All the Biggest Tombstones: M&A, ETF, Mailbag

I'm Maria Konnikova.

And of course, we'll be talking about the election, too. Listen to Risky Business wherever you get your podcasts.

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We're going to talk about private asset ETFs. And then we're going to do a mailbag. Mailbag. Mailbag.

M&A fees.

regulatory scrutiny is like the sort of big headline thing, but other reasons too. It's the golden age of antitrust. It's the golden age of antitrust. And so, like some big companies, sign big deals, and then they don't close. And if you're a banker whose fee is contingent on closing, then you don't get the fee, and then you're really sad.

And banks will say, if you get a breakup fee, we want a chunk of it. And both of those things, getting a chunk of the breakup fee and getting paid on announcement are like more common now. And they make up a greater percentage now than they used to. So it's like, now. banks are getting like an aggregate 20 or 25% of their fees on signing, as opposed to like five-ish percent a few years ago.

And they are asking for like a quarter of the breakup fee.

A lot of lawyers, like bankers, get paid success fees. There's a reason why bankers get paid success fees, right? So success fee, like when the deal closes. In, like a classic sell side assignment, if you're selling a company and they're getting $10 billion for themselves, you're like, I want half a percent of that. And they're like, yeah, it's like free money.

It's like all this money gushing in the door. You can have half a percent of it. And like, that's a lot of money, right? When you are a sell side banker and you get paid only on deal closing, you are effectively getting paid by someone else, right? The client who hires you is like, eh, it's not my money.

Like the buyer is paying that money anyway. We'll be gone. You know, we'll be great. You know, we're getting bought out at a premium. So we don't care about giving you half a percent of that.

Right. And so if you're a banker, you can charge a bigger fee if it's entirely contingent, if it's like, you pay no money unless you get bought out. Right. So it's an attractive proposition. It's just like if more deals don't close, then, like your business, gets very risky.

And like, sometimes, you don't make any money. You know, lawyers traditionally get paid much more reliably. They bill by the hour. Even law firms that charge success fees, if a deal doesn't close, they usually get paid something anyway. You know, whereas, like bankers, traditionally got less of that.

And the lawyers like the way they get paid. And there have been criticisms from like lawyers and judges of how bankers get paid, because, like if you're a banker and you get paid only on completing a deal, you have incentives to make sure that deals get done. Right. The client is like, I don't know if this is actually a good idea. Do we really want to sell?

Like we might be better off on our own. There is a stereotype that the banker is like, no, you got to sell. And this is not really true. And, like a trusted investment banker, knows when to say no and whatever. But it's like some amount of truth to this, where, like the investment banker is always incentivized to do a deal, whereas someone else might sometimes correctly advise the company, like do nothing.

Well, I don't know how you feel, but I was very excited.

They said that they were going to go for an IPO instead. But Bloomberg reported that Wiz decided it could ultimately be worth more as a public company, but also concerns about the potential for a protracted regulatory approval process also encouraged it to go this route as well. So, I mean, twenty three billion dollars is hard to walk away from. I think the CEO called it a humbling offer. But I mean, if the deal's probably going to come under scrutiny and probably won't close, maybe it's not worth the.

And so the money sounds great, but you might say, you know, this is like a mirage of getting all this money. I mean, from the banker's perspective, too, the deals that don't close are the ones that in some ways take the most work. Right. You sign the deal and that's like this antitrust investigation. You're like, sort of, you know, working to integrate the companies and also like respond to regulatory concerns.

It's a lot of work and then it doesn't close and you don't get.

The bankers are fine. Like what's happening is they're.

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I'm Maria Konnikova.

And of course, we'll be talking about the election too. Listen to Risky Business wherever you get your podcasts.

I'm not going to tell you how, but I'm going to talk to you about different attempts to do that. And you're going to opine on it. probably. There's all these proxy sort of things. It sort of is similar to when there weren't spot Bitcoin or Bitcoin futures ETFs.

So you would have these ETFs that were launched, that held a bunch of Bitcoin miners and things such as that. Those exist right now. Then there was this filing for the Crane Shares Man Liquid Private Equity Index ETF, which would basically seek to be a, quote, proxy for private equity performance and risk exposures, by focusing on small and mid-cap stocks that have characteristics similar to companies in private equity buyout funds. And I thought that was interesting because it's not buying shares of publicly listed private equity firms. There's a few ETFs that do that right now.

But it's basically trying to mimic the portfolio of.

And then you've kind of recreated a private equity portfolio. That is true at a very high level. And then it abstracts away from whatever operational improvements they make, whatever clever financial engineering they do. It takes away all of the stuff they pride themselves on doing. But the basic thing of buying some companies with cash flows and borrowing against them, yeah, you can do that on your own.

The idea is the ETF can do that on its own. I don't know if they actually do the leverage part as much as... But people started to publicly trade their vehicles to try to mimic private equity returns by doing that kind of trade. Yeah. It is unsatisfying, though.

One reason it's unsatisfying is that when you talk about private assets being a hot asset class, one thing that means is private credit is very hot. But when we talk about people who want to go to parties and say that they own blah, blah, blah, the thing they want to own is SpaceX or Stripe. It's these hot startups. Taking a slice of mid-cap companies. is not that.

There's no proxy for very fast-growing private tech space startups. This is a proxy for a middle market private equity fund, which is not quite the sexy thing that you're trying to sell. Yeah. Part of.

That's also kind of unsatisfying. I mean, you have an ETF. It does hold private assets. They can only be 15% of the funds, and then you kind of dilute the rest with equities or cash or something. I love the.

That's very amateurish financial engineering, but you do that. You short 85% as much of an S&P ETF, and there you are.

It's also weird, by the way, because the ETF structure is like. there are legal limits, but there's also. the point of the ETF structure is that you can create and redeem it in kind, right? Or you can create and redeem it anyway, right? If the price of the ETF is not in line with the value of the underlying assets, then some arbitrageur can buy the ETF and sell the assets or vice versa to bring the price back in line.

It's much harder to do with private assets that don't trade. Even away from the SEC rules, you need to set up some mechanism to keep the price in line. Because the easy way to do a private asset ETF more or less is, and we've talked about it a bunch of times, the Destiny Tech 100 Fund, right? The easy way to do it is you have a product that trades. that is a closed-end fund that owns private assets, right?

The whole problem with that is that the trading price of the product doesn't have to have anything to do with the value of the underlying assets. So Destiny traded at a huge premium in a way that makes it feel not like a great proxy for the assets, because you're not buying SpaceX, you're buying this huge premium.

Yeah, I was.

They're not just lines on the screen? Right, right. A company, all sorts of stuff, but you can completely abstract it to a line that trades every millisecond, right? Yeah. So the liquidity mismatch point is so strange.

What people worry about with bond funds, and it's really much more about mutual funds than ETFs, but people lump them together, people worry about, it's not the liquidity of the wrapper versus the liquidity of the underlying, it's. sometimes you want to take the underlying out of the wrapper, and that is hard, right? You're used to liquidly trading the ETF, and then you get the bonds, and oh, these bonds don't trade. With a company, that's not a problem, because you're not taking assets out of the company. Right.

With a closed-end fund, it's not a problem, because you're not taking assets out of the closed-end fund. The problem is, as with a company, it can trade at a price that doesn't reflect the value of the underlying assets. I would say. the other problem with this whole idea is that it's one thing to be like, people want to buy private assets, so we have to find a convenient wrapper to sell these private assets to retail investors, but where do you get the private assets? There's plenty of private assets in the world, right?

There's plenty of people who will sell you a private investment, but there are fewer people who will sell you SpaceX, right? There are fewer people who will sell you Stripe. The private assets that people really want are allocated. They're owned fairly tightly by big investors who, one, might not want to sell, and two, the company tries to keep them close, right? Stripe tries very hard to prevent its investors from selling any stock to Destiny.

I was going to say, BlackRock.

And so, to the extent this works mechanically, it's annoying for the issuers. And then the question is, if you have this product, it's easier for you to get bad private companies to be like, oh, sure, I'll sell you 100 million shares for your thing. You talk about BlackRock wanting to index the private markets. If you could get a true index slice of the private markets, first of all, that might be bad, right? What you really want is the good companies.

But the real worry is you would end up with not an index of all the companies, but the bad ones that are willing to be involved in your index. And that might be even worse than just... Yeah, so you want your blue chip.

that much, right? Would SpaceX go public?

Right. I mean, if you had an index of private assets, could you just do?

So you hold a derivative on the underlying asset, right? You get some hedge fund, bank, speculator to write you a swap on the value of SpaceX shares, and then you put that in the thing, and that's your proxy. That sounds like it could happen pretty soon. Yeah. It's tricky, right?

First of all, the SEC has rules about derivatives and funds, but again, it can be done, right? Bitcoin futures ETFs did it. Secondly, you have to have someone write you that swap and, be short, SpaceX or Stripe, which is a risky bet. Now, somebody who writes you that swap might be able to hedge it by owning the underlying shares, but that's a risky proposition too. You don't know who that person is, and their contracts with the company might ban them from hedging.

by writing swaps. You have pricing problems, right? Because the forward contracts. for some of these private companies, it's like when they go public, you deliver the shares, and so there's ultimately a price for the forward contract. But how do you market to market before they go public?

with an ETF? You need a daily market price, and it's hard to mark that thing to market without actual trading. With swaps, it's not obvious that some of these things will ever go public. I don't know. You could do it that way, but you have a lot of.

This podcast is supported by Apollo Global Management. When it comes to building and financing stronger businesses, Apollo turns some of the world's most complex challenges into growth opportunities. Apollo's customized capital solutions help drive innovation and growth, turning the great businesses of today into leaders of tomorrow. As one of the world's largest alternative asset managers, Apollo is helping to fuel the real economy by generating investment-grade credit, helping to fill gaps in America's financial ecosystem, and providing greater access to more resilient and diverse pools of capital. By providing companies with access to flexible financing solutions and partnering with management teams to help grow their businesses, Apollo is there every step of the way to drive positive outcomes for companies and power economic growth.

Apollo, investing in tomorrow, today. Learn more at Apollo.com

I'm Maria Konnikova. And I'm Nate Silver. And our new podcast, Risky Business, is a show about making better decisions. We're both journalists whom we light as poker players, and that's the lens we're going to use to approach this entire show. We're going to be discussing everything from high stakes poker to personal questions.

Like whether I should call a plumber or fix my shower myself. And of course, we'll be talking about the election, too. Listen to Risky Business wherever you get your podcasts.

Yeah, we got really.

podcast. We're going.

We were talking about Ron Barron last week, and Andrew wrote, I was catching up with Friday's show, listening to the general trend of active management getting squeezed on their fees. It reminded me of a conversation I had in the sauna with this guy who was in town for the Barron Fund's annual meeting. He ran money for an institution and told me he kept some money in their funds just for the entertainment at their annual meeting. Look at the bands that get to perform at their meetings. Fleetwood Mac, Justin Timberlake, lots of others.

I thought that type of thing would have been eliminated years ago, but he said you just have to have any amount of money invested and you get an invite. That is incredible. I love that. That's like a real model in investment management,

Because like he's putting his client's money into Barron so that he can go to the Justin Timberlake show. But like you read about, like private equity funds have, like LP advisory councils, like sort of like a board of directors or like a private equity fund, like, you know, 10 of their big investors will be on some sort of board where, like every quarter, they review the investments and like they chat with the GP, but they have those meetings. and like vacation destinations and like those meetings are fun, right? If you're like the like state treasurer or whatever, you can like go to, like a really ritzy resort for a weekend, to like be on your advisory council and like then maybe you allocate.

And one of the conclusions that you reached in the newsletter this week was that the parties are less fun because traditional stock picking is going.

The other thing, you know, in this vein, a famous fact about finance is like some number of investment firms either like started as or like, are marketed by email newsletters. And like Bridgewater is the most famous one. Like Bridgewater sort of starts as an investment newsletter. And people are like, oh, your newsletter is so good. I'd like to give you money.

And now, like they have the most money of any hedge fund. They sort of say, well, you know, some investors allocate to Bridgewater, not because the returns are so great, but because they like getting Bridgewater's research, right? You know, it's more boring than like going to the Justin Timberlake party. But again, it's like you're providing some benefit other than like managing the money in the best way. And people are willing to give you some of the money in exchange for, like nice aura around all the services you provide.

And they hope that you'll.

Is poker staking a security? Do you want to read this email?

By that, I mean that a person or a group of people provide some or all of the money the poker player is gambling with, parentheses, either as the entry fee to a tournament or the bankroll they use to play in cash games. And in return, they get some agreed upon percentage of the winnings, if there are any. There are even sites where you can buy and sell stakes for tournaments. Do poker stakes pass the Howey test? Are these staking websites unregistered security exchanges?

So I was talking to people.

And this question is a crypto question. Do you feel like they're trying to trick you? No, no. I'm not sure that our anonymous reader thinks it's a crypto question. It's just like it is a crypto question.

So here's the deal. There's an ancient Supreme Court case called Howey, where the Supreme Court said that a security, subject to SEC securities regulation, is an investment of money in a common enterprise with profits to come solely from the efforts of others. And so for most of my career, if you ask what is a security, people would be like, yeah, it's like a stock or a bond. And most SEC cases are about stocks and bonds. Not all, but most.

And that was like the focus of securities. And so you had this world where people would offer stocks and bonds and the SEC would regulate it. And you had this world of people who did other like investment opportunities, other, like, you know, ways to make money. People trade baseball cards, you know, like people have beanie babies. And all this stuff was like clearly not a security and like no one would think it was a security.

And then crypto came along and crypto was like, we're going to start companies. We're going to raise hundreds of millions of dollars from public offerings. We're going to use that money to do businesses and promise people a share of the profit of that business. And we're going to all call it crypto on the blockchain. And it's not going to be a security because it's not a stock or a bond.

And we're going to not be regulated and we're going to steal half of the money, right? Yeah. And so the SEC responded to that slowly by saying, well, this is all securities, right? This all passes the Howey test. This is an investment of money in a common enterprise with profits to come solely from the efforts of others.

And so it's all the security. and this is like hotly litigated and there's a lot of fighting over, like particular cases, but like that's what the SEC thinks. But one result of that is like the SEC then like kind of goes back and looks at everything else that like no one would have thought was a security 20 years ago. And it was like, oh, there's a lot of security. Like.

that kind of also looks like a crypto token. I quote sometimes Hester Pierce, who's a SEC commissioner, like the SEC basically like, approved some crypto company for doing like gift cards for private jet travel or something. And Hester Pierce said in a speech, like, if those tokens are securities, then you can't distinguish them from any other sort of gift card. that gives a Starbucks gift card of security. Right.

And like, there's like now, kind of almost like a live question, as a Starbucks gift card of security. So anyway, poker, like if you're investing in someone's poker business, yeah, it's clearly a security. It just is. We looked online and there's some law review articles being like, yeah, this is obviously security. Is there any history of enforcement?

In 2017, the SEC looked into one of these staking platforms and the staking platform actually sued the SEC to make them drop their case and say, we're not a security. That didn't get litigated. The SEC moved on and dropped the case. It's 2017.. Like, I think, the 2024 SEC, one, might not bother because they're busy with all the crypto lawsuits.

But two, if they did bother, they'd be like, this is clearly a security. What are you doing here? So I don't know, I might be missing something in the legal analysis that poker staking sites are currently doing. But yeah, this is a thing that the current SEC would probably think is a security.

Because if you are, then you have to register with the SEC, blah, blah, blah. If you're not, if you're only doing it to certain kinds of credit investors, then it's less of a problem. So maybe that's how poker staking works, but it's a little risky.

Then you just have a replacement market for portfolio managers, like long snappers. in the NFL. There's always exactly 32 professional long snappers, because teams all carry exactly one long snapper, I think. Imagine being the 33rd best long snapper in the world. There's like camps for long snappers.

Yeah. Where they train you to be a long snapper. And if you're the 33rd best in the world, you're like, yeah, you know.

If you think about like the big trades that, like these, like multi-strategy funds, do, it's things like index rebalancing, where they like buy all the stocks before they get put into the index, and then they sell them to the index funds. Or it's like the basis trade, where they buy treasury bonds and sell treasury futures, and like they're buying the bonds from treasury essentially, and they're selling the futures to, like investment managers who, for whatever reason, don't want to own the bonds themselves. All of this stuff is like service provision. It's like intermediation. It's like liquidity provision.

It's like some sort of like business, right? It's not like mystical skill of like picking the stocks that'll go up. It's doing work on behalf of people, and then you charge them money, and they pay you. So I think, if you have that model, this question is like a little easier to understand, right? Like how much alpha is there?

It's not alpha. It's like, you know, fees for services. And so. like, if you find a new market where it would be valuable to provide liquidity in it, then like there's more alpha in the world, and like you can do some of that, and you can get paid, right? And so like the question of like how do you train new portfolio managers, like again, like when I hear this description, I think of like what banks used to do before they got, like more risk-averse and more capital-regulated.

Like when I worked at a bank, it's like, yeah, like let's find a new, like customer base that we can sell new kinds of derivatives to, right? And like you sit in the lab, and you cook up derivatives, and you try to sell them. I think there's like something like that at multi-strategy hedge funds, where it's like you sit in the lab, and you think up, not like what alpha can we extract from the market, but like what's the need that people have? Like, what's the demand for a product that we can intermediate and then make money on? So I think that's the answer, right?

Like. and I think the other part of the answer is like, if you're doing that, one thing you're doing is making financial markets more efficient, right? Like. when you talk to a lot of these multi-strategy hedge funds, you're like what are you doing for society besides making a lot of money? And the answer is you're making markets more efficient, right?

When you make markets more efficient, there's more trading, and, like, you're capturing a smaller slice of that trading because the market's more efficient, but, like, you're capturing a smaller slice of a bigger pie because you've made the market more attractive, so more people trade. So, like, is there finite alpha? No, like. if you like, make the market more efficient, then, like, there'll be a bigger market,

You also. Noble and worthy. Right, like. Yeah.

That was so fun. Send us more mail at moneypod at bloomberg.net.

And that was the Money Stuff Podcast. I'm Matt Levine. And I'm Katie Greifeld.

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Nate Silver.