Tag: goldman sachs

IPOs and right to match

Long time readers of the blog might know that I’m not a big fan of the IPO pop. I’ve traditionally belonged to the party (led by Bill Gurley) that says that a big IPO pop is akin to “leaving money on the table” for the company.

And so as my party has grown, the IPO process itself has also changed. Way back in 2004, Google allocated shares using a simple Dutch auction. Facebook pushed its bankers hard enough on the IPO price that the IPO “pop” in that case was negative. Spotify and Slack and a few other companies went public in a direct listing. Nowadays you have SPACs. It’s all very interesting stuff for anyone interested in market design.

Over the last few years, though, Matt Levine has been trying hard (and sort of succeeding), in getting to move me to the side that says IPO pops are okay. His first compelling argument was the demand-supply (and market depth) one – in an IPO there is a large offload of shares, and so an IPO buyer can expect to get a discount on the shares. Another is that since the IPO is the first time the stock will be traded, buyers in the IPO are taking risk, and need to be compensated for it in the form of a lower price. Fair enough again.

Matt has outdone himself in his latest newsletter on the topic, where he talks about the IPOs of Roblox and Coupang. About Roblox, he wrote:

I mean, I’ll tell you the answer[1]: Roblox sold stock to venture capitalists at $45, and then it traded up in public markets to $70. In a traditional initial public offering, a company sells stock to mutual funds at $45, and then it trades up in public markets to $70. Venture capitalists are not happy when mutual funds get underpriced stock: It dilutes existing shareholders and “leaves money on the table.” Venture capitalists are of course perfectly happy when venture capitalists get underpriced stock; that’s the business they are in.

This served the purpose of moving me more to his side.

This blogpost, however, is about the Coupang IPO.

All normal enough. But here’s the unusual thing about Coupang. Apparently, of the hundreds of investors who put in orders to buy shares in the IPO—many of whom did roadshow meetings and put in work to understand the company and come up with a price—fewer than 100 were allocated any shares, with most of those shares going to about 25 accounts handpicked by Coupang. Coupang apparently kept tight control over the allocation, choosing its investors itself rather than deferring to its underwriters (led by Goldman Sachs Group Inc.). Now those favored investors—investors favored by Coupang, not investors favored by Goldman—will benefit from the IPO pop. Everyone else, who put in the work and decided they wanted to own Coupang, will have to buy in the aftermarket, from those initial investors, and pay up to do so.

Obviously Coupang has left money on the table, but who cares? Coupang underpriced its IPO, but the beneficiaries of the underpricing are the existing investors that it wanted to benefit.

Basically Coupang announced an IPO at a $27-30 price range. It did a roadshow to gauge investor demand. Demand was strong. And then the price range was upped to $31-34. Demand was strong once again. And then, instead of letting its banker Goldman Sachs price the IPO at 34, and allocate the shares to who Goldman thought would make the best investors, Coupang went to its existing investors and told them “we have a bunch of investors willing to buy our stock at $34. What do you think?”

And the existing investors, finding validation, said “Oh, in that case we can pay $35 for it”. In IPL auction parlance, Coupang’s existing investors basically had a “right to match option”. All the other potential investors were asked, and then the existing investors were “more equal” than the others.

The stock duly popped.

Now, right to match in an IPO might be an interesting structure, but I highly doubt that it will sustain. Basically banks won’t like it. Put yourself in Goldman’s shoes for a moment.

They have done all the hard work of pricing the IPO and taking it to potential clients and doing all the paperwork, and at the end of it, their buy side clients are a mostly pissed of bunch – they’ve again done all the hard work of deciding whether the IPO was worth it and then told that they were cut out of the deal.

The least Goldman’s buy side clients would have wanted is the right to match Coupang’s original investors’ offer ($35). Having done all the hard work, and then being forced to buy the stock (if at all) at the popped price of $49, they will be a totally miffed lot. And they would have conveyed their displeasure to Goldman.

One thing about IPOs is that the companies selling the stock play a one-time game, while the bankers (and IPO investors) play a repeated game, participating in IPOs regularly. And because of this, the incentive structure of IPOs is that bankers tend to favour buy side clients than sell side, and so the big pop. And so bankers will not regularly want to do things that will piss off the buy side, such as offering “right to match” to the selling company’s chosen investors.

So will we see more such IPOs?

My take is that inspired by Coupang, some more companies might insist on a right to match while selling their shares in an IPO. And this right to match will piss off the buy side, who will push back against the bankers and demand a right to match for themselves.

And what happens when both sides (company’s favourite investors and bank’s favourite investors) insist on a mutual right to match? We get an auction of course.

I don’t think anyone will have that much of a problem if IPO share allocation gets resolved by a Dutch auction, like Google did way back in 2004.

Bankers predicting football

So the Football World Cup season is upon us, and this means that investment banking analysts are again engaging in the pointless exercise of trying to predict who will win the World Cup. And the funny thing this time is that thanks to MiFiD 2 regulations, which prevent banking analysts from giving out reports for free, these reports aren’t in the public domain.

That means we’ve to rely on media reports of these reports, or on people tweeting insights from them. For example, the New York Times has summarised the banks’ predictions on the winner. And this scatter plot from Goldman Sachs will go straight into my next presentation on spurious correlations:

Different banks have taken different approaches to predict who will win the tournament. UBS has still gone for a classic Monte Carlo simulation  approach, but Goldman Sachs has gone one ahead and used “four different methods in artificial intelligence” to predict (for the third consecutive time) that Brazil will win the tournament.

In fact, Goldman also uses a Monte Carlo simulation, as Business Insider reports.

The firm used machine learning to run 200,000 models, mining data on team and individual player attributes, to help forecast specific match scores. Goldman then simulated 1 million possible variations of the tournament in order to calculate the probability of advancement for each squad.

But an insider in Goldman with access to the report tells me that they don’t use the phrase itself in the report. Maybe it’s a suggestion that “data scientists” have taken over the investment research division at the expense of quants.

I’m also surprised with the reporting on Goldman’s predictions. Everyone simply reports that “Goldman predicts that Brazil will win”, but surely (based on the model they’ve used), that prediction has been made with a certain probability? A better way of reporting would’ve been to say “Goldman predicts Brazil most likely to win, with X% probability” (and the bank’s bets desk in the UK could have placed some money on it).

ING went rather simple with their forecasts – simply took players’ transfer values, and summed them up by teams, and concluded that Spain is most likely to win because their squad is the “most valued”. Now, I have two major questions about this approach – firstly, it ignores the “correlation term” (remember the famous England conundrum of the noughties of fitting  Gerrard and Lampard into the same eleven?), and assumes a set of strong players is a strong team. Secondly, have they accounted for inflation? And if so, how have they accounted for inflation? Player valuation (about which I have a chapter in my book) has simply gone through the roof in the last year, with Mo Salah at £35 million being considered a “bargain buy”.

Nomura also seems to have taken a similar approach, though they have in some ways accounted for the correlation term by including “team momentum” as a factor!

Anyway, I look forward to the football! That it is live on BBC and ITV means I get to watch the tournament from the comfort of my home (a luxury in England!). Also being in England means all matches are at a sane time, so I can watch more of this World Cup than the last one.

 

Darwin Awards in Investment Banking

Some 20 analysts from Goldman Sachs and 10 from JP Morgan have been dismissed after it emerged that they were cheating during some mandatory tests during their analyst training program.

As the article says, it is not unusual for bankers to assist each other when it comes to tests in mandatory training and compliance, since they are seen as being time consuming and repetitive.

In that sense, that these guys copied or helped each other is not news. What matters, though, is that they got caught in the process. And that is unacceptable for a banker.

If you look at how investment banking has been shaped over the last decade or so, there have apparently been several people who have fudged stuff – from financial results to key rates to benchmarks, and gotten away with it because they haven’t got caught. And they continue to remain successful bankers.

So in the banking culture, fudging is okay, but getting caught isn’t. By getting caught fudging in tests during their training program, these analysts have betrayed the one skill that is necessary for being a successful banker, and for this reason they have been rightly weeded out.

It’s like the Darwin awards, except that for these guys it is only the end of their careers in banking.

Analysts, competition and Wall Street deaths

Yet another investment banking analyst has died. Sarvshreshth Gupta, a first year Analyst at Goldman Sachs’s San Francisco office reportedly killed himself after not being able to handle the workload. Reporting and commenting on this, Andrew Ross Sorkin writes:

Some banks, like Goldman, are also taking new steps, like introducing more efficient software and technology to help young analysts do their work more quickly. And investment banks say they are hiring more analysts to help balance the workload.

I simply fail to understand how these measures help balance the workload. I mean having more analysts is good in that the same work now gets split between a larger number of analysts. However, that there are more analysts doesn’t mean that the demand for Associates or Vice Presidents has actually gone up – that might go up only with deal flow.

In other words, what the above measure has done is to actually make the organisational structure “more pyramidal” (i.e. reduced the slope of the “pyramid’s walls”). So now you have a larger number of analysts competing for the same number of associate and VP positions. I don’t see how it makes things better at all!

On another note, I wonder if the number of deaths among Wall Street analysts has actually gone up, or if they have only started being reported more in recent times, after Wall Street got into trouble. Based on my limited understanding, I think it is the case of the former, and I attribute it to the lack of choice.

Back in 2004, I attended a talk by a Goldman Sachs MD (who worked in the Investment Banking Division, which does Mergers and Acquisitions, IPOs, etc.) in IIMB where he told me about the lifestyle in his division. That was the day I swore never to apply to that kind of a role. Given that the sales and trading side was doing rather well then, however, I had a choice to take up another equally lucrative, but less stressful-on-lifestyle career. That I chose not to (in 2006) is another matter.

The way I see it, following the crash of 2008, sales and trading have never recovered and don’t recruit as many as they used to. That takes care of one “competitor” of investment banking division. The other “competitor” is consulting, but they don’t pay just as well. In fact, with banking on the downswing, the supply of quality candidates to consulting firms has improved to the extent that they haven’t had to raise salaries as much. For example, starting salaries of IIM graduates at top-tier consulting firms in India have only grown at a CAGR of 6.5% since the time I graduated in 2006.

What this means is that few jobs can match the pay of investment banking, and that reduces the number of exit options. A few years back, anyone who found it too stressful had the option to move out to another job that was less demanding in terms of number of hours (though still stressful) without a cut in pay. This option has expired now, with the effect that people soldier on in investment banking jobs even if they’re not completely cut out for them.

And then some don’t make it. And so they go..

More on the Swiss Franc move

The always excellent Matt Levine has reported in Bloomberg (with respect to the recent removal of the cap on the price of the Swiss Franc) that:

Goldman Sachs Chief Financial Officer Harvey Schwartz said on this morning’s earnings call that this was something like a 20-standard-deviation event

While mathematically this might be true, the question is if it makes sense at all. Since it is mathematically easy to model, traders look at volatility of an instrument in terms of its standard deviation. However, standard deviation is a good descriptor of a distribution only if the distribution looks something like a normal distribution. For all other distributions, it is essentially meaningless.

The more important point here is that the movement of the Swiss Franc (CHF) against the Euro had been artificially suppressed in the last three odd years. So from that perspective, whatever Standard Deviation would have been used in order to make the calculation was artificially low and essentially meaningless.

Instead, the way banks ought to have modelled it was in terms of modelling where EUR/CHF would end up in case the cap on the CHF was actually lifted (looking at capital and current flows between Switzerland and the Euro Area, this wouldn’t be hard to model), and then model the probability with which the Swiss National Bank would lift the cap on the Franc, and use the combination of the two to assess the risk in the CHF position. This way the embedded risk of the cap lifting, which was borne out on Thursday, could have been monitored and controlled, and possibly hedged.

There are a couple of other interesting stories connected to the lifting of the cap on the value of the CHF. The first has to do with Alpari, a UK-based FX trading house. The firm has had to declare insolvency following losses from Thursday. And as the company was going insolvent, they put out some interesting quotes. As the Guardian reports:

In the immediate aftermath of Thursday’s move by the Swiss central bank, analysts at Alpari had described the decision as “idiotic” and by Friday the firm had announced it was insolvent. “The recent move on the Swiss franc caused by the Swiss National Bank’s unexpected policy reversal of capping the Swiss franc against the euro has resulted in exceptional volatility and extreme lack of liquidity,” said Alpari.

The second story has to do with homeowners in Hungary and Poland who borrowed their home loans in Swiss Franc, and are now faced with significantly higher payments. I have little sympathy for these homeowners and less sympathy for the bankers who sold them the loans denominated in a foreign currency. I mean, who borrows in a foreign currency to buy a house? I don’t even …

There is a story related to that which is interesting, though. Though Hungary is more exposed to these loans than Poland, it is the Polish banks which are likely to suffer more from the appreciation in the CHF. The irony is that the Hungarian market was initially much more loosely regulated compared to the Polish market, where only wealthier people were allowed to borrow in CHF. But in Hungary, the regulator took more liberties in terms of forcing banks to take the hit on the exchange rate movement, and the loans were swapped back into the local currency a while back.

In related reading, check out this post by my Takshashila colleague Anantha Nageswaran on the crisis. I agree with most of it.

 

A misspent career in finance

I spent three years doing finance – not counting any internships or consulting assignments. Between 2008 and 2009 I worked for one of India’s first High Frequency Trading firms. I worked as a quant, designing intra-day trading strategies based primarily on statistical arbitrage.

Then in 2009, I got an opportunity to work for the big daddy of them all in finance – the Giant Squid. Again I worked as a quant, designing strategies for selling off large blocks of shares, among others. I learnt a lot in my first year there, and for the first time I worked with a bunch of super-smart people. Had a lot of fun, went to New York, played around with data, figured that being good at math wasn’t the same as being good at data – which led me to my current “venture”.

But looking back, I think I mis-spent my career in finance. While quant is kinda sexy, and lets you do lots of cool stuff, I wasn’t anywhere close to the coolest stuff that my employers were doing. Check out this, for example, written by Matt Levine in relation to some tapes regarding Goldman Sachs and the Fed that were published yesterday:

The thing is:

  • Before this deal, Santander had received cash (from Qatar), and agreed to sell common shares (to Qatar), but wasn’t getting capital credit from its regulators.
  • After this deal, Santander had received cash (from Qatar), and agreed to sell common shares (to Qatar), and was getting capital credit from its regulators, and Goldman was floating around vaguely getting $40 million.

This is such brilliantly devious stuff. Essentially, every bad piece of regulation leads to a genius trade. You had Basel 2 that had lesser capital requirements for holding AAA bonds rather than holding mortgages, so banks had mortgages converted into Mortgage Backed Securities, a lot of which was rated AAA. In the 1980s, there were limits on how much the World Bank could borrow in Switzerland and Germany, but none on how much it could borrow in the United States. So it borrowed in the United States (at an astronomical interest rate – it was the era of Paul Volcker, remember) and promptly swapped out the loan with IBM, creating the concept of the interest rate swap in that period.

In fact, apart form the ATM (which Volcker famously termed as the last financial innovation that was useful to mankind, or something), most financial innovations that you have seen in the last few decades would have come about as a result of some stupid regulation somewhere.

Reading articles such as this one (the one by Levine quoted above) wants me to get back to finance. To get back to finance and work for one of the big boys there. And to be able to design these brilliantly devious trades that smack stupid regulations in the arse! Or maybe I should find myself a job as some kind of a “codebreaker” in a regulatory organisation where I try and find opportunities for arbitrage in any potentially stupid rules that they design (disclosure: I just finished reading Cryptonomicon).

Looking back, while my three years in finance taught me much, and have put me on course for my current career, I think I didn’t do the kind of finance that would give me the most kick. Maybe I’m not too old and I should give it another shot? I won’t rule that one out!

PS: back when I worked for the Giant Squid, a bond trader from Bombay had come down to give a talk. I asked him a question about regulatory arbitrage. He didn’t seem to know what that meant. At that point in time I lost all respect for him.

Anxiety and computer viruses

I think, and hope, that I’ve been cured of anxiety, which I was probably suffering from for over six years. It was a case of Murphy’s Law taken to its extreme. If anything can go wrong, it will, states the law, and in those six or seven years, I would subconsciously search for things that could possibly go wrong, and then worry about them. And worry about them so much that I would get paranoid.

Let me give you an example. Back in 2008, after a four-month spell of unemployment, I had signed up with a startup. Two days after I signed, which was three weeks before I was going to start work, I started worrying about the health of the startup founder, and what would happen to my career in case he happened to croak between then and my joining the company! It had been a major effort on my part to try and get back to finance, and that job was extremely important to me from a career signaling standpoint (it played a major role in my joining Goldman Sachs, subsequently, I think). So I started getting worried that if for some reason the founder died before I joined, that signaling wouldn’t happen! I worried about it for three days and broke my head about it, until sanity reigned.

This wasn’t a one-off. I would take ages to reply to emails because I would be paranoid that I had said something inappropriate. When I landed in Venice on vacation last year, my office blackberry didn’t get connected for an hour or so, and I thought that was because they had fired me while I was on vacation. It would be similar when I would look at my blackberry first thing in the morning after I woke up, and found no mails. I needed no real reason to worry about something. It was crazy.

When a virus attacks your computer, one of the ways in which it slows down the computer is by running “background processes”. These processes run in the background, independent of what you intend to do, but nevertheless take up so much of your computing power that it becomes extremely hard to function. Anxiety works pretty much the same way. Because there is always so much going on in your mind (most of it unintended, of course), a lot of your brain’s “computing power” is taken up in processing those unwanted thoughts (the brain, unfortunately, has no way of figuring out that those thoughts are unintended). And that leaves you with so much lesser mindspace to do what you want to do.

So you stop functioning. You stop being able to do as much as you were able to. Initially you don’t recognize this, until you bite of more than you could possibly chew a number of times in succession. And then, having failed to deliver on so many occasions, you lose confidence. And lesser confidence means more worry. Which means more background process. And means diminished mental ability. Things can spiral out of hand way too quickly.

I’ve been on anxiety medication for over seven months now, and the only times when I realize how bad things were are when I happen to miss a dose or two, and there is relapse. And having been through it, trust me, it is quite bad.

On the positive side, the impact a well-guided medication process (administered by an expert psychiatrist) can have on anxiety is also tremendous. For the six years I suffered, I had no clue that I was under a cloud of a clinically treatable condition. I didn’t know that it was only a virus that had attacked my CPU, which could be got rid off with sustained dosage of anti-virus, and I had instead thought my CPU itself was slowing down, maybe rusting (at the ripe old age of late twenties). After I started responding to my medication, I was delirious with happiness, with the realization that I hadn’t become dumb, after all.

It was sometime in March or April, I think, when I realized that my medication had come into effect, thus freeing up so much mind space, and I started feeling smart again. When I met the psychiatrist next, I told her, “I feel exactly the way I felt back in 2005 once again!”.

Project Thirty, Hippies and Capitalism

After getting out of Goldman Sachs (phew, now that I’m out, I can “out” myself. Was majorly stifling working for a company that stressed so much on “reputation” and stuff) two months back, I’ve put myself on a fourteen month long scholarship which I’ve titled as “Project Thirty”. As the title suggests, this scholarship will last till the day I turn thirty, which is in a little more than a year. There is no fixed amount of scholarship, but the funds are to be drawn out of the considerable savings I made having been a fat cat banker for a little over two years.

During the period of the scholarship, I’m forbidden to take up full-time employment. I am, however, permitted to pursue other money-making opportunities (as long as they don’t end up in my taking up a full time job). I’m setting myself up as a freelance quant consultant (right now the biggest pain point is it’s tough to explain to people what exactly I can do for them), and if things go well, that should provide some good supplementary income. However, the intention of this break is not to just take a shot at entrepreneurship, or explore non-linear opportunities for making money. It is fundamentally to do all those things that I’ve always wanted to do but never got down to doing during the first ninety percent of my twenties.

The Eureka moment happened some three-four months back, when I was reading some article on the internet about life expectancy. It was around the same time that I read the famous Steve Jobs speech, and I started thinking about what I’ve achieved in life so far. IIT, check. IIM, check. Brand name employers, check. Beautiful and intelligent wife, check. Some sort of local fame, check. I would be lying if I were to complain that I haven’t had a good life. However, several gaps remain. Found my calling in life, no. Stuck around in a steady job for an extended period of time, no. Made lots of money, not really. Traveled the world, not really. Wrote a book, no. Played for a band, no. And so it goes on.

It was around that time that I realized that it is not so bad to have regrets in life when you are twenty nine (which I’ll be next week). Thirty is still not too old, and you are still reasonably fit, and able to do all those things you’ve already wanted to do. What is not okay is to have regrets in life when you are fifty, or sixty. There is only so much of life ahead of you to make amends, and it could already be too late to do some of those things that you’ve always wanted to do but never gotten down to doing.

Project Thirty is the result a culmination of a lot of things. These thoughts. The fact that I’ve never really been happy in any of the high-paying high-pressure jobs I’ve been through. Stress. That though I’ve been married for a year now (today’s my anniversary), we still don’t plan to “start a family” for a while which gives leeway in terms of finances. That I haven’t yet really “found myself” and need to make an effort to do so.

So far, though, two months on, it has had mixed results. On the minus side (let’s quickly put that away) there’s been a lot of NED. I think I end up wasting too much time doing nothing (ok I’m not sure I should call that a “waste” but still I don’t feel good at the end of it). Then, a lot of writing which I want to get published in the mainstream media is lying on the hard disk of my desktop, as I haven’t really mustered the confidence to reach out to editors and send these out. I’ve identified one client for my quant consulting shop, but again haven’t been confident enough to approach them.

On the plus side, though, I have got a lot of writing done. I have started learning to play the violin again, this time in Western Classical style, and so far I’ve been really enjoying it. I’m associated with a public policy think tank and am doing some work for it. I gave (what I think is  ) a rather well-received speech on auto rickshaw economics. For the first time in my life I set a quiz which didn’t receive much flak. Watched cricket and football. Traveled a bit (a week in Turkey). And overall I’ve had a lot of peace of mind.

So what are the hippies and capitalism doing in the title of this post? Essentially given my current situation I don’ get why hippies are anti-capitalist. Because capitalism is precisely the reason I’m able to afford a sort of “hippie life” (using Aadisht’s definition) currently. Had I been living in a communist country, under the “from each according to his abilities” paradigm, I wouldn’t have been allowed to take this time off!