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Bloomberg Markets - April 2018

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April / May 2018
Volume 27 / Issue 2
ESG: Do Good, Do Well
Chasing a Tech Edge
Realm of the Bond Kings
Buffett’s Messenger
What works for the
planet can also work for
the bottom line p 56
JPMorgan, Goldman,
Morgan Stanley: The race
for supremacy p 78
How a $3 trillion industry
lourished in Southern
California p 70
Todd Combs is
heading Berkshire’s
health-care efort p 30
“This
isn’t just
about
China”
Jin Liqun, president
of the Asian Infrastructure
Investment Bank, talks
up regional development
and fends off criticism
of Beijing’s role
p 62
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Contents
B LOOM BE RG
M A R K E TS
VOLU M E 27 / ISSU E 2
70
Surfin’ the Yield Curve
Southern California: land
of sun and celebrities. This is the
story of how, beginning in the 1970s,
it became the home of ixed-income
royalty including Bill Gross,
Michael Milken, and Jefrey Gundlach
By John Gittelsohn
74
Cloud Dreams
Sachin Duggal saw that cloud
computing could be a new inancial
market arbitraged like any other
commodity. Today he’s the No. 1
reseller of Amazon’s services in India
By Edward Robinson
78
The Post-Human Race
Jamie Dimon, Lloyd Blankfein,
and James Gorman are in a battle
for technological supremacy as
artiicial intelligence transforms the
way banks win and keep business
By Hugh Son and Dakin Campbell
86
The Pot Banker
Even as Canada legalizes recreational
marijuana this year, the country’s
big banks are mostly shying away
from inancing the burgeoning pot
industry. Rob Paterson, CEO of
a credit union that got into the game
early, says that’s ine with him
By Doug Alexander
62
Q&A With the Asian Infrastructure Investment Bank’s Jin Liqun
The AIIB president and chairman says that, despite being perceived by
many as a creature of Beijing, the bank is designed to support development projects
around much of the world. “If I just represent China’s ideas,”
Jin says, “I don’t think it will be successful”
By Brian Bremner and Miao Han
PHOTOGRAPH BY GIULIA MARCHI / COVER ARTWORK BY STEVE CALDWELL
Contents
15
Surveillance
What opportunities
does synchronized growth ofer?
19
Forward Guidance
Doing Good, Doing Well
Private equity irms are seeking
to prove that sustainable investing
can be proitable
22
<GO>
Blooming Nuts!
After a four-year drought,
one of California’s biggest
exports is back
24
To Divest, or Not to Divest
How college endowments are
coming to terms with increasing
pressure from activists
29
What’s the Carbon Risk?
Find out which energy companies
have the most to lose if the world were
to stick to a climate change budget
30
Buffett’s Man in
The Middle
Todd Combs has quietly emerged
as a force inside Berkshire Hathaway.
He’s now leading an ambitious
efort to wring costs out of
U.S. health care
34
Macro Man on
Myths and Realities
Are there characteristics
that can be used to lag market
tops and bottoms?
38
Peso Predictions
Here’s how to get a read on
what foreign exchange
volatility tells us about Mexico’s
general election
44
Make or Break
Greenhill & Co. CEO Scott Bok
seeks to prove critics wrong about
the M&A boutique
48
Family Dilemma
Wealth managers, including one that
traces its roots to John D. Rockefeller’s
family office, grapple with how to
confront big corporations
52
The AI Dark Pool
OneChronos, a proposed trading venue,
wants to use artiicial intelligence to
match orders
56
Industry Focus: ESG
Environmental, social, and governance
investment strategies target better
outcomes over the long term.
How are they performing so far?
By Bloomberg Intelligence
and Bloomberg New Ener Finance
90
Cheat Sheet
The 18 most important functions you
should know about right now
92
A Function I Love
Almost instant insight into
global ETF lows shows you where
the money is going around
the world
LEGACY 500: YOU FEEL AT HOME
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those are key for me. They really make a difference while traveling. The cabin welcomes you as you get on the aircraft.
You feel at home. It’s very comfortable. The design is very sleek.
My father and my brother are both pilots, so the Legacy 500 took on special meaning for them in terms of the avionics,
fly-by-wire and HUD system. Safety is first for us and the Legacy 500 avionics help in that regard. We have a relatively
short runway and we usually fly a full payload. The Legacy 500 performs well in both aspects.
The sales team at Embraer was outstanding. They did a tremendous job for us. Really, they made us feel special. And with
that, they helped us to own a very special airplane. We can’t be more grateful for that.”
- Nathan Grindstaff, Board Member, Mastercorp
Watch Nathan’s story and request more information at
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Contributors
California, famous for
Silicon Valley technology and
Hollywood entertainment,
also fostered an empire
of financial innovation. John
Gittelsohn, a Bloomberg
News investing reporter based
in Los Angeles, chronicles
the fixed-income industry’s
Southern California origins
in “Surfin’ the Yield Curve”
(p. 70). It’s a saga that
stretches from Michael
Milken’s and Bill Gross’s early
years to today’s $3 trillion
realm of bond kings. “It’s
surprising how many colorful
characters gravitated to
what’s been considered
the boring bond business,”
Gittelsohn says. “Time will
tell how the next generation
keeps it going.”
Private equity firms are
finding ways to account for
environmental, social, and
governance factors in the
language of profit and loss.
But within the industry’s
pursuit of high returns,
combining satisfactory gains
with sustainable outcomes
remains a struggle. Melissa
Mittelman, who covers
private equity in Boston,
examines these nuances in
“Private Equity Wants You
to Feel Good About Investing”
(p. 19). “The industry is at this
interesting identity moment—
tasked with generating both
high returns and social
stewards,” Mittelman says.
“How firms respond to that
challenge could have
significant repercussions
for both the private equity
industry and society at large.”
Editor
Christine Harper
Art Director
Josef Reyes
Features Editor
Stryker McGuire
<GO> Editor
Jon Asmundsson
Special Reports Editor
Siobhan Wagner
Graphics Editor
Mark Glassman
Photo Editor
Donna Cohen
Bloomberg Markets utilizes the resources
of Bloomberg News, Bloomberg TV,
Bloomberg Businessweek, Bloomberg
Intelligence, Bloomberg Economics, and
Bloomberg LP.
Editor-in-Chief
John Micklethwait
Deputy Editor-in-Chief
Reto Gregori
Advisory Board
Tracy Alloway, Chris Collins,
Caroline Gage, David Gillen,
Madeleine Lim, Marty Schenker,
Joe Weisenthal
Creative Director
Christopher Nosenzo
Photo Director
Clinton Cargill
Managing Editor
Kristin Powers
Janet Lorin covers college
endowments at Bloomberg
News in New York. In
“When Should a College
Divest? Michigan State Is
Working Out an Answer”
(p. 24), she writes about
how some U.S. universities
are grappling with divestment
campaigns. With the value
of many college endowments
at record highs, Lorin notes,
all that money is garnering
lots of attention. “Students
want schools to drop
investments for social
reasons,” she says. “Parents
want the funds used to lower
tuition. And Congress wants
a cut, too—recently imposing
a 1.4 percent excise tax
on some of the richest funds.”
In our cover Q&A (p. 62),
Jin Liqun, president
and chairman of the Asian
Infrastructure Investment
Bank, fends off criticism
that the AIIB, whose biggest
shareholder is China, answers
to Beijing and makes
politically motivated lending
decisions. “I remain very
calm in facing all those critical,
sometimes very hostile
questions,” he tells Brian
Bremner, a Bloomberg News
executive editor based
in Tokyo, and Miao Han,
who covers the economy
and trade in Beijing. Jin
ranges across a variety of
subjects, from his youth
during the Cultural Revolution
to his affection for the works
of, among others, Chaucer,
Shakespeare, and Emerson.
Copy Chief
Lourdes Valeriano
Copy Editors
Marc Miller, Brennen Wysong
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Map Manager
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comments@bloombergmarkets.com
Surveillance
By JOANNA OSSINGER
MANY THINGS ARE GOING WELL for the global economy right now—all at the same time. The past
decade featured the global financial crisis, severe weakness in the euro area, a commodity
meltdown, and concerns about China. Now, although a chill has settled over Russia’s relations
with the West, there don’t seem to be too many worries on the horizon for markets.
The U.S. appears headed for growth this year in the mid-2 percent area, if not 3 percent,
as corporate earnings stay robust. Europe’s profits are finding their footing, and the European
Central Bank is pulling back on ultraloose economic policy. China isn’t growing as much as it
was some years ago, but fears of a severe downturn for the country haven’t taken hold. Even
Japan, once the poster child for economic failure, is making progress in its fight against deflation.
And emerging markets are along for the ride, too.
Early February brought a quick, sharp downturn in the markets, but the recovery has
been notable as well. The MSCI All Country World Index had made back more than half of its
losses by the last week of the month, and gauges of volatility such as the Cboe Volatility Index,
or VIX, were back almost to levels before the drop.
So economic data, stock prices, and volatility all seem to be behaving—for now. That
sounds a lot like global synchronized growth. But what does it mean, and where can investors
turn to take advantage of it? Here are some perspectives.
What
opportunities
come with
synchronized
growth?
15
So synchronized growth
is deinitely happening?
Energy then?
“Energy has historically been a very consistent late-cycle outperformer. The sector
has focused on cost reduction more so
than others and has lagged the performance of oil prices. Also, focus on Europe
and European stocks. The market is too
downbeat about them. People overlook
that European earnings were hit hard in the
past five years by bank deleveraging, then
the emerging-markets slowdown, then the
drop in commodities. They’re all now
turning higher at the same time, and synchronized growth helps all three of those
factors.”
“Synchronized growth is there—it’s just a
function of how much of an outperformance you’ve built into your numbers. The
continued moderate numbers are going to
allow the central banks to take their foot
off the pedal. I think it’s a function of how
aggressive monetary policy needs to be if
synchronized growth is going to be a longerterm trend. And I don’t really see any of the
alarms that people might see if they think
a recession is coming.”
Marvin Loh
SE NI OR G LO BA L M A R K E TS ST R AT EG I ST
AT BA N K O F N E W YOR K M E L LO N CO R P.
Andrew Sheets
CHIEF CROSS-ASSET ST RAT EGIST
AT M ORGAN STANL EY
What does it mean
for stocks?
“Normalizing inflation and declining global
deflationary risks are positives for equities
at this stage of the cycle, and we believe
there has been some overreaction to inflation headlines lately. Historically, moderating inflation combined with wage growth
led to stronger revenue growth, margin
expansion, and asset appreciation.”
Aren’t rising rates
a risk, though?
“Historically, the relationship between bond
yield and equity valuation is an inverted U.
Rising yields initially support higher multiples as this reflects stronger underlying
real economic growth and firming inflation.
At an inflection point, rising rates become
a headwind for growth and multiples, which
eventually turn into policy error. During
periods when growth ranged from 2 percent
to 3 percent, multiples were supported
until around 5 percent. Given global synchronized growth combined with policy
support, we believe an equity multiple of
about 18x is reasonable as long as yields
don’t exceed 4 percent. In our view, equity
investors should be more concerned about
unwinding quantitative easing in the face
of rising deficits than moderating inflation
and wage growth. The higher government
bond supply could potentially crowd out
equity flows and more significantly weigh
on equity multiples eventually.”
Dubravko Lakos-Bujas
H E A D OF U.S. EQU IT Y ST R AT EGY A N D G LO BAL
Q UA NT R ES E A RC H AT J P M O RG A N C H AS E & CO.
Where speciically might
be good to invest?
“One area that’s just been terrible for the last
three and a half years has been anything
energy-related, though numbers for oil
demand have been super strong. I think
they’re underowned. Another area that’s
cheap for what it is are European financial
companies. U.S. banks from 2012 onward
have been terrific performers, and you could
be in for a similar run in Europe, because
these things have lagged so significantly. If
you’re feeling aggressive about global synchronized tightening, look at Japanese banks:
They’re among the cheapest in the world, and
there isn’t a lot of bad credit stuff in there.”
Dubravko Lakos-Bujas
Could it be too much
of a good thing?
“Central banks do seem to be working in
lockstep. We seem to be in an era of coordinated actions, which has led to the most
Brian Barish
CH I E F IN V EST M E N T OF F IC E R
AT CA M BIA R I N V ESTO RS L LC
16
BLO O M B ERG M A R K ETS
synchronized global growth in 10 years. It
brings to mind the saying that rising tides
lift all boats. This is certainly a good thing,
and global investors play for incremental
gains between regions. The downfall could
be if we had synchronized global cycles
where all regions suffer downfalls and
recessions together. Then we would, in
essence, lose our diversification ability.”
What about the
U.S. dollar?
“Familiar FX-rate-volatility correlations are
failing as the global economy moves out of
the post-financial-crisis phase of absurdly
cheap money. The combination of rising
U.S. yields, rising equities, and a falling
dollar reflects a more synchronized global
recovery that is luring money away from
the dollar, something we last saw for a sustained period in 2004 to 2007. What started
then as optimism about the global recovery
after the Asian crisis, of course, ended in
hype, hubris, and excess. Hopefully, we’ll
not get to that stage again.”
Larry Peruzzi
D IR ECTOR O F IN T E R N AT I ON A L T R ADING
AT M ISC H L E R F IN A N C IA L G RO U P INC.
How about February’s
turbulence?
“In some ways, we got lucky that the volatility incident happened during a time of
strong growth. But we need to be mindful
that more things can come up. Are there
events later in the year that could create
uncertainty? What would actually be
painful for the market, and we haven’t had:
A lot of active managers and hedge funds
are overweight tech—if there’s a big rotation away from some of the leadership
sectors like tech and industrials, that could
be more painful for the market than the
early February drop.”
Guy Stear
HEAD OF EM ERGING M ARK ETS &
CREDIT RESEARCH AT SOCIET E GENER ALE SA
Does the U.S. iscal
stimulus matter at all?
“Many are critical of the fiscal stimulus the
U.S. is providing through tax cuts and
spending increases while the economy
continues to grow above trend. It produces
a large deficit and increases the U.S. debt
burden, but even those who accept the
need for public investment have serious
reservations about the magnitude of the
fiscal stimulus now. Although the world
enjoys a synchronized expansion, the great
financial crisis may not be truly over until
the downside of this business cycle is
managed. Pro-cyclical monetary and fiscal
policies exacerbate the challenge that lies
ahead for investors and policymakers.”
Andrew Sheets
Should we worry?
“If we compare the current environment to
that of early 2016, the last time volatility
spiked, there is a lot less to worry about in
the economy. Back then we had plummeting energy prices, all kinds of concerns
about an implosion in China, and European
banks feeling wobbly. Now we have
synchronized global economic growth, a
big corporate tax cut, and fiscal stimulus.
While these factors raise some concerns
about future inflation, the resulting higher
interest rates should be good overall for
financial sector earnings. So far, I have to
say that the volatility we have seen is “good
volatility,” reflecting a needed market correction, which should support increased
trading activity.”
Marc Chandler
GLOBAL HEAD OF CU RRENCY
ST RAT EGY AT B ROW N B ROT HERS
HARRIM AN & CO.
Any silver lining?
“We haven’t yet seen the surge in capital
expenditures that’s to come from the U.S.
tax cuts and may not appreciate the
amount of upside there is in corporate
profits and business activity.”
Frederick Cannon
Dean Curnutt
H E A D O F R ES E A RC H
A N D C H I E F EQU IT Y ST R AT EG I ST
AT K E E F E , BRU Y E T T E & WO ODS INC.
CHIEF EXECU T IV E OFFICER
OF M ACRO RISK ADV ISORS L LC
Ossinger covers cross-asset and market themes at Bloomberg News in New York.
VO LU M E 2 7 / ISS U E 2
17
Forward Guidance
Private Equity
Wants You to Feel Good
About Investing
By MELISSA MITTELMAN
I L L U S T R AT I O N B Y M AT T C H A S E
3 inches long from head to
tail, the dunes sagebrush lizard is in the
running for meekest creature on earth.
The tiny reptile lives on land in West
Texas where Vista Proppants & Logistics
Ltd. was looking to build a sand mine.
Vista is owned by a private equity firm,
First Reserve Corp., based in Greenwich,
Conn., and a casual observer of last
year’s stare-down between the masters
of the universe and the lowly lizard might
have figured the next step would be
bulldozers. The sand was of the highest
quality, and the lizard, even though it’s
been found in only 11 counties in Texas
and New Mexico, was prolific enough to
stay off any endangered or threatened
lists. What Vista did next may be
surprising. The miners worked with local
conservationists to make sure as few
lizards as possible were harmed in the
digging of their sand pit.
Altruism? Maybe not. If Vista and
First Reserve had come heavy, they’d
doubtlessly have had to deal with lawsuits,
habitat mitigation, and media reports
portraying them as villains. By engaging
with conservationists, Vista mitigated risk.
And by mitigating risk, Vista was making
a smart business decision.
More and more private equity firms
have been working to prove a thesis that
you can do well by doing good. Blackstone
Group LP has a team headed by its chief
sustainability officer, Don Anderson, that
works with portfolio companies such as
Equity Office Properties Trust and Hilton
Worldwide Holdings Inc. to turn off lights
in empty hallways, control room
AT LESS THAN
VO LU M E 2 7 / ISS U E 2
19
temperatures, and reduce water use.
The idea is to save money by saving natural
resources. KKR & Co. works with
nonprofits including the Environmental
Defense Fund to improve environmental,
social, and governance-related practices
at portfolio companies, focusing
on operational changes. London-based
Cinven Ltd. requires companies it controls
to report quarterly on metrics such as
employees’ work-related illnesses,
inclusion, and diversity.
Other firms have funds dedicated to
backing companies with an explicit social
or environmental mission. TPG’s Rise Fund,
for example, has invested in an app that
encourages people to accumulate their
savings by investing their spare change.
Through its Double Impact Fund, Bain
Capital LP backed a landscaping-materials
recycler and a fitness company operating
in underserved communities. Both
investment vehicles target the same
financial returns as those set for
the firms’ traditional buyout strategies.
Lawrence Heim, a managing director
at consulting firm Elm Sustainability
Partners LLC, says the business world is
in the midst of recalibrating the value
of sustainability. “We’re on the very front
end of seeing what kinds of new ways
there can be to monetize sustainability in
a truly meaningful way,” he says.
Arguably, private equity firms
are uniquely positioned to care about
long-term outcomes. While public
companies can and do invest in initiatives
that may take years to come to fruition,
their performance is tied to quarterly
earnings. Managements buy back shares
and increase dividends to support their
financial forecasts, and in cases of
stock-based compensation, add to their
own paychecks. Buyout firms, even those
that are public, answer first to the
pension funds, endowments, and other
investors who agree to give them large
sums of money for years. They often buy
controlling stakes in companies, with a
board seat included, giving them influence
to make changes.
What’s more, their investment
timelines are often much longer than those
of other investors. Traditional private
equity funds operate on a decade-long
fund cycle—and many are launching even
longer-dated pools—giving them the time
and space to prioritize long-term profits.
20
For example, it may take three years for
energy bill savings to be realized from
retrofit projects. That’s an easier sell when
you track returns over five and a half years,
a buyout firm’s average holding period,
according to Preqin Ltd., rather than a
quarterly reporting period.
Not everyone thinks profit will
automatically follow when social or
environmental factors prevail. The thinking
behind President Trump’s policies
assumes the Paris climate accord cost
American jobs; the Clean Power Plan
unfairly picked corporate winners
and losers; legal liability for polluting
waterways obstructed honest
moneymaking; and federal protection of
tracts of pristine wilderness, such as the
Bears Ears and Grand Staircase-Escalante
national monuments in Utah, thwarted
lucrative mining and drilling and starved
local communities of economic
development and jobs.
Many investors are turning toward
something more nuanced. Sure, it’s
cheaper to spew carbon dioxide into the
sky. Of course, dumping waste chemicals
into nearby waterways lowers disposal
expenses. No doubt it would be easier for
executives to eschew safety outlays that
prevent mishaps but eat into profits. All
these propositions are true, but only in the
short term. In the long run the costs will
be real—and high. And they’ll be borne not
only by companies, but also shared with
the wider world. “Part of our role is to have
a social license to operate and publicly
take a stance on what’s right,” says Kim
Thomassin, executive vice president
at Canadian pension manager Caisse de
dépôt et placement du Québec. “The voice
of institutional investors is extremely
important. We’ll never get rid of saying
money talks.”
That’s sort of what happened when
Trump relaxed the protection of federal
land. When his administration opened
Bears Ears to extraction companies in
February, there were no bidders.
To critics, the Trump philosophy
harkens back to a business community
unencumbered by social responsibility.
One has to return to America’s Gilded Age,
in the late 19th and early 20th centuries, to
find any reality that approaches that fever
dream. Later, the business boom after
World War II was marked by a morning
sickness drug that caused heartbreaking
BLO O M B ERG M A R K ETS
birth defects, the endangerment of the
iconic bald eagle, acid rain that reduced
Eastern hardwood forests to denuded
sticks, and mining accidents that
did irreparable harm to a generation of
workers. It wasn’t until the creation of the
U.S. Environmental Protection Agency in
1970, on President Richard Nixon’s watch,
that possible prosecution and associated
costs were taken seriously and companies
factored in extended public shaming as
a possible expense.
Threats to the planet now are plain
to see. Climate change has melted enough
Arctic ice to submerge whole islands.
Water pollution has rendered the entire
length of rivers uninhabitable. Coal miners
are being devastated by a resurgence
of black lung.
As consciousness about the
environment, worker safety, and diversity
has become more prevalent, at least in
most business circles, so has the
realization that danger lurks when those
considerations are ignored. To wit:
3M Co., the manufacturer of Post-it notes,
in February agreed to pay $850 million
to settle eight years of litigation over
dumping chemicals that got into
waterways. In a statement at the time,
John Banovetz, 3M’s chief technology
officer, said that while the company
doesn’t believe there’s a “public health
issue” related to the chemicals, the
settlement reflects its “commitment
to acting with integrity and conducting
business in a sustainable way.”
“Issues that used to be political
and not economic have married,” says
Henry Cornell, founder of Cornell Capital
LLC and a former executive at Goldman
Sachs Group Inc. “Environmental
consciousness is imbued in intelligent
private equity investing.”
Indeed, environmental and social
issues are becoming so ingrained in
corporate governance that private equity
firms have found a way to measure
sustainability goals in the language of
profit and loss.
Blackstone has reported savings of
more than 15 percent in energy costs from
efficiency programs at resorts and hotels
in its portfolio. TPG Rise has developed
a metric known as the impact multiple of
money, which tracks the lift to household
income at an Indian dairy business,
for example, or the measurable savings
PRICE OF AN IMPACT?
Index returns as of Sept. 30, 2017
1-year
5-year
10-year
MSCI Emerging Markets
22.91%
4.36
1.65
Russell 2000
20.74
13.79
7.85
S&P 500
18.61
14.22
7.44
MSCI World
18.17
10.99
4.22
Cambridge Associates Impact Investing Benchmark
8.49
7.94
5.10
Note: Impact Investing Benchmark returns are horizon calculations based on
70 private equity and venture capital funds. MSCI Emerging Markets index returns are gross of dividend taxes.
MSCI World index returns are net of dividend taxes.
Source: Cambridge Associates
related to health-care and legal costs
through portfolio company EverFi Inc.,
which delivers digital courses to educate
students and employees on topics such
as sexual assault prevention.
Private equity firms know their
audience, and they’ve devised ways
to show that the bottom line doesn’t have
to suffer—and can even improve—
when societal considerations are factored
in. Sustainability has earned a voice in
investment committee meetings.
But let’s not forget that private
equity firms are for-profit businesses.
Saving energy bills or wildlife has financial
benefits, but those measures are often too
marginal to be the deciding factor on
whether to do a deal in the first place. The
reason Vista developed that mine was to
sell the sand to frackers, who use it to blast
oil and gas from deep shale rock. Yes,
today’s world runs on the fossil fuels that
scores of oil, gas, and coal funds help
extract. Fossil fuels largely remain a
profitable enterprise, but carbon-emitting
activities are slowly degrading the planet.
Private equity dealmakers are
responsible for generating high financial
VO LU M E 2 7 / ISS U E 2
returns for their limited partners, and
funds dedicated to generating social or
environmental returns haven’t uniformly
outperformed more traditional pools.
From that perspective, it’s not surprising
that most private equity firms haven’t
gone all-in on sustainability. The danger is
they’re not factoring in the societal costs
they don’t currently have to shoulder.
In the long run they, and indeed society,
may pay a price.
Mittelman is a private equity reporter
at Bloomberg News in Boston.
21
<GO>
IN SID E
T HE T ERMI N A L
Blooming
Nuts!
drought that cut production of California almonds and brought
criticism of farmers’ water usage, one of the
state’s biggest exports is back. Almond production in the season that ended last year
topped the predrought record set in 2012.
The almond trees are indeed blooming here at Warner Hills Orchard, near the
Modesto Reservoir in Waterford, Calif. Amid
all this budding new life, employees of Paul
Arnold Apiaries of Michigan are checking
the health of beehives—an important supplier of pollinators. The nearby wind pump
powers a drip irrigation system for
the almonds.
The crisis made farmers more
mindful of potential spikes in water prices
that could kill profits, leading to more efficient timing of irrigation and improved
management of groundwater, says Daniel
Sumner, an agricultural economist at the
University of California at Davis.
The drought may have even led to
growers planting more trees, he says.
During the dry spell, some older trees at
the end of their productive life were
knocked down earlier than usual to save
water, he says. “The question will be
whether we overplanted,” Sumner says.
But with global demand rising and newer
uses such as almond milk becoming more
popular, he’s not betting on it.
For monthly statistics on prices paid
to U.S. almond producers, run {PPIJALMD
Index <GO>}, and to track annual sales, run
{FAINALMN Index <GO>}. —Alan Bjerga
AFTER A FOUR-YEAR
P H OTO G R A P H BY G EO RG E ST E I N M E T Z
Endowments
When Should a College Divest?
Michigan State Is
Working Out an Answer
By JANET LORIN
P H OTO G R A P H BY D O U G CO O M B E
POLITICAL ACTIVISTS SET their sights on Michigan State University
last fall.
Their objective: Push the school and a handful of other institutional investors to divest from a Renaissance Technologies fund.
The reason: The firm’s then co-chief executive officer, Robert
Mercer, provided funding to “several white supremacist organizations like Breitbart,” according to an online petition.
The pressure was more intense than usual but still … manageable. MSU Chief Investment Officer Philip Zecher says he
received a few dozen emails urging the $2.7 billion endowment to
pull its $50 million investment from the quantitative fund. Students,
alumni, and others posted on social media and started a petition
at Change.org.
On Nov. 2, Mercer announced he would step down from his
leadership role at Renaissance, saying in a letter to staff that he
considered discrimination on the basis of race to be “abhorrent.”
Less than two weeks after the campaign began, the push at MSU
abruptly stopped.
isn’t always going to be as
easy. Calls continue for colleges to divest from fossil fuels and for
pension funds to sell out of gun-related investments. After three
members of the California State Teachers’ Retirement System
were killed in the Las Vegas mass shooting in October, the state’s
treasurer called for the pension system to divest from retailers
and wholesalers that sell firearms and accessories such as bump
stocks. And following the shooting at Marjory Stoneman Douglas
High School that killed 17 in February, some Florida teachers were
surprised to learn that their state retirement funds are invested
in firearms makers. It’s only a matter of time before institutions
will be asked to drop investments over other matters, such as
opioids or debt in Puerto Rico.
Anticipating that he would face other divestment campaigns,
MSU’s Zecher started in December to articulate criteria for handling
them. Before recommending that the school strip an investment
RESOLVING DIVESTMENT CAMPAIGNS
24
from the portfolio, Zecher would consider four tests. First, a
campaign must have a clear and defined target. Second, it needs
broad-based agreement across the school community on the
moral imperative to divest. Third, there must be a case for taking
action, which could affect performance, to achieve the desired
outcome. Fourth, it should be clear that not being invested is better
than not having a voice. That criterion follows how BlackRock Inc.
is engaging the companies it invests in to become more socially
responsible. “If we have a voice at the table, we need to make sure
we’re acting in a socially responsible way as corporate owners,”
Zecher says. “I’m looking at ways the university can better do that
going forward, such as how do we vote proxies.’’
Income from MSU’s endowment, Zecher notes, provides
critical support for many students. “If divesting could impact that
support, we need to set a high bar,” he says. Zecher, 50, who earned
a doctorate in nuclear physics at MSU, started as the school’s first
CIO in December 2015.
(Michigan State, meanwhile, has itself faced upheaval after
a physician affiliated with the school, Larry Nassar, was sentenced
to prison for abusing young female athletes, including members
of the U.S. Olympic gymnastics team. MSU’s president stepped
down in February.)
THE PROBLEM WITH DIVESTMENT, of course, is that it can work against
the main purpose of pensions and endowments: making money.
Harvard’s $37 billion endowment, the richest in higher education, is often asked to shed certain investments. The school’s
outgoing president, Drew Faust, has described the endowment as
a resource, “not an instrument to impel social or political change.”
The head of Stanford’s $27 billion endowment in March also said
the school doesn’t use its fund to achieve social outcomes.
And the risk of losing money is real. The California Public
Employees’ Retirement System rarely divests unless mandated
to by the state legislature. In 2000, though, the pension fund voted
to divest from tobacco for internally managed portfolios and use
< G O> I NS I D E THE TE RMI NA L
Zecher
tobacco-free benchmarks for public equity and debt holdings.
The pension system also required outside managers to accept
tobacco-free benchmarks.
Those moves turned out to be costly. They reduced portfolio
returns by as much as $3 billion from 2001 to 2014, according to an
analysis from Wilshire Associates Inc., the fund’s consultant. Tobacco
stocks pay high dividends, and they’ve continued to perform well,
says Vivien Azer, an analyst with Cowen & Co. who follows the industry. “You have a large consumer base, and it’s very hard to quit
smoking,” she says. “They are willing to pay higher prices, and those
higher prices drive profit growth.” In 2016, CalPERS expanded the
prohibition to outside managers, removing their discretion to make
out-of-benchmark tobacco-related purchases.
of history with divestment. To protest apartheid,
trustees voted in 1978 to get rid of investments in companies that
did business in South Africa, becoming the first large U.S. university
to do so. Over the next few years, the school sold about $7 million
of holdings in about a dozen stocks, including IBM, Exxon, Xerox,
MSU HAS A BIT
and Michigan-based Ford, Dow Chemical, and General Motors,
according to archives of Michigan State and the American
Committee on Africa. The divested stocks made up more than
20 percent of the endowment. MSU’s high concentration in U.S.
equities at the time was typical of the way endowments invested
then. Today, portfolios are more complicated.
The largest endowments nowadays often have half their
assets in alternatives such as hedge funds and private equity. As
limited partners, they typically don’t control what companies the
funds buy. What’s more, money can be locked up for years—adding
another complication to divestment efforts.
college funds has moved to shed investments related to fossil fuels.
Barnard College in New York, with $327 million in assets, has
agreed to divest from companies that thwart efforts to address
the effects of climate change. “We can’t move the market because
we’re small,” says Robert Goldberg, Barnard’s chief operating
officer. “But if other institutions like us are attracted to this
A HANDFUL OF SMALLER
<GO> I NS I D E THE TE RMI NA L
25
For rankings of U.S. college and university endowments, run {ENDO <GO>}.
approach, it begins to build a coalition where companies will have
to pay attention.”
Lewis & Clark College in Portland, Ore., with $231 million, plans
to sell investments that contribute to global warming. Lewis & Clark
won’t purchase any new securities with fossil fuel exposure, because
of the fiduciary responsibility, not because it’s a social issue, says
CIO Carl Vance, who oversees the endowment. “There is a $100 trillion carbon bubble,” he says. “By selling these assets now, we won’t
have that exposure when the reckoning time arrives.” For both
Barnard and Lewis & Clark, private equity investments will remain
until the funds are cashed out, which could take a decade.
Still, endowments have largely resisted the pressure to divest
from energy. Almost three dozen endowments invest in funds run
by EnCap Investments LP, according to data compiled by
Bloomberg. The private equity firm has holdings in oil and gas and
energy infrastructure that in some funds have produced returns
as high as 50 percent, according to Bloomberg data.
Demand is so high that some endowments can’t get into
Houston-based EnCap or want bigger pieces. St. Olaf College, Old
Dominion University, and the University of California system have
put money in multiple funds, according to Bloomberg data. So has
Pomona College, one of the richest liberal arts schools in the U.S.
with an endowment of $2.2 billion for its almost 1,700 students.
Pomona, outside of Los Angeles, invested in at least two
EnCap funds, according to its public tax filings. Students at Pomona
asked the administration to divest from fossil fuel companies in
2013, in response to the threats that global warming poses. The
school declined, citing data from its investment consultant that
26
showed its endowment could decrease by almost $500 million
over a decade. “The loss of growth in the total endowment, caused
mainly by the need to withdraw from the best actively managed
commingled funds, would result in an estimated $6.6 million loss
in annual spendable income for such things as financial aid, faculty
and staff salaries, and program support,” according to a school
letter announcing the decision.
Wellesley College also found that divestment isn’t a good
option for its $2 billion endowment. After a push for divestment
from students, school administrators said they didn’t support
using the endowment as a lever for social change. “Although the
economic impact on fossil fuel companies would be inconsequential, the potential cost of divesting from all fossil fuel holdings,
directly and indirectly held, could be so high that it would seriously
compromise Wellesley’s ability to serve its educational mission,”
the Massachusetts-based school said in a statement.
FOR MICHIGAN STATE’S PART, the risk of underperforming because
of divestment isn’t something to take lightly, Zecher says. The
Renaissance Institutional Equity Fund is one of the lowest-fee
investments in the school’s portfolio and a good performer.
Dropping it would have met only one of Zecher’s criteria—a defined
target—he says.
Apartheid, four decades ago, was different. It would have
satisfied all four tests Zecher set out, had his criteria existed then.
“We’re being consistent with our past behavior,” he says.
Lorin covers college endowments at Bloomberg News in New York.
< G O> I NS I D E THE TE RMI NA L
LIVE ICONIC
T h e lo c a tio n , t h e sty l e, t he fe e l i n g you get w h e n you wal k t h rough t h e door –
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Your best life begins with a home that inspires you.
S iesta Key, Fl o ri d a
Property ID: PS PYGJ | sothebys realty.com
© MMXVII Sotheby’s International Realty Ailiates LLC. All Rights Reserved. Sotheby’s International Realty Ailiates LLC fully supports the principles
of the Fair Housing Act and the Equal Opportunity Act. Each Oice is Independently Owned and Operated. Sotheby’s International Realty and the
Sotheby’s International Realty logo are registered (or unregistered) service marks licensed to Sotheby’s International Realty Ailiates LLC.
Your best life be gins wit h a ho m e t h at i n s pi res you.
PA R A D I S E I S L A N D, BA H A M AS
LOS CABOS, MEXICO
PROVIDENCIALES, TURKS & CAICOS
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Southampton oceanfront ofering 14+ acres and 700± ft. of direct
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Sited on 3.25 acres, this estate compound features 12 bedrooms,
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Unique assemblage of 11 parcels spans 23 acres and includes an
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The Woolworth Tower Residences. The top 30 floors have been
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Perched high atop 4 East 72nd Street, this sprawling 13 room
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© MMXVIII Sotheby’s International Realty Ailiates LLC. a Realogy Company. All Rights Reserved. Old Elm at Medield, used with
permission. Sotheby’s International Realty® is a registered trademark licensed to Sotheby’s International Realty Ailiates LLC.
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TYPE SIRA <GO>
sothebys realty.com
ESG
How to Compare Climate Risk
Across the Biggest Oil Companies
By DEIRDRE FRETZ
To run the 2D Scenario Analysis Tool, go to {APPS TRACK <GO>} and
click on the Run App button.
Click here for an
analysis of how much
of an oil company’s
potential capital
expenditure would
produce profitably
in a world where
global warming is
restricted to 2C.
ENERGY COMPANIES COULD WASTE a massive $1.6 trillion by ignoring
climate risk, according to a study by London-based nonprofit Carbon
Tracker Initiative. To find out which oil and gas producers are most
exposed to these risks, use a new app on the Bloomberg terminal
that compares companies across the relevant metrics.
The 2D Scenario Analysis Tool looks at 68 companies in the
S&P Global Oil Index through a climate change lens. It starts with a
hypothetical: Let’s say the world manages to act to limit the rise in
average global temperature to 2 degrees Celsius (hence the 2D).
To do that, demand for fossil fuels will need to fall. It then asks: How
would that affect the oil companies? The analysis divides each
company’s assets into two categories: those that may still be profitable given the drop-off in demand and costs of development—and
those that likely won’t.
The third-party tool, created by Carbon Tracker and fueled by
data from Oslo-based Rystad Energy AS, is free on the App Portal.
Go to {APPS TRACK <GO>} and click on the button to run the app.
Consider Houston-based Apache Corp., for example. Enter
“Apache” in the Security Search field and click on the match. Select
the 2D Capex Transition Risk tab. The upper left quadrant of the
screen displays a summary of findings: An estimated $24 billion, or
39 percent, of Apache’s potential capital expenditures projected
by the tool may be developed profitably even if the world stays
within the budget of 2 degrees. The remaining $38 billion, or
61 percent, could fall outside the budget of 2 degrees. That’s the
biggest percentage of any company measured by the tool. The chart
at the bottom left of the screen shows the estimated breakeven
production rates for Apache’s potential capital expenditures.
Expenditures to the right of the blue dotted line would fund the
development of oil fields that may not be economical. Natural gas
breakevens are shown at the bottom right.
To take a glass-half-full view of climate risk, companies with
the highest cost of production may have the most to gain from diverting capital expenditure to other projects now rather than later.
Fretz is a Functions for the Market editor at Bloomberg in New York.
<GO> I NS I D E THE TE RMI NA L
29
Investing
Bezos, Buffett, Dimon, and the
Man in the Middle
TODD COMBS SPENDS most of his days reading
in a quiet office in Omaha, where he’s an investment manager at Berkshire Hathaway Inc. But
one day last year he found himself on a flight
to Seattle with an unusual mission: Pitch
Jeff Bezos on a bold idea for wringing costs
out of the U.S. health-care system.
Two of the biggest corporate chieftains in America—his boss,
Warren Buffett, and Jamie Dimon, who runs the largest bank in the
country—had already signed on. But they wanted the Amazon.com Inc.
chief executive officer on board as well.
Combs, 47, a former hedge fund manager who has no experience in the health-care industry and likes to keep a low profile,
was both an odd and an obvious choice as the CEOs’ emissary. He
had won Buffett’s confidence at Berkshire, where he sparked
the company’s largest acquisition, and he’d impressed
Dimon so much when the banker visited Omaha that he was
30
invited to join the board of JPMorgan Chase & Co. in 2016.
The outreach to Bezos worked. In late January the three
billionaires announced they were teaming up to form a company,
free from “profit-making incentives,” that would seek to lower the
cost of covering their hundreds of thousands of employees. Details
were scarce, but health-care stocks promptly plunged. Some of
the smartest minds in business were about to try fixing a
notoriously wasteful industry—one that costs America some
$3.3 trillion annually.
For Bezos, Dimon, and Buffett, it was another splashy headline in careers that have pushed boundaries. Behind the scenes,
though, Combs largely spearheaded the effort, according to a
person familiar with the matter. For months, Combs shuttled
among the CEOs to get them to commit to doing something about
a problem they’d discussed informally for years, the person says.
This was probably just how Combs wanted it: involved in the
action but out of the spotlight. The Florida State University
< G O> I NS I D E THE TE RMI NA L
J. GREGORY RAYMOND/BLOOMBERG
By NOAH BUHAYAR
To see Berkshire Hathaway’s reported holdings of investments related to
health care, go to {BRK/B US Equity HLDR <GO>}.
graduate was a virtual unknown in investing circles when Buffett
hired him in 2010 to manage a portion of Berkshire’s vast stock
portfolio. At the time, one of the few photos that news outlets
could find of him was a boyish high school yearbook shot. Since
then the world hasn’t gotten to know Combs much better. (He
declined to be interviewed for this story.)
This much is clear: Over the past seven years, Combs has
become an influential figure at Buffett’s conglomerate. In addition
to investing a slug of Berkshire’s money, he was behind the
$37 billion purchase of Precision Castparts Corp., a supplier to the
global aerospace industry, and worked on well-publicized trades
that saved hundreds of millions of dollars in taxes.
Combs is already in line to manage a huge swath of Berkshire’s
investments when Buffett, 87, leaves the scene. But his evergrowing portfolio has led some shareholders and analysts to speculate that he could one day become CEO as well. “Everybody else
is a slave to attention, and Todd seems indifferent to it,” says Steve
Wallman, a longtime Berkshire investor and money manager in
Wisconsin, who’s met Combs. “This is just the kind of behavior
you want to see in someone who’s lined up to succeed Warren.”
Combs is also a talented networker who has used his smarts
and drive to win the confidence of powerful men, according to
interviews with a dozen people who know him. Most asked that
their name not be used, even when they had positive things to say,
for fear of jeopardizing their relationship with someone who values
his privacy. Many of these people say they were surprised to learn
about his involvement in the health-care initiative, given his lack
of background in the industry.
WHAT COMBS DOES KNOW is financial services. A native of Sarasota,
Fla., he graduated from college in 1993 and took a job with
the state’s banking regulator. From there he went on to
Progressive Corp., working in a group that studied risk and determined what to charge for auto policies.
<GO> I NS I D E THE TE RMI NA L
31
In 2000, Combs started his MBA at Columbia Business
School. It was a chance to learn securities analysis in the same
halls where Buffett had long ago learned the craft from Benjamin
Graham, the father of value investing.
His first encounter with Buffett came during a talk that
year. The Berkshire CEO told students that one thing they could
do to get ahead was to read 500 pages a week, Combs recalled
in a 2014 interview with CNBC. The billionaire’s point, he said, was
that an investor could compound knowledge and get better
over time.
Richard Hanley, a hedge fund manager in New York, was an
adjunct professor in the MBA program back then. Combs, he says,
had a deep drive to get ahead and the mental flexibility to come
up with smart ideas. One assignment Hanley gave his students
was to devise a trade that would have the best performance over
the next several months. Unlike his peers, Combs decided to short
the stock he picked. Hanley forgets the company Combs bet
against, but his idea beat everyone else’s. “Todd was very intense,
very focused,” Hanley says.
Buffett’s advice about reading stuck with Combs as he
started his investment career, first as a financial-services analyst
at Copper Arch Capital and later at Castle Point Capital
Management, the hedge fund in Greenwich, Conn., he started in
2005. Combs’s approach was a race against the clock to consume
information, says one person familiar with his strategy during that
period. At Castle Point he’d get to the office early and leave late.
If he wasn’t in a meeting with his analysts or taking a break to
exercise, he was reading, three people say.
He was fascinated by psychology and the sorts of biases
that drive decision-making. Books such as Talent Is Overrated and
The Checklist Manifesto have become staples in the hedge fund
world, where money managers are constantly looking for an edge.
But Combs was interested in those ideas well before they became
trendy, one person says. Every month or so, he’d pick a book and
get together with his analysts to discuss it.
Berkshire acted. Combs enjoys digging into complex financial
companies and tearing apart the accounting, Nelson says. “They
probably saw a kindred spirit.”
Combs joined Berkshire early in 2011 and eventually moved
his family to Omaha from Connecticut. Ted Weschler, the other
investment manager Buffett hired to pick stocks at Berkshire,
chose to stay in Charlottesville, Va. People familiar with the two
men’s arrangements say Combs’s decision to relocate means
Buffett leans on him more. In public, however, the billionaire has
tried to treat both equally, saying that Combs and Weschler have
been great additions to the company and have “Berkshire blood
in their veins.”
Sitting next to Buffett has had other benefits for Combs,
who now manages about $12 billion for Berkshire. Dimon was
introduced to Combs by the Omaha billionaire, which led to the
young investment manager joining the JPMorgan board.
In some respects, Combs’s life hasn’t changed much from
his days running a hedge fund. “I read about 12 hours a day,” he
told the Florida State alumni magazine last year in a rare interview.
“Warren and I will usually catch up once or twice a day on stuff
that’s going on —deals, stocks, stuff with our companies.
Sometimes our managers reach out or a banker calls with an idea,
but that’s about it.”
There’s also travel for board meetings. In addition to
JPMorgan, Combs is a director of a few Berkshire subsidiaries,
including Precision Castparts and Duracell, the battery maker
Berkshire purchased from Procter & Gamble Co. in a tax-saving
stock swap Combs negotiated.
Less well-known is the time Combs spends hobnobbing
with people at the top of the business world. In January he was
with Buffett at a Washington luncheon hosted by Vernon Jordan,
the Democratic power broker, before the annual Alfalfa Club dinner,
a black-tie event where billionaires and politicians mingle. U.S.
Secretary of Commerce Wilbur Ross and Dimon were also there,
according to a person who attended.
I N E A R LY 20 07, Buffett said in his annual letter to Berkshire
shareholders that he was looking to hire at least one younger
money manager who would be able to succeed him as the company’s chief investment officer. Résumés poured in, and Combs
threw his own into the mix. But it didn’t stand out.
Castle Point’s mandate was to invest in financial-services
stocks. His company had done well but not exceptionally so. It was
also relatively small, overseeing about $400 million. Combs’s big
accomplishment was navigating the 2008 financial crisis relatively
unscathed. His fund ended down 5.7 percent that year, while the
S&P 500 plunged 37 percent, according to a letter to investors.
In 2010, Combs asked Buffett’s longtime business partner,
Berkshire Vice Chairman Charles Munger, for a meeting. Soon
after, the two met for lunch at the California Club in Los Angeles
and ended up having a conversation that stretched for hours,
according to an article at the time in the Wall Street Journal.
Afterward, Munger suggested to Buffett that he meet the young
money manager. Beyond his apparent smarts, Combs had the sort
of personality that was a “100 percent fit” for Berkshire’s culture,
Buffett told the newspaper. Mark Nelson, chairman of investment
manager Caledonia in Sydney, who had encouraged Combs to
reach out to Munger, says he was surprised by how quickly
IF COMBS HAS SETTLED
32
on an approach for the new health-care
venture, he’s remained tight-lipped about it. People who know
him speculate that the company could initially focus on squeezing
costs from middlemen who take a cut of prescription drug sales.
But the ambitions are clearly wider. “It would be very easy, I think,
to go in and shave off 3 or 4 percent just by negotiating power,”
Buffett said on CNBC in late February. “We’re looking for something
much bigger than that.”
The U.S. health system has powerful incumbents, including
hospitals and drug-benefit managers. Years of efforts to curb
costs haven’t accomplished much. Bezos, Buffett, and Dimon have
united around a common cause, but their plan could run aground
if the needs of their wildly different businesses aren’t met.
For now, the focus of the group is to find a CEO to run the
new venture, a process that Combs is working on with deputies
at JPMorgan and Amazon. One person says Combs may end up
being the health-care company’s nonexecutive chairman, given
how much work he’s put in so far. Were that to pass, it would be
a way for him to stay involved—but remain comfortably in
the background. —With Hugh Son and Spencer Soper
Buhayar covers real estate for Bloomberg News in Seattle.
< G O> I NS I D E THE TE RMI NA L
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visit our website at direxioninvestments.com. A Fund’s prospectus and summary prospectus should be read carefully before investing.
Investing in a Direxion Shares ETF may be more volatile than investing in broadly diversified funds. The use of leverage by a Fund increases the risk to the Fund.
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are not designed to track their respective underlying indices over a period of time longer than one day.
Direxion Shares Risks – An investment in the Fund involves risk, including the possible loss of principal. The Fund is non-diversified and includes risks associated
with the Fund concentrating its investments in a particular industry, sector, or geographic region which can result in increased volatility. The use of derivatives
such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. The Fund does not attempt to, and should not be
expected to, provide returns which are three times the performance of its underlying index for periods other than a single day. Risks of the Fund include Efects
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Market Mythbusters
Are There Indicators That Can Flag
Market Tops or Bottoms?
By CAMERON CRISE
A chart of the Euro Stoxx 50 Index shows what I consider a top and
two bottoms for the purposes of this analysis.
The drop after the
Brexit vote isn’t
considered a bottom
because it wasn’t
lower than the lowest
low within the
preceding six months.
that history doesn’t repeat itself, but it
often rhymes. Many market practitioners use historical analogues
as part of their analytical toolkit, operating under the theory that
similar patterns will tend to generate similar outcomes. One of the
holy grails of market analysis is to be able to identify significant tops
and bottoms with a reasonable degree of certainty. So, to that end,
the first step would be to figure out exactly what characteristics
are shared by past market extremes. Can we identify a set of factors
that have characterized historical tops and bottoms? I decided to
take a look. I’m a macro strategist who writes Bloomberg’s Macro
Man column, and in these pages I’ve been examining some market
maxims to see if the data support them—or not.
How exactly should we define a market top or bottom? In
analyzing past behavior, I identified tops and bottoms as a prominence that represented an extreme price for the six months before
and after the observation. So in looking at the Euro Stoxx 50 Index
from 2014 through 2016, for example, we can see bottoms in
October 2014 and February 2016, with a top in April 2015. The low
established in June 2016 after the U.K. Brexit vote wasn’t a bottom
THERE’S AN OLD SAYING
34
because it came within six months of a lower price extreme.
While everyone has a favorite technical indicator to identify
market extremes, a number of factors are often cited as indicative
of tops and bottoms. Here are the four that I examined:
Price divergence. Price reaches a new extreme, but a
momentum oscillator such as RSI doesn’t. (RSI—or relative
strength index, one of the most commonly used technical
indicators—compares the size of up moves with that of down moves
during a specified period, and indexes them to a scale of 0 to 100.)
I compared the 14-day RSI on the day of a price extreme with its
high (for tops) or low (for bottoms) of the prior 20 trading days.
Trading volume. It’s often thought that volume picks up after
market tops as investors start to rush for the exits. Conversely, conventional wisdom suggests that bottoms are formed as selling reaches
a crescendo, after which markets start to rise on lower trading volume.
I compared daily volume on the day of a market extreme with its
average over the prior week, month, and six months. I also compared
volume in the week prior to the extreme with that of the week after.
Price rejection. Everyone loves a good reversal candlestick
< G O> I NS I D E THE TE RMI NA L
MARKET TOPS: AVERAGE CHARACTERISTICS
Index
Number
RSI vs.
maximum
during
preceding
month
S&P 500
12
-3.4
105%
107%
111%
106%
0.2%
-1.1%
Nasdaq composite
18
-5.2
104%
104%
115%
110%
0.2%
-1.7%
Nikkei 225
18
-4.3
109%
118%
122%
95%
0.2%
-3.8%
Dax
15
-3.6
107%
106%
109%
107%
0.4%
-2.2%
FTSE 250
18
-4.0
116%
113%
112%
124%
0.2%
-2.4%
Euro Stoxx 50
14
-2.1
108%
108%
103%
107%
0.3%
-1.8%
Shanghai composite
18
-7.5
123%
166%
217%
85%
-0.4%
-0.5%
Volume vs.
one-week
average
Volume vs.
one-month
average
Volume vs.
six-month
average
Volume
one week
after vs.
one week
before
Daily price
change
on the date
of the top
or bottom
Volatility:
Two-week
realized vs.
three-month
realized
MARKET BOTTOMS: AVERAGE CHARACTERISTICS
S&P 500
17
2.5
118%
129%
141%
96%
0.2%
6.1%
Nasdaq composite
21
3.6
111%
120%
118%
93%
-0.2%
2.2%
Nikkei 225
21
3.4
120%
127%
132%
103%
-1.2%
5.5%
Dax
18
1.3
125%
139%
162%
100%
-1.3%
3.8%
FTSE 250
22
4.9
120%
128%
139%
93%
-1.1%
3.9%
Euro Stoxx 50
17
0.9
122%
136%
162%
97%
-2.7%
5.5%
Shanghai composite
20
4.6
106%
104%
93%
137%
0.1%
4.7%
Source: {SPX Index}, {CCMP Index}, {NKY Index}, {DAX Index}, {FTSE Index}, {SX5E Index}, {SHCOMP Index}
Bottoms are more
prevalent than tops.
charting pattern. A rejection of the prevailing trend—such as one
that happens at a top, for example—occurs with the market making
a new high but then closing lower on the day. I measured the market’s average move on days when tops and bottoms were formed.
Volatility. We usually think of tops coming during complacency and bottoms amid panic. Given that, I checked to see if
realized volatility was unusually low before market tops and
elevated before bottoms by comparing realized volatility of the
prior two weeks with that of the prior three months.
BLOOMBERG’S DAILY HIGH/LOW price data begin in 1982, and daily
volume figures start in the early 1990s. Using that data, I identified
market extremes across seven major equity indexes: six from
developed markets—the S&P 500, Nasdaq Composite, Nikkei 225,
Dax, Euro Stoxx 50, and FTSE 250—and one emerging market
benchmark, the Shanghai Composite.
So is there an archetype for market extremes? Well, kind
of. Markets clearly tend to exhibit certain types of behavior around
tops and bottoms, but the pattern is far from ever-present. Perhaps
the two clearest findings of the study are that bottoms form more
often than tops and that China’s stock market is unlike any of the
developed markets in the study.
at the average result for market tops
across our various stock indices, which is shown on this page. So
what does it all mean when we unpack it?
Negative divergence. On average, each market tends to
show some negative divergence in momentum. The RSI on the day
of the market top is lower than the peak of the prior 20 days in
each of the markets surveyed.
High volume. Volume on the day of the top is on average
higher than that of the prior week, month, and six months. Western
markets tend to see volume tick up thereafter. Interestingly,
Chinese volume tails off substantially after a top has been formed.
Price rejection. Most markets don’t exhibit tendencies of
price rejection when making tops, as the indices rally on average on
the day that tops are formed. Again, China is the notable exception
here, where the market tends to decline after making a high.
FIRST, LET’S TAKE A LOOK
<GO> I NS I D E THE TE RMI NA L
35
MARKET TOPS: HIT RATIOS
When market extremes occur, how often are these characteristics present?
Index
RSI
divergence
Volume
higher than
one-week
average
Gain on day
Low volatility
S&P 500
58%
40%
80%
70%
70%
58%
58%
Nasdaq composite
72%
44%
67%
89%
56%
61%
72%
Nikkei 225
67%
63%
75%
75%
44%
89%
78%
Dax
60%
56%
44%
44%
56%
67%
67%
FTSE 250
72%
55%
55%
55%
55%
56%
67%
Euro Stoxx 50
79%
33%
33%
44%
56%
86%
79%
Shanghai composite
83%
77%
61%
80%
30%
44%
56%
Index
RSI
divergence
Volume
higher than
one-week
average
Volume
higher than
one-month
average
Volume
higher than
six-month
avarage
Volume one
week after
is lower than
week before
Loss on day
Uptick
in volatility
S&P 500
59%
85%
92%
92%
77%
53%
76%
Nasdaq composite
57%
73%
82%
73%
73%
62%
52%
57%
80%
67%
67%
60%
71%
52%
72%
70%
80%
80%
70%
72%
78%
77%
73%
80%
80%
80%
77%
86%
Euro Stoxx 50
53%
75%
83%
92%
67%
82%
82%
Shanghai composite
85%
60%
73%
40%
33%
40%
60%
Volume
higher than
one-month
average
Volume
higher than
six-month
average
Volume one
week after
is higher than
week before
MARKET BOTTOMS: HIT RATIOS
Nikkei 225
Dax
FTSE 250
The tendency of
market bottoms to
occur on higher
volume is
comparatively strong.
Source: {SPX Index}, {CCMP Index}, {NKY Index}, {DAX Index}, {FTSE Index}, {SX5E Index}, {SHCOMP Index}
Volatility. Vol did indeed tend to be lower than usual immediately preceding tops, though again the effect was less pronounced in China than anywhere else.
Volatility. It should come as relatively little surprise that
realized volatility tends to be elevated around market bottoms.
but one of the problems with using
averages in a relatively small sample is that outliers can distort the
results. Let’s take a look at the hit ratio of each indicator in calling
tops, which is shown on this page. While the hit ratios are generally
better than even, they suggest that these metrics are far from a
failsafe indicator. They generally seem to work better in calling
bottoms than tops. Moreover, you can see that on many of them
the Chinese market tends to be an outlier.
When it comes to making market extremes, history clearly
doesn’t repeat. While it often rhymes, there are plenty of occasions
where market behavior diverges from the norm. Unfortunately, it
looks like the holy grail of calling tops and bottoms will have to
remain elusive for the time being.
THIS IS INTERESTING STUFF,
Do they exhibit archetypal behavior?
Positive divergence. Every market I examined had a higher
RSI on the day of the bottom than the prior 20 days. So it seems
momentum divergences may be a useful indicator of market extremes.
Volume. It looks as if a volume crescendo is indicative of a
bottom across most markets. China is a bit of an exception, where
bottoms form amid volume that’s unremarkable by the standards of
the prior six months. Intriguingly, Chinese investors appear to pile in
immediately after a bottom forms, whereas volume in other markets
is broadly similar the week after a bottom to that of the week before.
Price rejection. There is little evidence that bottoms form
when stocks make a new low and then close higher on the day.
While that is true of the S&P 500 and Shanghai markets (on
average), several other indexes tend to experience deep losses
on the day a bottom forms.
WHAT ABOUT BOTTOMS?
36
Crise is a macro strategist who writes the Macro Man column
for Bloomberg and blogs for Markets Live.
< G O> I NS I D E THE TE RMI NA L
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FX/Fixed Income
Getting a Read on Mexico’s Election
With Volatility Tea Leaves
By OWEN MINDE
presidential election, which is
scheduled for July 1, is drawing attention to the currency as well
as the candidates.
If you happened to chart the term structure of foreign
exchange volatility for the peso in mid-February, say, you might have
noticed something interesting. With about five months to go before
the voting, there was a pretty substantial peak at the six-month
tenor—which, of course, lay on the other side of the election.
Why? Well, for one thing, there was a significant chance that
Andrés Manuel Lopéz Obrador could win. AMLO, as the champion
of the left is known, could alarm Mexican markets, potentially
resulting in a weaker and more volatile peso.
Here are some tools you can use to assess the volatility
dynamics around the election—or other events, for that matter.
And if you have a view, these insights can potentially help you
execute a more efficient directional trading strategy.
M E XI C O’S M U C H A NTI C I PATE D
FIRST, TO TAKE A LOOK at the impact of the election on the volatility
surface, run {XCRV USDMXN <GO>}. To chart 25-delta risk reversals, for example, click on the arrow under Curve and select 25 Delta
Risk Reversals. In the field below that, select ATM Implied Volatilities
and make sure USDMXN is the currency. (A signal of market sentiment, the risk reversal is the difference between the implied volatility
38
of calls and puts at the same distance from the forward rate. Delta
is the change in the value of an option relative to the change in the
underlying exchange rate: In laymen’s terms, a 25-delta USD call is
an option that has a 25 percent probability of finishing in the money
at expiration.)
As of mid-February, both the risk reversal and at-the-money
implied volatility rose sharply at the six-month point. The market
expectation was that there will be significantly higher peso volatility
around the election—and that a weakening of the peso would be
more volatile than a strengthening of the currency.
TO CORRECTLY PRICE and value at-the-money (or ATM) FX options
with expiry dates between standard pillar tenors (for example, options
between the third- and six-month tenors), it may be necessary to
add a volatility weight adjustment to the election date so the term
structure of volatility will jump for options that span the July 1 date.
To make this adjustment, run {USDMXN Curncy VCAL <GO>} for
the Custom Volatility Calendars function. Use the drop-down in the
upper left corner of the screen to select your own custom calendar.
The weight for USDMXN for your custom calendar is now shown
in the center of the screen with the associated ATM volatility for the
expiry date given that weight. Scroll down to the dates around the
Sunday, July 1, election; you’ll find a smooth interpolation of the
< G O> I NS I D E THE TE RMI NA L
To view the term structure of volatility for the Mexican peso, run {XCRV USDMXN <GO>}.
As of mid-February,
volatility was elevated
at the six-month
tenor, which captures
the event risk
of Mexico’s July 1
general election.
Go to {VCAL <GO>} for the Custom Volatility Calendars.
Add a weight
adjustment for an
event such as the
Mexican election to
correctly price
FX options. You can
adjust to calibrate
to market volatilities.
ATM volatility between the three-month and six-month tenors. That’s
unrealistic. In fact, the market was pricing the 07/02/18 ATM vol at
15.9 as of mid-February, nearly a vol higher than where this option
would be valued assuming a linear interpolation of implied volatility.
To calibrate the additional volatility weight with the market and
add an event adjustment, click on the Weight Adjustments tab. Next
click on One Time. In the window, set the date as 07/01/18, the Currency as MXN, the Adjust by Weight as 90, and the Description as
Presidential Election. Hit Save. Click on the Daily Weights tab and
scroll down again to the dates around the election. Now you’ll see
the spread of variance more appropriately apportioned and the jump
in implied volatility for options with expirations after the election. You
can tweak this weight adjustment to calibrate with market pricing.
40
You can also automatically create a more realistic term
structure of ATM-implied volatility by incorporating Bloombergsuggested event adjustments. To do that, click on the Setting
button, select OVDV/OVML Default Calendar, and use the dropdown menu to choose Bloomberg Recommended. To view the
additional weights Bloomberg recommends, click on the gray
Bloomberg Recommended tab.
dynamics can enable you to
implement a directional trading strategy more efficiently. Let’s
say you want to bet on a potential scenario in which AMLO wins
and the peso significantly weakens initially after the election. To
price up a USD call spread that would benefit from a weaker
UNDERSTANDING THESE VOLATILITY
< G O> I NS I D E THE TE RMI NA L
WE’RE IN IT FOR
THE DURATION.
For nearly 90 years, through all market cycles, PGIM Fixed Income
has drawn on a deep discipline in research and risk management to
add value for our clients.
We’re a global fixed income asset manager bringing scale, stability
and broad capabilities in the pursuit of consistently strong,
risk-adjusted returns across the fixed income spectrum.
SOLID RISK INFRASTRUCTURE
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FOCUS ON CONSISTENCY OF RESULTS
Learn more at PGIMFixedIncome.com
For professional and institutional investors only. Your capital is at risk and the value of investments may go down as well as up.
© 2018. PGIM is the primary asset management business of Prudential Financial, Inc. (PFI). PGIM Fixed Income is PGIM’s public fixed income investment advisory business and
operates through PGIM, Inc., a U.S. registered investment adviser. Prudential, PGIM, their respective logos as well as the Rock symbol are service marks of PFI and its related entities,
registered in many jurisdictions worldwide.
Data as of December 31, 2017. There is no guarantee these objectives will be met. 2018-1085
To price a call spread expiring on July 5 that would benefit from a weaker peso
after the election, run {OVML CP MXN 07/05/2018 <GO>}.
The price of
2.55 percent of
notional captures
0.48 percentage point
of skew and smile
value compared with
the theoretical value
of the structure.
For payoff analysis, click on the Scenario subtab and select Graph.
The strategy profits
if peso spot rates
trade above 19.55 per
dollar, capped should
the peso reach 21.00.
peso and also take advantage of the elevated risk reversal after
the election to cheapen the overall structure, run {OVML CP MXN
07/05/2018 <GO>}. Click on the Views button on the red toolbar,
select Layout, and click on Full Data to select it.
The default USD call spread that will come up will be a long
ATM strike, discounted by selling a 25-delta call strike. If you want to
choose specific strikes, simply enter what you want in those fields:
Buy a 19.00 USD call, for example, and sell a 21.00 USD call. Note the
price of this strategy is 2.55 percent of the USD notional. We’ve cheapened up the strategy by capping gains should the peso weaken further
than 21 pesos per dollar. That discounts the strategy by 1.11 percent.
You can isolate the savings from implied skew and smile, which can
be thought of as how much the sensitivity to volatility changes with
42
respect to changes in spot and volatility, respectively. To do that,
compare the 2.55 percent to the T.V.—the theoretical value of the
structure assuming the legs were priced with the ATM volatility. By
selling the 21.00 USD call, we’ve cheapened the structure by
0.48 percent by selling skew and smile value. That wouldn’t be possible with a linear product such as a forward.
To view the P&L scenario analysis, click on the Scenario
subtab and select Graph. The strategy will profit when the USDMXN
spot rate trades above 19.55, but gains are capped should the spot
rate go above 21.00 pesos per dollar.
Minde is an economics and FX market specialist at
Bloomberg in New York.
< G O> I NS I D E THE TE RMI NA L
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Investment Banking
Greenhill Seeks to Prove Critics Wrong
By SONALI BASAK and KIEL PORTER
dark when Scott Bok’s plane lands in New
York on a rainy Friday morning in late February. He’s coming from
Washington, where he’d been for a client meeting. Now he’s heading
to the Park Avenue headquarters of Greenhill & Co., the boutique
investment bank he runs, where he’ll meet a potential recruit. His
firm’s stock has fallen 31 percent in the past 12 months, but his
spirits are up.
By midmorning, Bok is in a conference room at Greenhill’s
offices for an interview with two reporters. The company is adding
dealmakers and is poised “for a whole new chapter,” the chief executive officer says. The window beside him looks out on Park Avenue
buildings, some of them home to rivals that didn’t exist a decade ago.
To many outsiders—and to a number of current and former
employees speaking anonymously—Greenhill is facing a makeor-break year. The mergers-and-acquisitions adviser has watched
its market share shrink for much of the past decade amid a global
THE SKIES ARE STILL
44
boom in deals. It’s under mounting pressure to prove that a business model it pioneered can work in the long term. Bok, 58, is
betting every ounce of his energy, and a slug of his own wealth,
that it can. “In my view, we likely caught the bottom,” he says.
T H E M & A B O U T I Q U E —named
for its founder, star dealmaker
Bob Greenhill—was the first of its kind to go public, in 2004. Unlike
storied Wall Street partnerships that sold stock to catapult themselves into a new class of banking giants, as Goldman Sachs Group
Inc. did, Greenhill would have few assets and no businesses beyond
providing advice on corporate takeovers and other transactions.
Every day its dealmakers would show up, ply their connections,
and bring in contracts. If one day the contracts stopped coming,
the company’s revenue would dry up, too. And there would be
little left to sell but the desks and computers.
Taking the company public made good sense then, and still
< G O> I NS I D E THE TE RMI NA L
GREENHILL & CO. SINCE INITIAL PUBLIC OFFERING
Share price at month’s end
League table ranking in annual M&A volume
$100
2007
#14
75
2004
#33
50
2011
#43
25
2017
#52
5/2004
2/2018
0
Sources: {GHL US Equity <GO>}, {MA <GO>}
does, Bok says. A crop of boutique investment banks in the 1980s,
including Wasserstein Perella & Co. and Wolfensohn & Co., ended
up getting sold to larger companies. Going public gave Greenhill a
currency—stock—to pay new star bankers, while also allowing it
to endure after its founder leaves. “We wanted to have our own
firm for the long term,” Bok says.
After the firm sold stock at $17.50 in its initial public offering,
shares quintupled to a high of $95.63 in 2009. That proved investors
were willing to buy into an M&A boutique, blazing a path for others,
such as Roger Altman’s Evercore Inc. and Ken Moelis’s Moelis &
Co., to go public. But unlike Greenhill, many of those boutiques
have pushed into additional businesses or opened their wallets
to lure big names in investment banking. Their successes have
been a challenge to Greenhill: At least 40 percent of the managing
directors it had at the start of 2013 have left, two people say. Often
they went to work at rival upstarts.
What went wrong? Interviews with about a dozen senior
bankers who left the company paint a picture of a series of missteps by Bok, in both strategy and recruitment, with a board that
let it go unchecked and allowed dissenting voices to be sidelined.
The board does remain supportive: At every firm on Wall Street,
“there will be turnover,” says John Liu, a director. “The vast majority
of people at the firm are his supporters.”
With Greenhill sliding down the league tables that rank M&A
advisers by their work, bankers keep leaving. Disillusioned, many
question whether Bok, feted for his organizational skills, was the
right pick to succeed a charismatic founder with deep ties to
billionaire financiers.
Last year the company posted its first annual loss since
going public. It dropped to No. 52 in global mergers and acquisitions,
after being among the top 15 in 2007 and 2008, according to data
compiled by Bloomberg. “It’s something that’s left many
<GO> I NS I D E THE TE RMI NA L
45
scratching their heads,” says Brennan Hawken, an analyst at UBS
Group AG who recommends investors sell the stock.
The current and former employees agreed to describe tensions within Greenhill on the condition they not be named. Some
senior dealmakers, they say, have battled with Bok for years on
strategy, arguing that the company would be better off recruiting
big-name, albeit highly expensive, bankers. Others say the M&A
business should have diversified by going further downstream
and working on smaller transactions to steady its earnings. Bok
kept the company focused mostly on what made Bob Greenhill
famous: highly complex, cross-border megadeals.
For that, Greenhill needs rainmakers. Yet many longtime
bankers left after the company’s initial success. Bob Greenhill and
Bok have sold more than $500 million of their stock in the firm.
The founder, 81, isn’t as involved in day-to-day operations as he
was in the firm’s early years, according to people familiar with the
matter. Altogether, half of the eight members of the early management team have left since the company’s IPO, inevitably calling
attention to a warning tucked into the offering’s regulatory filings
that any departure of a senior dealmaker “could materially
adversely affect our ability to secure and successfully complete”
transactions. From October to early March, four bankers who
spent at least eight years at Greenhill left for rivals. Bok says he
now spends most of his time with clients, both for his own deals
and to help colleagues around the world. He says the firm’s attrition
rates, when annualized, are healthy and similar to competitors’.
And longtime clients such as grocer Tesco Plc and newspaper
publisher Gannett Co. have stood by the boutique.
Some assert that Bok was too attached to the dividend he
was paying shareholders and that the cash should have been
redirected to recruiting. Several senior bankers say the IPO made
it easier for them to leave, as it turned their stakes in the firm into
valuable stock they could cash out after a five-year lockup. As
their departures mounted, the stock entered a slide from which
it never fully recovered.
One thing Bok sought to do is preserve the firm’s collegial
culture, which could be disrupted by hiring big egos. Several top
performers who left say they would’ve preferred moving in that
direction to generate more business. Instead, they grew frustrated
watching amicable replacements struggle to land deals, hurting
the firm’s bonus pool.
Hiring packages for top-tier bankers can be expensive and
could have reduced the 45¢ quarterly dividend that Bok maintained
from 2008 until it was slashed to a nickel last year. Former executives argue that diverting some of that cash to recruiting would
have paid off in the long run. Instead, Greenhill sought to pay recruits
mainly with equity, a practice that risks creating a negative feedback
loop: The stock falls, and people leave; the stock falls again, and
more people leave. Such a cycle makes it all the harder to attract
and keep top talent. Bok disagrees. “I don’t think we did any better
when the share price was high. I don’t think we’re doing any worse
when the share price was low,” he says. “One could argue, if you
want to be logical about it, that the time to join and take the stock
is when it is low.” A recent hire says he agrees.
Greenhill’s heavy use of stock to pay bankers—a cost that’s
booked over several years—makes it harder for outsiders to track
underlying earnings, three people say. Many other firms have
backed away from the practice; Morgan Stanley CEO James
46
Gorman once said it “created a burden” on future profits. Bok says
that based on conversations with recruits, Greenhill’s pay practices
are normal and shareholders like aligning bankers’ incentives with
stock performance.
THE FIGHT OVER whether to shell out for rainmakers all comes back
to a question facing every boutique: Can such companies outlive
their founders? Eric Gleacher, who like Greenhill was a Morgan Stanley
veteran, formed his own company, too, but it eventually wavered as
he grew older and stepped away from regular operations. Gleacher
& Co. liquidated in 2014, ending a five-year stint as a public company.
Still, the concept of a shareholder-owned boutique remains
popular. After the 2008 financial crisis, publicly traded advisory
companies lured dealmakers away from giant investment banks
that were under pressure from investors and the government to
curb lavish bonuses in the wake of taxpayer-funded bailouts.
The M&A market, meanwhile, reached new heights thanks
to low interest rates and ample funding for takeovers. Global M&A
volume reached $3.4 trillion in 2017, according to Bloomberg data.
Boutiques have won roles on many of the biggest deals of the past
decade. But some doubt the sector will be able to grab much more.
“A lot of that market share gain is behind us,” says Mark Conrad
of Algebris Investments, which owns Lazard Ltd. stock. “I don’t
think that suggests necessarily that growth is done. I just think
perhaps the easy gains are in the rearview mirror.”
The companies that have sought to diversify by adding other
sources of revenue have had varying success with those businesses. Lazard, the largest independent merger adviser and almost
200 years old, now generates about half its fees from asset management. Evercore bought ISI Group, a research, sales, and trading
operation that recently lowered projections for profitability.
a move late last year that many on Wall Street found
clever. He hired Goldman Sachs to line up $350 million in borrowing
from investors, then used that money to buy back Greenhill stock
at a higher price. That lifted the market value and allowed the CEO
to pay down some debt. This year, in the first weeks of March
alone, he announced four hires. Now, he says, “our current team
is 100 percent behind our strategy.”
Bok has a lot at stake. In a sign of confidence, he and Bob
Greenhill each committed $10 million of their own money to help
recapitalize the company. Together they hold $60 million of the
company’s stock, ranking them among its top-five shareholders,
February filings show. That doesn’t include equity awards that
haven’t vested or can’t yet be sold. One of the firm’s largest outside
investors says privately it’s betting Bok can turn things around within
half a decade, as Lazard once did. Many new investors, though, are
seeking short-term gains, says UBS’s Hawken, which puts pressure
on Bok to show progress soon. Bettors are lining up against him,
shorting 30 percent of the company’s stock to profit if it falls.
Bok, who’s now on a search for talent, realistically has less
than 12 months to show signs of success, Hawken says, noting
that recent recruits are promising. Still, “you’ve got pretty big
questions around when things will actually turn around and get
better.” —With Anders Melin and Gillian Tan
BOK MADE
Basak covers Morgan Stanley and boutique banks,
and Porter covers deals at Bloomberg News in New York.
< G O> I NS I D E THE TE RMI NA L
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from your investments?
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and performance.”
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and performance.”
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Responsible Investing
The Family Office World Grapples
With How to Confront Big Corporations
By SIMONE FOXMAN and EMILY CHASAN
I L L U S T R AT I O N B Y M AT T H E W H O L L I S T E R
founded Standard Oil Co. and as a result
was the richest person on the planet when he died in 1937. Yet
some of his 200-plus living descendants have embarked on a
mission to challenge Standard Oil offspring Exxon Mobil Corp. on
climate change.
So it should come as little surprise that the investment
company that traces its roots to John D.’s family office is contending
with a related question: deciding just how much it wants to change
the world.
In March, Rockefeller & Co. transformed into Rockefeller
Capital Management following a transaction led by former Morgan
Stanley wealth management chief Greg Fleming, with financing
from hedge fund Viking Global Investors. The rechristened company,
with Fleming as chief executive officer, is owned by its management,
Viking, and a trust representing the Rockefeller family.
Fleming’s plans for the company, which had $12.7 billion in assets
under management at the end of 2017, include bulking up its asset
management effort, starting a strategic advisory operation, and
expanding its wealth management arm, which provides advice and
planning for wealthy clients. Part of that effort involves catering to
JOHN D. ROCKEFELLER
48
women and millennials with socially responsible investing products.
For Fleming, whose 30-year Wall Street career included a
stint as president of Merrill Lynch & Co., such environmental,
social, and governance-based offerings are integral to winning
clients. “The millennials are actually going to treat ESG investing
as something that’s important to them forever,” he says.
In a 32-page January report discussing the performance of
its sustainability and impact analysts last year, the company said
it voted 2,696 proxies and supported 46 percent of shareholder
proposals, including two it co-filed. Among the steps it took to
engage with companies it invested in, Rockefeller voted against
an entire board slate for the first time because of “corporate
responsibility shortcomings.” In the report, the company said it
was “dissatisfied” that Oracle Corp.’s board hadn’t made more
progress in aligning CEO compensation with long-term performance. It said it will continue to engage with Amazon.com Inc. on
human capital management, particularly regarding working conditions at its distribution centers.
Still, Rockefeller Capital’s chief investment officer, David Harris,
says the company will go only so far. It doesn’t want to rail against a
< G O> I NS I D E THE TE RMI NA L
company’s management in the press, for one thing. “The beauty of
being in public equities is that we can exit the position,” he says.
RESPONSIBLE INVESTING IN PUBLIC markets was long considered
by many financial professionals to be an underperforming niche.
Managers screened out businesses that investors disapprove
of—tobacco makers or oil companies—and clients accepted that
investing in this manner was likely to curb returns.
More recently, however, many investors have come to believe
that socially responsible investing doesn’t necessarily forgo gains—
and in addition, that such stock holdings can create an avenue to
making companies behave better. Earlier this year, BlackRock Inc.
CEO Laurence Fink wrote an open letter to chief executives urging
them to measure their success beyond earnings. Among his suggestions was that CEOs evaluate their companies’ impact on the
environment or the communities they serve. In the wake of
the Marjory Stoneman Douglas High School shooting in Florida
that killed 17 people, BlackRock and State Street Corp. said they
would engage with gunmakers.
To get a large public company to pay attention typically
requires one of two things: deep pockets or a loud voice. The vast
majority of shareholder proposals seeking to improve a company’s
environmental or social impact are still put forward and supported
either by large pension funds, such as the California Public
Employees’ Retirement System, or by nonprofit activists, such as
the Sisters of St. Francis of Philadelphia. Several small companies
that manage money for wealthy individuals, foundations, and
endowments—including Zevin Asset Management, Arjuna Capital,
and Trillium Asset Management—fall into the activist camp, but
they control a small fraction of the alternative investment industry.
Otherwise, money controlled by rich people has rarely been used
to push for corporate responsibility.
embrace shareholder engagement
and even shareholder activism? Why are few foundations or billionaires with strong values using their public stockholdings to
push for change?
Such questions are drawing the attention of wealthy people
and family foundations across the country, particularly after the Ford
Foundation announced last year that it would devote up to $1 billion
SO SHOULD PRIVATE WEALTH
<GO> I NS I D E THE TE RMI NA L
49
For an overview of a selected company’s environmental, social,
and governance performance over time and in relation to peers, run {ESG <GO>}.
of its $12 billion portfolio to investments that would make the
endowment money while also advancing its social justice mission.
Meredith Shields, managing director of the Sorenson Impact
Foundation, says Ford’s decision was part of what pushed Jim
Sorenson, founder of Sorenson Communications LLC, to reconsider how he was investing the publicly traded funds that endow
his foundation. After a yearlong discussion, the foundation shifted
a quarter of its publicly traded investments into socially responsible
strategies at the end of last year. Shields says this was the first
move in a two-year process conducted in conjunction with the
foundation’s financial adviser, Sepio Capital LLC.
The foundation’s goal at an existential level is to bring about
change, Shields says. “So to the extent that that requires being
more engaged with the companies—and saying, ‘We view you as
a great investment, with the exception of this thing you’re doing
over here’—I could see that as certainly a path we’d go down.”
Other foundations and family offices have started to engage
indirectly. Some are key supporters of Oakland, Calif.-based nonprofit As You Sow, which explicitly champions corporate accountability through shareholder action. Ian Simmons, who runs
single-family office Blue Haven Initiative with his wife, Liesel Pritzker
Simmons, is a member of the U.S. Impact Investing Alliance, along
with Sorenson and Ford’s Darren Walker.
Still, many family offices and foundations remain unconvinced that they can succeed in pushing for change at a large public
company. That requires either an enormous amount of capital or
a public campaign, says Greg Neichin, director of Ceniarth LLC, a
single-family office founded in 2013 that oversees the wealth of
the late Eugene Isenberg, former chairman of Nabors Industries
Ltd., and his family. Its mission is to make investments that benefit
50
underserved communities, but Ceniarth typically sticks to private
market investments where it can play a bigger role in the
decision-making. “The family office world is sort of stuck in
the middle without either of those tools,” Neichin says. “They don’t
necessarily hold enough capital to make that kind of impact.”
Although it may be difficult for individual families to play a
more active role as shareholders, there may be strength in
numbers. “If they group together or get together with asset managers, they could reach critical mass,” says Martin Whittaker, CEO
of Just Capital, a nonprofit that ranks companies on values such
as environment and community impact. Just Capital was established by a group that includes billionaire Paul Tudor Jones.
Companies might take notice if the family office for someone such
as Microsoft Corp. founder Bill Gates announced criteria for the
companies it would invest in. “I think they’d have to be willing to
be public about what they’re doing,” Whittaker says.
THAT MAY NOT BE a role Rockefeller Capital wants to take on. Yet,
meanwhile, the company’s team of five sustainability and impact
analysts are helping it to “find better companies, to identify risk
that a typical CFA, traditionally trained economics or finance major
might not necessarily be flagging,” CIO Harris says. Though not all
the company’s equity products are specifically ESG, most of its
portfolios loosely track its ESG investing.
In other words, Rockefeller Capital sees its sustainability
team as key to making money. Perhaps that’s the smartest strategy
of all.
Foxman covers family offices and Chasan is editor of
the Sustainable Finance Brief at Bloomberg News in New York.
< G O> I NS I D E THE TE RMI NA L
SHE’S FAST.
BUT CAN SHE KEEP UP WITH
THE CHANGING WORKFORCE?
Only 40% of teens graduate with basic job skills.
Help her get 100% ready.
JA.ORG/READY
Based on the 2015 National Assessment of Educational Progress
(NAEP) conducted by the U.S. Department of Education.
AI
Does the World Really Need an
AI-Powered Dark Pool?
By WILL HADFIELD and ANNIE MASSA
P H OTO G R A P H BY B R A D O G BO N N A
Suth, Littlepage, and Johnson
52
< G O > I NS I D E THE TE RMI NA L
MATHEMATICAL FORMULAS, scrawled in red and black, cover a glass
wall. The office is small, but the three men who work there, dressed
in jeans and sneakers, hovering around an array of computers, have
big plans. They want to run a stock market, and they say they and
their algorithms can do what even their leanest competitors would
need 80 human beings to achieve.
Kelly Littlepage, Stephen Johnson, and Richard Suth have
rented a 240-square-foot office in a building on a quiet side street
in Lower Manhattan. Next door, a shop sells black leather motorcycle
jackets (“Ride or Die”) and retro lamps made from old cassette
tapes. The three entrepreneurs say their company, OneChronos,
will fundamentally alter the business of buying and selling stocks
established more than two centuries ago by the New York Stock
Exchange, located just over a mile away.
OneChronos is seeking to be the first venue trading mainstream securities to use artificial intelligence to match trades.
Whereas stock exchanges use relatively simple math to match buyers
and sellers trading shares of individual companies, OneChronos
proposes matching trades among multiple stocks, trading in different currencies all at the same time. This would be impossible at the
kind of stock exchange with which we’re all familiar. And that’s why
OneChronos needs to use artificial intelligence, the great transformational force in finance today.
The company is currently awaiting approval from the U.S.
Securities and Exchange Commission and the Financial Industry
Regulatory Authority to operate a trading venue known as a dark
pool for U.S. equities. Assuming regulators give it the go-ahead, it
will match its first buyers and sellers later this year. Littlepage,
Johnson, and Suth, who each have an equal say in running the firm,
plan to add European equities and currencies as soon as possible
after that. “Our market is for someone who wants to sell out of
Apple, buy a European equity, and do the FX trade all at the same
time,” says Littlepage, 30, who founded OneChronos in 2016 with
his schoolmate Johnson, 31. “If we didn’t use AI, it would take longer
to match those trades than the amount of time left in the universe.”
In markets at least, AI has mostly been used to generate
returns. OneChronos is different: It wants to generate matching
orders. It’s promising to complete trades at a lower total cost than
any competitor. Its fees will be low, but, more important, the
company wants to show that trades on its platform move the market
less than trades on other platforms, alleviating the concerns of big
fund managers who live in fear that the value of their shares will
drop when they have a stake to sell and climb when they have a
stake to buy. When that happens, Littlepage says, “it’s death by a
thousand paper cuts.”
the brainchild of Littlepage and Johnson. They
were in the same running club at Arapahoe High School in a Denver
suburb in the early 2000s before Littlepage went on to study
applied computational mathematics at the California Institute of
Technology. There, he was taught by Preston McAfee, who now
works at Microsoft Corp. as the technology giant’s chief economist.
It was McAfee who introduced Littlepage to the math of combinatorial auctions. U.S. aviation regulators had pioneered the use of
these auctions to allocate landing slots at key airports to rival airlines.
The auctions had also been used to sell bands of wireless spectrum
to competing mobile phone companies. McAfee saw they might be
adapted to financial markets with their vast numbers of orders and
near-instantaneous trades, but, as Littlepage says, the computing
power to make that happen has only recently become available.
Littlepage had stayed in touch with Johnson, who went on to
become a cybersecurity specialist at Accenture Plc. As well as sharing
a sport, they liked to talk about how emerging technologies could
solve mathematical problems. In the summer of 2016, Johnson and
Littlepage, who’s worked at Crabel Capital Management LLC, a futures
and currencies trader, decided to take their OneChronos idea to
Y Combinator, a Silicon Valley startup funder. The seed accelerator
gave them $120,000 to set up OneChronos. Another five venture
capital firms, including DST Global and Data Collective, also invested.
One of the VC firms, Green Visor Capital Management Co.,
approached Richard Suth, 47, a former New York-based partner in
the equities division of Goldman Sachs Group Inc., to join the
startup. Suth, whose role is to sign up customers, has met with
hundreds of fund managers, banks, proprietary traders, and hedge
funds in the past 12 months. Big financial firms won’t commit to
use a new venue until it’s received regulatory approval and is ready
to launch, but Suth is bullish. “We will have a good portion of the
major market makers participating,” he says. “We expect a couple
of dozen market makers and banks.”
ONECHRONOS IS
TECHNOLOGY HAS driven change in financial markets since the NYSE
was founded in the aftermath of the American War of Independence.
Trading quickened as telegraph poles and then submarine cables
replaced messengers on horseback. But the pace of change has
been fastest in the last quarter of a century. In the 1990s, men (and
they were almost always men) in colorful jackets shouted orders
at one another in grand buildings with important-looking facades.
By the turn of the century, most markets had gone electronic.
Sometimes men picked up telephones to shout orders at other
men in distant offices. And then toward the end of the last decade,
electronic trading fragmented. While some of it stayed on the
<GO> I NS I D E THE TE RMI NA L
53
ROOM FOR ONE MORE?
U.S. stock-trading venues, by shares traded in February
54.8b
35.9b
31.8b
31.3b
3.7b
0.8b
Off-exchange
trading venues*
NYSE
Cboe
Nasdaq
IEX
Chicago Stock
Exchange
*Includes dark pools and bank-run crossing networks
Source: {MVS <GO>}
exchanges, a lot moved to new venues—including dark pools—
operated by banks or startups. A new breed of trader—the
high-speed, or proprietary, trader—came to dominate trading of
stocks and currencies. The men (they were still mostly men)
hung up their telephones and sought alternative employment.
Whether speed traders will flock to OneChronos is a different
matter. A senior executive at a large algorithmic trader says the
company’s processes are just too complex, while an exec at another
major trading house says the new venue will only work if firms supply
it with lots of orders in every asset class. But Larry Tabb, the founder
of New York research firm Tabb Group LLC, is more sanguine about
OneChronos’s opportunities. “The whole way of thinking about market
making is changing,” he says. “A couple of years ago, the buy side
would not listen to this idea. Now the bigger guys are all doing it.”
Several stock markets already offer auction services. Cboe
Global Markets Inc. operates the largest so-called periodic-auction
service in Europe, while London Stock Exchange Group Plc’s
Turquoise division and Goldman Sachs also run auctions that last
roughly 100 milliseconds—about the length of time it takes a hummingbird to flap its wings.
OneChronos is different from these other auctions in that
it uses AI to choose which of the mathematically possible matches
will result in the maximum number of shares changing hands. That
may deter some potential traders because the machine-learning
system that OneChronos relies on is autonomous; it cannot explain
why it chose the match it did. “The thing about machine learning
is that it’s a black box; you do not know why the machine is doing
something,” says Tim Cartledge, the global head of FX at NEX
Group Plc’s markets division. “Having a black box in the model,
that would put the fear of God into most people.”
Littlepage and Johnson, who train the machine, think they
54
can dispel such fears. They have set upper and lower limits on the
number of shares that can be matched by the AI during a single
auction. The lower limit is the number of shares that would have
changed hands if OneChronos was run like a stock exchange, only
matching orders of individual stocks during continuous trading.
The upper limit is the theoretical maximum number of shares that
could be traded if the AI had much longer to find an answer.
OneChronos may be alone in running an AI-powered stock
market, but it faces lots of competition. The U.S. already has 12 stock
exchanges and 32 off-exchange markets or dark pools. IEX Group
Inc.—the last eye-catching new exchange, which began life as a dark
pool in 2013—accounts for little more than 2 percent of U.S. equity
trading. How much volume does OneChronos need to succeed?
“For equities, even less than 2 percent would be plenty,” Johnson
says. “We want to get some size done there and then move into
different asset classes.”
For Suth, the real opportunity lies on the other side of the
Atlantic. Europe’s recent overhaul of markets rules, MiFID II, has
prompted fund managers to make greater use of auction services.
And having six different major currencies across Europe ensures
that any basket of stock trades is likely to involve a currency transaction, which OneChronos can handle in its auctions. “The U.S. is
not the golden goose,” Suth says. “It’s a huge market, but the
European market is potentially better.”
Without a regulatory green light, the potential and ambitions
clung to by Suth, Littlepage, and Johnson amount to little. But if
the regulators give the go-ahead, OneChronos may well need to
look for new—and larger—digs.
Hadfield covers market structure for Bloomberg News in London.
Massa writes about finance in New York.
< G O> I NS I D E THE TE RMI NA L
Research.
In detail.
In context.
Financial firms need to make decisions at
the speed of the market. With 250 analysts
covering 1,800 companies in more than
135 industries, Bloomberg Intelligence
delivers timely and unique perspectives
to enhance your in-house research.
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56
BLO O M B ERG M A R K ETS
Industry
Focus
ESG
POWERED BY BLOOMBERG INTELLIGENCE AND
BLOOMBERG NEW ENERGY FINANCE
Socially responsible assets and funds grew significantly over the last year,
as more investors looked for strategies that included progressive
environmental, social, and governance (ESG) criteria. In the following
pages and at {BI ESG <GO>}, Bloomberg looks at the growth of this style
of investing—and checks in on the progress toward its goals.
VO LU M E 2 7 / ISS U E 2
57
3
Pension funds and millennial investors
helped drive new demand for
environmentally sound and socially
conscious investment strategies.
ESG assets rose 37 percent in 2017 from
the year before, not only riding the rally
but also outpacing most broad market
indexes, according to Bloomberg
‘Good’ Funds
Don’t Always
Finish Last
Intelligence. The number of sustainable
funds created last year was twice that
of 2014. Yet traditional investment vehicles
remain dominant. “Assets have grown to
more than $445 billion, but ESG is still
limited to a niche market,” says Shaheen
Contractor, a Bloomberg Intelligence ESG
research associate. —Siobhan Wagner
ESG FUND ASSETS UNDER MANAGEMENT
1,452
$500b
Number of funds
250
1,051
2013
2
2017
Pricey Products
Fees for ESG investment vehicles
remain relatively high, partly because their
small size drives up costs. The median
expense ratio of ESG equity mutual funds
that Bloomberg tracks is 0.86 percent,
which is a little more than a third higher
than that of the average equity fund.
But as the broader industry lowers
its fees, ESG funds are following suit,
as Contractor points out. BlackRock Inc.
lowered the expense ratio of three ESG
exchange-traded funds. The iShares MSCI
EM ESG Optimized ETF and the iShares
MSCI EAFE ESG Optimized ETF were both
lowered by 20 basis points last year.
The fee for the iShares MSCI USA ESG
Optimized ETF was cut by 13 basis points.
The trend toward lower fees may fuel
consolidation, she says, perhaps making
deals such as Eaton Vance Corp.’s 2016
acquisition of Calvert Investment
Management Inc. more common. —S.W.
58
0
MUTUAL FUND EXPENSE RATIOS
Average fund Average ESG fund
Equity
0.63
0.86
Fixed income
0.51
0.61
Money market
0.18
0.26
BLO O M B ERG M A R K ETS
Higher fees could easily be justified
if ESG funds regularly delivered stellar
returns. But socially responsible fund
performance is historically a mixed bag,
and last year was no different.
The MSCI World ESG Leaders
Index, a benchmark made up of
companies that score well on ESG
metrics, increased 16.4 percent in the
year ended March 21, trailing the broader
MSCI World Index slightly. Among
alternatives for investors are funds that
rely on other investment criteria but
also have an ESG tilt, according to
Bloomberg Intelligence. The tilted MSCI
USA ESG Select Index, which
overweights ESG leaders, outperformed
its non-ESG variant, the MSCI USA,
over the same period by about 38 basis
points. The MSCI USA ESG Leaders
Index, which includes only companies
with high ESG performance, trailed the
Select index by 72 basis points. “Tilting
makes ESG an additional criteria, without
making it the sole criteria that can add
too much volatility and give too much
weight to a single factor,” says Gregory
Elders, ESG senior analyst at Bloomberg
Intelligence. —S.W.
PREVIOUS SPREAD, FROM TOP: MARTIN BERNET TI/AFP/GET T Y IMAGES, WIKTOR SZYMANOWICZ/BARCROFT MEDIA/GET T Y IMAGES, MICHAEL REINHARD/GET T Y IMAGES. THIS PAGE: ILLUSTRATION BY LA TIGRE FOR BLOOMBERG MARKETS
1
The Market Is Getting Bigger
(But It’s Still Niche)
Can Anything
Stop Clean
Energy Stocks?
BY STEPHEN MUNRO
You might think
President Trump’s
environmental policies,
so widely decried by
conservationists,
would be toxic for clean
energy stocks. If so,
then why did those
stocks generally soar
during his first year
in office?
Take the case of the
WilderHill New Energy
Global Innovation
Index, or NEX, which
lists low-carbon and
renewable-energy
companies from around
the world. Trump
initiated a number
of policies that would
seemingly damp the
performance of those
kinds of companies.
And yet during the
first year of the Trump
presidency, the NEX
rose 28.5 percent,
outpacing the
S&P 500, which
climbed 23.7 percent.
Indeed, the NEX’s
climb began on Nov. 14,
2016, shortly after
Trump won the election,
and didn’t peak until
late January of this
year, when some of its
component stocks were
hit by the global sell-off
by investors concerned
that higher inflation
would lead central
banks to end their
monetary stimulus.
Admittedly, there
are other significant
explanations behind
the relative health of
the companies of the
index, which WilderHill
New Energy Finance
LLC created. Many
are geographically
insulated from policies
crafted in Trump-era
Washington; less than
a quarter of them
are based in the U.S.
Still, Trump’s
policies didn’t stop
the share prices of the
two biggest U.S.
solar companies—
First Solar Inc. and
SunPower Corp.—from
rising 101.5 percent
and 23.8 percent,
respectively, during the
president’s first year
in office.
Another explanation
has to do with the
definition of “new
energy.” At the start
of 2018, almost
40 percent of the
NEX companies, as
measured by market
value, specialized in
fields other than power
generation; these
companies were in
the business of energy
efficiency, energy
storage, or energy
conversion.
Although the
success of NEX may
be attributable to its
diversified makeup,
clean-energy stocks
in general appear to
be faring well in public
markets. The Cleantech
Index comprises
49 companies from
around the world;
it gained 34.8 percent
in the year after Trump
took office.
The S&P Global
Clean Energy Index,
which provides
global exposure to
30 companies in
the sector,climbed
16.3 percent during the
same period. All of this
might suggest that the
fundamentals behind
clean energy are solid
enough to survive the
Trump era.
Munro is a policy
editor and analyst
at Bloomberg New
Energy Finance.
‘NEW ENERGY’ IN THE TRUMP ERA
Change in index since Inauguration Day
30%
WilderHill New Energy Global Innovation Index
15
S&P 500
1/20/17
3/7/18
0
Sources: {NEX Index}, {SPX Index}
4
Green Shoots Sprout in the Corporate Bond Market
ESG pioneers focused primarily on
public equities, but in recent years big
fixed-income investors such as insurers
have been pouring money into bonds
used to finance environmentally friendly
projects. In 2017, $163 billion of green
bonds were issued, up from $1.5 billion
in 2007, according to Bloomberg New
Energy Finance. Corporate issuance
mostly drove the market last year.
Companies in sectors including power
generation and electronics sold bonds
to finance green business activities
or sustainability measures, says Daniel
Shurey, a green finance specialist with
Bloomberg New Energy Finance. —S.W.
GREEN BOND ISSUANCE
Corporates Financials Other
$160b
80
2007
2017
VO LU M E 2 7 / ISS U E 2
0
59
With so much talk of ESG ringing
in their ears, investors thinking long term
about fossil fuel companies are likely
to wonder when we’ll reach peak
oil demand.
Estimates vary widely, but
most forecasters now agree production
growth will stop because of waning
demand, not declining supply. What’s
more, Bloomberg New Energy Finance
predicts fossil fuel demand may top
out sooner than big energy companies
forecast. Richard Chatterton, BNEF’s
lead analyst for oil demand, says
that increasingly alternative fuels such
as natural gas and hydrogen will
6
When Drought Risk Is in the Prospectus
Whether mining operations or
farmlands, companies worldwide have
assets exposed to water risk, which
the impact of climate change has
worsened. Last year companies such
as U.S. miner Alcoa Corp. and French food
company Danone SA committed
$23.4 billion in total to tackle water risk in
91 countries, according to nonprofit CDP.
South Africa (shown here) is
one country that’s become increasingly
parched, potentially complicating
operations for its mining industry.
MAPS <GO> shows that mines for metals
(including gold, diamonds, platinum,
and iron ore) are located in the country’s
most water-stressed areas.
Tourism is another sector at risk.
One of South Africa’s most popular
destinations, Cape Town, is contending
with its worst drought on record.
“If you compare this time vs. last year,
we’ve literally halved the water
consumption usage per individual
in Cape Town,” says Sisa Ntshona,
chief executive officer of South African
Tourism. —Emily Chasan
60
power commercial trucks.
Chatterton says mainstream
forecasts underappreciate the speed
and extent of the potential impact
of technological change and regulatory
constraints by underestimating factors
such as efficiency improvements and
proposed bans on petroleum products
(diesel and plastic among them). Electric
vehicles, he says, will be one of the
biggest disrupters. Most oil demand
forecasts project EVs will account
for 5 percent to 15 percent of the world’s
passenger cars by 2040, but BNEF
projects their share will reach at least
33 percent. —S.W.
WATER STRESS IN SOUTHERN AFRICA
Atlantic
Ocean
Indian
Ocean
Stress level
Low
Low to medium
Medium to high
High
Extremely high
Cape Town
Arid and low water use
BLO O M B ERG M A R K ETS
ILLUSTRATION BY LA TIGRE FOR BLOOMBERG MARKETS
5
How Much Time Does Big Oil Have Left?
7
#MeToo: An Opportune Moment to Push for Change
The #MeToo movement has helped
shed light on gender inequality in the
workplace. At the same time, an
increasing number of new gender-
focused investment funds that focus
on women in leadership, female
entrepreneurs, and workplace equality
have appeared. Last year, 32 of these
products were introduced, including
mutual funds, exchange-traded funds,
and private equity, venture capital,
and angel funds. —S.W. and E.C.
INVESTING IN EQUALITY
Number of gender-focused investment vehicles launched
30
15
2004
2018*
8
9
What Do Women Want?
Equal Pay and a Seat at the Table
Investors looking to push companies
toward equal pay and representation
have their work cut out for them. Among
nations that are members of the
Organization for Economic Cooperation
and Development, the wage gap between
genders is an average 14.1 percent,
according to 2016 figures from the
OECD. Women are also
underrepresented in management and
on boards. “Companies are receiving
increasing pressure from investors,
governments, and their own employees
to improve diversity as a way to better
identify and navigate new and changing
market opportunities,” says BI’s Elders.
Norway and France have implemented
board quotas, which helps explain why they
have more female directors than other
countries. —S.W.
WOMEN AT PUBLICLY TRADED COMPANIES
Median percentage of board
0
Median percentage of all employees
20%
40%
Norway
Australia
U.K.
France
Germany
U.S.
Japan
VO LU M E 2 7 / ISS U E 2
0
Reaching the
Top Isn’t Enough
MEDIAN DIRECTOR PAY AT PUBLIC FIRMS
Men Women
$300k
150
Europe
U.K.
Australia
U.S.
0
Even when women have a seat in the
boardroom, compensation isn’t equal.
Female directors tend to earn less money
yet sit on more committees, creating a pay
gap even at the pinnacle of the corporate
world. Many companies have increased
board gender diversity, but they haven’t
made similar strides improving diversity in
board leadership ranks. Company directors
usually earn a flat fee, but board and
committee chairs earn more, which opens
up a pay gap because these posts usually
go to men. The outlier is the U.S., where
there’s little premium for being the chair
of a board. —Gregory Elders, Bloomberg
Intelligence ESG analyst
61
The Markets Q&A
Jin Liqun:
“This isn’t just about China”
By BRIAN BREMNER and MIAO HAN
P H OTO G R A P H S BY
GIULIA MARCHI
a household name (yet), even though
he has one of the most challenging and important jobs in
global finance. Jin, 68, is the inaugural president and chairman of the Asian Infrastructure Investment Bank. The
AIIB, a Beijing-based multilateral development bank that
opened for business in January 2016, is an embodiment
of China’s aspirations to play a major role in the international financial system. Because the Chinese government
is the bank’s biggest shareholder, policymakers in Washington, Tokyo, and elsewhere question whether China is
trying to displace the longtime heavyweights in the field—
the World Bank and the Asian Development Bank—and
pursue its own geopolitical interests in Asia. Jin insists
the AIIB is independent. Like many during Mao Zedong’s
Cultural Revolution, Jin spent part of his youth in rural
China. A devoted student of English literature, he had a
long and distinguished run in the Chinese Ministry of
Finance, reaching the rank of vice minister. He’s also done
stints at the World Bank and the ADB.
JIN LIQUN MAY NOT BE
62
BLO O M B ERG M A R K ETS
VO LU M E 2 7 / ISS U E 2
63
BLOOMBERG MARKETS: When you’re making the rounds at
global inance meetings, what misconceptions about the AIIB
drive you crazy?
JIN LIQUN: “Why do we need the Asian Infrastructure Investment
Bank?” Sometimes the question can even be more blunt: “What
is China up to? The World Bank and Asian Development Bank
have been serving this region well over the last seven decades.
Why would China set up a new institution? Isn’t this a waste of
resources? Wouldn’t it be more cost-efective to put money into
existing institutions? Does China have an ax to grind? Is China
hoping the AIIB will help it achieve geopolitical objectives?”
I’ve had to deal with all of those questions. And the difficult part is that I’m a Chinese in the irst instance. I don’t think
it’s possible for me to tell the whole world I’m really neutral. I
cannot say that.
On the other hand, if I just represent China’s ideas, without
doing my part to incorporate the ideas, comments, concerns,
observations of all the people who are supposed to be part of this
work, I don’t think it will be successful.
BM: So tell us about the bank’s irst principles and vision.
JL:
When China launched its opening-up and reform programs in 1978, there was absolutely nothing which could be
described as modern infrastructure facilities in this country. No
expressway, no electriied railway, no modern seaports or airports, no supercritical power plants, no high-voltage transmission lines or efficient distribution systems. No nothing.
Under such circumstances, the modernization of China
was nothing but a wild fantasy. Then China started to invest
massively in infrastructure with inancial resources raised from
the World Bank—and later on, the ADB—as well as from its
domestic savings. Dramatic changes were beginning to take
place from the mid-1990s.
It’s interesting to note that when China embarked on a
borrowing program, some people thought it was crazy to put
foreign money on top of dirt. Can a road give you your money
back? Never heard of it! Years later, people came to understand
the huge diference between borrowing to consume and borrowing to invest.
China can now stand alongside Japan and Korea to ofer
tangible experience in growth through broad-based economic
and social development based on infrastructure investment.
In 2013, President Xi Jinping announced the Chinese government’s decision to create an MDB [multilateral development
bank] to promote infrastructure investment. The purpose of
this initiative was straightforward: Bottlenecks in infrastructure
investment have seriously hamstrung many developing countries in their growth eforts.
The idea of making a new type of MDB inspired by China’s
experience quickly began receiving positive responses—
irst from ASEAN countries [Association of Southeast Asian
Nations] and then from South Asian countries, followed by
Central and Middle Eastern countries.
BM: What sets the AIIB apart from the World Bank or Asian
Development Bank?
JL:
The strongest possible argument for setting up a new
institution is its new features. It’s not intended to be a clone or
a copy of existing institutions. The concept of a development
bank is not abstract expressionist art, such as Jasper Johns’s
64
paintings—the less comprehensible, the more charming. The
world should have something diferent compared to the existing
institutions, but with special features grounded in the learning
and experience of those institutions.
BM: And what are those special features?
JL:
The AIIB will resist being tied down by bureaucracy. We
will not create fancy, lamboyant, and mostly redundant titles
and positions. And we will ight against staf working in silos or
bogged down in interdepartmental squabbling.
We have put in place operating policies and procedures
to enhance efficiency, to promote cost-efectiveness, and to
achieve measurable results that respond to our clients’ needs.
We will continue to recruit professionals of the highest possible
caliber. No position will be created without full justiication.
BM: How do you make the AIIB corruption-proof?
JL:
I want the AIIB to be squeaky clean. There will be zero tolerance for corruption. We take care of two important aspects,
namely procurement through international competitive bidding
on our projects and our own internal corporate procurement.
For the former, we will work in close collaboration with our
clients to monitor the process of bidding and to make sure that all
the companies tendering their bids will be treated fairly and equitably. Any companies or individuals who violate the rules and
engage in bribery will be blacklisted. We are voluntarily debarring those organizations already debarred by the other MDBs.
For the latter, any corporate procurement will go through
the procurement committee and be subject to close scrutiny to
prevent irregularities or misappropriation of the AIIB’s funds.
I have empowered the chief internal auditor to check
the expenditures of the bank to make sure that nothing irregular happens. No resistance or obstruction will be tolerated.
Minor problems must be nipped in the bud so that they will not
fester. We must guard against any callous disregard for costefectiveness or intentional misuse of inancial resources. A
Chinese sage said thousands of years ago, “Felonies thrive where
misdemeanors are tolerated.”
BM: Making the best possible loan decisions, free of political
bias, is always a challenge at multilateral development banks.
How does the AIIB avoid that trap?
JL:
Sustained success comes from a decision-making process
which must be democratic, rational, and free of impulsive and
emotional reactions to external factors. Such a process is not
possible if challenging views are frowned upon or hushed,
candid and frank exchanges of ideas not allowed, or suggestions
from the staf ignored.
At the AIIB, no decisions will ever be made and then handed
down without thorough deliberation and consensus-reaching at
the executive committee meeting. Staf can speak up and challenge their supervisors. This practice applies all the way to the top.
I place great importance on democratic decision-making.
I have followed a number of interesting cases of the rise and
fall of great business empires. Without exception, an empire
was built up by an individual with extraordinary vision. But an
individual’s wisdom is limited, and even pioneers and trailblazers may not be able to keep abreast of everything at all times.
Disasters loom large when the empire builder refuses to listen.
Empire builders only see this when, at the denouement, the
empire collapses in their hands.
BLO O M B ERG M A R K ETS
“The whole world will judge us by
how we perform, not by what we claim. Therefore,
I do not mind if the jury is still out”
They say people never learn from history. I am one who
loves to read history and will learn from history.
BM: How has China’s development path shaped your thinking
about the AIIB’s operations and goals?
JL:
I would say that, based on the development experience of
China over the last few decades, plus my personal experience,
we believed it was important to have a new multinational development bank focused on infrastructure development.
First of all, China itself has beneited from the World Bank
and bilateral support from many governments. We came to
understand the importance of multilateralism.
Secondly, as I said, infrastructure is key to fast economic
growth. Finally, we wanted to create a bank with modern technology expertise, managerial expertise, and very good governance.
Each and every one is important, but they only work when they
work together in unison.
BM: You’ve been very careful to create some space between the
AIIB and China’s huge international infrastructure program,
the “One Belt, One Road” initiative. Why?
JL:
“One Belt, One Road,” proposed by the Chinese government, is a kind of platform, inviting all the participating countries to work together. President Xi has proposed the program
guided by the principles of broad consultation, joint construction, and shared beneit.
We are talking about 60 to 70 countries. The broad goal
is to improve regional connectivity in Asia, eventually even
global connectivity, thereby beneiting the people who have
been left behind.
This isn’t just about China. There’s a serious misconception that the program is about beneiting Chinese companies and labor. Some of these projects may actually not have
Chinese participation at all. China’s idea is to promote international cooperation.
BM: And how does the AIIB it into all of this?
JL:
“One Belt, One Road” and the AIIB are certainly initiatives proposed by the Chinese government. But they have
their respective functions and roles. One is a broad China-led
initiative for all the countries to work together. The other is this
multilateral development institution that operates by its own
standard of practice.
If countries involved in the “One Belt, One Road” programs would like to work with us [at the AIIB], we will be very
happy to consider them. But we need to look at the inancial
sustainability of the projects. We need to look at environmental
protection and the sentiment of the local people. We have our
own standards to process.
I believe we will be actively promoting those programs,
given our capacity and being responsive to the needs of countries. But we cannot cover everything.
BM: We understand the AIIB is considering launching a
dollar-denominated bond ofering in the international markets
this year. How signiicant is this for the bank?
JL:
We’ve been granted top-level ratings from the three major
rating agencies. This is due to the strong support of all the major
shareholders, including China and some European countries.
The bank’s management operates independent of any
government. We make decisions guided by our own standards
and our board. So internal governance, risk control, rigorous
inancial management, high-quality staf are key. And our team,
from the very top to staf out in the ield, looks at every investment with the integrity of the bank in mind.
All of this should give assurance to the rating companies
that this bank deserves the highest rating. With this rating, the
bank certainly can go to the market when the time is appropriate.
BM: Where does the AIIB it in the larger inancial evolution of
Chinese inancial markets?
JL:
I welcome China’s market being more open to the
outside, and I think China will continue to be more open
because we have more inancial talent and know-how. Our
[country’s] leadership wants to open up the Chinese inancial
markets, but to do so without creating chaos. We have learned
from the experience of the U.S. and European countries during
the 2008 inancial crisis.
BM: When Western and Chinese policymakers exchange
VO LU M E 2 7 / ISS U E 2
65
ideas and positions, is there something important that gets
lost in translation?
JL:
For China, I think English writing and communication
skills are really important. I think that I will never relax on my
eforts to improve communication. We are really lacking in
senior-level people in China who can communicate efectively
with the outside. I think it’s important to have a real understanding of other cultures. That’s why I try very hard to communicate
with the people in Western countries. I don’t want to have a war
of words. I want a reasonable discussion.
BM: You’re not a princeling who comes from a powerful family.
JL:
I was born into a family that had seen better days before
World War II. My great-grandfather on my paternal side was
a scholar who gave lectures in a local traditional school. As his
parents died early, my grandfather left home as a young man,
trying to make a living on his own in Shanghai and in neighboring cities.
He was a self-made engineer enjoying a very high income.
But he did not think much of money, and his dream was that
the family should return to its old glory days, with his ofspring brought up as men of letters. He could aford to provide
my father with a good education, even hiring for him a private
English tutor.
Things all changed when the Sino-Japanese War destroyed
virtually everything and their inancial situation deteriorated
quickly. But the traditional love for learning carried on. My
parents’ hobby was reading, and we followed suit.
While still a kid, I happened to ind some English books
in the attic. From my vague memory I recall them being hardcovered books, and one was Aesop’s Fables. There were also some
periodicals, such as Reader’s Digest, published in the 1940s.
My interest in the English language and literature was
aroused and was quickly reinforced when I was introduced to
the English-language course as a ifth-grader in elementary
school. It was hard to believe that elementary school ofered an
English-language course in the 1950s, but that did happen.
BM: And, not surprisingly, your initial career ambition was to
become an English professor.
JL:
As a high school student in the early 1960s, I started to
work very hard on the English classics. Summer and winter
vacations were the best seasons for me to concentrate on my
books without having to bother about some other subjects
at school.
I struggled with classics—mostly iction and poetry—
as I had no access to works of contemporary writers in the
English-speaking world. I read authors who would sound unfamiliar to the young students today. I was fascinated with the prose
of great essayists, such as Charles Lamb and Mary Lamb, William
Hazlitt, Joseph Addison, and Richard Steele. I still lip through
the pages of the works of Shakespeare, John Milton, and Chaucer.
As for authors across the Paciic Ocean, I loved Washington Irving, Ralph Waldo Emerson, and Nathaniel Hawthorne. I
worked on these authors, all in the original.
My eforts never discontinued—even during the
Cultural Revolution or while working on the farm. What
I learned in rural China in the ’60s and ’70s, however, is not
English and American literature. Rural life is not iction—it
is reality. The experience of those years has shaped, to a great
66
extent, my mental world and nourished my sense and sensibility to the mission of development.
BM: How so?
JL:
My daily contact with the villagers helped me understand
their dreams and aspirations for themselves and their children
and their children’s children. The pattern of their life cycles has
repeated itself generation after generation without much variance. A big breakthrough would be if one of their kids would go
to college and get an urban job with a higher income and social
security. As the saying goes, a golden phoenix has lown out of
the poor village.
Our village was connected to the electric power grid only
in the early 1970s. A two-storied farmhouse with electricity
and running water, a lushing toilet, a telephone, and storage
of sufficient grains and other foodstuf was what they had been
dreaming about. Their dream was still considered something
very remote, if not a wild fantasy, during the ’60s and ’70s when
I was over there.
BM: How did the Cultural Revolution and your time in rural
China shape you?
JL:
All this toughness belied the rural attractiveness for me.
The redeeming feature of this life is that I could have some spare
time reading without disturbance in my thatched cottage, especially in slack seasons.
The villagers could make neither head nor tail of my pursuance. But they were such nice people and never bothered me.
Perhaps they wondered whether I had my head screwed on the
right way.
I was outitted with a worn-out Remington typewriter and
a copy of Webster’s Third New International Dictionary of the
English Language, Unabridged—both purchased secondhand—
plus a number of English books. These books had come into my
possession at a small cost, having miraculously survived the bonires of the Cultural Revolution.
Decades later, some people thought that this crazy young
guy, as D.H. Lawrence would say, “had a strange prescience, an
intimation of something yet to come.” That I latly deny. I had no
foresight, no vision. What I had is nothing but passion—passion
for learning, for hard work.
BM: So how did a lover of English literature end up in banking?
JL:
In 1978, I was enrolled as a postgraduate student on
a national competitive basis and thus could go on to pursue
full time my English and American literature studies under
the supervision of one of the most renowned professors at the
Beijing Institute of Foreign Languages, now Beijing Foreign
Studies University.
As a graduate student, I was already a stafer on the editorial team of a new magazine, Foreign Literature. My papers
on William Faulkner’s iction were published in the irst-class
academic journal in China, and they were to secure my job in my
alma mater’s faculty right upon graduation.
An academic life that I had so coveted was just beginning
to unfold when I was urged to join the Ministry of Finance.
I was not aware that President [Robert] McNamara of
the World Bank met Deng Xiaoping in Beijing in 1980. The
PRC [People’s Republic of China] government took over Taiwan’s representation at the IMF and the World Bank, and it was
imperative to have some senior government officials posted to
BLO O M B ERG M A R K ETS
the executive director’s office in the World Bank, for which the
Ministry of Finance was the lead agency. Young staf were desperately needed for that purpose.
My academic supervisor, Professor Xu Guozhang, said
to me, “I’m sure that about 200 professors of English literature
would suffice for China. But there is an imminent and acute
shortage of professionals in the economics and inance ield,
particularly those who are at home with English. You can shift
to economics for a good reason.” Seeing I was bewildered, he
assured me that should I ind it difficult to be in my element after
such a shift, I would always be welcome back.
BM: Your rise up through the Chinese bureaucracy also took
you to the U.S., right?
JL:
I was encouraged by the ministry to apply to the Hubert
Humphrey Fellowship Program sponsored by the U.S. Information Agency, and I was selected and assigned to the economics department of Boston University as a Humphrey fellow in
1987-88. Immediately upon completion of the program, I went
back to the World Bank as the alternate executive director to
serve a four-year term.
And from 2003 through 2008, I served as vice president
for operations in the Asian Development Bank and delved into a
host of development issues confronting both the developed and
developing countries.
My ive years of service [from 2008 to 2013] as chairman
of the board at China Investment Corp., China’s sovereign
wealth fund, gave me the opportunity to manage a company,
albeit a quasi-SOE [state-owned enterprise]. And serving as
chairman of China International Capital Corp. Ltd. [from May
2013 to October 2014] provided me with a diferent perspective, as I could deal with the managerial challenges faced by a
private company.
BM: Getting back to your current job, what can you tell us
about the AIIB’s loan portfolio and projects?
JL:
First of all, by agreement we cover infrastructure and
private-sector projects. So right now, much of our loan portfolio
is focused on power, energy, and transportation.
India is the biggest borrower at this stage. This is a country
with strong capabilities and big needs. In India, Pakistan,
Bangladesh, there is an acute shortage of power. In Myanmar,
where we are involved in the development of gas-iring power
plants, two-thirds of the people have no access to electricity.
So this is an area of focus, as is transportation. I would
highlight our work supporting, say, a mass transit system like
a Mumbai or Bangalore subway. It’s so important. You don’t
want to encourage everyone to drive to work in congested
urban centers. You encourage them to take mass transit. This is
another approach to dealing with climate change.
BM: Have you set your sights beyond Asia?
JL:
We’ve done our irst project in a non-Asian country: Egypt
[where the AIIB is providing up to $210 million for a renewableenergy project involving 11 greenield solar power plants]. Oman
has an idea to move away from excessive dependence on fossil
fuels. They want to develop a port and alternative sources of
energy. We helped Oman to develop broadband so they would
have better access to modern telecommunication service. I think
it’s so important to help middle-income countries in the Gulf
area to be prepared for a low-carbon global economy.
In the future, probably—if we are successful over the next
few decades—gas might be the raw material for chemical fertilizer, and the oil could be the material for chemical products
rather than being burned. The transition might be very abrupt.
I met the new inance minister of Saudi Arabia in Davos,
and he is very much interested in working with us. I think in Gulf
countries, railway development is important. It can reduce the
cost of transportation.
BM: Is there pressure on the bank to make sure the basic infrastructure projects it funds are environmentally friendly?
JL:
To be green is of critical importance to our mandate. Promoting sustained economic development through infrastructure investment without leaving an environmental footprint is
our sacred mission.
VO LU M E 2 7 / ISS U E 2
67
“We certainly have faced a lot of skepticism and
questions about why China decided to set up this bank. …
I remain very calm in facing all those critical,
sometimes very hostile questions”
A green approach will ultimately contribute to long-term
growth of those developing countries which are grappling with
poverty and other economic and social challenges. They need a
helping hand. A stitch in time saves nine. People in dire poverty
have to survive.
Conserving natural resources is crucial, but being green
does not conlict with growth. For instance, there is an everincreasing demand for electric power. Power outages, blackouts, or brownouts, are very common, and a large segment of
the population in low-income countries has no access to power
at all.
Wherever possible, instead of building greenield dams or
power plants, we will make a big push for upgrading the existing
power grid and thus helping to reduce systemic loss in transmission and distribution. This is equivalent to building numerous
new power plants.
We will help with construction of mass transit systems to
reduce the traffic of individual cars on the road. Adopting new
technologies in constructing infrastructure facilities also contributes toward a green economy. We’re proactively working
with our members to help them reach their commitments in
implementing the Paris Agreement.
BM: Do you think the general public understands the positive
role that multilateral banks have played in postwar economic
development?
JL:
I remember when I read The Battle of Bretton Woods, a
very detailed history of post-World War II issues. In those days
there were difficult challenges to address, such as the transfer
of the economic power from the U.K. to the United States. The
other challenge was rebuilding European countries after a world
war. But looking at that and looking at the way we set up the
AIIB, I’m so happy to see we are all on the same page even from
Day One.
History is history. What happened 70 years ago is very different from what happens today, but over the last seven decades
we humans have come a long way in understanding the importance of promoting peace and development.
68
So when I look at this book and other books about the
creation of Bretton Woods institutions, I’m so happy that both
developed countries and developing countries, as well as European countries, are involved.
BM: A lot was at stake back in the early postwar years.
JL:
Those negotiations were really a matter of war and peace.
If you fail, you can have a repeat of the situation of the First
World War. If you succeed, you can have peace.
I think that, starting from 1980, I was involved in this
whole process of China opening up to the world. It gave me an
opportunity to see the world, to tour the world, to understand
other parts of the world. That experience was unique among
Chinese. I know the poverty issue. I know the miseries of some
people still sufering. As a result, I developed a sense of a mission.
BM: You’ve worked at the World Bank. What was that like for a
Chinese national in those days?
JL:
I have the passion for development. I was very lucky to
have the opportunity to serve in the Chinese Ministry of Finance
after I inished my graduate programs. My assignment was to
be posted to the executive director’s office of the World Bank
in 1980, and I started to learn about economic development
in China. I certainly learned economics before then, but it was
more along the lines of Das Kapital by Karl Marx. But in 1980, I
was exposed to Western economics for the irst time, and it was a
whole new picture.
BM: So has the international inancial community come to
terms with the AIIB?
JL:
I think China has achieved quite a lot in projecting this
idea, but still there’s some way to go to bring more and more
people to understand why China set up this bank, how China
set it up, and how this is going to be operated with China as the
major shareholder.
BM: Neither the U.S. nor Japan initially showed much interest
in participating in the AIIB. Are President Donald Trump and
Prime Minister Shinzo Abe rethinking that stance?
JL:
From Day One, China was very sincere in inviting
Japan and the United States to participate in the setting up
BLO O M B ERG M A R K ETS
of this bank. Whether to join or not is the decision of a sovereign government. And I don’t think it’s appropriate for me
to comment.
We certainly have faced a lot of skepticism and questions
about why China decided to set up this bank. Were we going to
cut the ground from under the feet of the World Bank or the
ADB? Is this bank going to push for infrastructure projects to
the neglect of environmental protection and human rights? I
remain very calm in facing all those critical, sometimes very
hostile questions.
I don’t ind anybody in the United States who is negative
about us. Americans are very straightforward. They’re very
honest. If they’re suspicious, they tell you. But if you show that’s
not the case, they say, I believe you. That’s something I like.
BM: What about Japan?
JL:
Japan’s corporations have come to see me, former political
leaders, too. They’re all very keen and believe Japan should be
part of this institution. But I tell them, regardless of the inclusion of the U.S. and Japan, we can work together. And I have Japanese nationals working here [at the AIIB].
To my knowledge, there are some Japanese media people
who are so curious about me. They went to my hometown and
interviewed a huge number of people. They were so curious
about me. And the reporting was positive. I would take this as
a kind of encouragement. Also, it’s a warning that you need to
keep it up.
If you do a good job, people give you recognition. I think
this is the beginning. You may need 10 or 20 years to come to the
conclusion that this is a good institution.
BM: Do you want to do more projects with the World Bank and
Asian Development Bank?
JL:
By its very nature, an infrastructure project is large.
Co-inancing in my view would be the norm for multilateral
development institutions as we go forward. The World Bank
has maintained its presence in so many countries with reduced
funding for each and every project. And we can chip in.
Particularly for mammoth projects, when you have more
institutions, you diversify your risks, and you have better communication with the government when it comes to policy dialogue. I am still very keen on co-inancing with the World Bank.
BM: You also are a big believer in keeping the AIIB lean and
mean, correct?
JL:
We will continue to recruit professionals of the highest
possible caliber. We practice merit-based recruitment and
international competitive bidding. Restrictions are imposed
neither on the nationality of the job seekers—nor the origins
of the companies tendering their bids for contracts under the
projects we inance.
This is the way to get the best talent and to provide the
highest-quality capital goods and services to our clients at the
lowest cost. The staf on our payroll, about 140 in total at this
stage, come from 36 countries. We have American and Japanese nationals taking on important positions, regardless of the
fact their countries aren’t members of the bank. We need to be
open and transparent.
BM: What kind of legacy do you hope to achieve at the AIIB?
JL:
The board has limited liability with regard to the performance of projects but has a big responsibility in policymaking
and supervision of the management. Without the “nuclear
umbrella” provided by the board, the management can be truly
exposed to the consequences of their judgment and decision.
Any reform is painful for the reformers and conservatives
alike. Reform is not a party. Reform is a serious matter, which
means breaking from that part of tradition which is no longer
relevant to the present-day world.
Frankly speaking, I could change nothing and continue
as president of the AIIB if I choose to, and I could simply serve
as the gatekeeper of projects to the board. I am not that kind of
person. I am every inch a man of principle, with a strong sense
of inancial and social responsibility to our shareholders, with
a deep faith that the governance and operational patterns of a
time-honored institutional system is ready for change.
It takes time to convince the world that this is a great
institution operating by the highest standard. I have reiterated on numerous occasions that we should not expect trust
from the outside world without earning it. The whole world
will judge us by how we perform, not by what we claim. Therefore, I do not mind if the jury is still out. The jury may linger
outside the court as long as they see it. But I am conident that
we are already building up our credibility. The AIIB is now a
well-recognized MDB with a high level of integrity from the
very beginning.
The daunting challenge is to keep it [that way]. I have
made it an overarching priority to develop an ethics-based corporate culture. Adherence to our basic principles of professional
and ethical integrity will ensure that this bank will produce
meaningful and measurable outcomes and results.
You cannot talk people into believing you. Credibility has
to be earned. Trust has to be earned. If people don’t understand
you, don’t trust you, do not bear any grudge against them. You
can bring other people around. So this whole process, lasting
four years, as a Chinese national, I’m proud to say this is a
process of developing mutual understanding with the rest of
the world.
BM: Any regrets about leaving the life of letters for the world of
global inance?
JL:
My life in the Ministry of Finance spanned three decades,
with 11 years overlapping my period of respective service at the
World Bank and ADB, and was a continuous involvement in the
opening-up and reform process. Apart from the domestic budgetary responsibility, I was always engaged in the multilateral
and bilateral dialogues on economic and inancial issues.
I have over the years developed my deep understanding of
international issues, global concerns over environmental, social
problems, and the approaches to addressing conlicts of national
interests related to trade and cross-border investment.
When I was given the task to work toward establishing a
new multilateral development bank, I came to understand that
all those years of academic pursuance, hard labor in rural China,
and experience of development work at the World Bank and the
ADB were just years of apprenticeship for my responsibility in
the AIIB. And this is life. Our life cannot be predicted, but it can
certainly be prepared for.
Bremner is a Bloomberg News executive editor in Tokyo.
Han covers economy and trade in Beijing.
VO LU M E 2 7 / ISS U E 2
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THE DRIVE INTO NEWPORT BEACH can feel like getting lost inside an
endless summer of money—especially along the Paciic Coast
Highway, winding past billion-dollar hills that plunge to white
sand beaches and the sparkling blue ocean.
It’s easy to forget this was once the California of John Wayne,
who moved here in the 1960s (when he could still aford it, as he
later joked). Back then oranges actually grew in Orange County.
These days it sometimes seems it’s money that grows on trees.
That spread next to the Duke’s old place? Nicolas Cage bought it
and then sold it in 2008 for $35 million.
Even so, on a foggy morning on the Balboa Peninsula, watching surfers shred the Wedge, you can still sense the Brian Wilson,
SoCal strains that sang to a young man from steel-town Ohio. His
name: William H. Gross.
It was the 1970s. The Summer of Love was long gone, and
young Bill, with shaggy hair and a $90 suit, had a job in the ixedincome department of Paciic Mutual Life Insurance Co., where
his irst duties included clipping bond coupons. The company had
recently moved from a gray building in downtown Los Angeles to
south of Disneyland. Gross had a new assignment he believed
would lead to something big. He told his parents he was going to
be the world’s best bond manager.
“They looked at me like I was loony,” he recalls.
You know the rest.
Gross went on to become the Bond King of Pacific
Investment Management Co. He lasted 43 years, until 2014 when
Pimco pushed him out. Like many dreamers, Gross found a place
in the West to reinvent himself. And yet Pimco is just one part of
a bigger saga of companies around Greater Los Angeles that today
manage $3 trillion in ixed-income assets.
What you probably don’t know is why and how it happened
here, in Southern California, to Gross and to others who became
towering igures in the ixed-income world.
THE STORY BEGINS in 1971, when Pimco and two other future bond
giants, Trust Co. of the West and Western Asset Management
Co., sprang up in the City of Angels. Others followed. In 1978,
Pimco was still a unit of Pac Mutual when a Wall Street banker,
originally from the San Fernando Valley, returned from New York
to set up an outpost for Drexel Burnham Lambert. His name:
Michael Milken. Before long, Milken’s new junk-bond-fueled
era was rocking to the strains of Ghostbusters with custom lyrics,
answering “Who ya gonna call?” from the original with “Call
Drexel!”
Jefrey Gundlach, future bond master of DoubleLine Capital
LP, arrived in L.A. with dreams of becoming a rock star. Scott
Minerd, later of Guggenheim Partners, moved West for the bodybuilding scene on Muscle Beach.
Let New York have its state of mind, its snow-bomb winters,
its stock exchange. Balmy Southern California, with its palm
tree-silhouetted twilights, would make its mark in ixed income.
Those who surfed the yield curve around L.A. will tell you that
the move West granted perspective and independence from the
groupthink of New York. “Maybe distance from Wall Street is
key,” says Gross, who turns 74 in April.
give or take. That’s about a 41-hour ride
in a ’67 Ford Mustang, the sort of horse Gross rode in 1971, after
Duke University, a Vietnam War-era hitch in the U.S. Navy, and
an MBA from the University of California at Los Angeles, where
he inanced tuition with winnings from the blackjack tables of
Las Vegas. Gross taught himself to count cards after reading Beat
the Dealer by Edward O. Thorp, and it was during a four-month
gambling binge that he irst practiced a version of portfolio risk
management that would underpin his bond funds.
When Gross applied for his job at Pac Mutual, Los Angeles
was stuck in the grim aura of the Doors’ L.A. Woman, the Manson
Family murders, and Stage 3 smog alerts. The next year, the
company bolted for a new suburban frontier: Newport Beach’s
Fashion Island, a luxury mall where they commissioned a spaceage, mushroom-shaped office pavilion designed to lure talent from
Southern California’s aerospace industry.
“Newport Beach was a revelation,” Gross says. “Fresh. New.’’
Pac Mutual also experimented with new ways to diversify,
DISTANCE: 2,797 MILES,
FIXED-INCOME MONEY MANAGERS IN SOUTHERN CALIFORNIA
Ares Management
$106b*
Los Angeles
County
Guggenheim
Investments
$250b
Western Asset
Management
$442b
TCW
$200b
Orange
County
Pacific
Ocean
Capital Group
$1.7t
DoubleLine Capital
$118b
Payden & Rygel
$117b
Oaktree Capital Group
$100b
Pimco
$1.75t
*Total assets under management, including equities, as of Dec. 31, 2017
Sources: Bloomberg, company websites
72
BLO O M B ERG M A R K ETS
one of which was expanding into a signature Wall Street
business—managing other people’s bond portfolios. And, unlike
most insurance companies, the unit that grew into Pimco wouldn’t
only clip bond coupons until the debt matured; it would also be
an active trader.
“That idea from Wall Street is something that we grabbed
hold of,’’ says Ben Ehlert, Pac Mutual’s former head of ixed income
and Gross’s irst boss. Gross, then 27, seemed sharp and, in the
words of another executive, Mike Fisher, “was a kind of coollookin’ dude.” Ehlert gave the dude $5 million of “play money”
and told him to get going.
Pimco took years to gain traction. East Coast pension executives were happy to visit, maybe take a boat ride to Catalina
Island. Putting money down, however, was another matter.
President Gerald Ford helped by signing the Employee Retirement
Income Security Act of 1974, which cracked open the club of big
bank money managers. Pimco’s breakthrough didn’t come until
1977, when AT&T’s retirement plan became a client. “It was the
pension fund seal of approval,” Gross says.
From that modest beginning, Pimco, with Gross at the helm,
grew into one of the world’s biggest and most powerful bond shops,
amassing $2 trillion at its 2013 peak. Gross’s thoughts were
courted by Federal Reserve governors and inancial-TV networks.
Yet he could toss of colorful rifs like a guy propping up the 19thhole bar at Newport Beach’s Big Canyon Country Club: “AAA?”
Gross wrote about the U.S. credit rating industry’s grades for
subprime mortgage-related securities in 2007. “You were wooed,
Mr. Moody’s and Mr. Poor’s, by the makeup, those 6-inch hooker
heels, and a ‘tramp stamp.’ ”
MAY BEGINS EACH year at the Beverly Hilton with a parade of black
Cadillac Escalades disgorging heads of state, cabinet secretaries,
and Wall Street billionaires. They come for “Davos with palm
trees,” as Milken’s annual conclave is known. This is the same
Milken whose junk bonds fueled the 1980s buyout boom, who
was slapped with a lifetime trading industry ban, who served
22 months in prison for securities and tax law violations, and who
surfaced thinly veiled last year in the Broadway play Junk, in
which the protagonist’s catchphrase is “Debt is an asset.”
Unlike other West Coast bond princelings, Milken started
out in Southern California. At Birmingham High School, a public
school in the San Fernando Valley, he was a cheerleader and prom
king. At the University of California at Berkeley he became the
radical antiradical, choosing Wall Street as his battleground to
change the world. After seeing the lames of the 1965 Watts riots,
he decided that creative inancing should become a tool for social
justice. “I concluded that the American dream required access to
capital,” Milken says. “We were denying a large percentage of our
population access.”
He went off to business school at Wharton and then to
Wall Street and Drexel, before returning to California, where he
tipped the credit world’s balance toward L.A. From his X-shaped
desk, Milken, along with Drexel, underwrote leveraged buyouts
for Carl Icahn and John Malone, among others. “An explosion of
money managers was created out here, many of them because
they wanted to be close to us,” says Milken, now 71. “Let’s just
say many of them got their Ph.D.s in capital structure and inance
when we worked together.”
David Lippman moved from New York to L.A. in 1985 to
escape the strictures of Wall Street and work for Milken. “The East
Coast was color inside the lines,” he says. “Out here it was the cutting
edge.” When Drexel collapsed after Milken’s 1990 guilty plea, his
minions spread across the inancial world. Lippman now runs TCW
Group. Leon Black and Antony Ressler co-founded Apollo Global
Management before Ressler left to start Ares Management.
Howard Marks was dispatched in 1978 from the fixedincome desk at Citicorp. He recalled his boss’s instructions in a
2016 speech upon his induction into the Fixed Income Analysts
Society Inc.’s Hall of Fame in New York: “There’s some guy in
California named Milken, and he deals in something called highyield bonds. Do you think you could igure out what that means?”
Marks met Milken and stayed. He eventually quit Citi to
join TCW, which he left in 1995 to co-found Oaktree Capital
Group LLC, which now oversees $100 billion.
Gundlach, child of snowy Bufalo, originally moved to L.A.
as the drummer for a band called Radical Flat (later rechristened
Thinking Out Loud). One day he saw an episode of Lifestyles of the
Rich and Famous that said the best-paid jobs were in investment
banking. Gundlach found TCW in the Yellow Pages, unaware that
the asset manager wasn’t an investment bank. A math and philosophy major at Dartmouth College and former doctoral candidate
at Yale, Gundlach got a job.
He worked his way up to chief investment officer at TCW
by 2005, only to be ired four years later during a power struggle,
sparking a two-year court battle. Three dozen employees and billions
of dollars followed Gundlach out the door to his new company,
DoubleLine. Oaktree provided office space and $20 million for a
20 percent stake in the company. “It wasn’t a decision we had to
agonize over,” Oaktree’s Marks says in an email. “And it’s the
highest-returning investment any of us have ever made.”
The East-West divide is not only about geography. Put
roughly, New York was dominated by the faster, more transactional
sell side, crowding out the slower, analytical buy side, which could
then lourish in Southern California. “The patience the buy side
takes relative to the sell side is meaningfully diferent,” says Ken
Leech, CIO of Western Asset Management, who joined the
Pasadena-based company in 1991 after stints on the East Coast
with Greenwich Capital Markets and Credit Suisse First Boston.
IN MAY 2014, Pimco moved to a new 20-loor tower that soars above
Fashion Island and the old mushroom pavilion. By then, Gross
was deemed by some to have lost his investing edge, and his underlings rose up in revolt, forcing his ouster four months later. Pimco’s
post-Gross assets plunged to $1.43 trillion, but by the end of last
year they rebounded to $1.75 trillion.
Gross now runs the $2.2 billion Janus Henderson Global
Unconstrained Bond Fund out of a small 14th-loor corner office
above Fashion Island, where he can watch the sunset if he stays
late enough. At his desk, Gross has a long view up the Paciic coast
that fades into blue haze behind Pimco’s headquarters, the white
tower Gross did so much to build. From the outside he now sees
his old company losing ground to other industry pioneers: managers of low-fee, passive funds. “Pimco,” he says, “will never reach
$2 trillion again.”
Gittelsohn covers investing for Bloomberg News in Los Angeles.
VO LU M E 2 7 / ISS U E 2
73
Cloud
Bought and sold like electricity, computing power is a hot commodity.
Few know that better than Sachin Duggal
D r e a m s
By EDWARD ROBINSON
P H O T O G R A P H B Y K A L P E S H L AT H I G R A
pretty chipper for a man who works in
three time zones simultaneously. After arriving in London from
San Francisco at dawn this December morning, the entrepreneur
attended a meeting for startups at the U.K. Treasury, then he
communicated over Slack with his colleagues at a cloud-computing
company he manages in Delhi. Now, ensconced at his usual table
in the polished marble brasserie at the Arts Club in London’s
Mayfair district, he’s taking a dinner break before he has to hop
on a call with investors in California.
Clad in a white T-shirt, jeans, and a hoodie, he looks out of
place in a members-only establishment favored by gallery owners
and international inanciers. But Duggal, a British-born man of
Indian descent who built and sold his irst company (and made
millions) before he was 30, enjoys geeking out amid the Champagne
and chatter of the jet set. Sipping sparkling water as his two smartphones chirp with messages from afar, he warms to his favorite
topic: the cloud, or more precisely, how on-demand computing
provided by the likes of Amazon.com Inc. has become a burgeoning market in its own right.
His company, Engineer.ai, is one of the top brokers of
Amazon Web Services (AWS) in India. “You have to think of the
cloud as a inancial-service or a monetary instrument and not
just as technology,” says Duggal, who turns 35 in April. “It has
capacity, diferent pricing based on commitments, and it’s becoming a commodity.”
Ever since Seattle-based Amazon leveraged its titanic technology capabilities into a separate cloud-computing business
12 years ago, numerous players have been angling to trade those
services in ways similar to how energy brokers buy and sell oil or
electricity. They range from global giants, such as International
Business Machines Corp. and Accenture Plc, to smaller players in
speciic markets, such as Duggal’s Indian venture.
As cloud computing has grown into a $160 billion global
industry in little more than a decade, the so-called cloud-service
brokerage market has soared as well. It’s projected to hit $9.5 billion
by 2021, more than twice the $4.5 billion in 2016, according to
MarketsandMarkets Research Pvt. Ltd., an Indian research irm.
Every day, traders in New York, London, Singapore, and beyond
make a market in what they call “reserved instances,” a phrase that
may sound like something science iction author Philip K. Dick
dreamed up but simply means blocks of cloud capacity.
Duggal and his co-founder, Saurabh Dhoot made a good
call by hitching their company to AWS in 2012. Initially dismissed
by analysts as a potential misstep, Amazon’s cloud service has
become a juggernaut that’s provided Jef Bezos with a war chest
to inance his expansion into new territory, such as the supermarket business and, most recently, health care. In 2017, AWS generated $4.3 billion in operating income on $17.5 billion in net
sales, eclipsing the $2.8 billion in proit produced by Amazon’s
core North American online retail division. Comcast, Netlix, and
Unilever, as well as NASA and the CIA, all use AWS to handle
some of their computing needs. So do countless startups. With a
34 percent market share in the fourth quarter, AWS dominates
the so-called public cloud, according to Synergy Research Group.
Runner-up Microsoft Corp., with its Azure services, has 13 percent.
Duggal says something bigger is at stake than Amazon’s
business fortunes: The advent of cloud computing is spurring
entrepreneurship in India and other developing economies by
SACHIN DUGGAL LOOKS
76
making it far more afordable for small businesses to run software
applications and store data. By dispensing with the need to buy,
maintain, and replace machines and software programs, companies can reduce their IT expenses by more than a third, according
to TSO Logic Inc., a Vancouver-based consulting irm. “One day
there won’t be data centers at companies,” Dhoot says.
Still, making this happen in a nation as vast and complex as
India is daunting. The government has been slow to build extensive digital infrastructure, roll out broadband, and address chronic
corruption, according to the Asia Cloud Computing Association,
a trade group based in Singapore. Moreover, India remains so
impoverished that its gross domestic product per capita ($1,709)
is running far behind China’s ($8,123). “Whichever way you look,
it’s a hard place to do business,” says Umang Bedi, a former managing director for Facebook Inc. in India and South Asia who now
sits on Engineer.ai’s board.
That appears to be changing amid recent digital breakthroughs in the country of 1.3 billion people. In 2016 the Jio mobile
network, controlled by the conglomerate Reliance Industries Ltd.,
swept the market by ofering consumers about six months of free
fourth-generation internet access and underpricing rivals ofering
2G bandwidth. That same year, AWS opened data centers in the
country and immediately saw a 60 percent increase in customers.
Today, AWS has more than 75,000 clients in India, including satellite television business Tata Sky and Hotstar, an entertainment streaming service that draws hundreds of millions of
viewers to cricket tournaments and other programming. Spending on all cloud services in the country is forecast to reach $2 billion
by 2020, a pace that’s outstripping the rest of the world, according
to the U.S. International Trade Administration. “India is a big
priority,” Andy Jassy, chief executive officer of AWS, told the
Hindu newspaper at a conference in Las Vegas in December.
Amazon declined to comment for this article.
By reselling AWS to more than 500 customers, including
Tata, Duggal has helped Engineer.ai sidestep the trouble and
expense of managing myriad accounts. With about 140 employees, his company makes money through arbitrage—it buys future
GROWTH STORY
Engineer.ai revenue
$160m
Forecast
$30m
15
$12m
Implied valuation*
2014
BLO O M B ERG M A R K ETS
2018
0
*10 times the year-ahead revenue
Source: Engineer.ai
HOST WITH THE MOST
Share of the global cloud-computing market in 4Q 2017
Amazon
34%
Other
35%
Alibaba
4%
Google
6%
IBM
8%
Microsoft
13%
Source: Synergy Research Group
capacity from AWS in bulk and then, using artiicial intelligence
algorithms to manage the low, parcels out blocks to clients for
higher rates. Customers save an average of 7 percent of what
they’d pay if they went to Amazon directly, Duggal says. In 2017,
Engineer.ai recorded $22.5 million in sales. This year, he says,
it’s on course to more than double that performance. It’s been
proitable since 2015.
With AWS, Engineer.ai is after more than just a commodity to peddle. Duggal’s company uses the service as a springboard
for selling businesses other products. In 2017, for example,
Engineer.ai introduced an ofering called CloudOps.ai designed
to help customers manage their IT costs. Many newbies to the
cloud don’t realize that you need to turn it on and of like a tap.
Failing to hit the switch is like leaving all the lights on in your
house when you go on vacation. To help clients prevent overspending, Duggal and his team provide their customers with an
online wallet that warns them when they’re hitting their limit.
It also issued a prepaid card for buying AWS capacity that can
be topped up if there’s a sudden surge in demand. Now the company’s product development team is collecting inancial information it can use to create new oferings. “The data accumulation
part is analogous to banking and trading,” Duggal says. “We can
see the aggregate data for all our customers, so we’re getting
valuable trends and color in the market.”
IN DUGGAL’S THINKING, inance and technology have been twinned
ever since he worked as a tech intern at Deutsche Bank AG when
he was 17. The geeky kid from North London whose idea of fun
was assembling his own computers arrived at Deutsche’s investment banking hub in the City at a heady moment. It was the early
2000s, and Anshu Jain, the company’s global markets chieftain,
was determined to make it a force in investment banking. Noting
Duggal’s resourcefulness, he made the tech whiz part of a squad
tasked with using cutting-edge technology to give the bank’s traders
an advantage. Duggal worked on a lightning-fast arbitrage system
for the foreign exchange desk and an on-screen toolbar that showed
sales teams their clients’ trading positions in real time. “I remember
Sachin’s time at the bank well,” Jain writes in an email. “He stood
out for his youth and his ceaseless enthusiasm.”
Years later, Duggal’s ebullience hasn’t abated. He has an
engineering degree from Imperial College London and a master’s
in entrepreneurship from MIT. At the Arts Club, he holds forth
on subjects as diverse as the strengths of Japan’s education system
and the efficiency of white tequila (it doesn’t cause hangovers).
Yet it’s the cloud, with its omnipresence and utility, that truly gets
him going. Duggal’s not shy about pointing out that he was
someone who saw its potential as early as 2004, when he formed
his irst company, Nivio, in Switzerland with his college friend
Dhoot. The company ofered customers in India a way to remotely
access Microsoft Windows programs on any computer.
In 2008 the World Economic Forum awarded Nivio a Technology Pioneer Award. Duggal gave speeches on cloud computing at the organization’s elite annual gathering in Davos in 2009
and 2010. “You know we trademarked the word ‘cloud’ back
then,” he says. Sensing skepticism, he taps his iPhone and unearths
an image of a document showing Nivio did indeed own the word
“cloud” in India and “CloudPC” and “CloudBook” in the U.S.
(The trademarks have since expired.) “We just knew it was going
to change everything,” he says.
Nivio raised more than $25 million from investors, but
after Duggal and Dhoot clashed with their backers in 2012 over
the company’s strategic direction, they cashed out, and Nivio
was eventually folded into other enterprises. The two friends
formed a company called SD 2 Labs and later changed its name
to Engineer.ai.
Their timing was good. By 2015, AWS was proving that
cloud computing was becoming a necessity for organizations in
business, government, and other sectors. But often its capacity
would lie untapped. This opened up opportunities for resellers.
Chris Wegmann, the head of Accenture’s AWS business group,
says he was struck by the parallels to the energy industry, where
fossil fuels or electricity routinely sat idle until sudden surges in
demand. Buying cloud services from AWS is pretty simple—it’s
like shopping on, well, Amazon—but managing a commodity with
spot prices and futures prices and the ebb and low of a dynamic
marketplace isn’t easy. “To get the most value, you have to be an
active manager of your capacity,” says Wegmann, who oversees a
cloud trading desk in New York with a half-dozen traders.
DUGGAL IS ROLLING OUT a new venture now—a cloud for develop-
ing software applications under the brand name Builder. The new
Engineer.ai platform enables budding entrepreneurs to order their
own app at a guaranteed price from a network of 50 software irms
and 10,000 developers. He calls the coders “bench capacity” and
says their handiwork can be packaged and sold in the same
on-demand method that cloud-computing services are.
Software development, long a pricey and opaque process,
should become a utility, just like cloud computing, Duggal says.
“What we’re trying to do is create an assembly line for software
development,” he says, inishing of a plate of sautéed cod. “It won’t
be a black box anymore.” With that, he excuses himself to jump on
his conference call to his investors in California. It seems there are
some things he still can’t leave to the cloud. —With Saritha Rai
Robinson covers fintech in London.
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Goldman Sachs Group Inc.’s glass-andsteel Manhattan headquarters on a warm August morning in 2013.
Eyes locked on their screens, traders and engineers shifted in their
seats as exchanges prepared to open.
Unbeknownst to anyone, the machines were about to revolt.
Bam. Bam. Bam. Dummy trade signals that were supposed
to stay within the company’s electronic systems broke loose and
slammed into computers at the New York Stock Exchange’s
options markets. So many orders crashed through that by
8:44 a.m., safeguards within Goldman Sachs sprang into action,
severing the connection between the company and the exchanges.
It took ages for anyone to notice the anomaly. At 9:01 a.m.
an employee inally saw the blockage and lifted it. A river of
mispriced orders surged through the restored connection.
Minutes later, the volume triggered another stoppage. And
another. And another.
By the time the trades were blocked for the last time, less
than an hour after they began, Goldman Sachs executed orders
to sell more than 1.5 million options contracts for $1. The cause?
A coder had mistakenly programmed a router to send placeholder
bids as live orders. If not for the good graces of the options
exchanges, the bank would have lost $500 million, according to
the U.S. Securities and Exchange Commission. Cancellations and
price adjustments reduced that to $38 million.
The blunder, in one corner of the stock market, exposed a
soft spot in the controls and technology at the company’s larger
equities business. Despite being the dominant equities shop on
Wall Street, its electronic operations had become almost an afterthought. Goldman Sachs had gotten to the top by catering to the
types of companies that ruled inancial markets for decades: longshort hedge funds and active asset managers. In the pre-crisis era,
Goldman’s human traders made billions of dollars in proit and
became the envy of their peers by using the company’s balance
sheet to take risks.
But as one of the greatest bull markets in history took of,
professional stockpickers struggled to generate adequate returns.
Volatility vanished as central banks placated markets. Trillions of
dollars moved from active strategies into index and exchangetraded funds, favoring electronic platforms, where commissions
SUNLIGHT BOUNCED OFF
are a fraction of voice trading. Quantitative hedge funds such as
Renaissance Technologies and Two Sigma Investments hoovered
up assets while their old-school peers withered.
The 149-year-old investment bank wasn’t alone in being
slow to anticipate the seismic shift in equities. But as excuses go,
Goldman Sachs had a couple of good ones. Senior executives
worried about cracks beginning to form in the market’s foundations. And for more than a decade, Wall Street’s bond traders
enjoyed unrivaled prosperity, buoyed by the expansion of new
markets for derivatives and a decline in interest rates that made
it more lucrative to simply hold investments.
Few beneited more from this than Goldman Sachs, which
became the most proitable company in Wall Street history under
former commodities salesman Lloyd Blankfein, who may step
down as chief executive officer as early as this year. Using house
money to facilitate bond trades—or principal risk-taking—was
far more lucrative than merely acting on clients’ behalf to execute
stock orders. In 2009, Goldman traders reaped $33 billion in
revenue, two-thirds of it from ixed income.
But constraints brought about by the inancial crisis ended
the leverage that had fueled the boom. Fixed-income traders
felt the brunt of the changes, and in the years since, equities traders
—especially those with a technology background—have enjoyed
a renaissance. Their rise has touched of a battle for supremacy
that’s come down to only three companies: Goldman Sachs,
Morgan Stanley, and JPMorgan Chase. These rivals are now
locked in a technological arms race to control a $58 billion-a-year
industry. As they each jockey for an edge over the other, no one
who trades on Wall Street is safe.
AROUND THE SAME time as the options mishap in 2013, in another
glass-and-steel office tower about 4 miles north of Goldman Sachs,
Morgan Stanley traders were digging themselves out of a hole.
Clients had abandoned the company during the inancial
crisis as subprime losses pushed Morgan Stanley to the edge of
failure. The bank had caught a case of Goldman envy and plowed
into mortgage-bond bets at precisely the wrong time. To survive
a share plunge driven by short sellers, then-CEO John Mack lashed
out at some of the same clients who paid them lucrative fees. The
Jamie Dimon, Lloyd Blankfein, James Gorman: As they jockey for technological supremacy
78
BLO O M B ERG M A R K ETS
bank was saved by a $9 billion investment from Mitsubishi UFJ
Financial Group Inc., but in the years immediately after the crisis,
it seemed a shadow of its former self. An equities executive at a
rival U.S. bank puts it this way: “I thought we left them for dead
in 2010. I remember telling people, ‘These guys are roadkill.’ ”
But the inancial crisis had one gift for Morgan Stanley.
Other banks that built a following with quants were damaged as
well. Lehman Brothers Holdings Inc. went bankrupt. Three
European banks—Credit Suisse, Deutsche Bank, and Barclays—
didn’t adapt quickly enough to the new realities and were later
forced to raise capital, sowing doubt among prime brokerage
clients. So for hedge fund clients who wanted the latest trading
technology, Morgan Stanley became the clear choice.
Under Ted Pick, who became co-head of the equities business
in 2009, the company went about persuading clients to come
home. The bank was back, hungry and open for business, lush
with liquidity for hedge funds to place bets. It emerged with a
sharper focus: The new CEO, James Gorman, made it clear that
the equities division, along with the company’s wealth management business, was key to the bank’s strategic vision.
A paradox seen among some senior equities executives is
that despite their high status and net worth, they often dress
slightly shabbily. It might be intentional, part of the pitch: We
don’t care what we look like. It’s all about you, valued client.
Pick, 49, fits this description. The day he meets with a
reporter, he’s got on a pair of beat-up loafers and a well-worn
suit. He could use a haircut and a couple more hours of sleep. The
walls of his office are bare except for some grainy photos of his
children. His only windows face the equities trading loor: Densely
packed with employees and computers, the vast room feels
5 degrees warmer than comfortable. Instead of being sequestered
in offices, his managing directors are scattered amid their charges,
the better to stay close to clients and the thrum of markets.
Pick’s fervor for Morgan Stanley borders on the maniacal.
Atop a mahogany cabinet—inherited from his predecessor, Vikram
Pandit—are rows of manila folders illed with the minutiae of more
than 30 quarters of equities results. Shortly after taking over the
stock division, he divided the world into nine boxes—cash equities,
derivatives, and prime brokerage across the Americas, Europe,
and Asia—with the goal of improving in every segment. The full
spectrum of oferings meant that whatever strategy or region a
client needed in a given environment, Morgan Stanley was there.
Pick keeps a close watch on all this data and, when the mood strikes,
pulls out a folder to recite igures from a long-ago period.
The company made investments that let clients send orders
with the least possible delay by moving servers closer to exchanges
and using wires that shaved microseconds of the process. It updated
its low-latency trading system Speedway and, in 2012, embarked
on Project Velocity, which anticipated the rising needs of quants
and other institutions that were embracing algorithmic trading.
The improvements strengthened what was already a leading electronic platform; almost a decade earlier, Morgan Stanley had been
the irst major broker to create an electronic swaps system, the
preferred mode for quants to trade in equities. Quants favor the
system because it gives them leveraged exposure to stocks without
owning them and having to pay taxes on dividends.
With the upgraded electronic system and revamped prime
brokerage, Morgan Stanley enveloped clients in a cocoon of
lightning-fast connectivity to markets everywhere and liquidity to
short stocks. Its systems were robust enough for the biggest quants,
and it could lease pipes and algorithms to smaller hedge funds that
couldn’t aford the technological investments the company made.
It all paid of. In 2014 the company grabbed the crown from
Goldman Sachs, exceeding its rival in equities revenue for the
irst time in almost a decade. Under Pick, Morgan Stanley had
gone from the recovery ward to the summit of the world’s most
iconic market in four short years. And yet reaching the pinnacle
hasn’t dulled their drive: Pick says they’re as hungry now as they
were in 2010.
In a sense, Morgan Stanley and Pick are reaping gains
from a prescient bet made two decades earlier. When Pandit
took over equity trading at Morgan Stanley in 1994, he noticed
that the cost of computing power was collapsing. That, combined
with abundant data on public exchanges that would enable automated trading, convinced Pandit of the need to prepare for a
post-human equities market.
“We realized that the human touch was interesting but actually a hindrance to what it took to really trade these markets
over one another, no one who trades on Wall Street is safe
By HUGH SON
and DAKIN CAMPBELL
I L L U S T R AT I O N S B Y
THOMAS PITILLI
Chasing the Edge
VO LU M E 2 7 / ISS U E 2
79
correctly,” Pandit, who served as CEO of Citigroup Inc. for ive
years, says in the Midtown office of his investment company,
Orogen Group. “The only thing you could do is igure out how
you automated all the human aspects of trading, understanding
what drove stock prices, and then used those algorithms to make
markets.” So Pandit gathered math and science experts to open
the Equity Trading Lab, or ETL, whose initial mission was to
automate the trading loor.
It helped that at the time Morgan Stanley was already known
as a hotbed for innovation; in the 1980s, the bank instituted an early
quant strategy called pairs trading. Employees from that era included
a computer scientist named David Shaw, who later founded a
legendary quant hedge fund. In the early 1990s, Peter Muller
founded an in-house quant fund called PDT Partners that minted
money for the bank until it was spun out after the inancial crisis.
Heeding the needs of its early quant clients—several of
whom were former employees—the ETL team built version 1.0
of its electronic-trading operation. The guiding principle was to
reduce friction for hedge funds: The team later created the
Trading and Position System, or TAPS, which helped prime
brokerage clients to receive automated reports. Because of these
innovations, quant funds such as Renaissance Technologies gravitated toward Morgan Stanley.
Morgan Stanley hugged its quant clients close. Instead of
merely ofering to execute trades, prime brokerage provides
all-important leverage and custody of assets. “Prime brokerage
is really the lifeblood,” says ETL co-founder Michael Botlo.
“This is the oxygen. This is what you’re immersed in. If all of a
sudden prime brokerage becomes terrible, then you’re toast. If
you can’t short anymore, you’re dead. If you can’t access your
swaps, you’re dead.”
As much as Pick talks up the bank’s people and culture,
the trading algorithms—an early form of artiicial intelligence—
are its secret sauce, according to Pandit. “Imagine the accumulated learning of having done it for the last 20 years,” he says.
The algorithms, he adds, are rules that essentially gather “all the
things you did wrong that informs what you should do today
that’s right. They’re so far ahead of the game, it’s going to give
them an edge for a while.”
80
among Wall Street’s active traders all
those years ago didn’t happen by accident. In the 1950s and
’60s, the legendary trader Gus Levy helped establish the whiteshoe investment bank in the rough-and-tumble world of trading.
Known as “the Octopus,” because he wanted a tentacle
gripping every transaction, he lew into a rage whenever a competitor won a coveted block trade. These were deals in which
Goldman used its balance sheet to purchase chunks of stock to
proitably peddle of to clients. He was also a pioneer in the
practice of risk arbitrage, or using the company’s money to bet
on takeover targets.
Levy, who died in 1976, instilled in the company an intensity
and risk appetite that would live long after him. A generation of
traders followed in his footsteps and burnished Goldman’s reputation in markets. Robert Rubin, who later became President
Clinton’s secretary of the Treasury, got his start in risk arb under
Levy and later ran the equities desk. Rubin, in turn, helped train
Richard Perry, Eric Mindich, and Daniel Och, all of whom would
go on to found successful hedge funds. Goldman alumni typically
stay close to their old colleagues, and this group was no diferent,
making Goldman the top choice for investors in search of market
intelligence, smart sales coverage, or inancing.
In 1998 the tectonic plates of inance shifted. That year the
SEC allowed a new breed of alternative trading platforms to
compete with traditional stock exchanges. In one stroke, regulators
fostered the rise of electronic-trading networks and weakened
the grip of human traders.
Perhaps recognizing that the low-margin, unfashionable
business of electronic market making wasn’t a part of its heritage
in the way it was at Morgan Stanley, Goldman just went out and
bought the capability.
In 1999, CEO Hank Paulson, who later served as Treasury
secretary during the inancial crisis, bought a stake in Archipelago
Holdings LLC, a relatively new trading platform beginning
to gobble up market share. Six months later he spent $500 million
for Hull Group Inc., a Chicago-based options broker and early
proponent in a new strategy using algorithms. In 2000 he spent
billions more for Spear, Leeds & Kellogg LP, a big employer of
human market makers on the floor of the New York Stock
GOLDMAN’S DOMINANCE
BLO O M B ERG M A R K ETS
Exchange. The Spear purchase included a stake in a small
electronic-trading system called REDIBook.
Then, in 2001, the SEC took another whack at proit margins
and further tipped the scales in favor of automation when it ordered
all exchange trading to quote prices in pennies rather than fractions.
Six years later, regulators demanded that trades take place on
whichever venue ofered the best price at a given time, sparking a
proliferation of venues, which now number more than 80.
For a few years after the Spear purchase, Goldman was a
top player in electronic trading as it steadily added capabilities.
But the ever-shifting landscape would prove to be fertile ground
for a new market inhabitant that would erode Goldman’s standing:
the high-frequency trader.
In the following years, a battle would rage within Goldman
about what to make of high-speed traders and their cousins, the
quants. (Quants deploy strategies that are diferent from those of
HFT companies, but they have similar technology requirements.)
It often pitted men who’d made fortunes in personalized, or “hightouch,” trading against technologists who arrived at Goldman
through its acquisitions.
Senior equities executives including Brian Levine were
convinced that Goldman should stick to its historic strength of
wielding risk capital for clients, according to people with knowledge of the situation. They questioned whether the returns generated by servicing quants, who use leverage to amplify returns
from thousands of bets on tiny price movements, were adequate.
Levine was also troubled by structural changes that he felt were
weakening markets. Glitches, such as Goldman’s options mistake,
and numerous others in the cash equities market were symbols
of the market’s vulnerability. (By 2013, Levine had seen enough
that he agreed to sit down with Michael Lewis for his 2014 book,
Flash Boys: A Wall Street Revolt, and the company later wrote a
Wall Street Journal op-ed calling for changes to the market.) It
was because of this conluence of concerns that Goldman failed
to anticipate how much the quant client base would grow. That
decision looks unwise in hindsight, but Goldman had generated
$13 billion in stock revenue in 2008, a high-water mark for the
industry. By some accounts, they were fat and happy. “I just
don’t think we were as concerned about electronic trading,”
TRADING PLACES
Equities trading revenue
Morgan Stanley
Goldman Sachs
JPMorgan Chase
$12b
9
6
3
2000
2017
0
Sources: {MS US Equity FA <GO>}, {GS US Equity FA <GO>}, {JPM US Equity FA <GO>}
VO LU M E 2 7 / ISS U E 2
81
SPEED GAME
Peak market data messages* per second
sustained over a one-minute interval
10.0m
7.5
5.0
2.5
12/31/04
12/31/17
0
*Messages include price quotes and trade orders
Sources: Financial Information Forum, marketdatapeaks.com, Tabb Group estimates
82
Levine recalls in December, his voice hoarse after holiday parties.
Part of Goldman’s weakness in automated trading was by
design. Following the Spear purchase in 2000, Goldman had kept
the electronic-trading unit in New Jersey, separate from the rest
of the operations. Goldman’s penchant for proprietary trading
was well-known, so clients fearful that their trades would be visible
asked the company to keep the technology at arm’s length. But
the separation prevented Goldman from developing the ability
to do principal trades in the electronic unit, meaning they couldn’t
ofer what quants needed: equity swaps that bundle inancing and
execution costs together.
The company inally merged its broker-dealers in 2013—
almost a decade after Morgan Stanley pioneered electronic swaps
trading. Goldman had dithered too long.
In February 2013 it was announced that electronic-trading
head Greg Tusar was leaving for a high-frequency trading
company. Ronnie Morgan, a senior equities executive with years
of serving clients in a high-touch capacity, was put in charge of
“low-touch,” or electronic, trading. Decisions such as this relected
a cultural bias for risk takers over technologists, says Michael
Dubno, a retired Goldman Sachs partner and chief technology
officer. “They lagged for a long time simply because they really
didn’t put their front-office tech leaders in ownership positions,”
he says. “They weren’t comfortable doing that.”
It didn’t help that some in the company were devoted to
doing as much as possible within its risk management platform,
known as Securities DataBase, or SecDB. Years earlier, executives had decided that trading algorithms should reside inside
the system. And for good reason: The strength of it was that
every trading desk fed into the all-seeing program in real time,
giving Goldman executives companywide views of risk. The
system’s reputation grew during the inancial crisis when it
helped Goldman outperform rivals. So for some inside the bank,
building a system outside of it seemed like sacrilege. But the
platform wasn’t engineered to handle the data rates of hundredths or thousandths of a second needed to compete in the
low-latency game.
Goldman continued to struggle with its place in the rapidly
changing market. As Morgan Stanley’s rise became apparent,
BLO O M B ERG M A R K ETS
Morgan and Levine invited employees of Goldman’s rival in for
job interviews, according to Lewis’s book. In the process, one of
the things the Goldman execs learned was that Morgan Stanley
was minting money with its high-speed oferings.
It got worse. Traditional Goldman clients such as multistrategy hedge funds started moving toward computer-driven
strategies. Asset managers such as Fidelity Investments became
even more sensitive about the quality of their trade execution with
Wall Street irms. And regulators didn’t react to Lewis’s book and
other eforts to sway public opinion. It took years for Goldman to
realize it had been wrong on quants.
When it inally awoke—in 2014—it acted swiftly. The irst
step was hiring Raj Mahajan as a partner, a dramatic move in and
of itself. Mahajan had begun his career in 1996 at Goldman’s
commodities business and later founded a tech company with
Marty Chavez, now the irm’s chief inancial officer. Mahajan
subsequently became CEO of high-speed company Allston
Trading LLC, known as a member of a small cabal of HFT executives who knew their way around the increasingly complex corners
of U.S. equity markets.
It’s clear that Mahajan, who finds a few minutes to talk
between client meetings, is obsessed with speed. As he attempts
to distill the complexities of market structure into simple analogies,
over and again he cites milliseconds and microseconds,
unfathomably tiny units of time. Once at Goldman, he went about
making some of the very decisions the company had resisted—such
as creating a parallel system outside SecDB that connects to it
only when necessary.
Mahajan determined that SecDB’s data constraints meant
it couldn’t capture the number of orders to buy or sell shares above
or below the price on ofer, what’s known as market depth. Without
that, he says, “it was hard for us to be able to make a quick pricing
decision on stocks we were trading algorithmically.”
He irst tackled the plumbing—the wiring that connects
dozens of systems, including those that keep track of inventory,
compliance, and post-trade processing internally as well as the
outside world of exchanges or broker-dealers. Each trade must
be scrutinized in accordance with a lengthy checklist, so Mahajan
had programmers write new code to speed up the process. “It’s
a computer science and physics problem in how to perform a
certain amount of work in a shorter amount of time,” he says.
As the number of exchanges and other trading systems has
multiplied, it’s become increasingly important to discover which
one ofers the best price at any given moment. Mahajan had to
make his systems fast enough to consume market data every
20 milliseconds to 50 milliseconds—less than half the time it takes
for a human eye to blink—and make almost-instantaneous decisions about where to route orders.
As a last step in his makeover, Mahajan ordered a wholesale
rewrite of the algorithms that decide how to break up an order.
Clients now have a choice of using those instructions or Goldman’s
plumbing to transmit orders to exchanges. “The guiding principle,”
he says, “is that we wanted to be the No. 1 electronic intermediary
in the business regardless of whether you are a large asset manager
or a quantitative hedge fund.”
Mahajan says Goldman has created a system that veriies a
trade, locates the best price, and moves quickly to process the
order before someone else snatches it. It has a success rate of better
than 99 percent. The bank is now one of the top three providers
of fast access to European markets, Blankfein said in a March
letter to shareholders touting the company’s eforts. The platform
also works for futures, commodities, and Treasuries.
Goldman’s aspirations are modest for a company that teems
with ambition. Knowing it’s difficult to get big-name quants to
switch all their business at once, the bank aims to attract smaller
shops or those active investors who are just starting quant strategies. The company reevaluates the rationale behind the project
every six months. So far, Mahajan says, “everyone’s heard the
arguments, it’s been debated, and it’s been unanimous: Keep your
foot on the gas.”
WHILE GOLDMAN SACHS and Morgan Stanley tussled for supremacy,
another threat emerged: Jamie Dimon. His bank, JPMorgan Chase
& Co., emerged from the inancial crisis as the most complete of
banking franchises, helped by a pair of takeovers and a reputation
for being a safe harbor amid the storm. As the fallout receded, it
ended up having leading businesses in almost every major category
of finance, including retail and commercial banking, asset
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83
management, and Wall Street advisory services. What’s more,
it was sitting on almost $1 trillion in deposits to fund it all, more
than its two rivals combined.
The glaring exception was in equities, the only major category
in which it didn’t have a top-three position. Jason Sippel, a 16-year
veteran of the company, remembers how hard it was to coax clients
to trade with the bank. The belittling was relentless. “Clients used
to beat us up when we saw them,” he says. “We didn’t have a strong
risk ofering for bigger trades, we were far behind in electronic
trading, and we didn’t have a low-latency ofering.”
Dimon, the aggressive leader who helped pioneer the inancial supermarket with ex-mentor Sanford “Sandy” Weill, wouldn’t
accept a subpar rank. In 2010 the bank hired Frank Troise, an
electronic-trading specialist from Lehman Brothers and Barclays
Plc and told him to build a world-class platform. At irst, Troise
and his new hires were a tribe unto themselves within JPMorgan.
To protect the nascent electronic business from the voice traders
whose livelihoods the unit threatened, Troise reported directly
to Carlos Hernandez, the global equities chief at the time.
By the time Troise left JPMorgan in 2015 to run broker
Investment Technology Group Inc., JPMorgan had tripled its
market share in equities electronic trading. The company began
pumping more capital into its prime brokerage for clients and
ramped up investment in quant services, creating a devoted risk
management team.
Sippel, who was head of prime services in 2015 and became
co-head of equities in 2016 with Mark Leung, now had a diferent
story to tell. Quants who needed the fastest access and ample liquidity were signing on. The company could market its growing inventory of stocks to other potential users, allowing them to match
more buyers and sellers, as well as longs and shorts, internally,
shaving expenses for everyone involved. Pricing their products
competitively, they also persuaded their existing customers—
JPMorgan has the world’s biggest ixed-income business—to use
the bank’s equities desks. In this arena, scale is all that matters;
those without it will ind themselves unable to invest in the technology to stay relevant.
Despite being years late, JPMorgan grew by leaps and bounds.
Sippel is blunt about how they got there: He calls it the Morgan
Stanley playbook. Anchored by electronic trading and prime brokerage, the company has illed every major segment in every region
of the world, a kind of convergent evolution with Pick’s nine boxes.
That helped JPMorgan pull clients from weakened European
investment banks. While the overall pool of trading fees shrank,
JPMorgan managed to increase its market share. It had 10.3 percent
of the global market in 2017, up from 5 percent in 2006.
Part of that story is the triumph of electronic trading. Even
though per-trade commissions are a fraction of those from voice
trading, electronic trading at JPMorgan has gone from a rounding
error ive years ago to pulling even with its higher-service counterpart. “The electronic side has won,” Sippel says. “And that’s
not something we forced on them. Clients are choosing it because
it’s more efficient, cheaper, easier.”
the game is changing again. The twin forces that have
always shaped the markets—technology and regulation—are
about to wreak havoc once more.
Investment banks are starting to unleash a new generation
of learning machines on the markets to customize, hedge, and
execute trades. It’s a step toward the post-human vision of
markets that Pandit had at Morgan Stanley in the 1990s. Across
the equities and ixed-income world, apart from a dwindling
pool of human traders working on bespoke deals and the human
minders of the machines, algorithms will be connecting sellers
and buyers.
Then there are the regulations, the never-ending cascade
of rules lowing from the wreckage of the inancial crisis. The latest
ones emanate from Europe in the form of the Markets in Financial
Instruments Directive II (MiFID II), which requires unbundling
trading commissions from research and increasing transparency—
and is certain to accelerate the tilt toward machines.
And yet, for all the ways in which inance is becoming a
place where machines transact with other machines, the race for
trading riches will ultimately be won or lost by people such as
Blankfein, Gorman, and Dimon, men driven to keep the throne—
or claim it at last.
BUT NOW
Son and Campbell cover finance at Bloomberg News in New York.
“The electronic side has won. And that’s
not something we forced on them. Clients are
choosing it because it’s more efficient, cheaper, easier”
84
BLO O M B ERG M A R K ETS
Rob Paterson, CEO
of a Canadian credit union,
was headed out to his car when
one of his executives caught
up to him and said,“You won’t
believe what’s come to us—
a weed company.” Paterson
dived deep into the facts and
figures, the pros and the cons.
Impressed, he came back to
his team and declared:
“Look, why would we not
do this business?”
The Pot Banker
Paterson at
Allan Gardens
in Toronto
By DOUG ALEXANDER
P H OTO G R A P H BY M A R K SO M M E R F E L D
Canadian town, Bruce Linton dreamed of
transforming an abandoned Hershey Co. chocolate plant into the
Next Big Thing, a medical marijuana factory. But the pot entrepreneur faced a crisis typical of his edgy industry: Banks shut their
doors in his face.
It began with Royal Bank of Canada. The 148-year-old
blue-chip company dropped him as a customer when it discovered
he ran with the cannabis crowd. “We must regretfully inform
you,” read the inancial Dear John letter he was sent. TorontoDominion Bank, Bank of Montreal—they stifed him, too. He
queried Bank of Nova Scotia and Canadian Imperial Bank of
Commerce. No luck.
Scouring Google, Linton lowered his sights, but the rejections kept piling up, like roaches at a Grateful Dead concert. No
“respectable” bank wanted to take a chance on an untried business
selling a product with the whif of vice.
Then Linton turned to an old-school credit union—that
paragon of community, rectitude, and caution—and found a
middle-aged banker named Rob Paterson. The chief executive
officer of Alterna Savings & Credit Union Ltd. seemed an unlikely
mark. He barely drank and hadn’t smoked a joint since his university days.
Paterson was headed out to his car in the parking lot at Alterna’s Toronto office when one of his lieutenants caught up to him
and said, “You won’t believe what’s come to us—a weed company.”
Initially, Paterson dismissed the idea. But then, like any
good banker, he hit the books. He and his crew spent several
months studying Linton’s business plan. They scoured the regulations on medical marijuana and even interviewed doctors. Paterson was impressed. He came back to his team and declared:
“Look, why would we not do this business?” The marijuana
company with the funky name, Tweed Inc., had found its bank.
IN A DOWN-AND-OUT
THAT WAS THREE YEARS AGO. Since then, Paterson has become the
go-to banker for the pot industry, and his irst cannabis customer,
Linton, the no-longer-desperate marijuana executive, is proud to
show off his 650,000-square-foot pot facility in Smiths Falls,
Ont.—a burg of 8,885 slowly rebounding from the shutdowns of
the Hershey and Stanley Works tool plants a decade ago.
“Chocolate Shoppe,” proclaim the golden letters on an interior wall—put there as a tribute to past glory—but Linton’s operation, now demurely christened Canopy Growth Corp., bristles
with high-tech equipment; the production area requires a ingerprint scan for access. Inside, rows of lush marijuana plants will be
harvested and dried and become fodder for joints and pipes as
well as reined into oils for soft-gel capsules to treat chronic pain,
nausea from cancer treatment, sleep disorders, and anxiety.
Canopy Growth is the world’s largest publicly traded marijuana producer, with a market value of more than C$6 billion
($4.6 billion). But its ticker, WEED, is true to its roots, and, similarly, Linton hasn’t forgotten Paterson and the credit union that
made it possible. “I’ve been a walking brochure for them,” he says.
THE TIMES MAY BE changing for the pot business as countries around
the globe shift from locking up dealers to passing legislation for
legalization. But banking remains a serious hang-up for an industry that’s set to generate $31.4 billion in annual sales by 2021,
according to Brightield Group, a Chicago-based research irm.
In the U.S., marijuana dispensaries have been known to tote
bags of cash around to banks to make deposits. That exposes couriers to robbery, gives the businesses a taint of the illicit, and spooks
banks that remain wary of the nascent industry following U.S.
Attorney General Jef Sessions’s promise to enforce federal laws
banning the plant. “If you’re a major institution, life’s too short
to take a risk of being in violation of United States federal banking
laws,” says Christopher Barry, a Dorsey & Whitney LLP attorney
who advises cannabis companies on cross-border inancing and
regulatory issues.
In this uncertain environment, Canada may ofer the sharpest glimpse of the future—and the business opportunities—for
MARIJUANA PRODUCER LICENSES ISSUED IN CANADA
Number of sites granted licenses
Sites licensed, by province*
50
Other
12
25
2013
2018*
0
British Columbia
20
Ontario
50
Quebec
6
Alberta
5
*Through March 16; some companies hold multiple licenses for different sites
Source: Health Canada
88
BLO O M B ERG M A R K ETS
inancial-services companies willing to take the risk. In 1999,
Canada began to allow legal access to medical marijuana. Even so,
the industry didn’t take of until 2013, when the government
changed regulations to make it simpler for companies to enter the
market. At least 20 countries—Australia, Germany, and Mexico
among them—and 29 U.S. states have followed suit.
Now comes legalized recreational pot. Nine U.S. states
and the District of Columbia have taken the step. This year,
Canada will become the irst country to do so since Uruguay in
2017. Already, Canada has the largest herd of “cannabis
unicorns”—ledgling publicly traded companies worth $1 billion
or more—such as Canopy, Aurora Cannabis, and Aphria. Canadian stock exchanges host at least 85 pot companies, with a combined market value of C$30 billion.
As for Alterna, it now has about C$750 million in pot-related
loans and deposits. Paterson estimates he banks two-thirds of the
almost 100 licensed producers in the business, and Linton isn’t
the only one spreading the word. “We’re getting a lot of referrals
from accounting and law irms,” Paterson says. “The call to me is
always, ‘Hey, hope this doesn’t sound crazy, but I’ve heard you
guys are in this industry, and I have a client who’s great but they’re
having trouble getting banking services.’ ”
In 2016, when word of Alterna’s involvement in the pot
banking business started getting out, Paterson expected a backlash,
but he encountered none.
Still, Kevin Sabet, a former White House drug policy
adviser under Presidents George W. Bush and Barack Obama,
says banks should steer clear of an industry that remains illegal
in much of the world and seeks to proit from a harmful drug.
“You now have a inancial system with all of its backing promoting an industry that is trying to get rich of of addiction,” says
Sabet, co-founder of Smart Approaches to Marijuana, a nonproit
that opposes legalization. “From a public health point of view,
that’s a very bad idea.”
Others wonder whether Paterson’s fortunes have peaked:
The major banks are starting to circle. Bank of Montreal and
Toronto-Dominion have quietly been providing some banking
services. Even Royal Bank and Scotiabank, which have been steadfast in not helping the industry, now say they’re open to reviewing
policies as the laws change.
David Baskin, president of Toronto-based money manager
Baskin Wealth Management Inc., which has long owned big-bank
shares, says the established institutions have so much market
power that credit unions such as Alterna can’t hope to match them.
“They’ll get left in the dust,” he says.
WHEN PATERSON ISN’T lying across Canada to meet pot executives,
he sometimes works from Toronto out of Alterna’s squat, 1970s
brown-brick building in an office park near Canada’s busiest
airport. (Alterna is headquartered in Ottawa.) It’s a far cry from
Paris, where he was born in 1967, the youngest of three sons, to
a Canadian mother and a Scottish father who was working there
as an executive for International Business Machines Corp. Following a stint in Hong Kong, the family moved to Canada in the
mid-1980s. At the University of Western Ontario in London,
110 miles southwest of Toronto, Paterson majored in philosophy
and, like so many of his classmates, did a little weed. “It was something every one of us did, experimented in one of the residences,
and passing to the left, you know,” he says. “That was it.”
After university, Paterson spent 15 years at Canadian Imperial Bank of Commerce before working in Asia as a McKinsey &
Co. consultant and returning to Canada to join JPMorgan Chase
& Co. In 2013, when he was an executive vice president at risk
manager Aon Plc in Toronto, a recruiter called with a lead: Would
he like to try to turn around Alterna, an underperforming credit
union? He took the CEO job in April, slashing 10 percent of operating costs in his irst 100 days. Paterson, who had a lifelong interest in tinkering with computers, also embraced digital banking.
Alterna’s assets have almost tripled since Paterson joined,
climbing to C$6.6 billion as of Dec. 31, and it’s become one of
Canada’s 10 largest credit unions. In 2016, Paterson earned
C$985,000 from Alterna, making him one of the better-paid heads
of Canadian credit unions (though his compensation was about a
12th of that of Royal Bank’s David McKay, the highest-paid bank
CEO in the country). That year, the latest period available, Alterna’s annual proit almost tripled, to C$16.3 million, compared
with the year before.
Paterson’s sparsely furnished ground-loor corner office in
Toronto overlooks the parking lot where it all began—or where
at least the weed part did. Alterna has a team of six commercial
bankers who specialize in the marijuana industry, with clients in
British Columbia, Alberta, New Brunswick, Quebec, and Ontario.
Paterson has visited at least 20 of the country’s largest cannabis
complexes. He’s got inal say on the deals. “We can tell someone
who’s sophisticated and has the capability to survive and go
through the whole process from those that aren’t,” he says.
As a credit union, Alterna can’t ofer one-stop shopping.
It can do checking and savings accounts, cash management, and
credit cards. As its client companies in the marijuana business
grow, Paterson will make loans of C$5 million to C$25 million
at interest rates 2.5 percentage points to 5.5 percentage points
above ive-year Canadian government benchmarks, which is
about what he’d charge a customer in the real estate business.
But for mergers and stock sales, marijuana concerns must look
to weed-oriented investment banks such as Canaccord Genuity
Group, GMP Capital, and Eight Capital.
Does the gap in business oferings mean that Alterna could,
in fact, get left behind? In January, Bank of Montreal became the
irst major bank to arrange a stock sale for a company tied to pot.
Its capital markets division helped lead a C$200.7 million equity
inancing for none other than Canopy Growth, Paterson’s irst
pot customer. CIBC, Paterson’s old employer and Canada’s ifthlargest lender, was part of a C$20 million credit deal signed last
year with producer MedReleaf Corp. Relatively small though it
was, that deal was a milestone: It marked the irst time a Big Five
Canadian bank made a loan to the industry.
Although they’ve shied away from pot, U.S. lenders regularly
call Paterson for advice on the market he pioneered in Canada.
He’s happy to help them plot their strategy south of the border.
He’s also heard from some of those Canadian banks that turned
down his irst client when it was desperate for help for the chocolate factory overhaul. When those calls come in, he gives the titans
a taste of their own medicine. With characteristic Canadian understatement, Paterson says, “We don’t tend to be so helpful.”
Alexander covers banking at Bloomberg News in Toronto.
VO LU M E 2 7 / ISS U E 2
89
Cheat Sheet
A Compendium of Functions—
New or Featured
In This Issue
FEATURED IN THIS ISSUE
ENDO
APPS
NEW ENHANCEMENTS TO TRY RIGHT NOW
Ranks U.S. college endowments by performance
and other metrics
26
Explore and test-drive third-party applications
that are integrated with Bloomberg data
29
APPS TRACK Download the free 2D Scenario Analysis Tool
by Carbon Tracker
FIW
29
Provides a comprehensive overview of an
institutional or an individual investor’s holdings
31
GPC
Displays candlestick charts for a selected security
34
XCRV
Enables you to analyze current and historical levels
for up to eight foreign exchange term structures 38, 40
VCAL
Create custom date weights in a calendar that can be
applied to an FX volatility surface, enabling you to
consider event risk when pricing FX options
38, 40
OVML
Prices custom FX option structures such as
call spreads
42
Lets you search for mergers-and-acquisitions data
and view league tables
45
HLDR
MA
ESG
Provides an overview of a company’s environmental,
social, and governance performance
50
MVS
Displays news and data on U.S. equity market
structure and volume
57
View insight, data, and news on the
transformation of the energy sector from
Bloomberg New Energy Finance
59
BNEF
BTMM The Treasury & Money Markets monitor now lets you
specify your default country so you can get your
preferred Treasury and money market data faster.
MAP
MAP is a new function that lets you visualize geospatial
risks to properties in select commercial mortgagebacked securities. On the map, you can see the
proximity of mortgage properties to nearby terrain,
retail centers, and road infrastructure as well as
to U.S. counties that received FEMA reimbursements
following natural disasters.
NIMY
My New Issue Monitor, which provides a central place
to view and filter new bond announcements you
receive, now lets you highlight the data that matter
to you. You can consolidate multiple deals for the same
issuer, and discrepancies between submissions from
different syndication desks are highlighted in red.
AHOY
Gives you full coverage of seaborne trade flows data.
Click the Berth Visits tab to monitor liquefied natural gas
shipments by location or vessel, or go to the Fixtures tab
to forecast product flows between global regions. The
Imports and Exports tabs show you U.S. daily imports
ahead of Energy Information Administration releases and
U.S. export trends for crude oil and refined products.
54
BI ESG Displays the Bloomberg Intelligence dashboard on
environmental, social, and governance research
The Fixed Income Worksheet function has been
enhanced with many features that enable you
to analyze pricing, performance, and liquidity across
lists of bonds. You can now create, save, and share
customized worksheets. To get started quickly with
a sample Bloomberg worksheet template, run
{FIW <GO>}, click the Worksheet button on the red
toolbar, select Switch worksheets, and then click,
for example, US IG for U.S. investment grade.
Faster, better answers—24/7. <Help><Help> for Bloomberg Analytics
The BLOOMBERG PROFESSIONAL service (“BPS”), BLOOMBERG TERMINAL and Bloomberg data products (the “Services”) are owned and distributed by Bloomberg Finance L.P. (“BFLP”), except that Bloomberg L.P. and its subsidiaries distribute the BPS in Argentina,
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may not share, reproduce, publish, distribute or communicate this Proposal or information of any kind relating to these responses to any company, third parties or persons other than within Customer and only to such persons on a need-to-know basis in connection
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April/May 2018, volume 27, issue 2, BLOOMBERG MARKETS (ISSN 1531-5061) (USPS 008-897) is published six times a year with issues in March, May, July, September, November and December by Bloomberg Finance L.P., 731 Lexington Avenue, New York, NY
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Helping you
lead the way.
As a full-service financial services provider serving
clients on 5 continents, BMO Capital Markets brings
a world of expertise to every client relationship.
Let’s discuss. bmocm.com
BMO Capital Markets is a trade name used by BMO Financial Group for the wholesale banking businesses of Bank of Montreal, BMO Harris Bank N.A. (member FDIC), Bank of Montreal Ireland p.l.c, and Bank of Montreal
(China) Co. Ltd and the institutional broker dealer businesses of BMO Capital Markets Corp. (Member SIPC) in the U.S., BMO Nesbitt Burns Inc. (Member Investment Industry Regulatory Organization of Canada and Member
Canadian Investor Protection Fund) in Canada and Asia and BMO Capital Markets Limited (authorised and regulated by the Financial Conduct Authority) in Europe and Australia. “Nesbitt Burns” is a registered trademark of
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® Registered trademark of Bank of Montreal in the United States, Canada and elsewhere.
™ Trademark of Bank of Montreal in the United States and Canada.
A Function I Love
Following Flows
By JOE WEISENTHAL
FFLO
<GO>
that spike
in February is a reminder that you
can only have a one-directional trade for
so long. That of course raises the big
question: If we’re entering a new regime,
where’s the new money going to go?
One way to figure this out is through
{FFLO <GO>}, which gives you almost
instant insight into global ETF flows.
The beauty of exchange-traded funds,
compared with other investment vehicles,
is that most of them provide inflow and
outflow data daily. Also, because there are
so many ETFs, in trading venues all around
the world, you can get very granular in
terms of seeing where the money is going.
If I pull up {FFLO <GO>}, the first
thing I see is the big picture, national
trends of where the money has gone so far
THE MARKET VOLATILITY
this year. Not surprisingly, the big U.S.
market has seen the highest net inflows. At
the bottom of the list you see that the U.K.
is leading ETF outflows—that’s perhaps
partly Brexit-related. But this is just a start.
If you click on the United States,
you’ll see the big inflow winners this year,
including IVV (an S&P 500 ETF) and QQQ
(which tracks the Nasdaq 100). Funds
that have seen substantial outflows
include ETFs such as LQD and HYG, which
buy corporate bonds. Adjust various
parameters to zoom in on specific periods
and measures of flows. For example, you
can examine funds based on flows as a
percentage of their assets to get a feel for
the countries or strategies seeing unusual
levels of activity.
You can also break down the
universe of ETFs by asset class, rather
than geography. So far this year, for
instance, equity ETFs overall have seen
substantial inflows as a percentage of
total assets. You can also see that among
fixed-income ETFs, investment-grade
funds have seen substantial inflows, while
high-yield funds have seen substantial
outflows–yet another way of perceiving
increased anxiety among investors about
risky assets.
It’s a tool with massive potential
value. With minimal effort, you can
instantly gauge real monetary allocations
by investors worldwide. Because of the
vehicles involved, the data are fast and
timely. So anytime you sense the market
potentially shifting to a new regime,
look here first.
Weisenthal co-hosts What’d You Miss? on Bloomberg TV and is the executive editor of digital news at Bloomberg.
92
BLOOMB E RG MA RKE TS
Putting
you at the
centre of the
global bond
markets
High grade IGRD <GO>
Emerging markets EMRD <GO>
High yield HYRD <GO>
Global Primary Bond Markets News & Analysis
» Official mandates
» Priced deal announcements
» Guidance updates
» League tables
» Pipelines
» Distributions stats
» Market perception
» Historical data
YOUR LENS DETERMINES YOUR PERSPECTIVE
BROADEN YOUR EXPOSURE
Fixed Income.
Develop a clearer picture.
Photography is not the only market that has
completely changed over the past decade.
Allocations to non-core bond strategies have
grown at a much faster rate than core according
to our proprietary database of thousands of client
portfolios. Morningstar® data also shows noncore bond strategies are more than three times
what they were 10 years ago.
When exposures change this dramatically, new
risks develop as well.
¨Õ«Ê¢ã¨Ćù«ÃÊÂÜÕãØèÂ
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Please consider the charges, risks, expenses and investment objectives carefully before investing. For a prospectus or, if available, a summary
ÕØÊÜÕãèÜÊÃã«Ã«Ã£ã¨«ÜÃÊã¨Ø«Ã¢ÊØÂã«ÊÃŌռܼ¼8ÃèÜ*ÃØÜÊÃãęđđőėėęőđĕĔĕÊØÊôüÊã¨Ć¼¢ØʶÃèܨÃØÜÊÃőÊÂŗ
info. Read it carefully before you invest or send money.
Investing involves risk, including the possible loss of principal and fluctuation of value. Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond
market is volatile. As interest rates rise, bond prices usually fall, and vice versa.
The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens. Foreign securities are subject to
additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all
of which are magnified in emerging markets. Derivatives can be highly volatile and more sensitive to changes in economic or market conditions than other investments. This could
result in losses that exceed the original investment and may be magnified by leverage.
The ETF (Exchange Traded Fund) is not a money market fund and does not attempt to maintain a stable net asset value. The ETF is new and has less than one year of
operating history.
Janus Capital Management LLC is the investment adviser and ALPS Distributors, Inc. is the distributor of the ETF. ALPS is not affiliated with Janus Henderson or any
of its subsidiaries.
Janus Henderson is a trademark of Janus Henderson Investors. © Janus Henderson Investors. The name Janus Henderson Investors includes HGI Group Limited, Henderson
Global Investors (Brand Management) Sarl and Janus International Holding LLC. Mutual funds distributed by Janus Henderson Distributors.
C-0917-12372 09-15-18
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