Worries, Volatility and Activism
(Bloomberg View) -- Programming note: Money Stuff will be off tomorrow, Thursday, May 18, but back on Friday.
People are worried that people aren't worried enough.
"Trump Faces Deepest Crisis of Presidency as Comey Memo Surfaces," is the headline here, from Bloomberg Politics. "GOP Reels From Trump Chaos as Congress Struggles to Chart Course," is another one, about how any sort of pro-business legislation is increasingly unlikely given the White House's daily disasters. "White House Turmoil Puts the GOP Agenda at Risk," adds the Wall Street Journal. And Ross Douthat writes that Donald Trump's own closest advisers "have no respect for him, indeed they seem to palpate with contempt for him, and to regard their mission as equivalent to being stewards for a syphilitic emperor." None of this is ... good.
"Here's What the Latest Trump-Comey News Is Doing to Markets," is the headline here, from Bloomberg Markets, and from the depth of the crisis I bet you can predict what it is doing to markets: not that much, really! "U.S. stocks could be in for a weak Wednesday if index futures are any guide, with S&P 500 e-mini futures down 0.6 percent as of 12:46 p.m. Tokyo time." (I see them down about 0.8 percent just before 9:30 a.m. in New York.) The S&P 500's realized volatility over the past couple of "complacent" months has been about 7 percent, approximating a standard deviation of daily returns of about 0.4 percent. "The Presidency Is in Crisis," notes Daniel Gross. "Why Are Financial Markets Still So Calm?"
Last week I scoffed at the notion that social media and the rise of fake news have caused the decline in volatility. "The reality is the opposite," I said: "Stocks are constantly moving around on dumb fake news, or on dumb news about entirely unrelated companies." But it is hard to resist the idea that there is a news-fatigue element to what is going on. Stocks, traditionally, have overreacted to news. A thing happened, and traders thought they were smart and over-interpreted it, and the next day something else happened and people over-interpreted it the other way. But there is just too much news now. If you over-interpreted all of it, you'd get whiplash. So a retreat into under-interpreting -- from panicking at minor news to shrugging off huge news -- seems like a natural reaction. The new way to tell yourself that you're smart is by not reacting to news; the meta-over-interpretation of the news environment is to under-interpret any particular piece of news.
Elsewhere, my Bloomberg colleague Tracy Alloway discusses a popular technical explanation for the lack of volatility, which is that dealers are long gamma on stock indexes:
Large dealer banks that buy or sell the S&P 500 to hedge exposure to U.S. equities are helping to suppress realized volatility and keep the VIX low, the Deutsche Bank analysts say. By their estimates, dealers would have to buy $14 billion if the S&P 500 fell by 1 percent. It’s all about "gamma" -- the third Greek letter.
“When dealers are long gamma they sell equities when equities are rising, but buy them when they’re falling,” write Deutsche Bank analysts led by Rocky Fishman.
But "technical" explanations often turn out to be fundamental explanations in different words. The reason that volatility is low is that dealers are suppressing it. The reason dealers are suppressing realized volatility is that they are long a lot of options and need to hedge.. The reason they are long a lot of options is that investors have sold them a lot of options. (The reason they need to hedge is that they are not in the business of taking outright positions: They are service providers, bookies, not bettors themselves.) The reason that investors have sold them a lot of options is, roughly speaking, that investors think volatility will be low. Combining all that, you get: The reason that volatility is low is that investors think volatility will be low.
That is a perfectly sensible explanation! The reason that anything is anything, in financial markets, is that people think the thing will be the thing. That's what financial markets are; they're mechanisms for transforming investor opinion into asset prices. But it is not a particularly explanatory explanation, or a particularly technical one. Interposing the term "gamma" between "investors think volatility will be low" and "volatility is low" has the feeling of science: Ah, see, there is a reason that volatility is low, a reason that can be explained with science and that is external to the aggregated feelings of market participants. But, nah, the science just explains how the feelings are aggregated; at bottom, the feelings are all there is.
Here is a story about how activist hedge-fund managers have run out of low-hanging fruit like stock buybacks and corporate breakups, and are increasingly seeking to make money by replacing chief executive officers at the companies they target. The CEOs, unsurprisingly, object:
Some CEOs who have been targeted complain privately that activists don’t understand their businesses. “They’ve never built anything in their life, except a spreadsheet,” one said recently. Others say boards should determine the CEO. They argue that activists seek too much power given the size of their stakes, which amount to as little as 1% in some cases.
To be fair, most of the CEOs named in the article owned less than 1 percent of their companies. So why should the CEOs have more power than the activists? I guess that is a dumb question. The CEOs are (or were) the CEOs. They were chosen via a standard and well-understood process by which the company's owners (the shareholders) delegate their authority to directors and managers. (Basically: In the distant mythical past, a CEO chose some board members, and the shareholders voted for those board members in uncontested elections, and the board members chose some other board members, who were also elected without much fuss, and the board members chose the current CEO.) There are feedback mechanisms connecting the CEO and the shareholders -- the CEO talks to the shareholders, and is compensated based on shareholder return, and she and the board have fiduciary duties to those shareholders, and so forth -- but they are sort of indirect. They embody a paternalistic idea of corporate management by directors and managers, whose duties to shareholders involve essentially doing the right thing for shareholders -- in the managers' own judgment -- not doing what the shareholders want.
The activist, on the other hand, has no formal power; if he gets any power over the company, it is by convincing the other shareholders -- or the board or CEO -- that he is right. He also has few or no fiduciary duties to other shareholders: He is explicitly acting for his own profit, not for the good of all shareholders. (It's just that the way for him to profit is to make the share price go up, which other shareholders will also like.) It is an idea of corporate management by direct shareholder participation, in which shareholders are much more closely involved in managerial decisions than they are in the traditional paternalistic model. Shareholders are not protected by managers' duties, or by the historical role of managers; they're protected by direct participation.
You can see why the CEOs prefer the first model! And it's not just that they like to keep their jobs. They're right, aren't they, that they have spent their lives CEOing and understanding their businesses, while activists -- and shareholders generally -- have not. Shareholders are good at shareholding, at picking companies; managers, in the model, are good at managing the companies; and boards are good at picking the managers. There is a division of labor, an expertise, a technocratic division between managers and investors. But the activists' pitch has an appeal too: They only win if they're right, or at least, if they can persuade shareholders that they're right.
Yahoo! Inc. has not yet closed the sale of its operating business to Verizon Communications and changed its name to "Altaba," but in the financial markets it is already rebranding itself as just a proxy on Alibaba Group Holding Limited stock. Yesterday Yahoo announced a tender offer to buy back up to $3 billion of its own stock, based on the trading price of Alibaba's stock: Yahoo will pay its shareholders between 0.37 and 0.42 times the price of an Alibaba share for each share of Yahoo that they tender. The purpose of the tender offer is presumably to get rid of some of the cash coming in from Verizon, as well as to give current Yahoo shareholders an elegant exit from the future Altaba husk:
The purpose of the tender offer is to provide liquidity to a potentially significant number of stockholders that will be forced to sell their shares at or prior to the closing of the pending sale of Yahoo’s operating business to Verizon Communications Inc. (the “Sale Transaction”) as a result of the fact that, upon completion of the Sale Transaction, the Company will be required to register as a closed-end investment company under the Investment Company of 1940 and its shares are expected to be removed from the Standard and Poor’s 500 Composite Index (the “S&P 500”) and other indices. The tender offer also enables the Company to potentially return a significant amount of cash to its stockholders by repurchasing shares.
But the numbers are also evocative. Yahoo owns about 384 million shares of Alibaba stock, and there are about 958 million Yahoo shares outstanding. That works out to one Yahoo share corresponding to about 0.4 Alibaba shares, plus whatever else Yahoo has (Yahoo Japan, a pile of cash, and, for a little while longer, the operating business). Tendering at a price range centered around 0.4 Alibaba shares per Yahoo share does send a nice hint that that's what the Yahoo shares should be worth.
Should index funds be illegal?
The idea that institutional investors undermine competition when they own shares in lots of companies in the same industry has spread across the Atlantic:
The rise of passive investing, led by asset-management powerhouses like BlackRock Inc., the world’s largest issuer of index-based ETFs, evokes memories of “Deutschland AG,” according to Achim Wambach, the head of the ZEW Center for European Economic Research in Mannheim and chairman of the Monopolies Commission, which advises the government on competition and regulation. He’s referring to the web of cross-shareholdings in German industry by banks and insurers that emerged in the late 20th century.
If an investment firm like BlackRock holds in its $1.3 trillion of global ETF assets stakes in Bayer AG and Merck KGaA, Germany’s largest publicly traded pharmaceutical companies, “then BlackRock has less interest in Bayer and Merck competing with each other, but rather that both companies are doing well,” he said. “It’s reminiscent of the old Deutschland AG.”
We have talked about this theory before, though I suppose the "Deutschland AG" version is somewhere on the continuum between "index funds are like the old monopoly trusts of the Gilded Age" and "index funds are like Marxism." Index funds are like ... someone owning a lot of companies, is the basic gist. That seems inarguable -- they really do own shares in a lot of companies! -- but BlackRock quibbles even with that:
“Deutschland AG was concentrated ownership whereby financial institutions had outsized investments in industrial companies,” said BlackRock Vice Chairman Barbara Novick. “This is a very different situation because BlackRock does not own the assets we manage, our clients do.”
That is actually a very odd defense? I mean it is trivially true that the ultimate economic ownership of companies owned by BlackRock lies with BlackRock's clients, just as the ultimate economic ownership of companies owned by German banks and insurers lay with their shareholders and policyholders. But presumably BlackRock manages those investments in those clients' interests, and if those clients want companies not to compete with each other, shouldn't BlackRock want that too? I am sympathetic with the intuition that diversified asset managers aren't "really" conglomerates who own lots of competing companies and who have economic interests in how those companies compete, but it is a little hard to articulate why that is true.
Elsewhere in indexing, "the Securities and Exchange Commission will reconsider its initial approval of a risky, first-of-its-kind exchange-traded fund that promises four times the daily price moves of S&P 500 futures contracts."
My Bloomberg View colleague Noah Smith writes about last week's Wall Street Journal article in which the reporter, Andrea Fuller, tried to figure out how much she was paying in fees on her investments. The answer turned out to be 1.4 percent -- 0.85 percent to her adviser, and 0.55 percent in mutual-fund fees -- but it took her forever to figure it out, and people kept telling her different things. Fuller's point was that the investing industry is weirdly opaque, even to sophisticated consumers. Smith's point is that "to pay 1.4 percent a year is an absolutely enormous amount," potentially a third of Fuller's lifetime savings over time. "I suspect that these quasi-hidden fees are a huge reservoir of financial dark matter," he writes, "a giant slush fund that feeds many of the excesses in other areas of finance."
But my reaction to Fuller's article was: This is a fee-only fiduciary financial adviser, right? There has been a lot of discussion recently about the conflicts of interest when investors get advice from brokers who are paid secret commissions to sell them expensive mutual funds with opaque fees; the Department of Labor, under President Obama, had written new rules to reduce those conflicts and require more brokers to act as fiduciaries for their customers.
But that's not the problem here. Fuller's mutual funds cost 0.55 percent, below average for stock funds (though way above what most good index funds charge). Her adviser costs 0.85 percent per year, the flat-fee structure that advocates of the fiduciary rule prefer, because it minimizes the conflicts of interest. But she ends up paying 1.4 percent a year, and as Smith points out, "her financial advisers have little chance of beating the market." All of the correct boxes are checked: Flat-fee adviser, unconflicted fiduciary advice, even relatively low-cost diversified mutual funds. And yet the combination still seems too expensive.
I don't know what you do with that. (I mean, I know what I do: "just go to Vanguard Group's website and buy some of its low-cost index funds and exchange-traded funds," as Smith advises.) When the Obama administration was advocating the fiduciary rule, it produced a report suggesting that it could save investors $17 billion a year, by reducing their investing fees from 1.3 percent to 0.2 percent. Fuller's fiduciary adviser costs 1.4 percent. If the fiduciary rule pushes investors from high-cost mutual funds recommended by commission-based advisers to medium-cost mutual funds recommended by expensive fee-based advisers -- and if investors' all-in costs aren't any lower -- then what have we gained?
Elsewhere in financial advising:
Advisers who work with millennials say dress isn’t the only way they may differ from older generations. Millennials—those born roughly between the early 1980s and the early 2000s—want their adviser to act more like a life coach and aren’t usually interested in hearing advisers’ predictions on how much they need to save now so they can retire later. They also want advisers to be tech-savvy and to host exclusive events, such as parties with famous artists, so they can be treated like VIPs.
The basic reason to start a startup is that it is fun to hang out with your friends and build computer things, and also you might get crazy rich. If you do get crazy rich, and take the startup public, then you have to exchange your hoodies for dress hoodies, and piously pretend that you are interested in creating long-term shareholder value instead of having fun hanging out with your friends. It is a weird pivot, and I get the sense sometimes that Twitter, Inc. has given up on it. Here is a Medium post from Twitter co-founder Biz Stone, who is returning to Twitter to do a job that sounds suspiciously like "hang out with his buddies":
My top focus will be to guide the company culture, that energy, that feeling. This is where Jack, and Twitter’s inestimable CMO, Leslie Berland, feel I can have the most powerful impact. It’s important that everyone understands the whole story of Twitter and each of our roles in that story. I’ll shape the experience internally so it’s also felt outside the company. More soon.
I’m not replacing anyone at Twitter. Somebody mentioned I’m just filling the “Biz shaped hole” I left. You might even say the job description includes being Biz Stone.
Yes, exactly, my role in my friend group is to be myself. My role in my job is to do my job. The distinction seems obvious to me, but it is blurred in Silicon Valley.
People are worried about unicorns.
"The Startup That Wants to Sell You a Subscription to New York City Tap Water Explains Itself," is the headline here, and the explanation is ... marginally less bad than you'd expect? Reefill, the startup, does not seem to be a unicorn, but I am obviously rooting for a tap-water unicorn. If you like Juicero, the startup that will sell you a $400 machine to squeeze juice out of a bag instead of using your hands, you'll love a startup that will sell you tap water. I hope they put the water on the blockchain. You wouldn't want anyone to hack the product by just turning on a faucet themselves!
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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
To contact the author of this story: Matt Levine at email@example.com.
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