MS may spin off Quant Desk

Remember how everyone with half a brain said imposing pay restrictions on TARP banks will cause a massive talent drain? At least MS is smart enough to try and keep a portion of the profits by spinning off its top prop desk. Still, cutting out a lion's share of profits will certainly hurt the bank's ability to repay taxpayers and invariably will lead to a weaker bank down the road.
Unfortunately all that Congress cares about is that evil traders can make billions without contributing nothing to society while our amazing public school teachers and autoworkers, who've given this country so much, are out begging on the streets and turning tricks. Of course those traders did make a ton more money for the union pension funds than they ever made for themselves, but hey that's not the key point here.

clipped from www.finalternatives.com Morgan Stanley may transform its biggest proprietary trading desk into a hedge fund as a way to sidestep new government restrictions on pay and hiring. PDT has had only one down years since it was launched in 1993, and has earned Morgan Stanley some $6.5 billion in pretax income over that span. PDT’s top traders are reportedly concerned about pay restrictions imposed by the federal government on firms receiving bailout money, as well as those on hiring foreign workers. Any move to spin the group off could be an effort by Morgan Stanley to hold onto talent that might otherwise leave to start their own hedge funds, or to join existing hedge fund shops.

pwned

Presented without further commentary:

Hedging Morals

If you know me, you know I’m not big on Kantian ethics and morals. Nevertheless I found myself in the middle of an ethical conundrum today. If I believe that the new Hamas-Fatah alliance and trouble in Iran will result in greater perceived risk for Israel then it makes sense that I short the Shekel and sell Israeli government bonds. The dilemma arises in that once I own the position I make money if Israel gets bombed, something that I definitely don’t want to see happen as a Jew with many relatives living there. My moral and monetary incentives are instantly misaligned.

The same is never the case when shorting US Treasuries or dollars – after all with that I’m betting on Bernanke’s babble, not another 9/11 which would have pronounced effects on all global markets - unlike Israel which is too small to affect many countries outside of its region.

In any case I put on the trade. I don't believe that Israel is in a good place right now, and even though I pray that nothing happens I know that's damn unlikely. With Israeli CDS spreads being as tight as they are now any serious militant attack is going to widen them considerably. One could say that the trade is like a call option on my morals (if something bad does happen, at least I'll make money) but I'm not going to go down that path. The bottom line is that when trading, especially with other people's money, you have to put your own (non-collective) morals and individual incentives aside so that you can execute the best possible strategy.

Bear Market Brides

Trader Daily has this column about traders and their crazy relationships. This month they talk about the pitfalls of having your work stress spill over into your personal life. While I agree that you should make every effort to not project your problems onto your partner, there is one case where I feel the trader was faultless.

Another trader named Dave was in his late 20’s and was in a long distance relationship with a woman in South Florida. He would spend his earnings on flying her into NYC and for him to fly down to the sunny beaches of Miami every other week. He worked 8-hour days and dealt with the frustrations of trading within the very volatile natural gas sector. Never a dull moment. Everyday that he misinterpreted the direction that this sector would take, he feared that he
would lose his job. He was under great stress.

He recounted a time that his girlfriend called him at work to tell him about her tough day as an elementary school teacher. She told a dramatic tale about how stressful it was when her student named Billy skinned his knee during recess and she had to take him to the nurse with blood trickling from his leg. Dave felt completely detached from this story, not having the ability to empathize with her perceived job stress. He pretended to care about her story and quickly ended the phone call to go out for drinks with his buddies.

The fact is that unless your teacher girlfriend is at a school where the faculty has to wear bulletproof vests chances are she doesn't have anywhere near as much stress as you do. Trader "Dave" actually went above and beyond the call of duty by taking his girlfriend’s call during work and listening to her story with any interest, be it feigned or not.

I've found that for some women drama is a competition and they always want to have more of it than their partner. Every tale of woe you tell will be seen as a challenge, and if you ever have the gall to imply that her trifles aren’t serious prepare for nuclear war. Relationships with individuals in other high-stress professions is arguably the best way to have someone who understands your daily stress and also has the sort of issues you can empathize with. I recommend surgeons as they have the added perk of being good with their hands.

I called it! Shell Offers to Cede Control. Of Sakhalin-2 to Gazprom

I’ve been saying that this would happen for several months now. It should have been obvious from Gazprom's actions. Why else would they have been building pipelines without devloping new fields and reserves? Shell has finally buckled as its kneecaps have been bashed by the mighty hammer and its head cleanly cut off by the sickle of Kremlin/Gazprom/Putin/Mafia. Now Gazprom can take a gargantuan new nearly finished field and get all the capacity it needs to deliver to China, Europe and maybe even its own starving people. Nobody can stop the behemoth, not until 2008 when Putin steps down, anyways.

Shell Offers to Cede Control. Of Sakhalin-2 to Gazprom
By GUY CHAZAN and GREG WALTERSDecember 11, 2006 10:18 a.m.
Royal Dutch Shell PLC, succumbing to months of pressure from the Russian government, has proposed ceding control of the $20 billion Sakhalin-2 project to Russia's state-run gas monopoly, OAO Gazprom, an official close to the situation said.
The move shows Shell scrambling to rescue a project that has hit numerous roadblocks in recent months, including threats by Russian officials to withdraw a key permit over alleged environmental violations.
The pressure was seen as reflecting Russian anger at the cost overruns at the project, the biggest single foreign investment in Russia, and comes amid intensifying efforts by the Kremlin to dominate the country's oil and gas sector.
Gazprom said Shell Chief Executive Jeroen van der Veer met Gazprom CEO Alexei Miller and Russian Energy Minister Viktor Khristenko in Moscow last Friday to discuss Sakhalin-2, and that Shell had put forward new proposals on the project to Gazprom. Neither company would give details of the proposals. A spokeswoman for the Energy Minister declined to comment.
Mr. Khristenko will hold a press conference Tuesday in Moscow, the ministry said, during which he will answer questions about Sakhalin-2.
Gazprom and Shell reached an agreement in principle in 2005 that Gazprom would take a 25% stake in Sakhalin Energy, which is 55% controlled by Shell. Gazprom had since publicly denied it was seeking a larger stake in the company. Shortly after the Gazprom and Shell deal was reached last year, Sakhalin Energy announced its projected costs would nearly double for Sakhalin-2, prompting Gazprom to say it couldn't make a final commitment on entering Sakhalin-2 until the cost of the project was confirmed.
Sakhalin-2, said by Sakhalin Energy to be the world's largest integrated oil and gas project, is developing oil and natural gas reserves off the coast of Sakhalin Island in Russia's Pacific Coast north of Japan.Japanese partners Mitsui & Co. Ltd. and Mitsubishi Corp. own 25% and 20% of Sakhalin Energy, respectively.

Kenny G Indebted

Citadel issues $500M of BBB-rated debt in the first-ever hedge fund offering.

Not to diss Ken Griffin, but… what the fuck Citadel? Well it's still a smarter move than the Fortress IPO - at least retail investors won't be buying Citadel debentures. Question for thought - could and should institutional investors in the fund buy debt as a hedge? Better yet - buy protection if we ever have hedge fund credit derivatives. I wouldn't mind doing some curve trades on those in the right climate.

Also, I love how no matter what the PMs think about the issue nobody bought in. Good call, too. Only 190bps over Treasuries for a hedge fund? Come on! At least the rating agencies were kind and gave it a BBB rating. Generous because Citadel's Kensigton fund has $9.5b AUM (that’s ~74% of all assets) is making heavy, and apparently rather volatile, energy bets (Amaranth, Blackrock anyone?). All in all their income this year was about 9.5% of AUM by my back-of-the-envelope calculations, which isn’t bad at all, but not spectacular either.

Anyways – now we have a hedge fund IPO and a bond offering maybe we'll see funds shorting each other... it'll be hedgemonium!

Russia Coming to America

One of Ambramovich’s more legitimate enterprises, Evraz Group SA, purchased Oregon Steel Mills for $2.3B, making it the biggest acquisition of a US company by a Russian one. I predict and hope this is the start of a trend. Why is this great news? Two reasons:
First, if Russians own American companies then the US can do the same shit to them that Russia does to its foreign investors. That is, coming up with phony violations and injunctions until the foreigners succumb to any and all demands. Not that any US party has the balls to actually do that outright, but it’s nice to know the possibility is there, and if American interests are oppressed far enough who knows what can happen. Anything that can possibly put a check on Putin’s despotic regime is a good thing.
Second, in order to buy out a public company or (better yet) take majority stake in a public company the buyer has to bare a certain amount of information. There is nothing better then thus subjecting Russian companies into exposing themselves, even if they’re only showing a leg. If this trend picks up the bra and the thong will come off soon enough. It’s a lot harder to trick/bribe the SEC (and US auditors in the wake of Sarbox) than the Russian government, so some Russian entities may actually have to clean themselves up to look presentable and legal. This would likely involve shaving some of the dirtier activities have heretofore been hidden from the public eye.
So even if I didn’t see these transactions as great opportunities for cross-border special situations arbitrage I welcome them, and hope they increase exponentially.

Who will Gazprom assasinate next?

After this cheeky bit of news:

“The head of a Russian fund that says it promotes the development of small oil
and gas producers was shot dead on Tuesday in southwest Moscow, the Reuters news agency reports. Zelimkhan Magomedov, 50, general director of the National Oil Institute Fund, was shot twice in the head.”

One simply has to wonder - who will be next? Will it be…

Arkady Ostorvsky for making the below comment in his article in the WSJ:
"Gazprom, the dominant gas supplier that frequently doubles as a Kremlin foreign policy arm, is not producing enough for an economy growing at more than 6 per cent a year. "

Vladimir Milov, head of the Institute for Energy Policy, for making the following comment to the media:
"Gazprom was given enormous privileges in exchange for providing the country with gas at regulated prices. If it wants to behave as a commercial company, it should not be a monopoly."

German Gref, minister for economic development and trade for implying Gazprom should be “independently regulated.”

Analysts at UBS Russia for questioning Gazprom’s strategy.

“Analysts say the problem is not the lack of gas - Russia has 16 per cent of the world's total reserves - but rather Gazprom's investment strategy. Over the past few years the company has spent vigorously on anything but developing its reserves. It has built a pipeline to Turkey, taken over an oil company, invested in UES and tried to gain a foothold in European distribution markets. All this was in the name of creating a national energy champion. But investment in Gazprom's core activity was inadequate.”

Why has Gazprom not been investing in developing fields? Because it’s going to take Sakhalin away from Shell (who has already done all the work).

The citizens of St. Petersburg as they re-experience the horrors of WWII when their city loses heat in the middle of winter.

The country of Turkmenistan for not supplying enough gas and quibbling with the Allmighty.

Chechnyan Warlords (or random Georgians who will be dressed up to look like Chechnyan warlords) who will then be blamed for the gas shortage as well as every other problem plaguing Russia at the moment.

Always seeking to profit from energy arbitrage, I am relocating some of my freelance monkey snipers (alluded to in the previous post) to Russia.

Fama Keeps Preaching (but the choir ain't singing)

Fama, my old nemesis, is still preaching efficient markets. Check out the interview.
I especially love the interviewer’s interrogation regarding the 1987 crash, although I am disappointed she did not ask him about his own little fund, Dimensional, and its strategies. Namely how does Dimensional pick “risks that are worth taking and the risks that are not.”

Some parts I shall comment on:
(FEN - Financial Engineering News, EF - Eugene Fama, BSD - Arbitrageur's apropos pseudonym)

FEN: As an undergraduate at Tufts, you tried to beat the market.
EF: Yes. I was already working on stock market data. I tried to figure out ways to beat the market for Harry Ernst, who taught economics. I came up with mechanical kinds of strategies. He always made me have a hold-out sample to see if the strategy worked on new data – and it never did.
BSD: …and as a way of justifying your failure you dedicated the rest of the life to erroneously proving that you were playing a game one cannot win (although – of course – some consistently do).

FEN: If markets are efficient, a stock price reflects the intrinsic value of a company, but does that mean the price is always right?
EF: It means you can’t figure out whether it’s wrong. It’s not always right because there’s some uncertainty about what right is, but basically you just can’t beat it.
BSD: In another life you would have made a great spin doctor or lobbyist. You neither answered the question nor provided any evidence to the contrary of the point presented – you simply questioned the meaning of “right.”

FEN: What about [inefficiencies in] smaller, illiquid stocks?
EF: That’s what people claim – that smaller stocks are not priced as efficiently as bigger stocks, that emerging markets are not priced as efficiently as developed markets. But anyone who looks at it empirically can’t find any evidence to that effect.
BSD: Yeah, anyone but the investors who’ve been consistently raping those markets precisely on the basis of exploiting inefficiencies that result from a poorly regulated market.

FEN: I was just talking to a trader in Canada who’s at a fund that has beaten the broad Canadian market by investing mainly in financials for the last 20 years.
EF: Look across the spectrum of all funds – you’ll always find people in both tails. That can happen even if nobody has any special information. Some people are going to be lucky and some unlucky. The lucky ones get the attention, and then they think they’re smart.
BSD: So guys like Stevie Cohen who’ve been “lucky” for decades must have made some deal with the devil, because statistically such a streak of luck is near-impossible.

FEN: Have you moderated your views over the years that markets are efficient? Many academics and others say you have.
EF: Many people get confused. Many people don’t understand the difference between efficient markets and the risk-return story.
BSD: I think you don’t understand the difference, homey. Your original paper, understandably, does not account for the many ways to hedge risk that currently exist. The problem is that, like a caveman driving a car on square wheels you are unwilling to change.

FEN: There’s no need for active investors to go in search of information?
EF: There’s no need for active investors who don’t actually succeed in uncovering new information. People who act on bad information make prices worse.
BSD: Correct. So, since – according to you – most active managers act on bad information their very existence erodes efficiency.

FEN: Are traders following momentum strategies an example of people without information moving the market away from the most efficient price?
EF: I don’t know.
BSD: BS. You do know, you just can’t explain it with your theory. You said (in this very interview) that there is “evidence that there’s some short-term momentum in returns” – the very existence of observable and predictable momentum in liquid markets implies profit potential through an active strategy.

FEN: You’ve been a skeptic of the idea that people’s irrational behavior and decisions affect market prices in predictable ways, and you’ve been a critic of behavioral finance more generally. Do you think behavioral finance poses a threat to the idea of efficient markets?
EF: It poses interesting questions and legitimate questions for research. I haven’t seen researchers in that area come up with much that indicates that prices are bad. They’ve produced a lot that indicates that individual investors don’t always act completely rationally. Those are two different things. At the micro-micro level, they have done some really interesting stuff. At the level of price-setting, it’s not so clear.
BSD: Assuming a significant number of price-setters who do not act rationally how can markets be efficient? You cannot say that there is no direct relationship between price efficiency and the rationality of market participants. Furthermore, there has been research applying behavioral finance to prices – you just aren’t bringing it up, perhaps because you can’t outright disprove it.

The Hedgie

Ok, so here is the much delayed scoop on my new job. It’s not that I haven’t had the time (I worked a blissful 55 hours last week), it’s just that I’ve been too busy enjoying my newfound free time.
There has been much inquiry into what it is exactly that I do every day. That is – what is my routine? The honest answer is that there isn’t a typical day. This is a phrase one hears very often, and a lot of bankers will say that because it sounds much better than “depends on who decided to rape me today” but the fact is in banking you’re working in either Excel or Powerpoint/Word making models and pitchbooks. The type of model and underlying company stops mattering after you’ve done them all twenty times over till 3AM. The key difference between working at the quant hedgie and investment banking is that whereas in the latter I could painfully see myself becoming ever more robotic and melancholy here I’m becoming smarter and every day. At this rate my brain will soon be sharper than a coke addict’s razor blade.
At the hedge fund my only routine is morning P&L when I mark-to-market our positions (which can take 30 minutes or 3 hours depending on how many new trades I have to account for, and whether or not our broker messed up) and execute new trades as dictated by my Portfolio Managers and our black box model. The P&L models themselves are about as complex as anything you’ll see at a bank – VLOOKUPs and VBA macros galore.
After that I may spend the rest of the day on a project that one of the PMs asked me to do (I’m rarely told what to do here, since everyone is extremely polite). The projects vary across all aspects of running a fund: so far I’ve been asked to write an optimization function for one of our models, research a way to trade global term structure volatility and come up with various investment hypotheses. The best part is that I never feel like a grunt here – all of my work is genuinely interesting to do and receives immediate feedback.
When I don’t have a project however, which is about half the time, I am free to learn about whatever I want. It’s free time to get smart on sexy topics in quant finance and think of ways to turn them into profit for the fund. Getting paid [extremely well] to learn about the things I am so passionate about is a great feeling, I believe it’s called joy – but I’ve forgotten after working in IB for 4 months.
I’m done with my day whenever I feel like it’s time to go, which tends to fall between 6 and 7. Since we don’t trade intraday the whole atmosphere is extremely relaxed – hourlong lunches away from the desk and leaving early to go out on Friday is not only accepted but outright encouraged. In short, I haven’t been this happy with a job since I worked for a fashion house where part of my duties involved interviewing models and attending open-bar fashion shows.

Go Big or Go Home

The two weeks of my vacation have been amazingly relaxing (I was at any given point either sleeping or drinking). In a world of compromises, sometimes excess is mandatory to break the routine.
Having thus rested up I started my new job, which is even better than I imagined. More on that in my next post. Meanwhile, I have some Brazilian swaps to execute.

Bye Bye Banking!

If I haven't made any posts in a while it is because I have been drunk with joy. And alcohol. Last Friday the 29th I resigned from my role as Investment Banking Analyst to pursue my dream of controlling the world's financial markets (the key to success is having modest, easily-achievable, goals). Here's how the Arbitrageur got a new job (and put some substance behind his name):

About a month ago I applied for a Portfolio Analyst role through craigslist to work for a "new quantitative hedge fund platform, a strategic growth initiative funded and seeded by []. This is a small company centered around quantitative fixed income strategies with an entrepreneurial work environment that is well suited for focused, energetic, self-motivated and flexible top investment talent." Although the job required 2-3 years of buy-side experience, in my desperation to get out of my shoddy sinking dinghy of a bank I applied anyways, hoping that my mix of derivatives and programming knowledge and the intellectual tenacity of an Oxford educated pit bull would carry me through.

A couple days later I got an email from the president of the fund, asking me to come in for an interview. Thus began a quest that would consist of 7 hours worth of interviews, masked as so many doctor's appointments that my MDs must have thought I have become either terminally ill, a hypochondriac, or both. The questions asked of me by the president and his elite team of quant Ph.Ds (I'm the only person employed by the fund without one) ranged from derivative modeling to programming to econometrics and math. Quite frankly, I'm surprised that I made it out alive. My black belt in bullshit isn't exactly applicable to questions such as "write an SQL program that calculates the aggregate return and risk of a portfolio." I guess you never know how far you can stretch yourself until put into the "seat of heat", and that's exactly why I can't wait to start my new job. My mind will be honed to have the all the speed and litheness of a gymnast on a racehorse.

Before I begin climbing the steep and shaky ladder to the top, however, I am taking two weeks off to shed my banker skin and come to work ready to be reborn. Expect a recap when I return from my world tour of debauchery. Till then, I remain your arrogant Aribtrageur.