Bubble economics: the active vs passive debate

Bubble economics: the active vs passive debate

EuroHedge - https://hfm.global/eurohedge

Bubble economics: the active vs passive debate

Posted By Drew Dickson On September 12, 2019 @ 4:03 pm

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Michael Burry’s comparison between passive investment in equity markets and the bubble in the synthetic CDO market back in 2007 (which he famously – thanks to Michael Lewis and Christian Bale – identified) sparked a robust debate this month.

Financial specialists on Twitter, a broadly pro-passive audience to begin with, mostly disagreed. This is for good reason, as passive investing is a lower cost way for retail investors (at least) to gain exposure to rising equity markets over the long term.

But I thought the chastising of Burry was a bit overdone. Burry asked a thought-provoking question, it’s just that “bubble” was the wrong word to use. It was wrong, because there is no bubble in passive investing, but the word was so incendiary that it was difficult to stay objective.

But it’s okay to ask if passive flows are affecting share prices. People have been asking these questions for decades, and the volume of analysis here is only increasing. These are interesting, even confusing, times. Money is pouring into passive vehicles, value hasn’t worked for over a decade and the S&P 500 is up 400% since March 2009.

Burry is simply wondering if the trend toward passive investing is having any impact on the prices of companies that are or are not in these indices. This is a good question – one I have been thinking about since my dissertation on the subject in graduate school, many moons ago.

Even back in 1998, it was reasonable to ask whether, given passive investing was becoming a larger part of the market, its effects were increasing with time. My co-author Craig Dawson and I didn’t reach that conclusion but left open the idea that with more time, datapoints and flows into passive funds, we might.

Now, 21 years later, the overriding question we are all asking is if passive investing is at the point where there are not enough active investors to correct prices. In other words, are we at the point where the passive free-riders are actually making prices?

At least at the broad, market level, I don’t think we are. Indeed, Cliff Asness – specifically on the issue of index investing and the “free-rider” issue – points out that accurate prices in many goods happen without so much impact from the “wisdom of crowds” but instead by expert judgment by just a few people.

But I simultaneously disagree with the view that pricing is always unaffected in the intermediate and long-term by behavioural biases. There are a host of strange behaviours that affect certain subsets of the market (value stocks, quality stocks, momentum stocks, etc).

We do not think that the tail is yet wagging the dog. We do not believe that passive investing is a bubble, nor do we believe that it is to blame for the underperformance of small caps or value, nor even that they deserve credit for strong equity markets in the US.

This is where it gets even more interesting. Ben Hunt of Epsilon Theory found the reaction to Burry’s article revealing. He saw it as rooted in a constantly-reinforced view that everyone knows stocks as an asset class always go up, and that passive vehicles are the cheapest way to get there. And the second-order, Keynesian-esque argument is that everyone knows that everyone knows these things.

He thinks this results in (and creates) the narrative in which we all are really saying “be long”. And given the S&P 500’s decade-long and continuing rise, that mantra is no surprise. Ben highlighted historical periods when the accepted faith – the things that people believed that people believed – was that markets did not go up forever. People operating under that faith actually did very well until things changed. And they did change.

And maybe they will change again? Will the undying love for passive investing will become a little tainted if the markets ever decide not to go up? What if some of this anti-Burry, pro-passive sentiment is a sign of the times, rather than something that we can be certain will always be?

This isn’t an unreasonable perspective, and neither is the view that “passive” investing is not in a bubble. As such, despite the fiery rhetoric from all sides, I don’t think my smart friends on Twitter are in as much disagreement as it appears.

Dickson is founder and portfolio manager of Albert Bridge Capital in London. This is a condensed version of the full article, which can be read here [1].

Short-sellers “should be knighted, not spited"

Short-sellers “should be knighted, not spited"

Excerpt from the Irish Times:

Stocktake: More volatility lies ahead for investors

Tue, Sep 3, 2019

Proinsias O'Mahony

Read the full article here: https://www.irishtimes.com/business/personal-finance/stocktake-more-volatility-lies-ahead-for-investors-1.4005079

Short-sellers “should be knighted, not spited”

Short sellers aren’t a popular bunch. Shorts make money from falling stock prices, something many critics find to be disagreeable. The critics should think again, however – according to a new study, short sellers are informed investors who make markets more efficient. The study, Best Short, finds high-conviction short bets – large positions relative to the size of a manager’s portfolio – greatly outperform short-conviction bets. In other words, when a hedge fund bets big against a particular stock, there’s a fair chance they have a good reason for doing so.

The researchers point to Carillion, the British construction giant which collapsed in January 2018, noting short bets against the company started increasing as early as March 2015.

They also note that Europe is unlike the US in that shorts are obliged to publicly disclose short positions once they reach a certain size. That effectively works as a constraint upon short-selling activity – many funds ensure their short positions don’t cross the regulatory threshold. Commenting on the study and on the European regulations, Albert Bridge Capital founder Drew Dickson tweets that this ultimately results in distorted pricing in Europe. “Most short sellers should be knighted”, says Dickson, “not spited”

Financial Twitter Loses a Source of Humility and Wisdom, but Good Voices Remain

Financial Twitter Loses a Source of Humility and Wisdom, but Good Voices Remain


An account called @Nonrelatedsense showed that some of the smartest minds in investing are learning, and having fun, on Twitter

By Jason Zweig, July 19, 2019 11:00 am ET

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Twitter isn’t just a megaphone for bragging about yourself and insulting your enemies, real or imagined. All investors should appreciate that some financial thinkers have turned the social-media site into a force for enlightenment and fun—if you follow the right people.

That’s never been clearer than it was a few days ago, when the person behind the @Nonrelatedsense account died, prompting an outpouring of love and grief in the financial quadrant of Twitter known as FinTwit. (Although I know who he was and where he worked, I’m honoring the wishes of his family and friends to preserve his anonymity.)

Those who followed him, even without meeting him in real life, felt as if we had lost one of our smartest friends.

NRS tweeted more than 117,000 times—an inimitable mix of investing insightssnarky quipsnature photographs and cocktail recipes. He exchanged what had to be thousands of direct messages with dozens, perhaps hundreds, of people who sought his opinions. (I was among them.)

NRS was bluntcynicaloften profane, but seldom cruel—even though he saw clearly that the business model of many financial companies is to pile up mountains of fees from a blizzard of flim-flam and gibberish. A financial adviser obsessed with mutual funds and income-oriented investments, he could smell baloney in a single sniff—and as soon as he detected ithe mocked it.

At the same time, his tweets and messages were infused with skeptical wisdom and profound uncertainty about how much anyone can ever know (“your confidence in this thesis is far too high to be credible”).

“I only knew him through his Twitter identity,” Cliff Asness, co-founder of AQR Capital Management in Greenwich, Conn., which manages $194 billion in assets, told me this week. “But it was very clear he was very knowledgeable about finance, a great wit and committed to the truth.”

Jeremy Schwartz, global head of research at WisdomTree Investments , Inc., says the firm had “for years” been mulling over the idea of a fund with enhanced exposure to stocks and bonds. A Twitter exchange that NRS had with two other investors, @EconomPic and @choffstein, helped spur the launch of the WisdomTree 90/60 U.S. Balanced Fund last summer, says Mr. Schwartz.

More importantly, he understood that investing is a lonely endeavor—and it’s easier to stay the course when you feel you belong to a group whose beliefs are based on valid evidence rather than on the fear and greed of millions of strangers.

NRS was at the center of “a community of like-minded people where I feel most myself,” says a financial adviser in Atlanta who tweets as @DadInvest. “It just felt like we were in this together.”

“I think NRS was on Twitter looking for intellectual stimulation,” says Lawrence Hamtil, a partner at Fortune Financial Advisors in Overland Park, Kans. “He made me better at what I do for a living, and that’s a valuable thing he offered as a pastime.”

Mr. Hamtil adds, after a pause: “It’s weird to get choked up about somebody you never met, but time and place aren’t as important as the depth and the nature of the relationship.”

Nicole Boyson, a finance professor at Northeastern University who studies compensation and conflicts of interest among financial advisers, says she exchanged at least 1,500 messages with NRS between October 2018 and his death. He clarified dozens of details critical to her study. On at least two days, she says, NRS got so engaged in debating and explaining that they messaged each other over Twitter “practically the whole day each time.”

Although NRS is gone, he remains a model of how financial Twitter can educate investors. In his honor, I’ve assembled a list of people who tweet in the same spirit.


For advice on what to read and how to think about financial decisions: @MorganHousel@abnormalreturns@farnamstreet@mjmauboussin@EconTalker@dollarsanddata@pcordway@ritholtz@AnnieDuke@RPSeawright@jposhaughnessy, @patrick_oshag@BrentBeshore@trengriffin@RyanKruegerROI@daniel_egan@brianportnoy@laurenfosternyc@OS_Mitchell@mikedariano.


For discussions on how to allocate assets and which investing strategies are likely to work or fail: @EconomPic@Jesse_Livermore@CliffordAsness@enterprising@syouth1@demonetizedblog@modestproposal1@awealthofcs@alphaarchitect@choffstein@MebFaber@lhamtil@bpsandpieces@ROIChristie@AlbertBridgeCap@svrnco@millerak42@RyanPKirlin@RA_Insights.


For updates and insights on market news and investing trends: @ReformedBroker@TheStalwart@matt_levine@researchpuzzler@JoachimKlement@charliebilello@michaelbatnick@DaveNadig@deborahfuhr@WallStCynic@timelyportfolio@toby_n@DavidSchawel@dashofinsight@tracyalloway@HayekAndKeynes@mdc@jsblokland@mrzepczynski@lynchbages.

For information and advice on financial planning: @CFAwealth@Dull_Investing@ClementsMoney@BasonAsset@nikir1@michaelrpiper@WadePfau@christine_benz@CarolynMcC@BlairHduQuesnay.

For broader economic topics: @MargRev@JohnHCochrane@elerianm@LorcanRK@M_C_Klein@wolfejosh@profgalloway@teasri@cullenroche@prchovanec@DanielaGabor@RencapMan@calculatedrisk@interfluidity@kitjuckes@Schuldensuehner@agurevich23.

For witty but informative market takes: @EpicureanDeal@OddStats@RampCapitalLLC@EddyElfenbein@NickatFP@SuperMugatu.

For value investors looking to identify and size up cheap stocks: @Greenbackd@footnoted@verdadcap@GnDsville@AustinValue@NeckarValue@iancassel@jtkoster@ElliotTurn.

For accounting and valuation: @retheauditors@AswathDamodaran@lev_baruch.

For financial history: @FedFRASER@jfc_3_@msamonov@CSpaenjers.

I’ve excluded people who are rude or partisan, foment short-term trading or other harmful behavior, or flog their own products or services. (I’ve also excluded the Wall Street Journal’s many Twitter accounts, which you don’t need me to recommend.)

From what I’ve observed, everyone on this list seeks to become smarter about investing and help others do the same. They are frank but fair; they admit when they were wrong; they defend ideas on the basis of evidence, not emotion. In short, they have a bit of NRS in them, as every investor should.


The Futility of Market Timing

The Futility of Market Timing

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5 February 2019, 05:01 GMT

By John Authers

Out of TimeBarry Ritholtz’s Weekend Reads included this gem from Albert Bridge Capital. To illustrate the futility of market timing, they compared a strategy of annually investing $1,000 in the S&P 500 at its low for the year every year, with a strategy of buying the S&P at its high each year. The former involves impossibly good market timing. This is how it would have done:

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Now, look at the returns made by the sucker who went in at the top each year: 

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The good market-timer did better, as was mathematically certain. But the gap between the two is minimal given the kind of effort (or extraordinary luck) needed to invest at the best time each year. As Albert Bridge put it:

So the difference between the perfect idiot and the man with perfect foresight, is the idiot has nearly 80% of the nest egg as the impossibly accurate market-timer.

So, not only can you not pick the perfect day to invest, there isn’t even a whole lot of upside from trying!

This might be a bit unfair. Market timing is not just about when to buy stocks; it’s also about choosing when to buy something completely different. Leaping into an uncorrelated asset class every time stocks are about to fall might look more impressive.

But overall the point is well taken. Much equity market commentary, from journalists and brokers is alike, is implicitly about gauging whether this is a good time to put spare capital into the stock market and whether this is a dip to buy. And that kind of speculative timing, beyond being close to impossible, is not worth the effort. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
John Authers at jauthers@bloomberg.net

To contact the editor responsible for this story:
Robert Burgess at bburgess@bloomberg.net

Albert Bridge borders on ‘suggestivism’ in backing Micro Focus recovery - Profiler

Albert Bridge borders on ‘suggestivism’ in backing Micro Focus recovery - Profiler

30 November 2018 | 13:52 UTC

Albert Bridge Capital has not engaged in activism per se in the case of the UK technology company Micro Focus [LON:MCRO], but its approach does “in some cases border on suggestivism”, according to the London-based fund’s CIO and Managing Director Drew Dickson.

The fund has previously taken a “suggestivist” approach in the case of Volkswagen [ETR:VOW], Dickson told Activistmonitor on the sidelines of the Sohn conference in London yesterday.

Albert Bridge’s approach is about making suggestions rather than demands, with suggestions typically limited to “intelligent things to do from a value creation perspective,” he said.

“We really just try to understand what their [companies] goals are and try to see if they’re aligned with ours,” said Dickson, who is the firm’s founder and a former partner at Perella Weinberg Partners’ asset management division. He has also managed investments at Fidelity and Och-Ziff.

Referring to the suggestions the fund might make to companies, Dickson said: “It [suggestivism] is not a key focus for us but in some instances it does make sense to at least share our thoughts with management,” he said. His firm typically seeks investments with “idiosyncratic volatility with asymmetric payoffs” based on investor biases, according to its website.

Dickson used his presentation at the Sohn conference to promote Micro Focus as a long investment, after the stock fell sharply following the poor integration of its most recent acquisition - the USD 8.8bn cash and stock acquisition of part of software business Hewlett Packard Enterprise [NYSE:HPE]. He did not disclose Albert Bridge’s stake but said it is one of the largest in his portfolio.

Micro Focus’s stock is still down 40% year-to-date but is recovering, and Albert Bridge believes there is still another 50 to 100 pence per share upside left in the stock, Dickson said.

After the company issued profit warnings in January and March, a 12 April media report said activist investor Elliott Management had bought the stock and was pushing the company to sell to a private equity firm. Elliott disclosed a 5.1% stake on 23 April, and said its holding went below 5% on 5 October.

“The stock was at GBP 9 at the time (that) Elliott got involved, and they spoke to the company as well… if the stock had stayed down at 7 or 8 or 9 pounds per share then perhaps (it might have been sold), but as it started moving back up I think a lot of the easy juice came out of the story.”

The company is “not as clear an activist story as it would’ve been”, he said.

In July, it was announced that Micro Focus would sell its SUSE Linux business to EQT for USD 2.5bn.

SUSE was the only Micro Focus asset actually growing, so it was a “nice-to-have” but was also a departure from the company’s traditional model, Dickson noted.

“Kevin (Loosemore), the chairman, his approach is that if someone wants to offer me more than I think it’s worth then I will sell it, and I think he got that with SUSE.”

Similarly, Dickson believes the chairman is not expecting buyer approaches for his other maintenance revenue businesses. “He’ll manage it himself and he’ll make it worth more than anyone’s willing to pay for it, which is why he got the asset so cheaply in the first place,” said Dickson.

by William Mace in London

Visit Activistmonitor's dedicated campaign page for Micro Focus/Elliott here.

Albert Bridge’s Drew Dickson at Ira Sohn

Albert Bridge’s Drew Dickson at Ira Sohn


NOVEMBER 30, 2018 

By: Jamie Powell

Alphaville was at the Sohn conference on Thursday, listening to fund managers pitch their best ideas. Here's two we wrote up earlier.

Micro Focus, the £6.7bn enterprise software company, has had a difficult year. Since January, investors have seen their holdings of the FTSE 100 business decline in value by 39 per cent. At one point, it was down almost 60 per cent:

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But all is not lost, said Andrew Dickson of Albert Bridge Capital at the Sohn Conference Thursday. In fact, he thinks it could at least double from here.

So what's the story?

First, a bit of background. Micro Focus is not your traditional tech company in that it has no interest in growing, Dickson said. Sure, we hear you say, that's what all melting ice cubes tell their investors. But Micro Focus has always made its strategy clear: it buys legacy software companies with sticky products, improves the margins and then watches the cash flow in. For a long time, it worked. Its operating cash flow ballooned from $35m in 2006 to $452m in 2017. To no one's surprise, its share price followed suit:

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In May 2017, it completed its biggest deal to date, paying $8.8bn in cash and stock for HP's enterprise software businesses. According to Dickson it was a steal: HP had spent $20bn acquiring the assets over the years, and due to pressures on then chief executive of HP Enterprise Meg Whitman, was a forced seller. Further, there were no buyers bar Micro Focus, said Dickson.

Here's the relevant slide, complete with a screenshot from Ferris Bueller's Day Off (Dickson has good taste in films, we can report):

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Now integrating a huge new business was always going to be painful. Cultural changes are not easy, even for small firms, and Micro Focus needed to realise those margin improving savings in HP's units to satiate investors in good time. It didn't happen.

Disappointing half-year results in January sent its shares down 17 per cent, but a profit warning in March proved the coup de grace: the shares collapsed 50 per cent. Dickson was bemused, he told us on the phone: “we fully expected the shares to fall 7-10 per cent on the news, but not 50 per cent!". When asked why the reaction was so extreme, he said “there was already some negative bias in the market towards the company, and it seemed to set off a feedback loop — the machines [algorithmic trading] didn't help either”.

Yet for Dickson, the story hadn't changed: Micro Focus' management had a two decade track record of hitting its targets after swallowing software companies, and there was little to reason to doubt them this time around, even if there were a few more bumps in the road.

In other words, Mr Market was, and is, wrong: Micro Focus is cheap as chips, trading at just 9.4 times 2019 estimated earnings, and those estimates are probably too bearish:

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Indeed the market, and the media, still seem down on its ability to embed the HP assets successfully. 9.7 per cent of the shares are sold short, according to Markit data, and of the dozen analysts with ratings on the stock, 6 have hold or sell ratings.

So there's room for sentiment to change, and if it does, there should be a significant re-rating of the stock. Apart from margin improvement, Dickson sees one catalyst in the short term: the planned sale of SUSE for $2.5bn, with $2.1bn being distributed to shareholders via a special dividend. Net this cash windfall off the current share price, and it looks even cheaper. If that doesn't change the game, then significant margin improvement from 2019 onwards should.

But what's it worth? Handily, Dickson provided a valuation slide to round things off:

At pixel, Micro Focus was trading at £15.57, down 1.02 per cent.

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At pixel, Micro Focus was trading at £15.57, down 1.02 per cent.


Volkswagen Stock Is Cheap and Has Lots of Horsepower

Volkswagen Stock Is Cheap and Has Lots of Horsepower

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Photograph by Noam Galai/Getty Images

Volkswagen stock has been in reverse over the past three years, losing nearly 40% from a high of 250 euros ($285) in early 2015 to about €152 recently. That leaves it in 27th place for performance among Germany’s Dax index of 30 stocks over the period.

VW’s equity is down mostly for nonfundamental and fixable cost problems, as we’ll explain below. Despite some significant issues, the Wolfsburg, Germany–based car maker has produced solidly growing profits in the past few years and again in the first nine months of 2018. Admittedly, global car-industry growth appears to be slowing this year.

Nevertheless, operational and valuation factors suggest that the stock is cheap. VW has about 295 million common shares (ticker: VOW.Germany) and 206 million preference shares (VOW3.Germany), with a price of €156, for a total market value of about €77 billion. The preference shares don’t offer a vote but are more liquid than the common shares. The Piech and Porsche families own 52% of VW common stock through Porsche Automobil Holding(PAH3.Germany), and another 20% belongs to the German state of Lower Saxony.

VW bulls say the stock’s low price more than discounts its problems, now that the company’s board has appointed a new, cost-cutting CEO and approved a partial or full divestment of Traton, VW’s truck and bus business. If it’s willing to go further down that road with other VW brands, such as Porsche—and some think it could—a sum-of-the-parts valuation puts the share price over €200. Even without that, VW can improve results by cutting costs after years of high spending on research and development.

The world’s biggest auto maker still suffers reputational and fiscal damage from the 2015 diesel emissions scandal. (VW admitted that it installed software in some vehicles to fool emissions tests in the U.S.) Worldwide, payments to settle the issue are expected to exceed €30 billion.

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The knock-on effect has been infighting in the executive suite, with new CEO Herbert Diess, the third helmsman in three years, coming on last April. Complicating matters, more-rigorous European Union emissions standards—the Worldwide Harmonized Light Vehicle Test Procedure—came into effect this year for car makers, with higher costs and production and delivery delays, which has hurt results.

The car market is in a funk, with U.S. sales flattish, Europe doing a bit better, and China—which, as the world’s biggest car market, represents over a third of VW profits—in retreat.

Despite these issues, VW last month reported a solid first nine months for 2018. Car deliveries were up 4.2%, to 8.1 million, and group sales rose 2.7%, to €175 billion, notes Drew Dickson, chief investment officer of Albert Bridge Capital. Operating profit rose to €10.9 billion from €10.6 billion, ahead of expectations.

The stock trades at just five times next year’s consensus earnings-per-share estimate of €28.52. VW, with “unmatched global brand strength” and higher cash flow in the first nine months than all of its European rivals combined, ranks near the peer valuation bottom, notes Arndt Ellinghorst, an Evercore ISI analyst. VW has weathered all of the stages of the cyclical auto industry and “mastered any crisis better than any other car company,” adds the analyst, who rates the stock Outperform and has a €240 target.

Diess, he says, is the most efficiency-driven of recent VW CEOs, and he has ample opportunity for savings. He can achieve them without cutting product quality or content, Ellinghorst says.

VW Costs Expected to Fall

New CEO Herbert Diess has ample targets to cut the carmaker's spending.Source: Evercore ISI

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In coming years, the analyst expects VW’s fixed costs—R&D, depreciation, and labor—will plateau at about €62 billion, then fall as a percentage of sales by three to four percentage points from a peak of 27.4% in 2015. Selling, general, and administrative expenses should normalize as the diesel crisis fades, he says. VW has targeted SG&A at 12% of sales in the auto business, down from about 14.1% in 2017. This could yield €4 billion in savings from 2017’s €27.9 billion, Ellinghorst adds.

VW’s conglomerate structure has always hindered valuation, but it appears that the board is re-evaluating which of VW’s many brands aren’t core. That might now allow it to slim down and create value.

“The paradigm of corporate governance and value creation has changed,” adds Dickson. VW has embarked, if tentatively, on a trail blazed by Fiat Chrysler Automobiles (FCAU) when it successfully spun off shares of Ferrari(RACE).

In September, VW said it is pushing forward preparations for a potential spinoff or initial public offering of Traton. “That would have been unheard of four years ago,” says Dickson. VW also reorganized its car lines in April into groups: volume, with the VW and Skoda/Seat brands; premium, such as Audi; and superpremium, which includes Porsche, Lamborghini, Bentley, and Bugatti.

Dickson assigns a market value of €11.5 billion, including debt, or €23 per VW share, for Traton, based on peer valuations. If the superpremium group were separately listed, Dickson says it would be worth about €55 billion to €60 billion, or roughly €114 per current VW share, using a price-to-sales ratio less than half that of Ferrari’s. That would total of about €137 per VW share.

Backing out the theoretical market caps of Traton and the superpremium group from VW’s current valuation leaves VW with a market cap of just €7 billion, equal to about one time its 2019 earnings per share from several major businesses. Among them: Audi, with €66 billion of sales; Chinese joint ventures, where VW’s 2017 profit was €4.8 billion; Skoda/Seat, with €30 billion of sales; and VW itself, with €90 billion of sales. Shares from superpremium and Traton would amount to a dividend of roughly €137 for a stock that trades around €150, says Dickson.

Addition by Subtraction

Based on a sum-of-the-parts valuation, VW investors are getting the stock for just one times earnings if you back out the trucking and Porsche units.

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He notes that VW recently poured cold water on a putative superpremium group IPO with a press release stating, “Porsche [brand] does not currently have any plans to pursue a (partial) initial public offering.” A spokesman declined to go beyond that statement this week.

“We really like the word ‘currently’ there,” Dickson quips.

A successful Traton IPO in the first part of 2019 could energize the shares as investors begin pondering a potential separation of the superpremium auto group and its implications for valuation, says Dickson.

Even if a superpremium IPO never happens, Traton alone gives an indication of how cheap the brands inside VW’s house are. The Fiat experience, which saw shareholders reap big benefits from the Ferrari spinoff, suggests VW shares are cheap.

Write to Vito J. Racanelli at vito.racanelli@barrons.com


The day Volkswagen briefly conquered the world

The day Volkswagen briefly conquered the world

By: Jamie Powell


 In midst of the great financial crisis, something odd happened. Volkswagen, the German carmaker, became the biggest company in the world. For one, brief day.

Looking back a decade, as many have recently, you'd be forgiven for thinking the worst asset to own was a US investment bank or mortgage originator. But it was nothing compared to being short the Wolfsburg-based business.

Exactly 10 years (and 48 hours) later, here's how it happened.

A tale of two families

The story revolves around two of Germany's most famous automakers — Porsche and Volkswagen — whose interlocking history rivals the great family sagas of German literature, such as Thomas Mann's Buddenbrooks.

We begin in 1931, when Ferdinand Porsche founded an automotive consultancy. One of his first major projects, at Hitler's behest, was to design Volkswagen's iconic Beetle, which was designed in 1934. The founding of the carmaking arm, Porsche AG, followed in 1948, with the Porsche family remaining in control of the company through the next half century.

A long history of collaboration followed, with Porsche outsourcing much of its manufacturing to Volkswagen. But the ties ran deeper than a business relationship.

Ferdinand Porsche's grandson, Ferdinand Piëch, became the chief executive and chairman of Volkswagen Group in 1993, after thirty years at Audi. He took the position in the midst of troubling times — the company had just recorded a $1.1bn loss, its largest ever — but he turned the company around, before retiring to become chairman in 2002.

Despite running another carmaker, Piëch and his wider family still retained 50 per cent of the voting rights in Porsche stock, with the other half held by the Porsche side. (Porsche AG was listed in 1984, but the public could only buy non-voting preference shares).

According to Handelsblatt, the German business paper, Piëch did not always see eye-to-eye with his cousins:

“[By the time he joined Volkswagen], Mr. Piëch’s rivalry with the Porsches was out in the open. That the self-styled Crown Prince Ferdinand [Piëch] openly had a relationship with his sister-in-law Marlene Porsche, which resulted in two children, didn’t exactly help to minimise tensions. Mr. Piëch made no bones about how he felt about his cousin Wolfgang “Wopo” Porsche, who headed the clan. For the private school warrior, Wolfgang the Waldorf school grad was soft and weak.”

This mesh of family and business relationships formed the backdrop for one of the decade's most memorable takeover attempts. As Porsche — run by former Volkswagen board member and Piëch's choice for the job Wendelin Wiedeking — sought to swallow the Wolfsburg-based car giant whole.

An extended courtship

Wiedeking's Porsche had long courted Volkswagen, seeing a takeover as a means to not only secure access to Volkswagen's manufacturing expertise for Porsche but, due to the overlapping interests between the companies, to buffer the company against a hostile takeover. He referred to it, perhaps unadvisedly, as a “German solution”.

Piëch was open to the merger, according to Fortune, as it would have cemented his control of Volkswagen (via his own Porsche stake), and allow him to realise his ambition to “lead a bigger company than my grandfather”.

Porsche played the long game. The first move came in 2005, when it announced it had taken a 20 per cent voting stake in Volkswagen. Over the next two years it slowly accumulated more shares, eventually passing the 30 per cent threshold where it would have to make a mandatory offer for the company in early 2007. The bid failed, but in October 2007 Wiedeking was given fresh hope by an unlikely source: the European Court of Justice.

The court, in a case brought by the European Commission, overturned the “Volkswagen Act”, an esoteric German law from 1960 that required a party to own 80 per cent of Volkswagen's voting shares before it could formally control the company (versus the 75 per cent normally required). As the state of Lower Saxony owned 20.1 per cent of Volkswagen, the legislation protected the business (and its workers) from the vagaries of international capital.

With the Act now in question (although Germany would go on to fight the ruling), the door opened wider for Wiedeking and Porsche. In March 2008, he was given the all-clear by Porsche's supervisory board to increase the holding to 50 per cent. By September 16, its stake had reached 35 per cent, with Wiedeking declaring:

“Our goal continues to be to increase our stake in Volkswagen to more than 50 per cent. Today’s step is a further milestone along this road.”

And then, everything went quiet.

A tempting trade

Around the same time that Wiedeking was building the Volkswagen stake, a hedge fund strategy was gaining popularity on Wall Street: event-driven investing.

Pioneered, according to Sebastian Mallaby, by investing legend Tom Steyer at the West Coast hedge fund Farallon, the strategy expresses itself in a number of ways, but what matters for this story is one particular strain: capital structure arbitrage.

It works something like this: an investor finds two securities which should have a relationship to each other — such as the shares and bonds issued by a company. The price of both should reflect assumptions about the company's future, so if they get out of whack it can present an opportunity. The investor sells short the security it believes to be overpriced, and buys the one it thinks is underpriced, with the idea that prices will converge when Mr Market comes to its senses.

In Germany, this tactic gained traction thanks to the Teutonic tradition of dual-share classes. According to a paper by Katie Bentel and Gabriel Walter, the practice dates back to the 1980s, where preference shares — which carry no voting rights but a fixed dividend — became popular as to protect German companies from both hostile takeovers and foreign influence. The outside investors got their dividends, and local owners kept control through the ordinary shares. Everyone was happy.

By 2003, 28 of the DAX-100 (Germany's largest listed corporations) had both ordinary and preference shares, according to data cited by Bentel and Walter.

If not for SAP, it may have been 29. The enterprise software group chose to retire its preference shares in February 2001, swapping them for ordinary shares. The idea was a clearer capital structure would attract more investors.

SAP's preference shares were trading at a 20 per cent premium to the ordinaries, due to the ordinaries low liquidity. Therefore investors who owned the ordinary shares, and had sold the preference shares short, made a profit as the two securities converged in price.

According to a friend of Alphaville (who goes by BrokenBanker on Twitter and helped to flesh out the details in this story) who was working in equity sales in Frankfurt at the time, SAP's switch made several event driven hedge funds handsome returns.

With such (relatively) riskless profits on offer, investors began scouring Germany for similar situations. Attention quickly turned to Volkswagen, where the preference shares traded at a significant discount to the ordinaries, in part because Porsche's takeover demand would target the latter rather than the former.

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Here's the chart, from 2000 to September 2008, showing the discount between the two share classes, expressed as the preference shares value relative to the ordinary shares:

As you can see, the discount undulated throughout the noughties, providing plenty of volatility for nimble funds, before falling below 50 per cent as Porsche began to buy up the voting shares from 2006 onwards in its takeover bid.

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This created a bizarre split in the two share classes, particularly as the preference shares began to fall as the financial crisis began in mid-2008:

Analysts were perplexed by the divergence, particularly as Porsche did not disclose buying more shares after a previous announcement that it had acquired 35 per cent of them on September 16.

In mid-October, Sanford Bernstein's Max Warburton put forward one explanation: Porsche could be buying cash-settled options on Volkswagen's stock, which — as the stock is only owned once the option is settled — would allow it to accumulate a large stake without disclosing it to the market.

Porsche did have a reputation for financial wizardry — €3.6bn of its €5.86bn pre-tax profits in 2007 were from options used to hedge against a rise in Volkswagen's stock — but the evidence that autumn was circumstantial at best. Porsche described Warburton's thesis as a “fantasy”.

With little news to go on and the spread widening to improbable levels, it was hard for investors to resist the arbitrage trade — particularly as other carmakers shares were stalling and Volkswagen wasn't following suit.

Funds like Albert Bridge Capital piled in. Here's how they described the trade:

“By late August, the prefs [preference shares] were trading at €100 per share, but the ords [ordinary shares] were twice the price at €200. Consequently, nearly everyone and their brother were short the ords and long the prefs, in what some viewed as a riskless trade. We, however, were not short. It felt like such a consensus trade and we knew that Porsche were suspiciously adept at playing the markets (and playing market participants).

But then, just three weeks later, the premium was over 3x (the prefs were at €90 and the ords at €270). That was enough for us to eliminate our “be anti-consensus” requirement, and we threw in the towel and got short in late September in two tranches at €261 and €278 — with the underlying value (represented by the prefs) nearly 70 per cent lower.”

Little did any of the funds realise what Wiedeking, and Porsche, were up to.

Red October

October 2008 was a pretty good month to be a short-seller. Equity markets were in turmoil following the collapse of Lehman Brothers and the panic of bankers throughout the global financial system.

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Yet, for some reason, Volkswagen's ordinary shares continued to ignore the doom and gloom of world markets, doubling over two months:

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This pushed the spread out to 80 per cent, as the price of the preference shares headed south:

However, over the week starting October 20, it seemed as if the fundamentals had caught up. Volkswagen's ordinary shares fell from €275 to €210. Here's Albert Bridge Capital again:

“Then the ords finally started to break, and just a week later, the spread was collapsing . . . so on that Friday (the 24th), we felt like this madness was on its way out, and we would soon return to normalcy. We thus concluded it was safe to size up, and we tripled our size and shorted two more tranches, one at €233 and one at €206.”

They weren't the only ones. By the end of the week, the 24th, according to Markit Data, 12 per cent of all shares were sold short, around $10bn worth.

But then on Sunday afternoon, while most were away from their Bloomberg Terminals, an explosive Porsche press release hit the news wires:

“Due to the dramatic distortions on the financial markets Porsche Automobil Holding SE, Stuttgart, has decided over the weekend to disclose its holdings in shares and hedging positions related to the takeover of Volkswagen AG, Wolfsburg. At the end of last week Porsche SE held 42.6 per cent of the Volkswagen ordinary shares and in addition 31.5 per cent in so called cash settled options relating to Volkswagen ordinary shares to hedge against price risks, representing a total of 74.1 per cent.

Upon settlement of these options Porsche will receive in cash the difference between the then actual Volkswagen share price and the underlying strike price in cash. The Volkswagen shares will be bought in each case at market price.”

Combined with Lower Saxony's 20 per cent holding, the shares available to buy on the open market had suddenly dropped to just under 6 per cent.

This was a terrifying prospect for the shorts. To short a share an investor must borrow it, eventually returning it to the lender. They sell the stock in the expectation the price will drop, and the mechanism requires each share be bought back to close a trade. With 12 per cent of the shares outstanding sold short, it was mathematically impossible for every short-seller to buy a share, and therefore close their position.

In other words, half the room were going to be left in a burning building with no way out. A panicked dash for the exit began.

On Monday morning Volkswagen's ordinary shares opened at €348, up 66 per cent from Friday's close, and kept rising. The shares closed at €517: a 149 per cent gain in the space of one day's trading.

For those who had not squeezed out the fire escape, the worst was yet to come.

The first tick on Tuesday was a touch lower — €497 — before the shares took off again, rocketing to an intraday high of €999, before easing off to €940 at close. For those who sold a share short on the Friday, the losses were brutal. If they had borrowed €100m of stock, it would have cost them €450m to buy it back. (This calculation has been updated since publication to clarify the cost of buying back the stock.)

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This chart does a pretty good job of capturing the madness:

Market participants do not remember the time fondly.

“It was one of the most painful days in my career”, Arndt Ellinghorst, now a Senior Managing Director at Evercore ISI, but then at Credit Suisse, told us. “The pain among investors was unparalleled versus any other market scenario I have encountered”, he added.

Our equity salesman friend, who had put on the trade for several of his hedge fund clients reminisced, “it remains the single biggest money losing situation I can remember for funds caught short — and a lot of them were”.

It also proved to be a historical moment in markets. At €999, Volkswagen briefly became the largest company by market capitalisation in the world, with a value of $420bn, eclipsing Exxon Mobil, Petro China and Microsoft.

It didn't last long.

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On Wednesday 29, Porsche, perhaps realising their actions had caused some damage, generously provided an extra 5 per cent of the shares to the stricken shorts. By Friday, Volkswagen's ordinaries closed at €497, down 50 per cent from the Tuesday highs as the squeeze loosened.

By December, Volkswagen's ordinaries were all the way back in the mid-200s. Calm had been restored.But that's not quite the end of the saga.


Indeed, it was the beginning of the end for Wiedeking and Porsche.

Despite lifting its stake to past the 50 per cent mark, Porsche was short of the cash required to take delivery of the shares it had committed to buying via the options, so as to pass the crucial 75 per cent mark. To add to the pain, Porsche had taken on €15bn of debt, in part to build the position, according to Der Spiegel, and €10bn was coming due in March 2009 just as global car sales were falling off a cliff. With banks wary of lending, Porsche faced bankruptcy.

In a twist that can only be described as ironic, Volkswagen bailed out Porsche AG (the car company) in July 2009. Later in August Porsche SE (the holding company) tapped financing from the Emirate of Qatar, selling a 10 per cent stake and 17 per cent of its cash-settled options in Volkswagen for €7bn.

Under this arrangement, Porsche SE retained its voting stake in Volkswagen (which today stands at 30.8 per cent of shares outstanding or 52.2 per cent of the voting shares), which would own the Porsche AG car company. Sound confusing? Here's a graphic of the structure from Porsche SE's last annual report to help:Wiedeking was turfed out but, for the trouble of taking the company to the brink, he received a golden parachute of €50m. He now runs a chain of pizza restaurants.

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Piëch, as the merger allowed him to retain control of Volkswagen via his stake in Porsche SE, could not hide his delight at the deal:

“Together, Volkswagen and Porsche have all it takes to occupy a leading position in the international automotive industry”

The transaction was completed in July 2012, with the price Volkswagen paid for Porsche AG coming to €8.4bn, not including assumed debt.

For the hedge funds nursing an estimated €20bn of losses, however, this was not the end of the story. Yet, so far, their anger has fallen on deaf ears.

Wiedeking and former Porsche chief financial officer Holger Härter were acquitted of market manipulation charges in March 2016. Then in December of that year, 19 hedge funds — including David Einhorn's Greenlight Capital — had a €1.2bn civil claim against Porsche SE for damages dismissed by Germany's federal court of justice. Several other lawsuits are still moving through the German courts, according to the New York Times.

Some have tried other ways to claw back losses. For instance a firm backed by Elliot Management, who were also caught in the short-squeeze, are financing litigation by a group of shareholders over the Volkswagen emissions scandal. In return for paying the upfront costs, they will collect up to 30 per cent of any of the winnings from the lawsuit. While not directly related to 2008, many have suggested it is in part a means for Elliot to settle old scores. Elliot declined to comment.

Teasing lessons out of such an anomalous market event is hard. It's not as if squeezes from stealth takeovers using options are an everyday occurrence. Indeed, one investor we spoke to, Drew Dickson, chief investment officer and managing partner of Albert Bridge Capital, was philosophical. “The thing to learn [from the short-squeeze] is that, it's such a rare experience and special case, we should not overreact. It's very easy to dislike Porsche after that but that should not stop you buying their shares in the future”.

Perhaps another lesson is that panic runs both ways. Often we associate a ruinous market event with things collapsing, such as Carillion last year, but the Volkswagen short-squeeze shows fear can propel securities upwards as well, and far beyond the 100 per cent downside on “long” investments.

It took a particular market era, particular legislation and particular actors for Volkswagen to briefly sit on top of the world. The question is not so much whether history will repeat itself, but when it does again, what form will it take?


A Challenge to the Biggest Idea in Behavioural Finance

A Challenge to the Biggest Idea in Behavioural Finance

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Two professors make an interesting argument, but the theory of loss aversion isn’t dead yet.

By Barry Ritholtz

9 August 2018

That sure hurt.  Photographer: Thierry Esch/Paris Match Archive/Getty Images

That sure hurt. Photographer: Thierry Esch/Paris Match Archive/Getty Images

A recent paper summarized in Scientific American raises an intriguing question: Is one of the founding theories of behavioral finance known as loss aversion -- the idea that people place more weight on avoiding losses than gains -- correct?

In the magazine, one of the study's authors, David Gal of the University of Illinois - Chicago, writes:

Why has such profound importance been attributed to loss aversion? Largely, it is because it is thought to reflect a fundamental truth about human beings—that we are more motivated by our fears than by our aspirations. This conclusion has implications for almost every aspect of how we live our lives, especially for finance and economics.

But Gal doesn’t see it that way. He writes that “loss aversion is essentially a fallacy.” He suggests that cognitive bias via loss avoidance doesn't exist, and messages framed in terms of losses are no more persuasive than those framed in terms of gains. 

Since this is an extraordinary claim, it requires extraordinary evidence. I don't believe that standard has been met and that the authors failed to make a case that convincingly rebuts the accumulated research.

Let's look at some of the hypotheticals Gal cites: “People do not rate the pain of losing $10 to be more intense than the pleasure of gaining $10.” That is not what most of the studies on the subject have found to be case; nor does it square with my personal experiences in dealing with any investor who has suffered losses.

He further writes: “People do not report their favorite sports team losing a game will be more impactful than their favorite sports team winning a game.” Again, numerous studies have found that despite the pleasures associated with being a sports fan, the opposite is true.

And one more: "And people are not particularly likely to sell a stock they believe has even odds of going up or down in price (in fact, in one study I performed, over 80 percent of participants said they would hold on to it).” Even if that is true (and I do not believe it is), the endowment effect easily explains why we place greater financial value on that which we already possess.

My pop psychology thesis on this is based on the asymmetrical impact of losses and gains. From an evolutionary perspective, the biological penalties for losses are existential threats to an individual’s or a specie’s survival; the upside of gains are modest -- you live to hunt (or avoid being hunted) another day.

In the modern human world, a loss can feel permanent. You exchanged your finite time for some money (this is otherwise known as employment). Or you risked capital and lost it. That money is gone forever. But get lucky in the markets or a casino and it is ephemeral “house money,” easy to spend thoughtlessly.

When Richard Thaler, Nobel laureate in 2017, was asked about the $1.1 million award that came along with the Prize in Economic Sciences, he cheekily said “I will try to spend it as irrationally as possible.” Thaler’s bon mots are a subtle admission of how humans behave in the real world. That’s what he was awarded the prize for in the first place.

No matter, the paper drew a good deal of attention from those like Drew Dickson, chief investment officer and managing partner at Albert Bridge Capital. In a pointed tweetstorm, he succinctly summed up their position, challenged their thesis, while noting that they perhaps have identified “other motivations for well-known biases.” But he too reaches the conclusion that loss aversion is alive and well.

Where I suspect the authors went astray was in the conflation of various cognitive failures, biases and heuristics with loss aversion. Consider for a moment a Las Vegas casino. If people were truly loss averse, the counterargument might suggest that casinos shouldn't exist. But they not only survive, but thrive. This is due to other powerful cognitive errors: 1) people tend not to understand how the odds are stacked against them and in the house’s favor; 2) others understand the probabilities, but irrationally believe they are an above-average gambler; 3) others simply gamble for its entertainment value and are willing to accept the inevitable losses.

The mere fact that gain-seeking behavior exists hardly eliminates loss aversion as a phenomena.

What is most fascinating to me about the premise that Gal and co-author Derek Rucker of Northwestern University's Kellogg School of Management have pushed forward is around the meta-concept that challenging the status quo is an uphill battle. They are on to something here, though surely they recognize that Daniel Kahneman and Amos Tversky’s famous theory was itself not accepted for a long time. Kahneman and Tversky’s ground-breaking 1979 paper was an assault on the status quo at the time, and it took decades before their thesis was assimilated into psychology and economics.

But this does bring up an intriguing concept: As any counterintuitive idea slowly becomes mainstream, it too is eventually challenged as the status quo. Perhaps this is what physicist Max Planck meant what he stated that “science advances one funeral at a time.”

For many good reasons, loss aversion has become accepted wisdom on how people make decisions under conditions of uncertainty. I suspect it will be a long time before that explanation is overthrown.




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Class, Behave!

When Richard Thaler brought the debate about behavioral economics to Chicago Booth, he entered a classroom that extends to Stockholm and beyond.

In 2017, Chicago Booth professor Richard Thaler won the Nobel Prize in Economic Sciences. Thaler’s students describe him as “a luminary,” “a guru”—someone who changed their lives and set their careers on a trajectory to success.

So it might be surprising to hear that those superlatives contrast amusingly with the way Thaler’s close friends and admirers—and even Thaler himself—have described the newly minted Nobel laureate:

“We didn’t expect much of him,” said Sherwin Rosen, AM ’62, PhD ’66 (Economics), his thesis advisor at the University of Rochester. 

Daniel Kahneman, the 2002 Nobel laureate in Economic Sciences and one of Thaler’s closest friends, described Thaler as “lazy.”

Early on in Thaler’s career, his fellow Booth professor and future golf buddy Eugene Famaonce quipped, “His work is interesting, but there’s nothing there.”

Thaler’s own self-assessment is hardly more glowing. He considers himself “at best, an average economist.” How did an “average economist” change the field of economics, gain a worldwide reputation, and influence public and corporate policies for millions of people—and win the Nobel Prize?

It turns out that Thaler’s ability to spot anomalies, tell stories, and share credit for his successes have made him not only a great researcher, but also a great teacher.

“One of the nicest things that has happened since the Nobel,” Thaler said, “is hearing from lots of students that I hadn’t stayed in touch with saying they still think about that class and they remember this story or that story many years later. When I first figured out the power of storytelling, I would tell my students that my plan was not to maximize what they knew at the end of the course but what they would remember five years later. Now I know that some of them remember it 40 years later.”

Looking for His Cello

Thaler decided to become an academic, he says, because he is “a really lousy subordinate.” Academia seemed the only career where no one could tell him what to do. He had no grand plan; he just wanted to get tenure. Two years into his career as an economics professor—teaching the MBA version of Econ 101 at the University of Rochester and frankly not having much fun—he came upon the work of Daniel Kahneman and the late Amos Tversky. It opened his eyes to the reason behind so much of what he observed. Economics, he was finding, was “a bit boring.” On the other hand, people watching was interesting. He suspected that the gap between psychology—what the two professors were studying—and economics was largely unexplored, with lots of low-hanging fruit. 

In a 2003 convocation speech at the University of Chicago, Thaler likened the moment to a story about world-renowned cellist Yo-Yo Ma. Ma began his musical studies as a toddler on the violin, on which he describes himself as only average, but when someone handed him a cello, he found his calling. In spotting the connection between psychology and economics, Thaler said he “found his cello.”

In 1977, he went to Stanford to spend a year with his idols, Kahneman and Tversky, who were there visiting from Israel. They helped him learn psychology, he helped them learn economics, and they became both friends and collaborators. At the end of that year, Thaler jumped to the SC Johnson College of Business at Cornell University. He created an elective course called Behavioral Decisions Theory. It was “a little off the wall,” with much material possibly “borrowed” from a class he had taken from Tversky, he recalled. The class was not very well attended. 

“I had to figure out how to increase enrollment in the class,” he said. “I changed the name to Managerial Decision Making and enrollment doubled.” Thaler asked his students how many chose the course based on the name. “No one said yes,” he remembered. “I said, ‘Half of you are wrong.’” 

Thaler, the professor, had arrived.

I want students to have to think about it, not just memorize what was said.
— Richard Thaler

The Power of Storytelling

Memories of Thaler’s teaching style have one common thread for all of his former students: laughter. They can’t describe a Thaler class without a smile. “He meanders up to the podium,” said Linnea Gandhi, MBA ’14, who has known Thaler as a student, a teaching assistant, and now co-professor as adjunct assistant professor of behavioral science at Booth. “Then he tells stories about foibles and fumbles, not just in companies but in his own life.” In most students’ recollections, this is done at a slight lean, against the podium, against the transparency machine in the old days, against whatever’s handy.

Thaler’s stories have become part of his mythology. A select few made it into his Nobel lecture. The story of the bowl of cashews, of the blizzard that kept him and a colleague from driving 75 miles to a basketball game, of his former professor’s wine collection: seemingly random, always entertaining, these slice-of-life stories led to research projects, which led to his theories on self-control, on mental accounting, and on the endowment effect, loss aversion, and status quo bias—all of that in the first few years of his career.

His teaching style is so avuncular and accessible, his body language so relaxed, that students often underestimate the content. They may sign up because of his reputation, or because of a shared love of sports, or—of late—because he’s recently been in an actual first-run movie with actual movie stars (The Big Short, winner of the Academy Award for Best Adapted Screenplay in 2016). On its face, the substance of his syllabus may seem easy. When students try to apply the theories, Gandhi said, “that’s when they realize how difficult it is.”

Thaler tells stories “because that’s what people remember.” His class includes what he calls “the little magic show,” part of which relies “on students having forgotten things they learned in statistics class” during a previous semester. “Nobody remembers some formula,” he said. “But they remember stories.”

Thaler’s storytelling style in the classroom has made an indelible impact on his students. If you were to ask the thousands of Booth graduates who have taken his courses over the decades which Booth course they remember the most, “a tremendous number would cite his class,” said Raife Giovinazzo, MBA ’03, PhD ’08. “He built it to be memorable—and therefore useful.”

Sports stories permeate Thaler’s classes. He has even managed to write an academic paper about the NFL draft. He is a sports fan, a golfer, and agnostic in his preference for football over baseball over basketball. As a behavioral economist, however, “my justification is that we get to watch the teams’ decisions in a way that we don’t in most of business,” he said. When Amazon was deciding whether to buy Whole Foods, for instance, the general public was not privy to the conversation. “We see that they did it and we see their reasons, but we don’t see the five things they thought about and didn’t do,” Thaler said. “If a firm is hiring a new CEO, we have no idea who they interviewed, how they made the decision.”

On the other hand, sports fans can see the decision-making process in play every second of a sporting event. “When a basketball player takes a two-point versus a three-point shot, we see that decision play out,” Thaler said. “There’s now data on every action by every player in every game.” There is no similar dataset on decision-making within firms.

No Right Answers

As a young professor teaching more basic economics courses, and giving exams that were more about data, Thaler found that his students disliked being graded on a curve. They balked at scoring only 65 when the average score was 72—it mattered little that their actual score would earn them a B.

Thaler didn’t want to make the exams any easier. But as a young professor with an eye on tenure, he wanted to keep his job. He kept the exam just as hard, with one exception: the number of available points rose to 137. When Thaler graded the test, the average score rose as well, to 96. Students might still get a B, but they felt better. Some of them were positively ecstatic that they scored “higher than 100.” 

Their joy, of course, makes no rational sense. The experience added to Thaler’s mounting list of “supposedly irrelevant factors,” or SIFs. SIFs form the basis of much of his thinking on why people behave in irrational ways, and why their irrationality is predictable. 

He once ran into a student who was studying for the final exam in his class and said he was busy outlining the articles they had read, a thought that appalled Thaler. “I want them to have to think about it,” he said, “not just memorize what was said.” So he started using a new type of exam. He would ask students to submit potential exam questions and then would circulate about 75 of those questions, saying the exam would be composed of (slightly edited) versions of these. The rule in generating questions was that they could not have a simple “correct answer” but rather force the students to ponder the material they had learned and then apply it to some novel situation.

 “It’s not the most precise way of measuring how much they’ve learned,” he said. “But it’s the best way I have found to maximize what they learn when studying for the exam.” 

“It’s different than a traditional exam,” said Drew Dickson, MBA ’99.

“On most exams, you go point to point, show your work, and here’s your grade. Thaler’s tests probe you, and show what paths you might go down to solve the problem. There might be more than one answer. You’re not done with the test when you finish the test. You have to apply your ability to think laterally. You learn how to question yourself.”

One of Thaler’s former teaching assistants, Dean Karlan, MBA ’97, MPP ’97, expressed relief that his TA stint predated the latest, nontraditional iteration of Thaler exams. “It sounds like a nightmare to grade,” said Karlan, now professor of economics and finance at Northwestern University and founder of Innovations for Poverty Action (IPA).

Thaler once compiled a list of the top 10 reasons not to take his class. Imprecise and subjective grading was on the list. “If you want exams with right or wrong answers,” he said, “take accounting.”

The people who helped him—he gives it back. . . . It makes for lifelong fans.
— Linnea Gandhi

Laziness as a Work Habit

Thaler’s nonchalance in the classroom downplays his brilliance and showcases his supposed laziness, a trait that he attributes to himself. There is no way he could have achieved everything he has if it were true, however. In fact, he “works his butt off,” according to Gandhi, who helped Thaler prepare both the final draft of Misbehaving: The Making of Behavioral Economics—his most recent book—and his Nobel lecture. With a caveat, Gandhi added: Thaler works only on things that interest Thaler. “When he gets an idea and begins to think about it,” she said, “it works its way into every conversation, every class, every speech.”

Cade Massey, MBA ’03, PhD ’03, worked with Thaler on research into the NFL draft over the course of 14 years. They began in 1999, published “The Loser’s Curse: Decision Making and Market Efficiency in the National Football League Draft” in 2005, and updated their findings in 2012. Now a practice professor in the operations, information, and decisions department at the Wharton School, Massey is working with an NFL team on what has come to be known as people analytics.

“He’s not lazy,” Massey said. “He just wants to work on things that amuse him. Then he’s not lazy at all. He doesn’t like to do things he doesn’t want to do.”

Nudge: Improving Decisions about Health, Wealth, and Happiness, Thaler’s best-known book and a best seller, originally appeared in 2008. One chapter, about the Swedish social security system, evolved from a 2004 paper he wrote with a Swedish doctoral candidate, Henrik Cronqvist, PhD ’05. When a scandal involving the system arose in 2017, Thaler contacted Cronqvist, now chair of the department of finance at the University of Miami. “He said, ‘Let’s put the band back together,’” Cronqvist recalled. Last December, while in Stockholm to accept his Nobel, Thaler addressed the Swedish Parliament in anticipation of a paper published the following month called “When Nudges Are Forever: Inertia in the Swedish Premium Pension Plan.” 

Given the size of the dataset—every pension choice made by every Swede since the system’s inception—the idea is likely to continue kicking around in Thaler’s head, cropping up in every class, every conversation, every speech. As in the work he did with Massey on the NFL draft, he will stick with something for years until he resolves it in his own mind. The man leaning casually against the lectern is his own toughest critic and does not grade himself on any curve. 

“He’s amazingly productive,” said Karlan of Thaler’s work habits. “But with a strong preference for hanging out.” 

The Chicago Approach

It is hard to imagine two more different individuals, two more different teachers, or two more different economists than Thaler, Charles R. Walgreen Distinguished Service Professor of Behavioral Science and Economics, and Eugene Fama, Robert R. McCormick Distinguished Service Professor of Finance. Thaler’s theories—once referred to as wackonomics—took decades to be accepted by the economics establishment. Even post-Nobel, there is still some skepticism from the quant side of the house. Fama, the father of much of the efficient-market hypothesis, is known for exactitude, and for not suffering fools well, if at all. Professor Fama does not lean nonchalantly on the podium and tell stories. On his exams, there is most definitely a right answer and a wrong one. 

And while it was Fama who said that there wasn’t much to Thaler’s work, unlike his colleague Merton Miller, Fama did not oppose Thaler’s coming to Chicago. When Thaler did arrive in 1995, Miller was asked why he had not blocked the appointment. He replied: “Each generation has to make its own mistakes.” Quite a welcome!

The seemingly unlikely relationship between Thaler and Fama—good friends and golf partners, and yet diametrically opposed in so many ways—encapsulates the appeal of Booth to so many students. It’s not about the disagreement; it’s about the ideas and the ability to debate those ideas without rancor or ill regard. 

“Miller and Fama gave me the framework I start with to this day,” said Dickson, founder and CIO of Albert Bridge Capital in London. “But Dick Thaler gave me the red pill. He’s been showing me how deep the rabbit hole is ever since.”

Dickson mentions how Thaler likens the debate between behavioral economists and efficient-market economists to a face-off between Homer Simpson and Mr. Spock from Star Trek. “When you look at markets, on the other side of the table from Mr. Spock sits Homer Simpson, a human being. In my business, any Spock can see when a stock is cheap or expensive. But what can I find that proves that the market is acting like Homer? The value-added is the application of these tenets of behavioral finance.” 

When Giovinazzo arranged his PhD committee, he sought out the best group, regardless of any supposed differences. Fama and Thaler sat on his committee. “Both believe in looking at the facts,” said Giovinazzo, who passed up a career as a professor and has become a partner at Fuller & Thaler Asset Management in San Mateo, California. “There wasn’t even any controversy on how they approached the committee. They might disagree on how far you can extend the facts, but if the analysis is done in a sensible way, they will be in sync on it.”

Thaler provokes debate with and among his students, both in class and out. When Executive MBA students take his class at the same time they’re taking Microeconomics, “he loves to get them arguing the micro side of things and then help them see what micro is missing,” Gandhi said. “Booth does a better job of training for ideas than any other business school,” added Giovinazzo. Thaler’s “little magic show” is a prime example.

As part of that show, Thaler presents a bunch of questions people typically get wrong, predicts the incorrect answers most students will give, and then reveals the right answer. “They’re always different,” Thaler said, “and my predictions of their answers are almost always right. The point is to show them they are not as smart as they think they are. I can predict the mistakes they are going to make.” Far from any sort of professorial one-upmanship, his magic show starts an inquiry that forms the basis of behavioral economics and of his unique teaching style. 

When Thaler first came to Chicago, he made Fama’s course a prerequisite for his PhD course in Behavioral Finance. “You have to know the standard theory before you can criticize it,” Thaler said. “You can argue the empirical validity of the efficient-market hypothesis, but there would have been no behavioral finance without it. It’s the benchmark to which we were comparing things.”

The Chicago Approach, both men agree, is to have fierce arguments in workshops but never make them personal, to debate principles and ideas rather than personalities and egos. It is not just intellectually stimulating and distinctly different from any other business school; it shows a generosity of intellect uncommon in any workplace. 

“He’s fearless,” Karlan said. “I came to this after he’d already cut against the grain. That’s what got him here. He was like a dog with a bone and wouldn’t let it go until others said, ‘Maybe he’s onto something.’”

As attendees to Thaler’s Nobel lecture (viewable on NobelPrize.org) found their seats in a large auditorium, they were shown a slideshow that was running until the lecture began. Fifty slides recognized more than 100 people who have helped him in his work. The slides were his idea and he was very insistent on their inclusion, according to Gandhi. 

“He did not climb the ladder,” Gandhi said. “He didn’t step on people. He followed stuff that was odd and weird, and he didn’t care what others thought. The people who helped him—he gives it back. It is the coolest, most surprising side to him. And it makes for lifelong fans.”

—By Rebecca Rolfes


Albert Bridge Capital's Dickson Included in The Hedge Fund Journal Tomorrow's Titans 2016

Dickson, formerly of Fidelity and Och-Ziff, spun his Alpha Europe strategy off the Perella Weinberg Partners (PWP) platform, launching the strategy independently in the spring of 2016 with assets under management of $125 million.

Former PWP colleagues have re-joined him, including Doriana Pavlicu, Charles Hwang, and Jeremie Dadoun, filling out a team of nine backed by a large US university endowment. Dickson’s formative years working and studying under behavioural economist Richard Thaler at the University of Chicago, underpin the behavioural finance elements of the investment process.

The Albert Bridge team follows a bottom-up, deep-dive fundamental equity strategy with the goal of generating differentiated, idiosyncratic returns, capitalising on superior, objective analysis; while taking advantage of biases of the consensus investor. He constructs the portfolio in a reasonably concentrated manner, with the top ten positions representing 65% of assets under management since the strategy’s inception in April of 2008.

Before spinning off the PWP platform in December of 2014, cumulative net returns in the Alpha Europe Long Only Fund had reached 135.9%, representing annual returns of 13.5%.


Albert Bridge Hires Former BAML’s Kenny for Marketing

Albert Bridge Hires Former BAML’s Kenny for Marketing

Andrew Dickson’s Albert Bridge Capital, which started trading in London this year, has hired Mairead Kenny, Bank of America Merrill Lynch’s head of capital introductions, to lead fundraising.

Kenny has joined as director of marketing and investor relations, the money manager said in a June 7 statement. Kenny led the U.S bank’s unit helping European hedge funds raise money for more than four years.

Dickson, former money manager with Perella Weinberg Partners, started trading the AB Alpha Europe Long Only Fund in April.  The fund had support from a U.S. university endowment and raised $150 million.  It has a capacity of $750million, Dickson said in April.

Kenny “will bring enhanced strategic leadership to the non-investment side of Albert Bridge and make a significant contribution to the service and transparency we can provide to our investors and to the growth of our business”, Dickson said.  The fund previously hired Stuart Bohart, who has held senior positions at Fortress Investment Group and Morgan Stanley Investment Management, as a non-executive partner and member of the firm’s advisory board. 

Albert Bridge hires BAML cap intro head

Mairead Kenny joins as director of marketing and investor relations

London-based hedge fund Albert Bridge has hired Bank of America Merrill Lynch head of cap intro Mairead Kenny as director of marketing and investor relations.  Kenny had been head of European capital introductions with Baml for four years and her hire follows the appointment of former Fortress Investment Group co-CIO Stuart Bohart to Albert Bridge’s advisory board. 

Albert Bridge, a Perella Weinberg spinout, launched in April and runs the Alpha Europe Long Only Fund, which focuses on European developed-market equities.  The Cayman-domiciled fund initially launched with $100m and the firm is looking to close at $750m.

“I am delighted that someone of Mairead’s calibre and energy has joined us in this new role,” said the firm’s founder Drew Dickson.  “She will bring enhanced strategic leadership to the non‐investment side of Albert Bridge and make a significant contribution to the service and transparency we can provide to our investors, and to the growth of our business.”

Dickson left his role as partner and portfolio manager with $8.6bn Perella in January and has previously held roles at Fidelity and Och-Ziff Capital Management having also founded his own hedge fund firm Dickson Capital, which he ran between 2008 and 2012. Dickson Capital was merged into a Perella fund in 2012 to form the Alpha Europe Fund, which closed down in 2014 after failing to reach the requisite AuM.

The firm recruited former Perella director Doriana Pavlicu, who was also part of Dickson Capital, as head of operations as well as ex-Perella analyst Charles Hwang.


Ex-Fortress and Morgan Stanley heavyweight joins hedge fund startup

Ex-Fortress and Morgan Stanley heavyweight joins hedge fund startup


A former president at alternatives giant Fortress Investment Group and one-time head of Morgan Stanley's investment arm, has taken up an advisory role at a London-based hedge fund.

Stuart Bohart has joined Albert Bridge Capital as an advisor, according to the firm's website.

Bohart has held a number of roles in the investment industry, most recently serving as President of liquid markets and co-chief Investment officer of Partners Funds at Fortress, until his departure in the Summer of 2015.

Fortress is one of the largest alternative investment managers in the world, managing about $70.6 billion of assets for institutional and private investors across a range of strategies.

Prior to Fortress, Bohart was co-head of Morgan Stanley Investment Management, a job that gave him oversight of more than $400 billion in retail and institutional money, according to his profile on Albert Bridge's website.

Albert Bridge was set up by Andrew Dickson, a former partner at Perella Weinberg Partners - the firm received authorisation from the UK's Financial Conduct Authority in March 2015.

It employs a team of seven, including Dickson, as well as two advisors: Bohart and David Grant, a former analyst at Fidelity Investments.

According to a Reuters report in December, which cited people familiar with the matter, Albert Bridge launched with a $100 million fund that could eventually close at $750 million.

Bohart could not be reached for comment.

Ex-Perella Weinberg Manager Raises $150M for Startup

Ex-Perella Weinberg Manager Raises $150M for Startup

Andrew Dickson, a former money manager with Perella Weinberg Partners in London, has raised US$150 million for his new firm, Albert Bridge Capital.

His AB Alpha Europe Long Only Fund will focus on European developed-market equities and have a capacity of $750 million, Dickson said in an interview on Wednesday. He has backing from a U.S. university endowment fund, he said, declining to identify the institution.

Dickson’s previous firm, Dickson Capital Management, was acquired by Perella Weinberg in 2012. Since then he has run the New York-based firm's Alpha Europe unit. He previously worked for Och‐Ziff Capital Management Group.

Doriana Pavlicu, who previously worked at Perella Weinberg and Dickson Capital, is Albert Bridge's chief operating officer. The firm is currently hiring a head of investor relations. Albert Bridge employs seven people including Dickson.

The launch comes amid a slowdown in new hedge funds globally. Shutdowns outnumbered start-ups last year for the first time since 2009, according to data firm Hedge Fund Research, as the global industry contracted.

Former Perella Weinberg Partners Exec Dickson Launching New Hedge Fund


Andrew Dickson, formerly a partner with Perella Weinberg Partners Capital Management, is prepping a new London-based hedge fund firm.

The new company, named Albert Bridge Capital, will launch in the first quarter of next year with an initial equity-focused fund of around $100 million, according to a Reuters article that cited six unidentified sources familiar with the matter. Albert Bridge has reportedly submitted the requisite paperwork to the U.K.’s FCA and has an eventual AUM target of $750 million.

The initial fund will focus primarily on 15-25 equity positions. Eventually, Albert Bridge plans to open a second fund that will be more of a long/short vehicle, according to Reuters. 

Dickson joined $8.5 billion alternative asset manager Perella Weinberg in 2004 after jobs at Fidelity and Och-Ziff Capital Management. He also founded equity hedge fund Dickson Capital Management, which eventually meshed with Perella Weinberg before it was shut down last year.

Joining him at the new venture is former Perella director Doriana Pavlicu, who will be head of operations at Albert Bridge, and ex-Perella analyst Charles Hwang.

Ex-Perella Weinberg partner launches Albert Bridge Capital

Andrew Dickson set to launch first long-only fund in first quarter of 2016.

Ex-Perella Weinberg Partners Capital Management partner Andrew Dickson is launching an equities hedge fund business in the first quarter of 2016 with an initial $100m, HFMWeek understands Albert Bridge Capital’s Alpha Europe Long Only fund will focus on European equities, holding between 15 and 25 stocks, and is targeting a $750m close. The firm is also considering the launch of a long/short fund.

The firm is understood to be expecting significant flows into the Cayman-domiciled fund from endowments and institutions.

Dickson left his role as partner and portfolio manager with $8.6bn Perella in January and has previously held roles at Fidelity and Och-Ziff Capital Management having also founded his own hedge fund firm Dickson Capital, which he ran between 2008 and 2012.

Dickson Capital was merged into a Perella fund in 2012 to form the Alpha Europe Fund, which closed down in 2014 after failing to reach the requisite AuM.

London-based Albert Bridge is awaiting FCA authorisation.

Dickson has recruited former Perella director Doriana Pavlicu, who was also part of Dickson Capital, as head of operations as well as ex-Perella analyst Charles Hwang.

In July Perella Weinberg money manager Daniel Arbess left the firm to focus on investing in private markets having managed Perella’s Xerion hedge funds, which closed in late 2014 after the main fund fell -7% in the first 10 months of the year.

Barrons - Focus on Funds, AM Funds Roundup

Barrons - Focus on Funds, AM Funds Roundup

Third Avenue Management’s CEO David Barse has left the firm, according to anonymous sources. Gregory Zuckerman, Rob Copeland, Matt Wirz & Serena Ng, The Wall Street Journal.

Why ETF flows aren’t a good indicator of market sentiment. Chris Dietrich, Barron’s.

Third Point’s Daniel Loeb didn’t take the weekend off from putting pressure on Dow Chemical (DOW) and its proposed merger with DuPont (DD). Michael J. de la Merced, The New York Times.

Former Perella Weinberg Partners Capital Management partner Andrew Dickson is planning to launch what could be one of Europe’s biggest new hedge funds of the year. Maiya Keidan and Simon Jessop, Reuters.

The fall Citic Securities—once called the Goldman Sachs of China—may have started with a probe into shorting instruments it was marketing to hedge funds.  Bloomberg News.

Natural gas prices tumbled to their lowest levels since 2012 as unseasonably warm weather in much of the nation sent demand for heating oil to a seven-year low. Myra Saefong, MarketWatch.

A wave of investor withdrawals led Stone Lion Capital to suspend redemptions in its credit hedge funds. Rob Copeland, The Wall Street Journal.

Ex-Perella Weinberg partner to launch equity hedge fund

Former Perella Weinberg Partners Capital Management partner Andrew Dickson is preparing to launch an equities hedge fund firm called Albert Bridge Capital, six sources familiar with the matter said.

The firm is set to open an initial fund with $100 million in the first quarter of 2016, one source said, while a second added the size could be in the "low hundreds of millions". A third source said the fund would close at $750 million.

Reaching $100 million would put the fund among the biggest regional launches. Just 14 Europe-based hedge funds kicked off with that much in 2015, data from industry tracker Preqin showed.

The need to reach that figure has become more acute in recent years as a result of rising regulatory costs. Many funds also want to reach a size that makes them more attractive to institutional investors.

Dickson left his role as partner and portfolio manager at $8.6 billion investment manager Perella in January.

As well as previous stints at fund firm Fidelity and U.S. hedge fund Och-Ziff Capital Management, Dickson had also co-founded equity hedge fund Dickson Capital.

That firm's fund was eventually merged into Perella and renamed the Alpha Europe Fund, before it was shut at the end of 2014 after failing to reach "critical mass", despite positive performance, a fourth source, close to Perella, said.

The third source said Albert Bridge's first fund would buy just 15-25 stocks and be the firm's main focus for the next few years. A second fund that is able to bet on falling share prices may also be launched in the future, he added.

The firm had submitted its application for authorisation to the British regulator, but was not yet marketing to potential investors. However, the third source said he expected significant interest from U.S. endowments and institutions.

Joining Dickson in the start-up is ex-Perella director Doriana Pavlicu, who also worked alongside Dickson as head of operations at Dickson Capital Management, the role she will take at Albert Bridge, and ex-Perella analyst Charles Hwang.