Angel index One theory of passive investing is that every public company is the same, so there's no real point in spending time and energy trying to pick the best ones. I am exaggerating, but not all that much. There's an excellent 2017 research note from Michael Mauboussin et al. (which I wrote about here) finding that "listed companies today are on average larger, older, and more profitable than they were 20 years ago" and speculating that "the maturation of listed companies has also contributed to informational efficiency in the stock market," which "may be one of the catalysts for the shift that investors are making from active to indexed or rule-based strategies." When there are dramatic differences between public companies, it pays to pick the good ones and avoid the bad ones. When they are all mature and profitable and probably correctly priced, buying all of them is fine. On this theory, indexing and algorithmic investing should come to dominate the increasingly efficient public markets, and people who are good at spotting value and profiting from inefficiency should migrate to private markets where that is still possible. Private companies are still different, so spending time picking the good ones is still worthwhile. There is however another, opposite theory of passive investing, which says that actually there are only a handful of good public companies, and if you miss out on investing in one of them it's a disaster, so you might as well invest in everything. The downside of buying a bunch of duds is not as bad as the downside of missing out on one of the few winners; you buy every stock not because they're all equally good but because almost none of them are. "The best-performing four percent of listed companies explain the net gain for the entire U.S. stock market since 1926, as other stocks collectively matched Treasury bills." You'd better not miss any of them! What does this theory tell you about private markets? Compared to public companies, early-stage startups are far more uncertain, so presumably an even smaller percentage of them account for all of the net gains. For every Facebook there are 24 dud public companies but hundreds of dud startups. One possible conclusion is "so it's extra important for venture capitalists to have lots of skill and pick the right startups," but you might be tempted by the opposite conclusion. Maybe you should just buy an index fund of all venture deals, because that will minimize your risk of missing out on the good deals, which is the only risk that matters. Obviously there isn't really an index fund of venture deals—it's not a standard product the way it is in public markets—but maybe there should be? Here's a fun study from Abe Othman of AngelList: Conventional investing wisdom tells us that VCs should pass on most deals they see. But our research indicates otherwise: At the seed stage, investors would increase their expected return by broadly indexing into every credible deal. … How can you avoid missing the best seed deal? The simplest way is to put money into every credible deal. Maybe you have a crystal ball that gives you perfect foresight, in which case you can pick only the best winners. Even then, if your crystal ball is even a little cloudy eventually you will miss a winning deal—and that winning deal might have been the best-performing investment. Simulations on 10-year investing windows for seed-stage deals suggest fewer than 10% of investors will beat the index, even if those investors have skill in picking deals. Like Vanguard has taught us in the public markets, individual investors could benefit from viewing the index as the default and then overlaying individual deals that they like. Only at the seed stage; in later rounds it's better to pick good deals. But at the seed stage: Our research provides a principled quantitative underpinning for a broadly indexed "spray and pray" model of investing at a company's earliest stages. This is a controversial and contrarian point of view because this kind of investing has been maligned, or at least misunderstood, by traditional venture capitalists. … A VC who pitches their careful diligence, hard work, and sophisticated criteria for investment selection seems like a much better steward of an LP's money than a VC who pitches making so many early-stage investments that they could not keep up with their companies even if they tried. Yeah but you could have said that about public stock mutual funds 50 years ago, and now look at us. Start your angel index fund now! Capital Here, from Johannes Borgen, is a great little story about bank capital. Yesterday Coventry Building Society, a U.K. bank, announced "a correction to its calculation of risk weighted assets" that will lower its common equity Tier 1 capital ratio from 34.2% to 32.6%. That's still well over regulatory requirements, so this is not a big deal. But the way Coventry messed up is funny: The Society uses Internal Ratings Based ("IRB") models to calculate its Risk Weighted Assets ("RWAs") and is seeking to update these models to ensure compliance with upcoming Basel III reforms. During the process of transitioning models, the Society has identified an omission in connection with its historic calculation of its RWAs. Specifically, the necessary 6% scalar was not applied to the core IRB model outputs. The core IRB models themselves are not impacted. For banks that use Internal Ratings Based models, the way the Basel capital rules work is that you apply a complicated formula to calculate the risk weights of your assets, and then at the end of the formula you multiply everything by 1.06. That's kind of weird. (The Basel capital regime for banks using IRB models "applies a scaling factor in order to broadly maintain the aggregate level of minimum capital requirements, while also providing incentives to adopt the more advanced risk-sensitive approaches.") It's weird enough that in the "upcoming Basel III reforms" regulators plan to get rid of it: The 1.06 multiplier is a kludge, and if you measure your risk-weighted assets a bit more accurately and conservatively, you shouldn't have to multiply them by 1.06 at the end. I assume that, in preparation for those reforms, someone at Coventry went to the model to see what would happen if they deleted the "times 1.06" at the end of the model, and … uh … noticed that it was already deleted? They'd never put it in in the first place! Oops! Coventry's measure of its risk-weighted assets was 6% too low because it didn't multiply by 1.06 at the end. This doesn't really mean anything, it's just funny. The moral is, like, banks should do their math right? Bank supervisors should check their math? There are not a lot of places in finance where the last step in the process is "just multiply by an arbitrary number." I guess there are some. Usually the arbitrary number is significantly different from 1, though, so if you forget to multiply you'll notice. Here the difference was just 6%, and they missed it. Elsewhere in capital regulation, "the former head of the Basel committee of international banking regulators has hit out at bank lobbyists who argue for weaker rules so they can lend to green causes or small companies." And here is a Basel discussion paper on "designing a prudential treatment for crypto-assets." The proposed capital treatment for crypto-assets is, unsurprisingly, about as conservative as can be: Banking book treatment: bank exposures to crypto-assets would be subject to a full deduction from Common Equity Tier 1 capital. This treatment reflects the high degree of uncertainty about the positive realisable value of crypto-assets in times of stress; Trading book treatment: crypto-asset exposures held in the trading book would be subject to the equivalent of a full deduction treatment for market risk and credit valuation adjustment (CVA) risk (ie a 100% risk weight for delta, vega and curvature risk, with no diversification benefits permitted). … Banks would not be permitted to use the internally-modelled approaches for any crypto-asset exposures when calculating market risk, counterparty credit risk and CVA risk capital requirements; I suppose you could imagine a future where banks hold a lot of stablecoins, and the stablecoins are stable, and everyone accepts that they work, and the banks are like "this is just like holding dollar reserves and they should get a zero risk weight." But not yet, not yet. Congrats Aramco It's all going great: Saudi Aramco shares jumped for a second day, with the oil giant's value hitting the $2 trillion mark that alienated global investors and potentially making further share sales abroad more difficult. The stock climbed by the daily 10% limit to 38.7 riyals at the open in Riyadh before trimming gains. It was up 5.8% at 37.20 riyals at 1:54 p.m. local time in trading of 381 million shares, compared with 31.6 million for all of Wednesday. The surge reflects the kingdom's efforts to engineer a successful start to trading after international investors balked at the price: Saudia Arabia encouraged local individuals to buy and hold the stock through cheap loans and a bonus-share plan, while pushing wealthy families and regional allies to buy as well. The offering consisted of only 1.5% of Aramco's stock, so that investors who didn't get allocated shares in the IPO had to buy in the secondary market. Man, people in the U.S. are constantly complaining about the "IPO pop," but take a look at Wednesday's trading in Aramco. Aramco offered 3 billion shares, just 1.5% of its stock, in the initial public offering, and priced it at 32 riyals on Tuesday. Then it opened for trading on Wednesday and traded 31.6 million shares, "roughly 1 per cent of the company's free float, which is far below the average amount of trading expected in a newly listed company." For context, Uber Technologies Inc. sold 180 million shares in its IPO, and 186.3 million shares traded the first day. Trading more than 100% of the float on the first day is pretty normal. Trading 1% is not. If you are cynical about this IPO, as I am, you might attribute that to various artificial constraints on supply: local retail investors who get a bonus for keeping their shares for the long term, that sort of thing. (And: "The government has encouraged wealthy Saudi families, who own large conglomerates, to invest as a national duty, The Wall Street Journal has reported. Stock analysts don't consider them easy sellers.") But that's not actually the explanation, as you can see from the much greater volume that has traded on Thursday. The actual explanation is simpler: It was an artificial constraint on price. The Riyadh exchange has a 10% limit on daily price moves, so Aramco went limit-up its first day and stayed there. People wanted to buy for more than 35.20 riyals, and nobody wanted to sell for 35.20 riyals or less, so nobody traded. The next day there was a new limit, there were buyers and sellers below that limit, and so the stock can trade. It has reached, if not a "fair" or "correct" price, a price that at least for now seems to balance supply and demand. If the government of Saudi Arabia was run by Silicon Valley venture capitalists, at this point they would be complaining that Wall Street had helped out its investor buddies by selling them Aramco stock too cheap so they could make a guaranteed profit. Why not just sell the stock at the correct price, rather than at a 15% discount to the correct price? If on the first day everyone wanted to pay more than 35.20, and no one wanted to sell for less, pricing the IPO at 32 seems like a missed opportunity. But it seems pretty clear that this is what Saudi Arabia wanted: They wanted Aramco's IPO to trade up, they wanted a show of confidence from the market, they wanted investors to make some easy money, because they are playing the long game and they want to entice other, later investors to invest much more money down the line. This IPO is practice for an international share sale later on, and Aramco wants to set a precedent of investors making money. This is all the stuff that bankers tell founders and venture capitalists in regular startup IPOs too, by the way, but the founders and VCs have kind of stopped believing it, and now everyone seems to think that companies are being cheated if their IPO investors make a quick profit. Aramco doesn't think that, though. Oh, also, it is probably not a coincidence that the right price is right around $2 trillion.[1] That's the number that Aramco, and Saudi government leaders, wanted. They didn't get it from international investors in a big IPO, and they didn't even get it from local investors in their scaled-back IPO, but they got it two days later. And everyone knew that was the target: Several hedge funds, seeing the listing as an effective one-way bet, have bought shares, with the intention of selling out once they hit the $2tn mark, people familiar with the matter have said. You can kind of see that in the chart: The stock went limit-up this morning and then fell as some investors said "right, $2 trillion, that's done" and got out. And: "Saudi Aramco investors should take profit now after shares in the world's biggest company jumped 10% in their first day of trading Wednesday, analysts at Sanford C. Bernstein & Co. recommended in a note to clients." Spy vs. Spy Well here you go, the former head of Credit Suisse Group AG's joint venture for spying on its employees is accusing Credit Suisse of spying on her: Colleen Graham, who worked for a joint venture half owned by the bank, said she believes a woman followed her over three days that month, allegedly in retaliation over her stance on an accounting issue at the joint venture, according to filings released Tuesday by a U.S. labor court. Ms. Graham was previously Credit Suisse's compliance head for the Americas and spent 20 years with the bank before being selected to co-head the joint venture, called Signac. She wasn't an employee of the bank at the time of the alleged surveillance. … Ms. Graham previously alerted the bank to the alleged surveillance in a whistleblowing complaint against Credit Suisse and data-mining company Palantir Technologies Inc., filed with the U.S. Department of Labor in November 2017. The two companies were equal partners in Signac, a joint venture spun out of Credit Suisse in February 2016 to identify bad behavior by traders through data analysis. At the time, the bank and Palantir said Signac's trader-surveillance product could prevent losses and lower compliance costs, and would eventually be marketed to other banks. Yes! Well! I see her point; there's nothing you want less, after a long day of building a comprehensive surveillance system to monitor your coworkers' every move, than to find someone following you on the way home from the office. Shocked, shocked! I can't believe the employee-spying venture spied on its employees! Credit Suisse and Palantir deny it, by the way, and Graham has other commercial and employment disputes with them. ("Ms. Graham in a statement Wednesday said she will pursue claims against Credit Suisse and unnamed others, 'for wrongful use of the Trader Holistic Surveillance software.'" The wrongful use is doing the Holistic Surveillance without her!) On the other hand Credit Suisse has a bit of a history of embarrassingly trailing disgruntled employees, and … Palantir is a spy company and …. Signac was a spying-on-employees venture and … I don't know, I am at a loss, what did anyone here expect to happen? Things happen Ken Griffin Has Another Money Machine to Rival Hedge Fund. JPMorgan Takes Aim at Rivals in Wealth Business Revamp. Federal Reserve Keeps Interest Rates Steady, Sees Long Pause. Lagarde's ECB Keeps Policy on Hold as Strategy Review Looms. Vatican Uses Donations for the Poor to Plug Its Budget Deficit. Two Texas Billionaires Think They Can Fix Philanthropy. The Filecoin Testnet Is Live. Germany Pushes Forward on European Financial Transactions Tax. Nikki Haley Faces Backlash at Goldman After Confederate Flag Comments. Switzerland Investigates Metal Trader Over Congo-War Allegations. The Cynic's Guide to Reading Business Books. "That sentence has the aura of a curse, like if you read it too many times or even think about it for too long you will die or go blind or start to hear horses speaking to you in English." Pachelbel's Canon Played by Train Horns. Adam Neumann to be played by Cousin Greg. Luxury hotel guests keep stealing mattresses, survey reveals. 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] Aramco has 200 billion total shares, and the exchange rate is about 3.75 riyals to the dollar, meaning that a price of 37.50 gets you pretty much exactly to a $2 trillion valuation. As of 11 a.m. Eastern today the stock was a bit below 37 riyals, after hitting 38.70 on the open. | 
Post a Comment