| Programming note: Money Stuff will be off tomorrow, back on Monday. MelvinMy basic thesis about hedge fund managers is that the essential skill of a hedge fund manager is not picking stocks that go up, but rather continuing to manage a hedge fund. There is overlap between those skills, but they are distinct; in particular, plenty of people continue managing hedge funds even after losing lots of money, and if you want to be a "successful" (in my sense) hedge fund manager you should study their methods. (Alternatively, you can just always pick stocks that go up, which will probably make you pretty successful in my sense too, but that seems hard.) Classic methods include: - Institute strict lockups when times are good, your stocks are going up and investors love you, so that when times are bad and your stocks are going down the investors can't get out.
- Raise permanent-capital vehicles when times are good, so that when times are bad investors really can't get out.
- Just have a lot of good years before your bad years, so investors write the bad years off as a fluke.
- Write really good investor letters explaining why the losses aren't your fault.
- Etc.
Gabe Plotkin's Melvin Capital Management seems to have done at least some of these things; in particular, he had a really good performance record before getting blown up on a GameStop Corp. short trade in January. But he also made use of an arguably more novel technique: People close to his backers say they doubled down because they have faith in his trading acumen and personally like Plotkin, who's known as family-oriented and relatively nice in an industry that's famously cutthroat.
I'm sure that faith in his trading acumen mattered a lot, but I really love the idea of a pension-fund allocator saying, "Well, look, this hedge fund lost half our money last month, but the guy is actually nice, and it is pleasant for me to deal with one hedge fund manager who's nice, so I'm not going to make a big deal out of him losing all that money." Seriously, though, if your goal as a hedge fund manager is to gather and retain assets, rather than just pick stocks that go up, you should perhaps devote some effort to being nice. Like, being a good dad ("family-oriented") seems to have helped Plotkin retain clients after losing their money. "Sorry, I can't stay late at the office discussing investment ideas," you should say, "I have to go home and have dinner with my family. I don't want to of course, but it's the right business decision for the long-term success of our fund." Anyway, their faith in his trading acumen also seems to be paying off: After adjusting strategy, Plotkin pulled off an almost 22% gain in February, about eight times the return of the S&P 500. So starts the most arduous part of the 42-year-old hedge fund manager's bid to climb out of the hole left by January's clash, in which retail investors organized on social media to drive up stocks such as GameStop Corp. that Melvin and others had bet would fall. The episode cost his investors -- including billionaire Steve Cohen, Brown University and the Robin Hood Foundation -- more than $6 billion. But even with the rebound, Plotkin's fund, which had $8 billion at the start of February, will need to produce an additional 75% gain for earlier clients before they break even. Clients who have stuck by or piled into the firm are betting he'll be able to do that given his track record, which ranked him as one of the best stock pickers until this year.
The strategy changes are also kind of interesting. Here are some: He did modify his wagers on stocks he expects to tumble, saying in his testimony that he would avoid crowded shorts. A person familiar with his strategy said he also will take smaller-sized positions to limit exposure to single companies. And Plotkin told his team of data scientists to scour social media and message boards to look for shares that retail investors are rallying around. He has stopped using exchange-traded puts that show up on his quarterly filings with the Securities and Exchange Commission -- clues that allowed his firm to be singled out by the Reddit crowd.
Ugh, I am sorry, but the trade here is: - Scour Reddit to see what stock retail investors are rallying around, sure.
- Just before the end of a quarter, buy a few listed puts on that stock.
- Just after the end of the quarter, but before your 13F filing deadline, sell the puts and buy a ton of stock instead.
- File your 13F, indicating that you're short (via puts), even though you are currently long.
- Reddit, which likes the stock anyway, will see that you are short, get angry and decide to squeeze you by rocketing the stock to the moon.
- Now you are rich.
I'm sorry, I'm sorry, that is not legal or investing advice, but it is a little tempting, isn't it?[1] I often write that it is a pleasant and lucrative situation for an investor to be able to move a stock simply by announcing that he's taken a position in it. Melvin Capital has that ability. In a negative way, sure—Plotkin can move a stock up by announcing that he's short it—but so what. The ability to predictably move a stock is the valuable thing here; you gotta take advantage. GalvinElsewhere in endless GameStop fallout, the next frontier of financial regulation is absolutely going to be how much in-app confetti is allowed in retail stock trading: Robinhood Markets is weighing whether to scrap its iconic confetti animation after concerns that the popular trading app is making investing too much like a game, according to people familiar with the matter. The animation has come to symbolize the Silicon Valley firm, but is also a lighting rod for criticism from watchdogs fretting over how investing apps such as Robinhood drive compulsive behavior. … When Massachussetts financial regulators filed a complaint against Robinhood last year, accusing the app of encouraging frequent trading with carefree animations like the confetti, the firm defended itself. "Confetti do not appear after every trade," Robinhood said in response to the complaint. "Thus, confetti do not, as a factual matter, have anything to do with frequent trading." "There's nothing wrong with app features like confetti, and the Division's attempt to define confetti as dishonest or unethical reflects a distinctly antiquated view of communication in the digital age," it said.
I have to say, I sometimes play computer games on my phone, and my impression is that the thing that distinguishes Robinhood from other smartphone games is not so much the in-app animations as it is the money. Like, on Robinhood, you play a game on your phone, and sometimes you win money! Other times you lose money! Surely no one is trading on Robinhood for the confetti? No one is like, "Welp, I lost money on that last trade, but I was consoled by animated confetti, so I might as well do a few more dumb trades because I can't get enough of that confetti"? If that is an actual behavior then I am going to release my own stock-trading game; it will be a lot like Robinhood except: - Much more confetti, and
- It's not linked to your bank account and the trades are all pretend.
If there are people who are in it for the confetti, why make them buy the actual stocks? I will happily sell this idea to the Massachusetts financial regulators if they want. Separately, making it super-easy to trade stocks for free on your phone probably does contribute to gamification, addictive behavior and poor financial decisions by some Robinhood customers, but that's not about the confetti. I think a plausible regulatory response to Robinhood would be, like, "Stock-trading apps have to charge at least $1 per trade and the user interface should be kind of stodgy and annoying." I'm not sure that's correct—I have some sympathy for Robinhood's view that it is democratizing investing, though also plenty of sympathy for Massachusetts' view that it is gamifying it—but if you do want to prevent the gamification, banning confetti does very little. Elsewhere, here is a Bloomberg Businessweek story about William Galvin, the secretary of the commonwealth of Massachusetts, who is leading its case against Robinhood: William Galvin is as old school as they come, even for a state securities regulator. Galvin, 70, drives an Impala, uses a flip phone, and leaves the emailing and tweeting to his staff. … In December his office sued Robinhood, alleging that the trading platform violated state law by emphasizing the addictive thrills of trading over helping novice investors learn how to make sound investment decisions. He says the company's brightly designed smartphone app is promoting the "gamification" of investing with features such as animated confetti when users make their first transaction and promotions giving away free stock for signing up or referring friends. … Galvin won't necessarily have an easy road, says Abu Jalal, a finance professor at Suffolk University in Boston. He must prove that Robinhood's features are materially different than those offered by other trading platforms. "There's still a bell ringing or a text sent when your order has been filled," Jalal says of other brokers' apps. "And you can still go in and see if you managed to make some money."
Yeah, again, I think that the main dopamine payoff of the game is probably seeing if you made money. Wash tradingHere's the sweetest saddest little enforcement action from the U.K. Financial Conduct Authority. Adrian Horn was an equity trader at Stifel Nicolaus Europe Ltd., making markets in real estate stocks. His job was to place bids to buy and offers to sell the stocks he covered, and ideally to buy them at the bid and sell them at the offer and trade a lot of shares and make a lot of money. If you are a market maker, you are evaluated in part on your ability to trade a lot of volume. If you keep posting bids and offers on a stock and nobody trades with you, that means you are not being aggressive enough, not bidding high enough or offering low enough, and you are not making any money for your firm. Also I guess it would be kind of boring, being a trader who doesn't do trades. One of the stocks Horn covered was a company called McKay Securities Plc. McKay's stock didn't trade that much in 2018 and 2019, the period for which Horn got in trouble. Horn believed that it needed to trade more, because McKay was in the FTSE All Share Index, and Horn worried that it would fall out of the index for not trading enough. From the FCA order: The FTSE All Share Index represents the performance of all eligible companies listed on the LSE main market. It captures 98% of the UK's market capitalisation. For an issuer's shares to be included, there must be a minimum amount of liquidity or tradability of its shares. If a constituent of the FTSE All Share Index fails to meet the liquidity criteria as per the index provider's annual calculations performed in June of each year, the company will be removed. It would then fall into the FTSE Fledgling Index.
It is good to be in the All Share Index (more index funds, etc., buy your stock) and not as good to be in the Fledgling Index. Horn wanted what was best for McKay: During the Relevant Period McKay was listed on the LSE and was a constituent of the FTSE All Share Index. Stifel acted as corporate broker and financial adviser to McKay. The nature of this agreement required Stifel to perform various tasks such as market-making in McKay shares and providing share price and market information. There was no requirement in the agreement for Stifel to trade a specified number of McKay shares.
Horn apparently decided that McKay's stock needed to trade 13,000 shares a day. This is not in fact how the All Share Index liquidity calculations work—they involve monthly medians of daily trading volumes—but equity trading is, uh, not always a precise science. And so Horn took it upon himself to make sure it traded 13,000 shares a day. If it got near the end of the day and McKay hadn't hit that number, Horn would trade the extra shares with himself. On one side he'd put in an order to buy (or sell) shares directly, using Stifel's access to the stock exchange; on the other side he'd put in an order to sell (or buy) shares through another broker[2]: Mr Horn would check to see how many McKay shares had traded before the market closed and, if the volume traded was below 13,000, would make up the shortfall by executing wash trades with himself. Mr Horn thereby placed buy orders in McKay shares that traded with his existing sell orders (and vice-versa). With a view to avoiding detection, Mr Horn usually placed one order into the market through a third-party broker via a Smart Order Router ("SOR") and the order with which it would execute via Stifel's direct access to the LSE.
For instance: An example of Mr Horn carrying out wash trading took place on 7 May 2019. At 7:53:00, Mr Horn placed two limit orders. Each order was for 3,000 McKay shares and was placed directly on the LSE order book. The buy order was priced at £2.35 and the sell order was priced at £2.45.
He was making a market: Offering to buy or sell stock with anyone who wanted to trade, with a 10-pence spread between his bid and his offer. But: By 14:56:14 no trades in McKay shares had been executed in the market that day. Mr Horn entered a 5,000-share sell order through a third-party broker's SOR at a price of £2.42. This order became the best offer price (the previous best offer had been £2.44). The purpose of the sell order was to try to encourage other market participants to trade.
He had traded no McKay stock all day and was getting bored, so he tightened his market to try to get someone to trade. Fine. At 15:00.45, a trade for 8,219 McKay shares was executed in the market. Mr Horn was not involved in this trade but would have been aware of it. By 16:05:00, the number of McKay shares traded that day was 8,219, which was 4,781 short of 13,000. At 16:05:01 Mr Horn entered a 5,000-share buy order in McKay at a price of £2.42 per share. The order was placed onto the LSE using Stifel's direct membership. This buy order executed against the 5,000-share sell order Mr Horn had placed at 14:56:14. Mr Horn thereby conducted a wash trade as he had traded McKay shares with himself.
There hadn't been enough trading with him, so he traded with his own order to make up the difference. He bought 5,000 shares at 2.42 pounds, sold the same 5,000 shares at the same 2.42 pounds, and could at least say he'd traded some McKay stock that day. Sort of. He did 129 wash trades on 68 days over roughly 10 months, representing about 5.4% of the volume during that period. "On the days that Mr Horn executed wash trades, on average they accounted for 39.4% of the total market volume in McKay shares." As far as I can tell no one told him to do this, and it ended when Stifel noticed he was doing it and told him to stop. His motivation seems to have been … sort of charmingly innocent? Mr Horn's motive for executing the wash trades was to ensure that at least 13,000 McKay shares were traded each day which he believed, from conversations with colleagues, was a liquidity requirement to remain in the FTSE All Share Index. He assumed that McKay wanted to remain in that higher index for status and rating purposes. Mr Horn thought that by assisting McKay to remain in the FTSE All Share Index he would benefit the relationship between Stifel and its corporate client McKay. Additionally, whilst Mr Horn was not asked to execute a certain volume of shares a day, he considered that it would reflect badly on him within Stifel if McKay did not achieve sufficiently high trading volumes.
That all seems sort of directionally right: Most companies do want to stay in the good index, making companies happy is good for the relationship between clients and brokers, and trading a lot of shares is good for a trader's reputation within his firm. I suppose if he never traded any McKay shares then (1) his bosses would think he wasn't a very good trader, (2) maybe McKay would have fallen out of the index, and (3) maybe McKay would have noticed that Stifel never traded its stock and blamed Stifel for falling out of the index. But it was all sort of implicit; he doesn't seem to have discussed it with anyone. He just felt bad that he wasn't trading much McKay stock, so he traded some of it with himself. For this, the FCA banned him from the securities industry and fined him 52,500 pounds. You really can't do this stuff! Wash trading, bad. On the other hand the FCA notes that he doesn't seem to have made any money off of it—for his firm or for himself—and it's not clear that he did much harm. "As the liquidity of a stock is a factor a market participant may consider prior to making an investment decision, market participants may have made decisions to buy or sell McKay shares (or other related companies) based on the artificially high volume of trades reported due to the wash trades," says the FCA, and that is true enough, but it's not like he was creating frenzied activity in order to pump up a stock. He was just creating a little activity because he thought the stock seemed lonely. College reunions?Here is sort of a bizarre finding from Harvey Cheong, Joon Ho Kim, Florian Munkel and Harold Spilker: Material private information transmits through social networks. Using manually collected information on networks of alumni reunion cohorts, we show that hedge fund managers connected to directors of firms engaged in merger deals increase call option holdings on target firms before deal announcements. Effects are larger when reunion events for connected cohorts occur just before announcements. Independent directors, directors with short tenure, and directors with low stock ownership are more likely to transmit information. Our results are robust to confounding factors and alternative specifications. These findings highlight the role of social networks as channels of private information dissemination.
The paper is called "Do Social Networks Facilitate Informed Option Trading? Evidence from Alumni Reunion Networks." The "alumni reunion networks" are fascinatingly weird; basically the idea is that people who went to the same college some integer multiple of five years apart are more likely to be friends with each other: Many universities organize reunion events in the form of "mixers" for multiple classes celebrating milestone graduation years. For example, alumni celebrating their 5th, 10th, 15th, 20th, etc. reunions are often invited to the same reunion event every five years. This feature makes the reunion events a forum in which invitees from arbitrarily chosen class years can interact and develop relationships.
And so in fact a hedge fund manager who went to the same college as a corporate director, say, 15 years apart is apparently more likely to buy call options on the director's company just before it is acquired in a takeover than a hedge fund manager who didn't go to the same school, or who did go to the same school but 14 years apart. Huh. Okay? I would not have guessed either that: - Buying call options on potential merger targets was a major hedge fund activity,[3] or
- People regularly became friends with members of their five-years-apart "alumni reunion cohorts."
But perhaps that's why I don't manage a hedge fund; perhaps the path to success in hedge fund management is socializing with the older classes at your alumni mixers, because some of them will be asset allocators and give you money, and others will be corporate directors and give you stock tips. Rocket: rocketOkay, sure, sure, sure, sure, sure, sure, this again, sure: The individual investors that powered GameStop Corp.'s meteoric rise have a new target: Rocket Cos., the parent company of Quicken Loans. Shares of the mortgage lender surged 28% since the end of last week. Nearly 377 million shares traded hands on Tuesday alone, more than a 10-fold increase from the previous day. After surging 71% on Tuesday, the stock lost some steam on Wednesday, falling 33%, or $13.59, to $28.01. … Trading of Rocket shares was halted several times this week because of its volatility. Individual investors on WallStreetBets, the Reddit community that gave birth to GameStop's rise, have been encouraging each other to buy the stock in recent days and sharing evidence of their own massive gains. They have relished in the company's name——Rocket——an apt one for their goal of higher prices. "The $RKT is fueled and ready for liftoff," one user wrote early this week.
There are some fundamental catalysts—good earnings, a special dividend announced last week, rising rates—but I guess we're going with "it's a meme stock"? ("The initial move made some sense, but since then, fundamentals haven't been driving it," says an analyst.) It's got a good name for it. People on Reddit loved putting rocket emojis next to GameStop's ticker when it was having its moment, and the Reddit GameStop sea chanty features rockets prominently. "Rocket" is just a word that gets used next to stocks that WallStreetBets wants to go up. An important feature of modern stock markets, unfortunately, is that companies sometimes go up not for any fundamental reason but because their names or tickers sound like something good. Usually this is, like, a small public company whose name sounds like a hot private company that just did a merger or announced a planned IPO or launched a good product or had Elon Musk tweet about it; people want exposure to the good private company and buy the small public company instead. But sometimes—I mean, here is a November 2016 article with the headline "Chinese Stock That Sounds Like 'Trump Wins Big' Wins Big," which makes absolutely no sense at all, and yet it happened: Wisesoft Co., whose local-language name "Chuan Da Zhi Sheng" sounds like "Trump Wins Big," closed 6.4 percent higher with trading volume six times the three-month average. Yunnan Xiyi Industrial Co., or "Aunt Hillary," tumbled 10 percent.
Why shouldn't a stock whose name is "rocket" rocket up? People come to Reddit, see all the rocket emojis, say "hmm I guess the point here is to buy rockets," so they buy Rocket. It makes as much sense as everything else, which is to say none at all. Things happenBank Appetite for Bonds Fueled by Capital Holiday. Hedge funds cash in on the 'great reflation trade.' Zoltan Pozsar on What Just Happened with the Treasury Market. SpaceX's Biggest Rocket Manages First Landing, Then Explodes. KKR Moves to 'Democratize' Private Equity as SEC Signals Industry Scrutiny. Mania in First Bitcoin ETF Cools in Canada After Robust Debut. Inside Pfizer's Fast, Fraught, and Lucrative Vaccine Distribution. Sands to Sell Las Vegas Properties for $6.25 Billion to Apollo Global, REIT. Why the Biggest U.S. ESG Fund Has No Direct Renewable Holdings. Square acquires majority of Tidal, Jay-Z's streaming service, in $297 million deal. "The Mavericks have decided to accept Dogecoin as payment for Mavs tickets and merchandise." Boris Johnson Gives Up ' Late-Night Cheese' to Lose 14 Pounds. 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] You may recognize it as a variant of a funny trade that Josh Wolfe suggested to me during the GameStop debacle. In Wolfe's trade, you buy stock and then publish a *short research report*, causing indignant Redditors to push the stock up. This trade (file a 13F with puts) is better than that one in that it seems less like "manipulation." (Though maybe a little like manipulation: Why were you buying those puts?) It's worse in that it takes a longer time to work out (you have to start it before quarter-end, and finish it after the 13F filing 45 days later), and Reddit's opinion or influence may change in that time. [2] It might seem a little weird for a market maker to go through another broker to trade stock, but actually it seems like it was more efficient for him. The FCA says: "Each SOR featured an algorithm that would place the order across various exchanges in a particular way. Mr Horn was able to add instructions as to how he wanted the order executed. For example, he could request that the order be worked as a percentage of the total volume traded in the market that day. Mr Horn would typically default to a third party SOR due to its fast speed and its ability to route the order to various exchanges. If Mr Horn placed an order via Stifel's direct access to the LSE market, the order would only go to the LSE." [3] Surely it is forbidden by the Second Law of Insider Trading? | 
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