SecondAct One broad, cruel stereotype of the financial industry is that it is about getting people to do things, and charging them for it, and then getting them to undo the things, and charging them for that. What is market making if not selling stuff to people, buying it back moments later, and charging a spread on both trades? On a longer time horizon, there is a popular reductive view that leveraged finance bankers are in the business of loading companies up with debt in the good times, restructuring that debt in the bad times, and charging fees all the time. Or that mergers-and-acquisitions bankers are in the business of convincing CEOs to build sprawling conglomerates, and then convincing them to break up those conglomerates, with big fees on the way in and on the way out.[1] It's a little unfair but there is an important truth to it. The financial industry is in the business of intermediation, and it earns its living by doing trades. It is a volume business, "moving not storage"; the job is not to do the platonically correct transaction but to keep doing transactions. If you could find the platonically correct transaction, the thing that makes your client happy forever, you wouldn't have the client anymore. If the allocation of capital ever became perfectly, permanently correct, a lot of people would be out of jobs.[2] Or they'd become ESG investors. Here's a funny story about Jeff Ubben: Activist investor Jeff Ubben has left ValueAct Capital, the $16bn hedge fund he founded, to launch a new environmental and social impact investment company. ... Environmental and social impact is a logical next step for activist hedge funds, said Mr Ubben, who is famous for a friendlier approach to activism which avoids public battles with target companies in most cases. ... "Companies, as governed today, with investors asking for more current returns and more buybacks and so forth, aren't working for society or nature," he said. "But I have to prove that there's a return [in long-term impact], because otherwise . . . you're not really changing anything." Activists can still "bully little companies to sell to private equity," he said, but doing so will only provide modest profits. "Finance is, like, done. Everybody's bought everybody else with low-cost debt. Everybody's maximised their margin. They've bought all their shares back . . . There's nothing there. Every industry has about three players. Elizabeth Warren is right." At FT Alphaville, Jamie Powell amusingly compares each sentence of that last paragraph to ValueAct's activist campaigns over the last few years, which have involved pushing debt-financed acquisitions, maximizing margins, buying back shares and consolidating industries. "Perhaps Ubben has had a change of heart," says Powell, but I want to suggest that that's the wrong way to read this. When Ubben says "finance is, like, done," he doesn't mean that it's bad. He means that it has completed its work. This is a victory lap; Ubben is boasting that activist investors have, by their own standards, perfected the corporate universe. Activists activisted all the companies until there was no more activisting to be done.[3] Now you gotta activist the other way! That's just how this works! Once you have dug the holes, you have to fill up the holes; the content does not matter; at the highest level of generality this has nothing to do with anyone's views about the nature of capitalism or the social purpose of the corporation or the value of leverage. This is just, you do the trades, then you undo the trades. You pour the water from one bucket into the other bucket, and then when that one is full you pour it back into the first bucket, because your job is pouring water and that's what you're paid for. Taking companies to one extreme of financial capitalism creates the conditions to move them back toward the other extreme. Someone has to tell companies to sell bits of themselves to pay down debt, reduce margins and sell more shares; someone has to charge management fees for doing it. Again, that is probably too high a level of generality, this is a cruel and reductive view of the work of financial intermediaries, people's priorities change, some ideas produce more long-term value than others, I'm sure Ubben genuinely cares about inclusiveness or whatever, etc. It's just, you know, this is a simple explanation of how the machine works. ESG CDS This is a few weeks old but I love it, this is finance right here: This month will see a significant step forward in the evolution of ESG (environmental, social and governance factors) as a part of fixed income investing, with the launch of the iTraxx MSCI ESG Screened Europe CDS (credit default swap) index. ... The iTraxx Main index already allows investors to gain long or short exposure to the risk and return profile of a basket of 125 of the most liquid CDS referencing underlying European investment grade bonds, and attracts trading volumes close to €1.5 trillion a year. The new ESG index will be an exclusion-based version of the Main, and will start trading from 22 June 2020 at the five year tenor. If you are a socially responsible investor, should you buy this? (That is, should you go long this index?) On the one hand, you are putting your money on good, green, socially responsible companies (by whatever metric the index uses). On the other hand, you are not exactly investing in those companies. You're not buying their bonds. They're not getting the money. You are entering into a zero-sum bet with some financial counterparty, referencing those bonds. Your socially responsible investing is purely abstract, disconnected from the actual process of funding companies that do good work and not funding companies that do bad work. But so is everything. If you invest in a socially responsible stock mutual fund, that fund is not buying much stock from socially responsible companies. Public companies—socially responsible or otherwise—just don't sell that much stock that often. Your mutual fund is buying stock in the secondary market from, basically, high-frequency traders. Essentially none of your money is directly going to fund green products. Socially responsible bond funds are a little different, since bonds mature, and institutional bond investors do more of their buying in the primary market. But we have talked about the possibility of secondary trading of green certificates detached from green bonds: You can buy an issuer's pure promise to do green stuff, not from the issuer. BlackRock or whoever can say "hey I've got some Danish promises not to pollute lying around, want to buy them?," and you can buy them, it is wild stuff. The point of all of this is pretty well understood and uncontroversial: If you buy nice companies' stocks and avoid evil companies' stocks, the cost of capital for nice companies will go down and the cost of capital for evil companies will go up. The effects are indirect but real enough: Nice companies will have an easier time borrowing money with a high stock price, they'll have an easier time attracting workers with stock options, they'll have an easier time acquiring other companies in stock mergers. Nice private companies will have an easier time raising money and going public, and nice people will be more likely to form new nice companies because their financial prospects will be better. Etc. The CDS story is similarly straightforward: If you buy nice-company CDS, that will lower the cost of hedging nice-company debt, which will make it easier for nice companies to raise money to do nice things. It's fine, you are helping the nice companies without ever giving them a penny. It is indirect but sure, why not, it should work. You just have to believe in the invisible strands that tie modern high finance together. And also want to be socially responsible. Give to the rich, give to the poor Here are two weird stylized facts about the "Robinhood market": - The new, fun-seeking retail traders buying stocks on Robinhood seem to be doing pretty well, and
- The people selling them stocks also seem to be doing well.
I mean, the second fact is pretty straightforward. If the stock market is a casino that happens to still be open—if people have piled into mobile-phone-based stock trading because traditional forms of gambling and entertainment are closed due to pandemic—then the people running the casino should be making a lot of money. They are: Citadel Securities and its majority owner Ken Griffin are among the big winners from a boom in retail investing, cashing in on the zero-fee trading that has lured huge numbers of first-time investors to the US stock market. ... Citadel Securities pays tens of millions of dollars for this order flow but makes money by automatically taking the other side of the order, then returning to the market to flip the trade. It pockets the difference between the price to buy and sell, known as the spread. Easy access to the market against the backdrop of wild swings in prices have led to higher trading volumes for stocks and options this year — increasing the raw material Citadel Securities uses to turn a profit. At the same time, the rise in volatility has forced spreads wider, increasing the potential income for market makers. Day traders buy and sell stock through retail brokerages like Robinhood. The brokerages send their customers' orders to wholesalers like Citadel: If you want to buy stock on Robinhood, you press the buy button, and Citadel (or another wholesaler) sells you the stock. This is a lucrative business, being on the other side of the trade from you, so Citadel is willing to pay Robinhood to do it. On the other hand the way casinos make money is that their customers lose money. That is not not happening here, exactly—here are some scary stories about Robinhood customers recklessly trading options—but overall the Robinhood crowd seem to be doing okay. Here's CNBC from last week: Retail investors are giving Wall Street pros a run for their money during the market comeback, with the amateurs' top picks outperforming those of hedge funds, according to Goldman Sachs. Goldman — using Robinhood, Robintrack and FactSet — compiled a portfolio of popular stocks among retail investors and the basket of equities is up 61% since the depths of the bear market in March. The firm's hedge fund basket is only up 45% in the same period. And here's Bloomberg News on June 13: Just because small-time investors are a presence doesn't mean they're wrong. To date ... the lion's share of their trades have been money makers. Stocks surging now are the ones that fell the most in February and March -- evidence to some observers of a healthy buy-low bent. And while expected earnings may not justify the moves, buying equities when the Federal Reserve has all but guaranteed rock-bottom interest rates through 2022 may be a perfectly logical decision. Being on the other side of the trades from bored novice day traders is a lucrative business, but not because the bored novice day traders consistently lose money. It's lucrative because market makers like Citadel are in the volume business, buying at the bid and selling at the offer; as they do more buying and selling, and as bids and offers get further apart, they make more money. Citadel is not in the business of betting against retail traders; it is just in the business of making their trades happen and collecting a spread. Still it's a little strange. Part of the way that Robinhood traders are doing well is that they are picking good stocks (mostly) and stocks are going up due to general economic conditions. But another part of the story seems to be that Robinhood investors' picks are self-fulfilling prophecies. Lots of small retail traders are buying stocks because they are popular on Robinhood, or mentioned in online forums to discuss day-trading; the stocks go up because so many retail traders buy them, not because the retail traders identified some external fact in the world that would make them go up. "Basically Robinhood is one giant momentum algo," one reader put it to me by email. The classic explanation for how Citadel and other market makers make money by trading with retail investors—and why they pay for those investors' order flow—goes something like this. Market makers buy at the bid and sell at the offer: Their business is to buy stock for $9.99, sell it at $10.01, and collect that $0.02. If they trade with big smart hedge funds, this will often go poorly for them: If a market maker sells 100 shares to a big smart hedge fund, that probably means the price is going higher, either because the hedge fund is smart (and knows some reason that the price will go higher) or because it is big (and will buy a lot more stock, pushing up the price). Selling 100 shares at $10.01 is not a good trade if the price goes to $11 before you can buy it back at $9.99; trading with big smart hedge funds leaves you at risk of this sort of "adverse selection." Trading with retail, on the other hand, is pleasingly random: If you sell 10 shares to a teen trading on her phone, she probably doesn't have proprietary information and probably isn't about to buy 10,000 more shares. You can sell her 10 shares for $10.01, and then buy 10 shares from another teen for $9.99 a minute later, and keep your book balanced while collecting the spread. As one of those articles about retail options trading puts it: "Such firms find it more consistently profitable to trade against individuals, with their small orders, than against institutional investors, which can push prices up or down with large trades." Except that Robinhood, collectively, can do that too now? Maybe more so than most institutions: Most big investors try to minimize market impact so they can buy or sell stock efficiently; the distributed army of retail momentum traders doesn't care, and in fact day traders on Reddit seem to explicitly enjoy pushing stock prices around. If a teen on Robinhood buys 10 shares of a stock, there is a good chance, now, that thousands more teens will do the same and the price will move. Velocity of money I don't write a lot about monetary policy around here but is this a thing? Banks around the U.S. are running low on nickels, dimes, quarters and even pennies. And the Federal Reserve, which supplies banks, has been forced to ration scarce supplies. ... Rep. John Rose, R-Tenn., sounded the alarm last week during a hearing before the House Financial Services Committee. "My fear is that customers who use these banks will react very poorly," Rose said. "And I know that we all don't want to wake up to headlines in the near future such as 'Banks Out of Money.' " The congressman warned that if businesses are unable to make exact change, they'll be forced to round up or round down, "in a time when pennies are the difference between profitability and loss." All I want, right now, is to read one company's quarterly earnings call transcript where the chief financial officer is like "well we unexpectedly swung to a loss this quarter because we had to round up people's change, which destroyed our margins." That should be a line item on the income statement, Loss Due To Rounding Up Change. "Meanwhile our suppliers rounded down our change, which also hurt." Here is, uh, the Fed's explanation: During the lockdown, many bank lobbies where people can recycle coins were off limits. And coin-sorting kiosks in retail stores saw reduced traffic. With many businesses closed, unused coins piled up in darkened cash drawers, in pants pockets and on nightstands, even as banks went begging. "The flow of coins through the economy ... kind of stopped," Powell said. People talk endlessly and breathlessly and loosely about how much money the Fed has been "printing" for the last decade or so, but there is still work to be done: Federal Reserve Chair Jerome Powell assured Rose that the central bank is monitoring the situation closely. "We're working with the mint to increase supply, and we're working with the reserve banks to get that supply where it needs to be," Powell said. "So we think it's a temporary situation." Money printer go clang, clang, clang, etc. I hope there's an arbitrage. I have a $10 roll of quarters, do you think I can get $11 for it? Who controls a company? We have talked a few times about this question, and I tend to take a practical view that whoever has the keys to the front door, or the password to the corporate Twitter account, controls the company. Sure there is a legalistic hierarchy of control, and the shareholders can appoint the board of directors who appoint the chief executive officer, but if the shareholders and the CEO have a disagreement and the CEO has the keys and the shareholders don't, they are going to be stuck banging on the door. In China the equivalent of the keys is the corporate seal (and the WeChat password): Arm Ltd., the chip designer owned by SoftBank Group Corp., ousted the head of its Chinese venture after discovering the executive had set up an investing firm that would compete with its own business in China, according to people with direct knowledge of the decision. … What followed was a public, acrimonious clash between Arm Ltd. and [Arm China CEO Allen] Wu, who refused to budge and used the Chinese venture's WeChat account to amplify his defiance. That Arm and Hopu [the main shareholders in Arm China] have been unable to assert their will reflects the intricacies of Chinese rules that confer an advantage to Wu as the holder of key registration documents. As the legal representative of Arm China, Wu holds the company's registration documents and the company seal, or stamp. Changing the legal representative requires taking possession of the company stamp -- something Wu has refused to give up. Arm Ltd. and Hopu could go through the courts, but the process could take years. To fire the CEO, they need the stamp, but the CEO has the stamp, so he has to approve his firing, and he won't do it. Oh sure sure sure the shareholders have formal ownership rights, they "could go through the courts," but in practice the seal is the reality of control and the ownership is a mere abstraction. I hope they're sending a team of cat burglars to get the seal back. Are Masayoshi Son's PowerPoint slides bad? No, they are very very good. Here is a roundup of some of Son's greatest PowerPoint hits, coupled with an argument that they were once good, when SoftBank Group Corp.'s investments were going up, but now that those investments are going down the slides are bad: His proclamations may be easy to laugh at, but they belie a serious shortcoming: Son is having a hard time communicating his message. When SoftBank was largely a domestic player, audiences in Japan were used to his eccentric style — from declarations about curing human sadness to SoftBank's Pepper robot reading out financial results. But in recent years, global investors have tuned in — only to be baffled or worse by Son's presentations. "That kind of quirkiness used to contribute to Son's charisma. But the legendary investor halo he once had above him has slipped and now these things are working against him," said Justin Tang, head of Asian research at United First Partners in Singapore. But there are more important things than winning investor support, or even making good investments. Son's slides are beautiful, they are absurd business art, they take dry business facts—"we give companies lots of money so they can grow faster than their competitors," etc.—and turn them into something wild and transcendent. What a loss it would be for the world, and even for SoftBank investors, if they got Son to stick to business and stop doing weird slides. Things happen Junk Bonds Topple Monthly Sales Record in 'Party Like No Other.' Wirecard scandal leaves German regulators under fire. Wirecard's Downfall Blows Up $1 Billion Lifeline From SoftBank, Credit Suisse. Credit Suisse Reviews Funds Linked to SoftBank-Backed Firm. SoftBank raises $14.8bn from T-Mobile US share sale. Culture of Inflating Oil Reserves Helped Stoke U.S. Shale Boom. Wrongfully Accused by an Algorithm. "Yield farming." The Segway is officially over. Barcelona Opera Reopens With An Audience Of Plants. "He's the J. Edgar Hoover of lifeguards." 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] I have lost track of what Dell Technologies Inc. is doing with VMWare Inc., but it sort of bought it and sort of spun it off simultaneously, then it sort of bought it some more, and now it might sort of spin it off some more (or buy it some more?). "Dell Technologies Inc.'s magical merry-go-round of financial engineering is spinning once again," is how my Bloomberg Opinion colleague Brooke Sutherland puts it. The bankers charge fees for each ride. [2] Thomas Philippon has sort of a famous 2014 paper about the efficiency of the financial industry, finding that financial intermediation has "an annual cost of 1.5% to 2% of intermediated assets." He writes: "The unit cost of financial intermediation appears to be as high today as it was around 1900. This is puzzling. Advances in information technology (IT) should lower the physical transaction costs of buying, pooling and holding financial assets. … The comparison with retail and wholesale trade is instructive. In these sectors Philippon (2012a) shows that larger IT investment coincides with lower prices and lower (nominal) GDP shares. In finance, however, exactly the opposite happens: IT investment and the income share are positively related." [3] Obviously you can disagree with him, plenty of activists are still pushing share buybacks, etc.; this is just one man's entertainingly expressed view. | 
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