The Saturday - 9/26/20 Edition
Volume 1, Issue 1.
Alright, alright, alright. Welcome to the first edition of The Saturday!
For those who didn’t receive the pre-launch email, The Saturday provides light, quick recaps of interesting stories from the financial markets over the preceding week. No exhaustive research reports, just an easy read that takes no longer to get through than it takes to drink your first cup of coffee on Saturday morning.
To that point, let’s get right into it. It’s Saturday, September 26, 2020.
Fishy Dealings
How about this article’s title: “Managers at Major Index Provider, Sushi Restaurant Charged With Insider Trading.”
This story is all about index funds and has nothing to do with the fish or restaurant industries, so you could be forgiven for finding the sushi reference a bit random. The more I think about it though, investing in index funds isn’t all that different from eating an omakase sushi dinner. I mean, omakase literally translates to “I’ll leave it up to you.” Anywho.
The SEC and DOJ have charged an S&P index manager and his friend (who happens to manage a sushi restaurant) with insider trading after the former provided the latter with $3,000 in seed capital and nonpublic information about which stocks were about to be added to various S&P indices. The friend would then (allegedly) buy short dated call options, get big returns, send some money back to his source, and then do it all over again.
How successful was their scheme? The $3,000 “invested” in April 2019 had grown to over $900,000 by October. Over that period, the sushi manager (still allegedly) sent at least $300,000 back to the S&P manager.
If you carve out the illegal activity portion, that’s a pretty great trade. This also has me wondering though: if index inclusion (or exclusion) materially moves asset prices, is index investing truly passive? And is it consistent with the Efficient Market Hypothesis? Probably not.
The more popular index funds and ETFs become, the more it seems like the power of diversification becomes a self-fulfilling prophecy. I’d wager that most investors piling into index funds are agnostic as to which individual securities are included in their basket. Yet, demand for the fund inherently results in demand for the individual securities in that fund, so their price (generally) moves in lock-step regardless of what investors might think about any one stock.
I can’t help but to wonder when the “passive” index investing strategy breaks. While it’s true that random, diversified baskets of stocks have historically delivered higher Sharpe ratios, truths in financial markets are temporary. The best trades eventually get crowded and lose their alpha. More Money Than God, a history of hedge funds written by Sebastian Mallaby, is replete with good, logical trades becoming too crowded to continue outperforming.
The “passive” index trade is massive, so it’s not going anywhere anytime soon. Someday, however, I’d expect arbitrageurs to crack the code and “active” managers to make a comeback. Sushi is forever though.
EV Thrill Rides
It’s been a hell of a year for electric vehicles. Tesla is famously up 777%. Nikola is infamously volatile and now laden by revelations that its electric truck’s test drive was faked - the company admitted the truck was just coasting downhill on neutral and their Founder/CEO resigned.
Not to be outdone, an obscure renewable energy company, SPI Energy, announced this week that it was starting an electric-vehicle subsidiary. Here’s how investors reacted (chart from CryptoWhale):
Leaks
So… banks are in the spotlight for the wrong reasons again. The International Consortium of Investigative Journalists (“ICIJ”), of Panama Papers fame, got their hands on over 2,000 suspicious activity repots (“SARs”) filed by various international banks with FinCEN. ICIJ’s reporting reveals over $2T (not a typo) of suspicious transactions with shady individuals and sanctioned countries over the 18 year period ending in 2017.
SARs are widely used crime detection and prevention tools used by financial institutions and regulatory authorities. The Department of Treasury requires financial institutions to report any suspicious activity - i.e. potential criminal activity, money laundering, etc. - by filing SARs with FinCEN.
Two important things to know about SARs. First, SAR filings are confidential and it is a crime to disclose that a SAR has been (or will be) filed. Second, filing a SAR doesn’t prevent an institution from continuing to transact with a client. The institution doesn’t need to be the final adjudicator of wrongdoing; it just needs to report potential issues. So the fact that banks file many SARs isn’t all that shocking. In fact, an average of 2 million SARs were filed yearly between 2011 and 2017.
Still, according to ICIJ, JP Morgan moved over $1B for a Russian “Boss of Bosses” on the FBI’s Top 10 Most Wanted List, another $2B for a Ukranian oligarch wanted on criminal charges in the US, and helped the exiled former President of Ukraine move hundreds of millions of dollars through its correspondent-banking business.
JP Morgan was far from the only bank affected; HSBC, Citi, Deutsche, and others were implicated. The report is exhaustive and worth a read. It’s also worth pointing out that nearly every bank involved has already entered into deferred prosecution agreements for these transactions. Bad press, but barring congressional hearings, the fines are already paid and likely priced in.
Separately, because SARs are highly confidential and contain sensitive information relating to matters of national security, FinCEN is also investigating the leak. I’d expect charges, just not against the banks.
App Store Drama
This summer, Fortnite owner Epic Games created a new in-app payment system to avoid the Apple App Store’s 30% fee on all in-app purchases. Apple responded by kicking the popular game off of the App Store.
This week, Epic teamed up with Spotify, Match, and 10 other companies to launch The Coalition for App Fairness, ramping up the dispute. Even Facebook, the worldwide leader in ripping off apps, piled in with its own criticism of the iPhone maker. Oof.
Now, Apple is giving in. A little bit. Apple does not levy its fee on sales of “real world services, such as home rentals through Airbnb or gym sessions bought on ClassPass.” Due to the pandemic, however, many “real world” services have now shifted online. For example, ClassPass has upped its offering of online exercise classes.
From the App Store’s perspective, this shift from physical yoga classes to online yoga classes means that the bulk of ClassPass sales are now subject to the 30% fee. As a temporary concession, Apple has now agreed to waive its fee through the end of the year for businesses impacted by COVID-19.
For Facebook, this also means that apps will now be allowed to process customer purchases through Facebook Pay. (Ha! There it is.)
As for Epic Games who spearheaded App Store reform? No such luck. According to Apple, gaming creators haven’t “been impacted by the pandemic.”
Fortnite. TikTok. The war on teenagers rages on.
Have a great weekend.