executive officer, and you can raise lots of money privately, you should. The "discipline of the public markets," for you, is mostly a series of nuisances; you'll spend more time dealing with securities lawyers and activist shareholders and employees upset about stock-price volatility and less time building your business. Historically that was just the tradeoff you made, because there wasn't enough money in the private markets to fund rapid growth, but now there is. One thing that means is that some number of relatively dumb companies can raise lots of money privately while avoiding disclosure, short selling, earnings guidance, public-market discipline, etc., but another thing that it means is that some number of good valuable companies can do the same thing. There is no particular reason to expect much adverse selection, much sorting in which the good companies go public sooner and the bad ones stick to the shadowy private markets. "We'll give you goofy amounts of money without asking too many questions" obviously appeals to bad startup founders, but I think it also appeals to good startup founders who want to pursue genuinely lucrative long-term visions without distractions from pushy investors. And so if you are an investor with lots of money and the ability to invest in late-stage private companies, you kind of still have to. And so people keep raising funds to do that. Obviously you should try to invest in the good unicorns and not the bad ones, though that is not easy. The disappointing public debuts of some unicorns might undermine the argument for investing in those unicorns, but it doesn't really undermine the argument for investing in unicorns as a general idea, or the structural shifts in the market that led to the unicorn boom. D-Sol I have been spending a lot of time watching "Frozen" and "Moana" recently, for reasons, and I would like to think that they have given me some insight into the career arc of Goldman Sachs Group Inc. Chief Executive Officer David Solomon. Every time I read a story about him, it features his side hustle as a club DJ, and everything I read about that side hustle makes me think that he'd be a good Disney hero. Here's a profile of Solomon at Fortune: It's then, at half past midnight, at the LIV nightclub in the basement of Miami's Fontainebleau hotel, that the chief executive of Goldman Sachs emerges, picks up a chunky pair of white headphones, and steps behind the turntables and into his disc jockey alter ego. … Then he drops a Bingo Players ditty whose lyrics consist primarily of the cheeky refrain, "Everybody wants to know how little I care, how little I care." It's hard not to interpret it as a droll retort to anyone who would question whether the CEO of Wall Street's most storied institution—who sipped tequila at the club until almost 3 a.m.—belongs in such a hotspot while the rest of the Goldman Sachs board is presumably asleep. Solomon was outed as DJ D-Sol by the New York Times in 2017, when he was still one of two copresidents gunning for the top job at the firm. Known at the office as an über-professional, hard-charging manager with little patience for small talk, Solomon was anxious that people would no longer take him seriously—mistakenly equating the side gig with some sort of midlife crisis. Some advisers told him to hang it up. "I thought for a minute, Well, can I do this, can I not do this?" recalls Solomon, who donates the proceeds from his gigs and Spotify plays to drug-addiction-related philanthropies. (He says the total he has raised is in the six figures.) Those doubts soon dispersed, especially after his boss at the time, then-CEO Lloyd Blankfein, and others endorsed it. "You know what, it's who I am, and nobody would tell me not to play golf," Solomon says now. "And why shouldn't I—because I'm a CEO?" I just want to see this on screen so badly. I want to see the crusty older bankers telling Solomon to give up his dreams of being a DJing investment banker. "David, you're a good banker, one of the best. But this DJing stuff won't fly, not at Goldman Sachs, which as you know is one of Wall Street's most storied institutions. You've got to give up these childish dreams, hang up your chunky headphones, and focus on the work." And then Solomon will say "yes you're right, it's for the best," and there will be a sad scene of him putting the headphones in a closet and giving them a long sad lingering look, and then he will meet a wise old guru (Lloyd Blankfein) who will sing a little song telling him "look into your heart, it will tell you what to do, about the DJing." And then Solomon will sing the a big showstopper song ("How Little I Care"), the gist of which is "actually I have decided that I can be both a successful investment banker and a DJ, watch out world." And this one act of true love (for electronic dance music) will lift the curse that has been placed on Goldman Sachs (1MDB), and there will be a final scene in which Solomon stands at the turntables spinning a happy tune while his lieutenants come up to him to report record P&L in every division. Also whenever I read these stories about the skepticism Solomon faced from other investment bankers as he rose to the top of the profession while also DJing, I want to read the other side of the story, about the skepticism that (I have to assume) he faced from other DJs as he rose to the basement of the Fontainbleau while also investment banking. It's all well and good to be like "oh the staid boring investment bankers can't handle an electronic-dance-music DJ in their midst," but how does the DJ community feel about a top Goldman Sachs executive in their midst? Were his DJing advisers like "hang it up D-Sol, you can never really succeed as a club DJ if you're on the management committee of a global investment bank during the day"? Did he consider their advice, and sadly put his business suits and pitchbooks in the closet, and then break into an uplifting song about how actually advising multinational companies on financing options is also his passion and makes him a better DJ? Oddly the rest of the profile is largely about how Solomon is making Goldman more of a normal company: Gone, too, is the blanket ban on taking photos inside the office, once enforced by building security guards; Solomon now frequently posts such pics to his Instagram account. "The organization has a lot of bureaucracy I'd like to simplify," says Solomon (though he doesn't take credit for changing the drug or photo policies). "I think we can do some work to be more admired and respected, and a little less envied and feared." … At its investor day on Jan. 29, Goldman Sachs will welcome some 300 shareholders, analysts, and regulators inside its Manhattan headquarters for the first time and unveil Solomon's new innovation: a three- to five-year strategic plan. That may seem unremarkable, but until now the firm, believing the market too unpredictable, had only ever budgeted through each calendar year. "The way we made investments is we'd rub sticks together, we'd sprinkle a little bit on something," says Solomon. In other words, each year Goldman's people had to find a way to bring in more money than the last, but anything that required a longer-term commitment of resources to pay off later was off the table. "You don't just get to run faster, jump higher, and have more profit just because we're Goldman Sachs," says COO John Waldron, reinforcing the focus on investing. "You've got to put money in the ground that grows over time." Disclosure, I worked at Goldman from 2007 through 2011, and I guess I sort of internalized the envied/feared/rubbing-sticks-together approach? There was a certain ethos of, like, nerds running around chasing weird trades without much of a plan, driven not by a five-year strategic vision but by an aesthetic commitment to doing complicated stuff and, sure, a love of money. I was pretty junior, though, and not particularly good at it, so I am willing to concede that a strategic plan might have some benefits. Also there is this: When Solomon became CEO, Friedman advised him to preserve a "small core" of cultural values, but that "everything else has to be subject to change." Solomon has led by that creed. In March, he tore up the firm's age-old dress code, a 35-page dossier with outdated stipulations about suits, ties, and shoe color. When I was there, I never got a 35-page dress code, or wore a tie on days when I didn't have client meetings. When we last talked about the dress code, there was a Bloomberg article headlined "Goldman Sachs Allows Bankers to Trade Bespoke Suits for Khakis," and I suggested that Solomon was maybe getting credit for a more radical change than he had actually enacted. Lloyd Blankfein's Goldman Sachs did not require bespoke suits and properly colored shoes! As far as I can tell, the pre- and post-Solomon dress codes are both pretty much "business casual, but if you're seeing clients dress for them." I guess now jeans are okay? But the legend seems to be growing, and by next year it will be canonically accepted that before 2019 Goldman bankers had to wear white ties, tailcoats and top hats to work every day and were instantly fired if their shoes were scuffed or their monocles fell out. I probably should start promoting that legend myself. Envied and feared! Things happen WeWork's Quarterly Loss Doubled to $1.3 Billion as IPO Faltered. Ex-Obama adviser leads Lazard quest for bigger share of dealmaking. Schwab Boosts New Trading Accounts 31% After Fees Go to Zero. Hedge fund firm Two Sigma just started selling a risk analysis tool, and it shows how secretive quants are now looking to make money sharing their tech. Carl Icahn Makes Case for Xerox-HP Union. Europe's Weakened Banks See a Road Around New Capital Rules. EU prepares tweak to Mifid market rules after industry backlash. Here's How KKR Might Just Pull Off the Biggest LBO in History. H2O auditor flags rule breach during summer liquidity squeeze. Zillow, Opendoor Pay Close to Market Value for Homes, Study Says. Elizabeth Warren Slams Goldman Over Apple Card Bias Claims. More South Korean academics caught naming kids as co-authors. Research claims role in the school nativity can predict future earnings. Feral Hogs Find and Destroy Cocaine Worth $22,000 Hidden in Woods. "Local singles tell The Post that the way to a guy's heart these days is through a nice, big meal of chicken parmigiana." If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! |
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