Five stories stand out as the dominant stories for and about pursuers of alpha in the year just passed. There is nothing arbitrary about the list below. We admit, though, that the order in which we present them is arbitrary: that is, it is not a ranking, and it is only very roughly chronological.
Epic Meltdown in Cryptocurrencies
The cryptocurrency world seemed for much of 2018 to be melting away like the Wicked Witch of the West in the Wizard of Oz, having been splashed with a bucket of cold water in December of last year.
The “cold water” was global and regulatory. China not only shut down its own exchanges, it made clear that it had under consideration a blanket prohibition on any of its residents trading bitcoin on foreign exchanges. South Korea was likewise said to be “considering” a crypto trading ban. This was a gut punch given South Korea’s importance for the industry.
More generally, the market was spooked by the idea that some of the world’s regulators were going to start treating bitcoin, and its many imitators, not as an idiosyncratic sort of property, and not as currencies, but as securities.
Bitcoin peaked in the middle of December 2017 at a value of above $17,000. By September of this year, it was valued in the neighborhood of $6,500. As it hobbles into a new year, the flagship of this asset class is at a value below $4,000, less than a quarter of peak value. Other cryptocurrencies suffered alongside, or more severely than, their parent. Ethereum, which peaked at near $1,400 early this year, is selling at less than one tenth of that at present.
Signs that Blockchain will Survive and Thrive
The blockchain technology brought into the world by the cryptos seems a good deal more robust at year’s end than the cryptos themselves. Blockchain, after all, is not something that one buys simply because there may be a “greater fool” who will take it off one’s hands for more. Blockchains (or “distributed ledgers”) are useful practical tools that perform a lot of tasks for various operating companies. The key to this performance is the application of a computer algorithm to create an alphanumeric character for content that cannot be back-computed.
This has proven helpful in keeping track of quite traditional financial transactions, involving stocks, bonds, and mortgages and the auditing of private equity. But it also may provide the world over time with useful medical databanks, community policing, etc.—the whole “internet of things.” How to play this ongoing revolution? Ah, that is the multi-billion-dollar question begging an answer.
Brexit and the Unknown Unknowns
The Brexit referendum of June 2016 and the subsequent contentious negotiations between the United Kingdom and the EU over the terms of divorce has certainly been one of the most fascinating ongoing political, economic, and diplomatic stories of the whole period 2016-2018. This year, especially in the last two months, as Prime Minister Theresa May has had more luck reaching understandings with her counter-parties across the Channel than with the factions within the House of Commons at home, matters have come to a frenzied boil.
Alpha’s pursuers react to this is their usual way: they look for a way to play it.
Marshall Wace, the London-based manager of several long/short equity funds, has a sizeable short exposure on British retail as that sector especially faces a possible cliff. Marshall Wace funds have borrowed 2.92% of the shares of Marks & Spencer, and the group has short positions, too, on Debenhams, Intu, Dunelm Group, and the branded clothing company Superdry. One of the founders of the management firm, Sir Paul Marshall, contributed £100,000 to the Vote Leave campaign. In what have been a political hedge, the other co-founder, Ian Wace, gave £100,000 to the Remain campaign.
Meanwhile, portfolio manager Verdad Advisors is operating on the premise that Brexit and the related caution has driven stocks to a level at which they are bargains. Verdad’s founder, Dan Rasmussen, is long on the Ei Group, which owns a lot of UK real estate, on much of which is in pubs.
Speaking more generally, Rasmussen has told Forbes, “the political risks, even in the worst case, are overblown,” in the UK as in Italy.
SEC Adopts Transaction Fee Pilot
Meanwhile, in the United States, the Securities and Exchange Commission has adopted a Transaction Fee Pilot in NMS stocks. The idea (expressed as rule 610T of Reg NMS) is to determine whether rebates are really necessary to keep the market liquid.
The Order Protection Rule requires the routing of marketable orders to the platform that is displaying the best available automated quotation. But the OPR concerns only the display itself, not fees charged accessing that quote. This allows for some game-playing and, in order to limit the gamesmanship, the SEC has capped access fees at 30 cents per 100 shares.
Over the decade since the adoption of NMS, the practice has developed whereby markets charge at or close to the cap, but then give back the money to market participants as rebates. But to which market participants? Ah, there’s the rub. The rebates go to the participants deemed to have contributed to liquidity, in the maker/taker model. So, the system of fee-and-rebate ends up taking money from some market participants for the benefit of others, and liquidity serves as the justification. One is reminded of a John Maynard Keynes’ warning about the anti-social “fetish of liquidity.”
The pilot program will likely provide a lot of data showing that this transfer of wealth is not necessary, and indeed not helpful. Whether that results in any broader reform in the years to come is in the lap of the gods.
Property Auctions and Farmer Anger
We’ll conclude this year with some mention of a perennial fact. Just because it’s perennial one cannot infer that it is unimportant. The fact: institutions that profit from the distress of certain assets are likely to attract enemies, perhaps politically well-organized enemies. They are often going to take the heat for the distress.
The latest high-profile example of this old truth is a farmer protest, and a call for “unity against vulture funds,” in Dublin; specifically, a protest by the Irish Cattle and Sheep Farmers’ Association at the offices of BidX1, an online property trading platform. In this case, the unhappiness of the disrupted owners of the rural property at issue was surely compounded by the impersonality of the whole notion of online trading.
In reaction to the protest in November, BidX1 agreed to withdraw the lots at issue from its portfolio. But this didn’t change the fact that here are buyers looking for distressed assets, and much rural land in Ireland remains distressed. In the words of Seamus Sherlock, an ICSA official: “The problem has merely moved in that other auction houses have taken up the mantle and continue to act on the instructions of vulture funds. This needs to stop.”
If history is any guide, it won’t.