Speaker 1: Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2: There was a comment on Spotify on our most recent podcast,
Speaker 2: last week's We Just Find It. I thought it was
Speaker 2: Hello and welcome to the bird Stuff Podcast, your weekly
Speaker 2: podcast where we talk about stuff related to birds and
Speaker 2: the European starling. He's doing quite well. He's perching, he
Speaker 2: started to feed himself.
Speaker 1: Oh great, two out of three exactly.
Speaker 2: He's stopped screaming quite as loudly as my parents to
Speaker 2: feed him like a baby. The flying we need to
Speaker 2: work on though. He's really good at flapping, but you
Speaker 2: know he's lacking some confidence when it comes to flight.
Speaker 1: Do you have a training program ready for working on
Speaker 1: the flying?
Speaker 2: I think we just need to let him out of
Speaker 2: the cage, similar to Wells Fargo, which we'll talk about.
Speaker 1: Oh what a transition. Hello and welcome to the bird
Speaker 1: Stuff Podcast, your weekly podcast where we talk about stuff
Speaker 1: related to birds. I'm Matt Levine and I wrote the
Speaker 1: Bunny Stuff column for Bloomberg Opinion.
Speaker 2: And I'm Katie Greifeld, a reporter for Bloomberg News and
Speaker 2: an anchor for Bloomberg Television and a bird owner.
Speaker 1: It's actually the money Stuff podcast in case anyone has,
Speaker 1: I mean dots. It's gonna be weird if this is
Speaker 1: your first episode speaking of being let out of your cage.
Speaker 1: Wells Fargo let out of its game.
Speaker 2: Charlie Sharp playing offense. This was expected, but I think
Speaker 2: it was still somewhat surprising to get this news this
Speaker 2: past week that the asset cap the FED had imposed
Speaker 2: on Wells Fargo back in twenty eighteen has been lifted.
Speaker 1: So. The Bloomberg article about this reported that when Charlie Sharff,
Speaker 1: the CEO of Wells Fargo, he joined the bank like
Speaker 1: a year after the asset capitalism post, and when he
Speaker 1: was like interviewing, he was aware of the asset cap
Speaker 1: because it was a pretty high pye profile thing, but
Speaker 1: according to the article, they couldn't tell him exactly how
Speaker 1: they were doing with progressing to fix it because that
Speaker 1: was confidential supervisory information and it would be illegal to
Speaker 1: leak it to anyone, including the CEO candidate. So basically
Speaker 1: he was like, so, how's it going with the FED?
Speaker 1: And they're like, hey, I can't tell you. And then
Speaker 1: they hired him and he came in and he's like, okay,
Speaker 1: so how's it going with the Fed? And they're like,
Speaker 1: really bad. Sorry we didn't tell you earlier.
Speaker 2: Surprise.
Speaker 1: I think he sort of came in expecting it to
Speaker 1: be a one year process after he joined. It turned
Speaker 1: out to be like a five year process after he gied.
Speaker 1: But now now it's all better. Yeah.
Speaker 2: Our reporting on the matter suggested the same. Well, fast
Speaker 2: forward to twenty twenty five, and we're finally here. It's
Speaker 2: again somewhat interesting that it happened this week. There had
Speaker 2: been a lot of anticipation about this, if you just
Speaker 2: look at the share price, for example, since President Trump's
Speaker 2: election in November, I think Wells Fargo heading into this
Speaker 2: week was up like twenty percent on a total repase
Speaker 2: return basis, and the KVW Bank Index as a whole
Speaker 2: was only up about seven percent in that time. So
Speaker 2: there was the anticipation was there. But also according to
Speaker 2: our reporting, it took some senior executives by surprise.
Speaker 1: Oh yeah, one of them was like doing an intern
Speaker 1: visitor or something.
Speaker 2: I think the chairman was celebrating his seventy third birthday,
Speaker 2: So this is a nice surprise. Before we talk about
Speaker 2: what this means for Wells Fargo, the future of Wells Fargo,
Speaker 2: Matt I wasn't really paying that close attention to Wells
Speaker 2: Fargo when this cap went into place in twenty eighteen.
Speaker 2: I'd love to hear your thoughts on the lead up
Speaker 2: there and how unprecedented this was.
Speaker 1: I feel like in twenty eighteen everyone was paying attention to.
Speaker 2: Wellswere I was worried about currencies.
Speaker 1: I have rarely seen a bank scandal get people so
Speaker 1: angry as the Wells Fargo fake account scandal, which I'm
Speaker 1: not sure was like the direct precipitator of this, but
Speaker 1: it was like one of the big things they pointed
Speaker 1: to to be like you can never grow again. Wells
Speaker 1: Fargo opened millions of fake accounts because they had like
Speaker 1: a culture of cross selling and also not a culture
Speaker 1: of supervising people very closely, I guess, And so like
Speaker 1: they told thousands of bankers, your job is to open
Speaker 1: eight new financial products today, and so they're like, okay, fine,
Speaker 1: everyone who signs up for a check account, we're gonna
Speaker 1: give them a credit card too, and like didn't tell
Speaker 1: the customers, and so people got all these credit cards
Speaker 1: they didn't sign up for, and that got Wells Fargo
Speaker 1: in trouble. And also many people are really mad because
Speaker 1: it just sounds bad. I think it, like it sounded
Speaker 1: a little worse than it was, but it was pretty bad.
Speaker 1: And I thought it was an interesting scandal because people
Speaker 1: disagree with me about this, but like it didn't help
Speaker 1: Wells Farga to open these fake accounts. There were like
Speaker 1: a few accounts where like you know, you open a
Speaker 1: credit card and you charge your credit card fee, so
Speaker 1: like Wells Fargo made a little bit of money from
Speaker 1: the fake accounts, but it's like negligible. Almost all of
Speaker 1: these fake accounts were like nothing happened in them. It
Speaker 1: was truly just like the employees gaming the management right,
Speaker 1: Like the employees were told you got to open eight
Speaker 1: accounts to day. I'm like, fine, we'll do that. But
Speaker 1: like it was just these meaningless accounts that didn't help
Speaker 1: Paul's fago. But that like met quotas, and that is
Speaker 1: not a problem of a bank with like evil intent
Speaker 1: at the top. That is the problem of a bank
Speaker 1: that has management troubles, and like trouble like supervising it's
Speaker 1: thousands of employees, and trouble like designing incentives and designing
Speaker 1: programs to make sure that people are operating the best
Speaker 1: interests of the bank. And you know, you always used
Speaker 1: to read like people talking about banks being too big
Speaker 1: to manage, and you know, like you look at that
Speaker 1: scandal and you're like, yeah, like this is maybe a
Speaker 1: bank that doesn't have a handle on all of its
Speaker 1: employees and all of what it's doing right. This is
Speaker 1: a bank that has not figured out how to manage
Speaker 1: its bigness. And so I always thought that there was
Speaker 1: like a poet of justice to like the punishment for
Speaker 1: some of these scandals being bank regulators saying you can't
Speaker 1: grow your balance sheet anymore, because you know, that's like
Speaker 1: a direct cap on bigness. It's not a cap on
Speaker 1: like employee numbers, but it's a cap on size, and
Speaker 1: it sort of focuses the mind on like, Okay, we
Speaker 1: got to be able to manage the bank the size
Speaker 1: that it is before we grow any bigger. The punishment
Speaker 1: is like an asset cap and then like stays in
Speaker 1: place basically until they convince their regulators that they have
Speaker 1: improved their risk management and board processes such that you know,
Speaker 1: they can run their business in a safe way. And
Speaker 1: I don't know, they seemed like sort of a reasonable punishment.
Speaker 2: I have two thoughts. One, I have a Wells Fargo account,
Speaker 2: which is funny. So you know, the extent of me
Speaker 2: thinking about this in twenty eighteen was I wonder if
Speaker 2: they gave me a credit card too.
Speaker 1: I don't have a well Swargo looking at I do
Speaker 1: have a well Square credit card and I use it
Speaker 1: almost never. It's just like a spare credit card. And
Speaker 1: like once every like two years, I get a letter
Speaker 1: from them being like, we're going to close your credit
Speaker 1: card unless you tell us not to or use it.
Speaker 1: And I'll like go to the store and buy a
Speaker 1: pack of gums so that I give the credit card open.
Speaker 2: Oh you want it, I don't care.
Speaker 1: Okay, It's like sitting in my desk doesn't bother me, right.
Speaker 1: I wonder if I get those letters because they're like,
Speaker 1: you know, they're looking at my account. They're like, oh no,
Speaker 1: what if this is a fake account, So they're making
Speaker 1: sure that my credit card is not fake.
Speaker 2: I will say I decided to specifically open a Wells
Speaker 2: Fargo account right before I went to college because I
Speaker 2: was going to Haverford College, which we'll actually get to
Speaker 2: a little bit, but it was very close to campus
Speaker 2: and they had horses on the card the stagecoach, which
Speaker 2: is one of the things that Charlie Sharp did away with.
Speaker 2: He did away with the.
Speaker 1: Look to keep it, to keep them under the asset cap.
Speaker 1: They fired the horses.
Speaker 2: They actually they fired the horses. They also fired tens
Speaker 2: of thousands of employees. The other thought that I had
Speaker 2: was that it's interesting that it feels pretty binary, like
Speaker 2: the cap was on and now it's off. There wasn't
Speaker 2: any step like, oh, you can grow the balance sheet
Speaker 2: by half a trillion one trillion because you're doing such
Speaker 2: a good job.
Speaker 1: Yeah, it's a super weird regulatory move. It's not a
Speaker 1: common punishment. Would not be normal to say, okay, you
Speaker 1: can grow by one hundred million dollars. Those be weird.
Speaker 1: They're just like they've put this mary draconian punishment on
Speaker 1: and now it's been fixed, and they're like, okay, fine
Speaker 1: crow again. So it'd be funny if they doubled in
Speaker 1: size next month, but I assume that they won't.
Speaker 2: If you think about the last seven years for Wells Fargo,
Speaker 2: I was obviously fiddling with the charts. JP Morgan's balance sheet,
Speaker 2: one of our reporters sold me has grown by an
Speaker 2: entire Wells Fargo since this cap went into place. You
Speaker 2: take a look at Wells Fargo's shares since the start
Speaker 2: of February and twenty eighteen, They're up forty three percent
Speaker 2: in total return terms since that time. You compare that
Speaker 2: to JP Morgan up one hundred and seventy eight percent,
Speaker 2: Goldman up one hundred and sixty percent. This has been
Speaker 2: crippling for the performance of this company.
Speaker 1: Yeah, I mean, like the Bloomberg reporting suggests that there
Speaker 1: was some amount of like, if you can't grow, you
Speaker 1: have to focus on the businesses that you really like.
Speaker 1: But yes, that only does so much for you in
Speaker 1: an environment of Dellwin's for banks.
Speaker 2: Yeah. Also, this one was kind of funny. I was
Speaker 2: looking at his valuation as well. It's price to book.
Speaker 2: Wells Fargo trades at a price to book of one
Speaker 2: point five. You compare that to JP Morgan's JP Morgan
Speaker 2: trades at like two point two. City City trades at
Speaker 2: point seven, which I think says more about City than
Speaker 2: it does about Wells Fargo. But that was kind of fun.
Speaker 1: Okay, City catching astraight here speaking of Haverford, Pennsylvania. You
Speaker 1: know what else is there besides Katie's College.
Speaker 2: The Egan Jones rating company, No, it was.
Speaker 1: The branch of Wells Fire that you bank on College
Speaker 1: Yesty operates out of a house in Harford, Pennsylvania, where
Speaker 1: they rate thousands of private credit deals.
Speaker 2: They actually have since relocated to King of Prussia, which
Speaker 2: is also in the suburbs of Philadelphia, but we'll get
Speaker 2: to that. Yeah, this ratings company, which calls itself the
Speaker 2: biggest rating company in the private credit space, operated out
Speaker 2: of a four bedroom colonial in Haverford, Pennsylvania, on Haverford
Speaker 2: Station Road, literally across the street from my college. And
Speaker 2: it's a pretty interesting business model, pretty scrappy.
Speaker 1: I love the ratings business model, right. I mean, like,
Speaker 1: so you can join this fighter by Shawane Egan, who
Speaker 1: kind of made a name for himself in the financial
Speaker 1: crisis criticizing the big three ratings agencies for their conflicts
Speaker 1: of interest. Right. People think of ratings agencies as organizations
Speaker 1: that write reports saying whether an issuer is a good
Speaker 1: credit risk? Right. I mean, like this came up a
Speaker 1: lot recently when the Booty's is the last agency to
Speaker 1: downgrade the US government, and I was like, oh, what
Speaker 1: does it mean?
Speaker 2: Right?
Speaker 1: Because like these agencies are sort of seen as like
Speaker 1: the arbiter of credit risk, and his criticism in two
Speaker 1: thousand and eight was these agencies are paid by the
Speaker 1: issuers of the bonds, and therefore the issuers want to
Speaker 1: have high ratings, and so if a ratings agency gives
Speaker 1: them a low rating, the issue is say, we won't
Speaker 1: pay you anymore if you don't give us a high rating,
Speaker 1: and the agency say, fine, fine, fine, we give your
Speaker 1: high rating. And this is like the sort of conflict
Speaker 1: of interest model. And it's particularly a concern in the
Speaker 1: structured product rating, where you have a bank that gets
Speaker 1: ratings on hundreds of products, and if it isn't satisfied
Speaker 1: with the ratings it gets, it can take its enormous
Speaker 1: book of business to another ratings agency. And the Egan
Speaker 1: Jones model was, I think this is not entire one
Speaker 1: hundred percent try now. But like the general idea of
Speaker 1: the model was they would get paid by consumers, They
Speaker 1: would get paid by people who wanted to buy the debt,
Speaker 1: and therefore they would have fewer conflicts of interest because
Speaker 1: they would be looking at for the interests of the
Speaker 1: investors the lenders, rather than the interests of the issuers,
Speaker 1: and so when they told you this is a good
Speaker 1: credit risk, you would know they mean it because you
Speaker 1: were paying them. And I don't think that's the right
Speaker 1: way to understand a ratings agency. I think that, like
Speaker 1: if you're a buyer of credit, if you're a lender
Speaker 1: and you're getting a rating, you're not doing it for you.
Speaker 1: You're not doing it to figure out if the company
Speaker 1: is a good risk or not right, because, like you're
Speaker 1: a lender, you're in the business of knowing whether it's
Speaker 1: a good risk or not. You might be interested in
Speaker 1: like the credit ratings. It might give you some sort
Speaker 1: of baseline understanding of what the credit is like, but
Speaker 1: you can probably do your own credit analysis. The reason
Speaker 1: you're getting a rating is you have some constraint on
Speaker 1: who you're allowed to lend to, or like what your
Speaker 1: book is supposed to look like. So if you're an
Speaker 1: insurance company and you make investment grade loans or you buy
Speaker 1: investment grade bonds, then you don't have to hold very
Speaker 1: much capital against them. And if you make non investment
Speaker 1: grade loans, you have a lot of capital. You know,
Speaker 1: you get the rating to satisfy your capital regulators that
Speaker 1: you are running your business prudently, and so you have
Speaker 1: the same incentives as an issue, right, you want a
Speaker 1: high rating. You don't care. Like if the world worked
Speaker 1: in such a way that like every bond could be
Speaker 1: rated triple A, you'd be like, great, I can buy
Speaker 1: every bond I want. You wouldn't buy like the worst bonds.
Speaker 1: You do your own credit analysis, but you wouldn't have
Speaker 1: to worry about regulation anymore, whereas regulators don't like that, right,
Speaker 1: And so the ratings agency ultimately is not really working
Speaker 1: on behalf of the issuer, and it's not really working
Speaker 1: on behalf of the lender. It's working on behalf like
Speaker 1: the lender's regulator or the lender's ultimate customer, right, like
Speaker 1: the insurance company customer or the bank customer or whatever.
Speaker 1: And so you know, you were read at Egan Jentes,
Speaker 1: like you know, there's a big bloomber article about their
Speaker 1: process and they're being run out of a four bedroom
Speaker 1: house and also about like you know, there's a couple
Speaker 1: of deals that they rated that kind of went bad,
Speaker 1: and like there's some criticism of them, and there's some
Speaker 1: like people are like other ratings firms issue twenty page
Speaker 1: ratings reports and they issue one page rating reports. It's
Speaker 1: like no one cares, no one reads that. Like the
Speaker 1: goal is like a regulatory goal, and they are providing
Speaker 1: a product that consumers in the market want, but you know,
Speaker 1: you might not like why they want the product.
Speaker 2: Yeah, So basically what you're saying is that it just
Speaker 2: transfers the risk that is conflict of interest, and the
Speaker 2: heavy insinuation in this article which you alluded to, is
Speaker 2: that they're basically just rubber stamping these ratings on private investments.
Speaker 1: I don't think that that's right. I don't think that.
Speaker 2: They're One of the things the article describes is that,
Speaker 2: I mean you mentioned that they have a small staff
Speaker 2: and they have one page reports. Bloomberg News colleagues also
Speaker 2: write that they offer their initial workups within twenty four hours,
Speaker 2: a formal verdict in less than five days, whereas you
Speaker 2: compare that to an S and P or a Fitch
Speaker 2: and those rating decisions can take months at a time.
Speaker 2: So they're working with a much smaller staff and in
Speaker 2: very compressed timeframes.
Speaker 1: Yeah. Right. They say their ratings generally perform well, right,
Speaker 1: I mean, you can always like find someones that aren't
Speaker 1: very good that you know, the default rate on like
Speaker 1: a you know, triple B company is not supposed to
Speaker 1: be zero, so you can always find some triple B
Speaker 1: company that defaults and then it's like, you know, oh
Speaker 1: that was wrong, right, But it's like, statistically you have
Speaker 1: to have some of those. But if you ran a
Speaker 1: ratings agency that gave everything in triple A, like there
Speaker 1: would be demand for that, but like you wouldn't last long,
Speaker 1: Like there wouldn't really be demand for that, or like
Speaker 1: it'd be great to get everyone, every anything rated triple A,
Speaker 1: but it wouldn't really satisfy your regulators, It wouldn't really
Speaker 1: satisfy anyone. So I don't think that they are a
Speaker 1: rubber stamp. I think that they're doing genuine credit work.
Speaker 1: But I think, you know, there's some insinuation that they
Speaker 1: have a tendency to rate stuff higher than other people
Speaker 1: would rate it, and particularly they were working in the
Speaker 1: private credit space where the ratings are not for broad
Speaker 1: public consumption because it's a handful of lenders making the loans,
Speaker 1: and those lenders can kind of pick their own rating agency,
Speaker 1: and yeah, they're gonna want the one that works with
Speaker 1: them nicely and is maybe a little bit.
Speaker 2: Generous well to the point on generosity. There is a
Speaker 2: description in this part of about the kerfuffle that was
Speaker 2: raised by this report from the National Association of Insurance Commissioners.
Speaker 2: Apparently they rescinded this report, but it showed that smaller
Speaker 2: outfits such as Egan Jones tended to rate private investments
Speaker 2: three notches higher on average than the association's in house
Speaker 2: valuation office. This report was rescinded, but it was heard
Speaker 2: around the industry. Apparently it was rescinded, according to people familiar,
Speaker 2: because of backlash from insurers as well as some of
Speaker 2: the ratings firms. But kind of, I mean there's some
Speaker 2: evidence there.
Speaker 1: Yeah, I've never fully understood it. Like there's there's some
Speaker 1: real controversy going on at the National Association of Insurance Commissioners. Like, yeah,
Speaker 1: there are a lot of insurers who really like private credit,
Speaker 1: let's say, really like alternative asset managers. Some of these
Speaker 1: insurers are big customers of those alternative asset managers. Some
Speaker 1: of them are owned by those big asset managers, and
Speaker 1: so all of those insurers are like basically like, we
Speaker 1: would like to chuck a lot of our money into
Speaker 1: private credit. We think getting paid for liquidity and like
Speaker 1: it's a good investment and we should be doing this
Speaker 1: and it's professionally managed, and like, you know, we're doing
Speaker 1: a good job. And there's a lot of other insurance
Speaker 1: companies who do more traditional bond investing and are really
Speaker 1: mad at the private credit insurance companies and think that
Speaker 1: they are taking wild risks with customer money. You know,
Speaker 1: they think the asset manager owned insurance companies are like
Speaker 1: making too much money. So there is like controversy within
Speaker 1: the insurance world where like some insurers are trying to
Speaker 1: basically stop people from investing in private credit, and other
Speaker 1: insurers are saying, we want to back up the truck
Speaker 1: for private credit. And so some of that controversy has
Speaker 1: played out in like the issuing and rescinding of reports.
Speaker 1: But it's a point of contention. And yeah, the report
Speaker 1: about ratings is I think part of that.
Speaker 2: I don't have it in front of me, but there
Speaker 2: is a professor quoted in the piece I believe that
Speaker 2: was talking about the performance of their rated companies, and
Speaker 2: the professor make the point that the public investments that
Speaker 2: they rate it tended to do okay. It's just that
Speaker 2: it kind of deteriorated as it got into more private
Speaker 2: sort of investments. It's kind of the whole point of
Speaker 2: their business though, was to rate private investments, and you
Speaker 2: can cherry pick examples and any rating agencies will have that,
Speaker 2: but there were some great examples in this piece as well,
Speaker 2: and most of them were triple BE rated, it seems
Speaker 2: like before they blew up.
Speaker 1: Then as a banker, we did this analysis for companies
Speaker 1: that was like what is the optimal credit rating to have?
Speaker 1: And I never fully understood that there was like some complicated,
Speaker 1: you know, model that told you what the optimal credit
Speaker 1: rating to have was based on your unique facts and circumstances.
Speaker 1: But the answer was always triple to B minus, which
Speaker 1: makes total intuitive sense because basically there's like a break
Speaker 1: point where investors can buy anything grated triple B minus
Speaker 1: or above and they can't buy anything graded w B
Speaker 1: plus or below, and so you get access to the
Speaker 1: investment grade buyers, which lowers your cost of debt if
Speaker 1: you're a triple B minus or above, but anything better
Speaker 1: than that you're leaving money on the table. You're like
Speaker 1: under levered, right, Like you want to be as levered
Speaker 1: as possible and still have access to investment grade credit.
Speaker 1: And you know, like in the private credit wor old
Speaker 1: same story, right, Like you want to lend money to
Speaker 1: the most exciting, riskiest companies that will pay you the
Speaker 1: most consistent with getting a triple B rating, and so yeah,
Speaker 1: if you can push out the boundaries of risk on
Speaker 1: triple B a little bit more, then that's a better
Speaker 1: deal for you. Similarly, like you wouldn't get a lot
Speaker 1: of A ratings because like if a company doing a
Speaker 1: private credit deal would get an A rating, then you're
Speaker 1: just like, well, let's borrow more then until we can
Speaker 1: get down to triple B. But like below triple B
Speaker 1: is bad. So there's a reason it's all triple B.
Speaker 1: But yeah, there's a couple of examples in the story,
Speaker 1: of which the funniest is probably Chicken Soup for the Soul,
Speaker 1: which I think I wrote about in the day, Like
Speaker 1: Chicken seap for this Soul had a weird slide into bankruptcy,
Speaker 1: but it was triple B rated at Egan Jones until
Speaker 1: like through like twenty twenty three.
Speaker 2: Yeah, fourteen months after Egan Jones reiterated it's triple B
Speaker 2: rating for the company, it filed for bankruptcy, and its
Speaker 2: lawyer said at the time it only had twenty five
Speaker 2: grand left in the bank, So that one was pretty funny.
Speaker 2: Can I tell you what the most surprising thing in
Speaker 2: this article was? Though, Yeah, okay, bring it back to Haverford.
Speaker 1: I knew it was going to go back to Haverford.
Speaker 2: A beautiful Philadelphia suburb. On the mainline. Apparently they sold
Speaker 2: the four bedroom colonial on Haverford Station Road in late
Speaker 2: twenty twenty four for eight hundred and sixty five thousand dollars,
Speaker 2: which seems pretty cheap.
Speaker 1: It's funny when you said, can I tell you the
Speaker 1: most surprising thing, I was, like, this is probably gonna
Speaker 1: have a preferred real estate thing. It does seem cheap.
Speaker 1: On the main line, Yeah.
Speaker 2: I wish I had bought it. I guess it was
Speaker 2: zoned for commercial use though, because apparently a psychotherapy practice
Speaker 2: took over the space. Egan Jones is now legally headquartered
Speaker 2: in King of Prussia, So there you go. But very
Speaker 2: close to Haverford College, beautiful, great nature trail which I've
Speaker 2: run hundreds of miles on. I have to go in
Speaker 2: nine minutes.
Speaker 1: Matt, Well, then let's talk about whatever. The third thing was.
Speaker 2: Let's talk about Paul Marshall and Ian wasce Yes, the
Speaker 2: billionaire odd couple, as the Wall Street Journal called them
Speaker 2: in a recent profile. This was so well written. I
Speaker 2: really enjoyed reading this by Caitlin McCabe over at the
Speaker 2: Wall Street Journal.
Speaker 1: Right, there's a great anecdote at the end about you know,
Speaker 1: like any hedge fund, they like give job applicants like
Speaker 1: puzzles and challenges and stuff, as you know from our.
Speaker 2: Special still recovering from that episode.
Speaker 1: And they waste one's challenged a group of hires to
Speaker 1: visit the most countries in Europe within twenty four hours,
Speaker 1: and one guy went to every embassy in London, so
Speaker 1: he like won on a technicality and they hired him.
Speaker 1: Ways says it was a bit too cute. I was
Speaker 1: really thinking about, like, you know, it's not like everyone
Speaker 1: at a hedge fund needs to be like a person
Speaker 1: who can find a game to you know, get around
Speaker 1: the stated rules of a problem. But like you want
Speaker 1: some of those people at your hedge fund. That's a
Speaker 1: useful skill and like you know, if you like give
Speaker 1: someone a challenge like that and they come back and
Speaker 1: they're like, I cheated, gotcha? You're like, okay, fine, you
Speaker 1: got a job.
Speaker 2: Come in?
Speaker 1: Yeah, right, that amused me. I Mean, the main thing
Speaker 1: that is so interesting about Marshall Waste is like they
Speaker 1: have found this way they call it tops to monetize
Speaker 1: sell side research and sell sides doock to right, Like
Speaker 1: you know, you run a hedge fund. Like people are
Speaker 1: calling you all day from banks saying like, hey, you
Speaker 1: should buy this stuck And conventionally the response is, well,
Speaker 1: I run a hedge fund and you don't, So why
Speaker 1: Like if you're telling me to bout the stuck, Like,
Speaker 1: clearly I'm better at this than you are, so why
Speaker 1: why would I listen to you? And Marshall Base is
Speaker 1: like we're gonna write them all down and we're gonna
Speaker 1: see if any of them provide useful signals. And now
Speaker 1: they have this like very complicated quantitative system that like
Speaker 1: extracts signals from what like their cell side coverage tells them.
Speaker 1: And that is endlessly fascinating because like, like one thing
Speaker 1: that is happening here is like the cell It's like
Speaker 1: they can understand the cell side analysts like better than
Speaker 1: those people understand themselves, because like they're you know, putting
Speaker 1: it into a quantitative model, and the cell side guys
Speaker 1: are just like you know, calling clients all day and
Speaker 1: so like, yeah, you know, they have the anecdote of like,
Speaker 1: you know a research analyst who has really good ideas
Speaker 1: but tells you to take them off too soon. He
Speaker 1: cuts his winners too soon, and they will analyze that
Speaker 1: and see that he always it's his winners too soon,
Speaker 1: so they'll just ignore him when he cuts his winners,
Speaker 1: and like they will do better with his recommendations then
Speaker 1: he will do with his recommendations. And so there's a
Speaker 1: lot of stuff like that where like you know, if
Speaker 1: you know that someone is really good in the morning
Speaker 1: and really bad in the afternoon, then you only trade
Speaker 1: on her ideas in the morning and you make more
Speaker 1: money than like if you just naively took her ideas.
Speaker 1: There's sort of two skills at a hedge fund, right
Speaker 1: There's being an analyst, which is like understanding companies and
Speaker 1: coming up with ideas, and there's being a portfolio manager,
Speaker 1: which is like making like the last step of like
Speaker 1: turning it into a trade and taking off the trade
Speaker 1: and figure out how much risk to take. And they
Speaker 1: are like being the portfolio manager with like thousands of
Speaker 1: analysts who work for their cell side coverage, and they
Speaker 1: are taking the like raw information of the analysts and
Speaker 1: turning it into useful trades that make money for them.
Speaker 1: Or that's like the basic idea.
Speaker 2: Yeah, it very loosely reminded me as I was reading
Speaker 2: this profile of something we've talked about before, which is
Speaker 2: you have short sellers who write research reports and then
Speaker 2: they sell them to hedge funds to actually do the trades.
Speaker 1: Yeah, and they do some of that too. They do that,
Speaker 1: Like there are some like other other hedge funds who
Speaker 1: are like, we can't do this trade for whatever reason,
Speaker 1: but like you run a giant multi strategy fund, you
Speaker 1: could put this trade into your portfolio, and so they
Speaker 1: do it.
Speaker 2: Yeah. I also thought it was funny. I mean, the
Speaker 2: article in the Wall Street Journal spent some time talking
Speaker 2: about how they have many fewer employees than a Citadel,
Speaker 2: for example, I think they have seven hundred and fifty
Speaker 2: employees versus Citadel's hedge fund has somewhere in the ballpark
Speaker 2: of three thousand. But it feels like, you know, they've
Speaker 2: outsourced for a lot of their trade ideas, so that
Speaker 2: potentially lightens the headcount needs.
Speaker 1: Yeah, those headcounts comparisons always like I never understand them
Speaker 1: because like you know, conventionally need less headcount to do
Speaker 1: quantity things. Then you know, there are different kinds of
Speaker 1: businesses and a hedgehund, and some of them require more
Speaker 1: headcount than others. But yeah, like intuitively, if like instead
Speaker 1: of employing a lot of analysts to find ideas, you
Speaker 1: just like employ yourself side coverage to find the ideas,
Speaker 1: then you need fewer analysts. I will say that when
Speaker 1: I write about this, I get a lot of emails
Speaker 1: from people who are cynical, and the cynical take on
Speaker 1: this system, and like other funds have done this, and
Speaker 1: like Blackrock Ages Ago got in trouble for doing something
Speaker 1: not this, but like the somewhat related thing, which is
Speaker 1: like sending out an analyst survey. People don't like this
Speaker 1: because they worry about fairness. Right, Like, if you send
Speaker 1: out a survey of analysts and you say, what do
Speaker 1: you think about this stock? Some of the analysts might say, oh,
Speaker 1: I think it's bad, while they still have a buy
Speaker 1: recommendation on because they're going to later change their buy recommendation, right,
Speaker 1: They're gonna like you might get like a more updated
Speaker 1: view than like the published seal side research analysis. Similarly,
Speaker 1: if you're like surveying your salespeople and you say, what's
Speaker 1: a good trade idea? One worry that a lot of
Speaker 1: people have is that your salespeople will say to you
Speaker 1: not like the idea they just thought of, but rather
Speaker 1: something that is predictive of like client. Right, Like, the
Speaker 1: salespeople know a lot about what other people are doing,
Speaker 1: and if you ask them for their best trade ideas,
Speaker 1: they might be leaking information to you. This is a
Speaker 1: worry that people have. I don't know if it's true.
Speaker 1: And like in this in this journal article, they point
Speaker 1: out that like because of the way that Martial Waste
Speaker 1: does it, which is like with this automated system that
Speaker 1: like there has lots of timestamps and a lot of data,
Speaker 1: Like they have a better audit trail than like, you know,
Speaker 1: the conventional hedge fund approach of like calling up your
Speaker 1: salesperson and saying, hey, what are other people doing? Right,
Speaker 1: Like it's it's arguably more transparent and like less risky
Speaker 1: thing than like the normal fundamental manager model. But it
Speaker 1: is a thing that a lot of people worry about
Speaker 1: that like you're leaking other institutional flows because your salesperson
Speaker 1: is like trying to compete to give martial waste the
Speaker 1: best ideas.
Speaker 2: Yeah, and the article does mention that when this started
Speaker 2: in the late nineties, there's was some skepticism, some suspicion
Speaker 2: that is this even legal.
Speaker 1: I can report from my email that that skepticism remains.
Speaker 2: It remains. Yeah. Well, something I always think about when
Speaker 2: I read that is, you know, I try to imagine
Speaker 2: hedge fund like this launching in twenty twenty five and
Speaker 2: what the reception would be. Like It's easy to read
Speaker 2: this and be like, oh, well, it's been around for
Speaker 2: thirty years, so it much to be okay. But I
Speaker 2: imagine something like this launching now, you know, there would
Speaker 2: be endless ink spilled about that.
Speaker 1: Yeah, I mean, you really do need scale to do this,
Speaker 1: because like you need people to fill out your little form.
Speaker 1: Like when you know, like the company that got in
Speaker 1: trouble for doing this was ten years ago. They settled
Speaker 1: with New York. It was black Rock because like, yeah, Blackrock,
Speaker 1: they can do whatever they want. If they ask analysts
Speaker 1: to like fill out forms, they'll fill out the form.
Speaker 2: Right.
Speaker 1: If you started a new hedge fun today and you
Speaker 1: asked every research analyst to fill out a form, they
Speaker 1: wouldn't do it. But yeah, there was also I forget
Speaker 1: it was called, but like there was this startup Edgemhen
Speaker 1: in the last year or two that was, like their
Speaker 1: business model was, we're going to have analysts and we're
Speaker 1: not going to have portfolio managers. We're gonna have like
Speaker 1: an algorithmic thing that will aggregate the analyst's recommendations into
Speaker 1: a portfolio. Basically, we were gonna keep having human analysts
Speaker 1: because they're valuable, but we're going to automate the portfolio
Speaker 1: manager job. That's not exactly this, but it's related, right,
Speaker 1: like this one. You know, they do the portfolio manager job,
Speaker 1: but it's it's very quanti, right, Like they're using algorithms
Speaker 1: to aggregate the like investment ideas that they get from
Speaker 1: from like the cell side, and also doing other stuff.
Speaker 1: The I mean to suggest that's all they do, but
Speaker 1: like that's you know, the thing they're kind of famous for.
Speaker 1: But like the the no PM thing is a little
Speaker 1: similar idea.
Speaker 2: There's a quote from either Marshall or Waste in there
Speaker 2: talking about how we're not just taking Joe Schmo's stock
Speaker 2: ideas we do more than that they do have. In
Speaker 2: addition to this, tops is about forty billion of their
Speaker 2: seventy billion in assets. They do have a fundamental stock
Speaker 2: picking side of the business as well.
Speaker 1: Yeah, I assume that, by the way, like this is
Speaker 1: not in the article, and I don't actually know how
Speaker 1: true this is, but like, certainly, if you run a
Speaker 1: business that rigorously analyzes the investment ideas of like hundreds
Speaker 1: of seal side people, if you notice that one of
Speaker 1: them is really good, you should probably hire that person, right, Like,
Speaker 1: you should probably move them over to your fundamental stock
Speaker 1: picking side rather than just let them, you know, give
Speaker 1: their ideas everyone.
Speaker 2: This whole Street Journal article spends a lot of time
Speaker 2: talking about how different these two guys are, and it
Speaker 2: was a lot of fun to read this. But it's
Speaker 2: unique to see this hedge fund work so well. They
Speaker 2: found it in nineteen ninety seven or something, and we
Speaker 2: have the very recent example of two Sigma for example,
Speaker 2: it's co founders getting in such a brawl that they
Speaker 2: had to be separated.
Speaker 1: So also worked quite well.
Speaker 2: Though, Yeah, I know, but just in terms of the
Speaker 2: relationship there at the very top, you know, there was
Speaker 2: some intervention so that was a charming factor in this article.
Speaker 1: I've had it refreshing when two people are like, yes,
Speaker 1: we've worked together for thirty years. It's a really good
Speaker 1: professional partnership. We don't socialize, it's just the job's cool
Speaker 1: man like us exactly looks like our podcast.
Speaker 2: It's all for the camera, you guys can't see, but
Speaker 2: it's all I'm looking at is myself in the return. Okay,
Speaker 2: I have to go now.
Speaker 1: The the