Malt Liquidity 18
Risk off, Mask on
The all gain, no brain market continues to hurdle onward
Friday, I wrote about how trading returns weren’t really skill dependent due to stuff like “searching Signal in your broker and buying the stock” rather than searching on, you know, Google, and finding out that the app is made by a nonprofit. Well…
I suppose people just didn’t get the memo. It’s not like Signal, the app, came out and said they weren’t publicly traded. Oh wait, they did Friday itself? And Monday again?
While trading returns aren’t necessarily skill dependent - in fact, it is extremely hard to prove that someone did have actual edge, as opposed to just survivor bias or “good luck”, and if you had purchased SIGL on Friday you could have easily 5x’d your money on a few lots - what is skill dependent is knowing when to de-risk. Random irrelevant penny stocks going from .50 to 70 in 2 days and 39 year old "retirees" entirely levered against TSLA, one of the most volatile stocks in the history of “large cap” stocks, are a good sign for even non-skilled investors to de-risk, if nothing else.
Speaking of de-risking…
ZM hit an all time high around mid-October at roughly 570 a share. As of time of writing, it is around 340. That’s about 40% off of highs! I have written before about how if you think your stock is overvalued, you can “either sell more stock, as you believe your company is trading at a premium, and buy it back later at a more reasonable valuation, or you can acquire as many companies as possible through as much stock as possible”, but it is worth reemphasizing that you only do this when you think your stock is overvalued. So, naturally, ZM is deciding to offer shares 40% off their highs:
Zoom Video Communications Inc. said Tuesday it has commenced an underwritten offering of $1.5 billion shares of its Class A common stock..
Zoom shares fell 2.6% in premarket trade on the news, but remain up 362% in the last 12 months, while the S&P 500 has gained 16%.
Even more indicative is that this is about 3x the amount they raised in the IPO in 2019:
Founded in 2011, Zoom raised $447.9 million in net proceeds through its initial public offering, according to one of its quarterly filings in 2019.
Of course, the stock opened up 2% on the indication that the company thinks 40% off their highs is overvalued, rather than down. When even a company CEO tweeting out that his “stock price is too high” (for added hilarity, read back on the replies now) ends up leading to a 600%+ rally, that’s probably another good sign to de-risk.
Look at me, I am the ETF now
When the average person thinks of a hedge fund manager, they probably associate the billionaires of the group as having some sort of outsized skill. Certainly, being right helps, though if you are right one time in finance, people will give you money for years on end (as neatly satirized by Gary Shteyngart.) However, hedge fund managers take a percentage of Assets Under Management as a fee, and on top of that, they take a cut of whatever profits are made. Thus it’s sort of incentivized to raise a bunch of money selling the image that you alone can create crazy outsized returns, with the returns as sort of a secondary concern. So, in my eyes, hedge fund managers have a lot more in common with college presidents than one would think.
But the traditional hedge fund model was 2+20: 2% fees on AUM, and 20% of profits. If this sounds ridiculous, it is, because most hedge fund managers don’t really create great returns for anyone other than themselves:
The hedge funds performed best in the first period studied, from 1999 to June 2009, generating better than 3.5% outperformance on average. From July 2009 to the end of 2018, however, the market soared 13.5% a year and the average fund’s outperformance was barely detectable—even before counting fees.
After incentive fees, however, there probably wouldn’t be much left for the funds’ limited-partner investors. “If you’re being pessimistic,” says Amir-Ghassemi, “then the translation of that 2.5% into what the limited partner ultimately gets is not great.”
Now while I think measuring against the S&P 500 is a pretty questionable methodology for hedge funds, the point remains that the fee structure incentivizes fundraising rather than outperformance. With investors naturally balking at fees, you can do one of two things, as a prospective hedge fund manager: you can either cut your fees and bet on outperformance, or cut your fees and market yourself as an ETF, allowing public funds to flow in as well. The calculus is simple: if people want to invest through an ETF vehicle, why not provide it? Sure, the fee structure isn’t as great, but you still get a cut of AUM with the total market being publicly traded money in ETFs rather than having to pitch accredited investors on speculation of a nebulous nature.
Simple math would tell you that 2% of 200 million is .4% of 1 billion, so even proposing to halve your fees from a projected hedge fund of 200 million and taking it to the public markets (assuming you have inflows like above) would double your fees. As such, IVOL’s fees are roughly 1% - if they can hold 1 billion in AUM up until July 2021, that’s 10 million in fees alone. If I’m running a 2+20 hedge fund with 200 million AUM, I need 30 million in returns to hit 10 million in total compensation, which requires a 15% return. So just by turning into an ETF and halving the fees, if the marketing works, you’ve essentially accounted for what would be an absolutely fantastic year for the average hedge fund.
The ETF is “beneficial to our investors because it gives them lower fees, it gives them the transparency of a managed account, it gives them liquidity, it gives them no incentive fee,” Davis, founder and CIO at Quadratic, said in a phone interview.
This is true for any ETF, so I’m not sure what the value add here is compared to investing in, I don’t know, any of the other 7000 ETFs inevitably trading a similar strategy. I suspect she didn’t highlight that on the phone call. Though “hedge funds using public markets to raise money” isn’t particularly new, I suspect we’ll see a lot more of “hedge funds choosing to identify as ETFs” in the coming years.
On that note…
Interesting point on ETF/HF trade-offs especially in light of Cathie Wood's active ARK ETFs thumping their competition.