ArtGone You can think of index investing as an algorithm that says that the stocks with the highest prices today will be worth the most in the future. So you take your money and bet a lot of it on the stocks that are worth a lot now, and less of it on the stocks that are worth less now, and (with all but the broadest indexes) none of it on the stocks that are worth only a little bit now. This is a pretty good strategy—not perfect, but better than a lot of other strategies—because markets are mostly pretty efficient and today's price mostly is a pretty good predictor of tomorrow's. Not perfect. If you only invest in the companies that are worth a lot now, you will miss out on the brilliant disruptive innovators that are just starting out. And if you invest in all the companies that are worth a lot now, you will occasionally put money into silly overvalued bubbles and frauds. This is not all that strong an argument against indexing: Those bubbles and frauds got inflated because somebody else, some active investor who was picking stocks, overvalued them. Index investors are not uniquely susceptible to bubbles; if they were, there'd never be bubbles. Still there is that dynamic. One way it can go is like[1]: - Company X is a small company whose stock suddenly goes up a lot.
- Now it meets the size requirements to qualify for the index.
- It gets added to the index.
- Index investors buy Company X according to its index weight, further pushing up the stock.
If Step 1 was based on solid fundamentals, this is fine and good. If Step 1 was an irrational bubble, then the passive investors are the victims of the bubble: They buy a bubbly stock at the top. One thing you can say about this dynamic is that it doesn't work in reverse[2]: If the price of Company Y's stock is stagnant or going down, it won't get added to the index, and index funds won't pile in to buy it. So passive investors have a tendency to buy buzzy things at high prices, but no offsetting tendency to buy undervalued gems at low prices. (This is not so different from active investors, to be fair.) Another thing you can say about this dynamic is that it is pretty transparent and exploitable. If you're an active investor, and you see Company X's stock soaring, and you know that it's going to be added to broad indexes because of its new large market capitalization, and you do 10 minutes of research and conclude that it's an obvious fraud, you should probably buy it anyway, because index funds are going to be buying it tomorrow at even higher valuations and you can make a quick buck on the trade. The index funds are, in certain circumstances, extremely predictable greater fools; they can provide a great dumping ground for pump-and-dump schemes. Not entirely predictable. This is pretty fun: MSCI Inc. scrapped plans to add a high-flying Hong Kong stock to its indexes because of concerns about investability, a rare reversal that sent the stock plunging 98%. ArtGo Holdings Ltd., which had soared almost 3,800% this year for the world's biggest gain among companies with a market capitalization of at least $1 billion, erased nearly all of that advance within minutes on Thursday as investors reacted to MSCI's decision. The stock wiped out more than $5.7 billion of value before trading was suspended. MSCI, which had announced its intention to include ArtGo just two weeks ago, said in statement on Wednesday that it would no longer do so after "further analysis and feedback from market participants on investability." An ArtGo representative said the company, a marble producer that has been expanding into other businesses like real estate, couldn't immediately comment. I know nothing about ArtGo, or why its stock went up, but "the company has been losing money for two years," "its net tangible assets as of June were only $132 million," and "there have been numerous examples in Hong Kong of stocks inexplicably rising high enough to qualify for index inclusion on the basis of its market value, only to fall hard afterward." You could draw the obvious conclusion, and some people did: In September, activist shareholder David Webb issued a "bubble warning" about ArtGo and said he had written to the Securities and Futures Commission, the city's market regulator, calling for a probe into its ownership. On Thursday, Mr. Webb said he was right to call it a bubble. "I believe the stock was being manipulated and was closely held, but whether the SFC can prove that remains to be seen," he said in an email, adding that the commission hadn't updated him on the case. I am not sure what lessons one should take from this. Conclusions like "manipulation is bad" or "index providers should not fall for pump-and-dumps" would be fine, but it's not like MSCI has actually alleged anything like that; it has gone with the much vaguer "feedback on investability." Traditionally market regulators like SFC, not index providers, are in charge of figuring out if prices are being manipulated. Broader conclusions, though, just sound weird: Mr. Webb also said index compilers needed to improve their selection criteria, for example by examining if extremely high valuation multiples were justified. "It is too lazy to just look at market capitalization and turnover," he said. He said this could lead to index-tracking funds suffering if bubbles burst. Index providers should examine if valuations are justified? Or: "It's good that MSCI is listening to what market participants are saying," Daniel So, a strategist at CMB International Securities Ltd., said by phone. "It's positive for the health of the market. It's hard to avoid adding some stocks with bubbles into the benchmark if we just focus on data like market cap. So it's good that MSCI is doing case-by-case studies." Index providers should do case-by-case studies of stocks? Look, if you said to me that investors should do careful case-by-case analyses of the stocks they want to buy in order to make sure that their valuations were justified, I'd be like, sure, yeah, that sounds like investing all right. But if you told me that the indexes used by passive investors should do careful case-by-case studies of all the stocks they include in order to make sure that their valuations were justified, I'd be like, no, wait, that doesn't sound like indexing at all. That is fundamental analysis; it is subjective and controversial; the whole business of stock markets is to adjudicate disputes over whether valuations are justified. The general idea of indexing is that you stay neutral in those disputes, and just buy stuff at whatever valuation the market gives to it. But then sometimes you might be wrong! You don't want to be wrong, do you? And so you end up finding yourself saying things like "well obviously index compilers need to make sure the valuations are right, otherwise index funds will suffer when bubbles burst." Of course index funds will suffer when bubbles burst! That's the whole point of index funds! It's the whole point of bubbles! "Index funds should match the market except if there's a bubble," okay. "Index funds should match the market except if the market is wrong." It sounds nice but I feel like there might be problems with it. Quality voting The way most public companies work is that all shareholders get to vote on certain questions—election of directors, mergers, approving executive pay, some governance and social stuff, etc.—and they get one vote for every share they own. A lot of people do not like this system and want different shares, or shareholders, to get different numbers of votes. Some people dislike the one-vote-per-share system for more or less philosophical reasons: They think that public-market shareholders are too focused on short-term results, and that companies' long-term focus could be improved by changing the voting rules. There's an idea called "tenure voting," in which, the longer you hold on to your shares, the more votes you get per share; this is supposed to give long-term investors more influence over corporate decisions. There are not tons of U.S. examples, but academics love talking about it, and it's part of the marketing pitch (though not yet the rules?) of the new "Long-Term Stock Exchange." There are other philosophical issues. There are people who think that index funds shouldn't get to vote, either because they are too passive and not engaged enough to make good decisions, or because they worry about the antitrust implications of competing companies being owned by the same set of voting shareholders. The point is you could have some theory about which shareholders are good voters and which are bad voters, and then you could try to set up a voting system that gives more votes to the good ones and fewer votes to the bad ones. Other people dislike the one-vote-per-share system out of straightforward self-interest: Lots of startup founders think that they should have more votes than their public shareholders, because they founded the company. So they give themselves super-voting stock. Unlike the tenure-voting stuff, this happens a lot in practice, and it is pretty widely accepted. Academics mostly dislike it, and investors often grumble about it ineffectually. But there is an arguable theory for it too. Maybe the founder is a good voter; she is really committed to the company, has taken it this far, is in it for the long term, etc., while public shareholders are flighty and ill-informed and short-termist. Giving more votes to the good voter (the founder) will make things better for everyone in the long run; public shareholders should want to give up their voting rights and let her make all the decisions. I want to suggest here that there is a third category of people who dislike the one-vote-per-share system just because it is too simple. I don't think they'd say it like that. But it's just, you know, here you are, a financial engineer, you are always looking to find ways to make stuff more complicated. The economic structure of corporate ownership is infinitely malleable: You can sell senior bonds, or junior bonds, or preferred stock, or common stock, or warrants; you can structure derivatives on existing shares that lets people make very fine-tuned bets on whether the stock will go up, and when, and by how much, and by what particular path. Any economic thesis you like can be expressed by some combination of instruments, and there is an intellectual joy in putting that combination together. And then everyone just gets one vote per share? Pshaw! They should get a number of votes that is the square root of some utterly surprising quantity; that is just science. It is possible that I am wrong and that there is no one in this third category. Except me! When I read arguments that companies should have tenure voting because public shareholders are too short-termist, or that index funds should not vote because they are too disengaged, I find myself bored and unconvinced. But then I read about the mechanics of how tenure voting would work and I cackle gleefully and try to think of how I would game it. Anyway here's "Quality Shareholder Voting" by Lawrence Cunningham of George Washington University Law School: Quality voting refines time-weighted voting to account not only for duration but conviction. That is, quality voting grants additional votes to shares owned for a long time in large stakes. The proxy for conviction is shares representing a substantial portion of a shareholders' portfolio, measured as a percentage of the shareholder's total public company equity portfolio. For example, two votes per share could be granted to shareholders allocating between 1 percent and 5 percent of such a portfolio to the company and three votes per share to those allocating more than 5 percent. If tenured voting implicitly assumes that longer-held shares cast higher-quality votes, the hypothesis follows that shares owned by those with greater exposure will also have such merit. There is a table, combining duration and concentration. Owning stock for under one year, representing less than 1% of your portfolio, gets you one vote per share. Owning stock for more than three years, representing more than 10% of your portfolio, gets you nine votes per share. The crude way to game time-weighted (tenure) voting is of course: - I set up the Tenure Gamesmanship Fund.
- I sell shares in the fund to hedge funds that want to own Company X.
- I use the money to buy shares in Company X.
- When the hedge funds want to sell their shares, they sell shares of the fund.
- Shares in the fund move around actively, but shares of Company X just sit in the fund's vault, accruing tenure.
- The fund votes its shares of Company X however the fund's shareholders tell it to (proportionally, or even winner-take-all).
- Eventually the fund owns lots of long-tenured shares and has lots of votes, and shares of the fund trade at a premium to the underlying stock because activist hedge funds can buy lots of voting power through the fund.
It seems on first impression like there'd be even more fun ways to game quality voting. Do all your investing through a portfolio of funds, each of which puts 100% of its money in one stock: high conviction! Or put 100% of your portfolio in one stock, have nine of your hedge-fund buddies do the same thing with other stocks, and write swaps to each other to diversify your economic interest while keeping high concentration for the votes. That's just the obvious stuff; I'm sure there are other approaches. And you get to do all the tenure-voting gamesmanship too, because this proposal weights votes for both concentration and tenure. (Each Tenure Gamesmanship Fund has to be 100% invested in one stock, etc.) Obviously I hope this proposal is widely adopted, because it is fun. Though if it is, I might have to go back into investment banking. Softwork One weird part of SoftBank Group Corp.'s bailout of WeWork—and it is all weird parts—is that $3 billion of the $9.5 billion that SoftBank is putting up won't go to bail out WeWork. The point of the bailout is more or less that WeWork was running out of money and could really use some more, and so SoftBank (and some banks) is lending WeWork $5 billion to keep it afloat, as well as accelerating a $1.5 billion investment it already planned to make. But also, as part of the same deal, SoftBank is putting in $3 billion more to bail out WeWork's investors: It will spend $3 billion on a tender offer for WeWork stock, none of which will go to WeWork. It will go to other WeWork investors, and employees, and most notably about a billion dollars of it will go to WeWork founder Adam Neumann. It seems somehow less urgent: WeWork needs SoftBank's $6.5 billion to keep operating, but it could keep operating just fine without channelling $3 billion from SoftBank to its other shareholders. "Presumably—though who knows!—SoftBank does not have limitless money to pour into WeWork," I wrote at the time, "so it's strange that such a big chunk of its WeWork rescue investment is not going to fund the company." One possibility was that SoftBank pushed for this, as a condition for providing its bailout: Maybe it wanted to consolidate control and buy as many shares as possible in one go while the price was cheap. The other possibility was that WeWork's board and existing shareholders pushed for this, as a condition for agreeing to SoftBank's bailout (instead of accepting a competing financing proposal from JPMorgan Chase & Co., or I suppose no financing proposal). Maybe the investors who controlled WeWork wanted out, and would only accept a deal to bail out WeWork if it also bailed them out of their stock. And by "the investors who controlled WeWork" I mean mostly Neumann, who had a majority of the voting stock at the time. "In effect," I wrote, "the price of Neumann allowing SoftBank to rescue WeWork was that SoftBank had to hand Neumann a billion dollars for himself." I still don't really know what the dynamic was at the time, but it's pretty clear what it is now: Executives at SoftBank are looking for a way to reduce the size of a $3 billion offer for WeWork stock as part of its rescue package, as the office-sharing behemoth makes wide-ranging cuts to staff. The discussions at SoftBank center around shrinking a $3 billion tender offer for WeWork shares owned by founders, employees and investors, according to people with knowledge of the talks. Such a move would be designed, at least in part, to limit the amount paid to co-founder Adam Neumann, said the people, who requested anonymity because the matter is private. It's unclear how SoftBank could renege on its agreement with WeWork investors and crucially, with Neumann. Any effort to re-draw terms could result in a legal battle, one person said. As part of the deal, Neumann has the ability to sell $970 million worth of WeWork stock to SoftBank. Oh man I really want to see that legal battle, don't you? I want to see Adam Neumann sue SoftBank over this. "I sold them all this stock at a $47 billion valuation, and then they promised to take my stock off my hands at $8 billion, and now they won't, what gives, this is fraud," he will tell the court, and I will laugh and laugh. Oh also "WeWork Says It's Cutting 2,400 Jobs Globally," obviously. A metaphor Yesterday Tesla Inc. unveiled its astonishing Cybertruck, a "large metallic trapezoid" that looks like it was designed by people who give things names starting with "cyber." It looks like someone whittled the crude outline of a car and then stopped. It looks like an 8-bit video game. It is amazing and I want one; it makes me want to throw out all of my pretty Apple devices and replace them with clunky angular metallic cyberpunk monstrosities. I would 1,000% buy a Tesla smartphone designed by the people who made this thing; it would weigh 15 pounds and the sharp corners would cut holes in my pockets, but I'd feel like an intergalactic bounty hunter every time I texted someone. Anyway also this happened: In the demo, Tesla chief designer Franz von Holzhausen initially took a sledgehammer to the truck, which withstood the impact. Then it all went wrong. Von Holzhausen took a metallic ball in his right hand, wound up and tossed it at the truck -- smashing the front driver-side window, stunning the audience and viewers live streaming the event. "Oh my f---ing god," Musk said, when the window broke. "Maybe that was a little too hard," Musk said after the ball cracked the glass. So they tried again. A second test broke a second window. It's the Tesla way, isn't it? - Elon Musk announces that everything is great and nothing can possibly go wrong.
- Then he throws stuff at Tesla until it breaks.
- Brief awkward pause, some swearing.
- He does it again.
He's so great. I make fun of Elon Musk a lot, but that's only because he's fun a lot! The other day I was reading David Graeber's 2012 essay about superheroes, in which he writes: These "heroes" are purely reactionary, in the literal sense. They have no projects of their own, at least not in their role as heroes .... In fact, superheroes seem almost utterly lacking in imagination: like Bruce Wayne, who with all the money in the world can't seem to think of anything to do with it other than to indulge in the occasional act of charity; it never seems to occur to Superman that he could easily carve free magic cities out of mountains. Almost never do superheroes make, create, or build anything. The villains, in contrast, are endlessly creative. They are full of plans and projects and ideas. Clearly, we are supposed to first, without consciously realizing it, identify with the villains. After all, they're having all the fun. People often compare Musk to a comic-book supervillain (though they even more often compare him to Iron Man), and of course he is occasionally villainous, but really the point of the comparison is mostly just that he is so busy. In a movie, if an eccentric billionaire was building tunnels under the earth and sending rockets to Mars, it would be part of a nefarious plan to destroy the world. But no, he just likes tunnels and rockets!"I'm going to build a cartoon truck and then throw metal balls at it until it breaks!" What? Why? Who does that? Elon Musk does that! I'm so glad he does. Things happen Deutsche Bank CEO's Last-Ditch Plan to Save Best of His Business. Wall Street Wades Into Sports Gambling as Legalization Spreads. Powell Says Fed Has No Plans to Create Digital Currency. Xerox Threatens to Go Hostile With HP Takeover Bid. Tokyo woos hedge funds in crisis-hit Hong Kong. Kalanick Sells Almost $1.5 Billion of Uber in Weeks After Lockup. Robocall Scams Exist Because They Work—One Woman's Story Shows How. Bumble Bee Files for Bankruptcy With $925 Million Offer From Taiwan's FCF. People are worried that people aren't worried enough. Trump's Fed Pick Judy Shelton Cast Doubt on Central Bank Independence. Donald Trump's US tariffs cast a cloud over Beaujolais arrivals. The Mysteries of 'Baby Shark.' "Have you ever considered that your problems might be because of [the kind of thing our form of therapy says all problems are because of]?" Unicorn Meteor Storm. Time for Land Bees! 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! [1] There's an important variant, which is like: (1) Stocks in Market Z go up a lot, (2) passive investors say "hey Market Z is big now, we should invest in it," (3) Market Z stocks are added to broader indexes, based on investor demand and/or mechanical market-cap-weighting rules, and (4) passive investors rush in to buy Market Z stocks according to their index weights. This dynamic can also generate bubbles, on a more macro scale than the one in the text. [2] I mean the way it works in reverse is that some company gets kicked *out* of the index because its market cap is too low: Buy high, sell low. | 
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