British pound coins and a U.S. one dollar bill are arranged for a photograph in London, U.K. (Photographer: Chris Ratcliffe/Bloomberg)

It’s Better to Be Rich Than Right

(Bloomberg Opinion) -- How’s David Einhorn doing?

One apparently out-of-consensus view that I have is that, while most people seem to think that the essential skill of a hedge fund manager is identifying investments that will have high returns, I think that the essential skill of a hedge fund manager is continuing to run a large hedge fund that pays you a lot of money. Obviously those skills overlap, and the most straightforward way to keep your clients is to keep making money for them. But they are conceptually distinct. For instance here is a sequence that you sometimes see hedge fund managers go through:

  1. Achieve high investing returns.
  2. Attract billions of dollars from investors.
  3. Tell those investors that, if they want access to the manager’s genius, they need to lock their money up for a very long time, possibly forever.
  4. Get the investors to say yes.
  5. Achieve investing returns that are indifferent or worse.
  6. Continue managing billions of dollars while your investors gripe about how bad returns are now and how difficult it is to get their money out.

Is this success? By the popular standard, no, it is not: Success means getting good investment returns, not bad ones. By my standard, it sure is, it sure is: Success means continuing to be rich, being on the boards of fancy charities, and being so famous that your investors’ complaints about you appear on page A1 of the Wall Street Journal.

I can’t prove to you that my standard is the correct one, but I think that upon some introspection you will agree that it is. Like: Would you rather be able to identify good investments but not be able to monetize that skill, or monetize that skill without having it? I believe that there are poets and painters who are devoted to solely to the perfection of their art and indifferent to money; I am skeptical that there are many such hedge fund managers.

After more than a decade of winning on Wall Street, Mr. Einhorn’s Greenlight Capital Inc. has shrunk to about $5.5 billion in assets under management, his investors estimate, from a reported $12 billion in 2014, and his investments are struggling.

“My patience is wearing thin,” said Morten Kielland, chairman of investment-management firm Key Family Partners SARL and an early Greenlight investor, who said he has withdrawn much of his firm’s money from the fund. “This is unbelievable.”

Greenlight’s main fund is down 18.7 percent for the year, and was down 11.3 percent from the end of 2014 through the end of 2017. This is sad for his investors, and I suppose for him, but it also presents an exciting opportunity for people who have been nursing honestly quite mild grievances against Einhorn for 17 years and can now retail them to the Journal:

In 2001, John Burbank, who was starting a research service and later became a hedge-fund manager, pitched Mr. Einhorn on refiner Valero Energy Corp. , said a person familiar with the meeting. Mr. Einhorn dismissed the idea and spent half an hour lambasting him for not doing his homework.

“You really should go for better businesses,” Mr. Einhorn said, according to this person, telling Mr. Burbank to steer clients to one of Greenlight’s largest holdings at the time, WorldCom Inc., the person said. A year later, WorldCom declared bankruptcy. Valero’s stock more than doubled over the next three years.

Yes right and after that prescient call in 2001 John Burbank went on to be right about everything, quickly becoming a billionaire household-name hedge-fund manager who could do no wrong, while David Einhorn immediately faded into obscurity because of his mistake on WorldCom! Come on, man. Hey if anyone else has a story about a time they were right and David Einhorn was wrong, please email me about it, I am dying to know. If David Einhorn told you in third grade that stepping on a crack would break your mother’s back, and you stepped on a crack and your mother is fine, be in touch.

Anyway, whatever you think of his ability to pick profitable investments over the past few years, the real moral of the story is that Einhorn is good at running a hedge fund. Not perfect—he seems to have been rather ornery with clients, napping during the day and going clubbing at night, which I guess loses loyalty from the clients who value orderly habits above all else in their hedge fund managers—but he got the big things right:

Greenlight could be difficult to deal with, some current and former investors said. While most hedge funds let clients withdraw money once a quarter, Greenlight in 2005 began requiring a three-year commitment with one chance a year to withdraw after that.

There is permanent capital, too; “Greenlight has said 18% of the money it manages—or about $1 billion—is from the reinsurance company it controls.” Here is a Greenlight investor with some astonishing point-missing:

“The liquidity terms are onerous and out of the norm today,” Mr. Pearlstone said. “Investors would be more comfortable with those terms if the returns were better.”

Well but the returns aren’t better! And the investors would no doubt be quite comfortable withdrawing their money if the liquidity terms were less onerous! The downside of strict liquidity terms, for a hedge fund manager, is that when your performance is bad your investors complain to the press about your liquidity terms. The upside is that they can’t take their money out. If you had loose liquidity terms and they took all their money out, you wouldn’t be a hedge fund manager anymore. And they probably wouldn’t even compliment you to the press on the way out! “Sure, Derek Schmeinhorn lost us a lot of money, but we appreciate his commitment to quarterly liquidity,” investors never say after withdrawing from money-losing hedge funds. If your investors are complaining to the press about how onerous your liquidity terms are, you made the right call on the liquidity terms. If they were less onerous, your investors would be gone.

Robots.

There is a lot of talk about how humans will lose their jobs as the financial industry becomes more automated, but usually that talk is about humans generally, or at least broad types of humans (analysts, salespeople, etc.). It’s not usually, like, “Fred, you are going to lose your job as soon as Fredbot 4000 rolls off the assembly line.” The robots aren’t usually personal.

The avatar was created after shooting Mr Kalt's head for half a day using more than 120 HD professional cameras on a special scanning rig. The digital rendering is such that a customer might think they're looking at a video of a real person on a conference call – but the experience is designed not to deceive them, Mr Fitzgerald said. 

UBS clients will see Mr Kalt's likeness on a video screen and when they ask it questions, it has been programmed to respond with answers the real Mr Kalt has taught it to deliver. It's therefore a controlled deployment of IBM's Watson AI technology, which won't be interpreting how Mr Kalt might respond to a question it doesn't know.

Rather, it will allow the chief investment office's "house view" to be disseminated to a broader range of clients than would be able get access to Mr Kalt's human form.

Meat-Kalt is actually not losing his job; they still need him to come up with the house view for Robo-Kalt to disseminate. He just doesn’t have to schlep out to meet with all the clients to repeat the same lines over and over again. It’s a pure improvement for him. It is frankly embarrassing for the clients, though. (And for the coverage bankers who are introducing them to Robo-Kalt.) Like, “hey guys, we know you’re going to ask the same questions everyone else does, so we’re just going to have a computer give you the answers we’ve given many times before. But we know you’re afraid of computers so we’ve used 120 HD professional cameras to create an uncanny simulacrum of a person to make you more comfortable.”

This particular job seems well suited to this particular form of automation. There is something a bit robotic about the chief economist’s function: You’re coming up with a house view and then repeating it endlessly to clients. Your role in client meetings is not to give individual clients specific advice on their situations, but a general view on the economy, and the only reason you need to be at the meeting (instead of just, like, the banker giving the client a one-page handout of your views) is to make the client feel special and catered to. And of course you have to be suave and polished and appropriate. It’s a good gig for, like, C-3PO.

I will be more excited when banks start applying this technology to a broader range of tasks. I want someone to use 120 HD professional cameras to digitize a trader who communicates in monosyllabic grunts and misspelled chat-room obscenities. I want a finance android who simulates the messy humanity of finance people, not just the smooth client-facing façade.

Also on a personal level I am looking forward to the day when MattLevineBot can take over the grunt work of writing Money Stuff. “Do the bond market liquidity one, bot,” I will shout from bed, and the rest will be taken care of.

Banker fees.

“It is a mystery why bankers earn so much,” writes John Gapper, and he lists some possible reasons for why mergers-and-acquisitions advice is so expensive. (High stakes, paying with other people’s money, large dollar amounts, complex and hard-to-evaluate work, etc.) They all seem reasonable to me. But I might emphasize a point on the demand side that Gapper alludes to, which is that the fees for selling a company “can cover years of unpaid work.”

The basic model of financial advisory work is that you never charge clients the correct value of the work. You do lots of quite substantive work for free: You come to them with good ideas for mergers and financings and restructurings, you give them frequent market updates, you bring in a robot economist to answer their economics questions and a tax specialist to help them with thorny tax problems, you help them with their financial modeling, you recommend good people for jobs at the company, and you never send them a bill for any of it. Then one day they do a merger and you send them a bill for $30 million. You understand, they understand, everyone understands that the $30 million isn’t just for the work you did on the merger. It’s the payoff for the whole relationship.

This helps keep fees high. For one thing, there is no transparency around how much things cost or why they cost that much; everything is a big vague bundle of relationships. For another thing, after all the years of free work, they like you; they feel indebted to you and want to give you a generous reward. The free work creates the illusion that you are their friend and have been selflessly working on their behalf, and they want to deserve your friendship. Gift economies sometimes require not pure reciprocity but rather escalating gifts; you want to give people back more than they gave you, to demonstrate your importance and generosity. 

Meanwhile from the banker’s perspective, this is all very lovely and remunerative when it works out, but it doesn’t always work out. Sometimes you do tons of free work for a company and they end up selling themselves using a different bank. Then not only have you done work and not gotten paid for it, but also your bosses come and pester you and ask “why weren’t we on that deal, was our relationship not good,” and you are like “well I dunno I called them constantly and did lots of free work for them,” and your bosses nod quietly and walk away whispering mean things about you. It is not a good look, to spend years buttering up a client and then not get the mandate. The stakes are high. And since everything is high-risk, the bankers demand a hefty risk premium. If they just charged an hourly fee for everything they did, the stakes would be lowered, and the fees probably would be too.

Will Trump leak the jobs report on Twitter again?

“It’s very difficult to predict if (a) there will be a tweet, and (b), what the tweet will be,” said an interest-rates strategist here in the dumbest of all possible worlds. I bet he wishes a robot had written that. He’s talking about the question of whether Donald Trump will leak tomorrow’s jobs report on Twitter, like he did the last time. If he does—if he tweets “looking forward to the jobs numbers!” or whatever—then I guess the trading implications are clear, or clear enough. (Good jobs numbers.) If he doesn’t, then it is hard to know if that means (1) the jobs numbers aren’t that good, (2) someone told him to stop leaking on Twitter and he listened to them, or (3) he just got distracted by some other Twitter feud. I don’t envy you if you are a trader figuring out how to position yourself for the president’s tweets or lack thereof, but really your positions are the least important problem with all of this.

It’s too hot.

There are fractal layers of detail involved in being good at trading stocks. For instance it is helpful to have a good correct view of the macroeconomy and the likely impacts of trade policy and interest rates on the business climate. It is good to be able to model a company’s cash flows and understand its effective tax rate and judge the character of its senior executive officers. And then way down in the basement you gotta know which stock exchanges to send your orders to first, and how many microseconds to wait between the time you send an order to one exchange and the time you send it to the next. If you’re off by even a tiny fraction of a second, then high-speed traders who see your order on one exchange will race to the next exchange to raise prices, and all your hard work in understanding economics and companies will be … it’ll be fine, really, but maybe you’ll pay an extra penny for some of your stocks?

Anyway this week the northeastern U.S. melted and so time got out of joint:

High humidity is impeding radio transmissions Tuesday among three New Jersey data centers where U.S. stocks trade, according to a note Nasdaq Inc. sent customers. It’s taking about 8 microseconds longer to send information from Nasdaq’s facility in Carteret to the New York Stock Exchange data center in Mahwah, and an extra 2 microseconds to send data to Cboe Global Markets Inc.’s exchange in Secaucus.

So everyone’s precisely sequenced order routing is now ever so slightly messed up. If you lost money trading equities this week I recommend explaining to your boss that it’s the heat that did it.

Things happen.

This German Insurer Wrongly Bet Its Home Country Would Win the World Cup. Singapore watchdog says Grab-Uber deal hurts competition, proposes fines. U.S. Soybean Cargo Races to Beat China Tariff. Hedge Funds Bridgewater, Winton Get Nod for China Expansions. “One doesn’t have to shovel manure on a cricket farm and the smell is trivial.” M.B.A. Programs Try Catering to Liberal-Arts Types—With Math Camp. “Fastidiously appointed with preponderant design assemblage, your thirst for unrivalled condo indulgence is concluded now.” Church of England warns wedding guests not to check mobile phones during World Cup match on Saturday. “‘The Supreme leader Kim Jong-un!’ squealed one onlooker as the socialist state chief was mobbed by selfie-seekers in the icon of capitalism — Times Square.”

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