Just How Big (And Powerful) Is Blackrock?

Blackrock is the world’s largest shareholder you’ve never heard of – or maybe you have, if you’re reading this blog. As we all know, this blog’s readership is the result of aggressive self-selection by the savviest amongst us…

Anyway, a few days ago, an article on The NYT by Susanne Craig highlighted this behemoth. An excerpt (emphasis, mine): 

BlackRock’s size is mind-boggling. With almost $4 trillion under management, it is, according to a recent University of Michigan study, the single largest shareholder in one of every five United States companies. It manages money from pension funds and endowments as well as retail investors, controls large stakes in companies like JPMorgan Chase, Wal-Mart and Chevron and owns 5 percent or more of roughly 40 percent of all publicly traded companies in the country.

These investments give BlackRock tremendous influence, particularly now, during proxy season. At this time of year, public companies hold annual meetings, and shareholders vote on executive pay and elect corporate directors. Inside BlackRock, the small group of analysts led by Ms. Edkins meets every morning for about an hour, hashing out how BlackRock will vote its clients’ shares in hundreds of contests, zeroing in on directors they feel have been around too long, or ones who they think are overpaying executives.

For more about how it wields this power (or doesn’t) and how varies parties want it to do more, you can read the full piece here

A New Way To Pay Hedge Fund Managers

Recently, I stumbled on Barry Ritholtz’s blog “The Big Picture” and experienced both admiration and a serious case of “how the heck does he do it?”. [You may want to check out the blog and then subscribe to his daily newsletter. He covers business news, but with a heavy emphasis on finance.]

Something from his newsletter (yesterday’s edition) that I found interesting, and wanted to share, was his proposal to more closely align hedge fund managers’ compensation to clients’ returns: Compensation based on Alpha, not Beta (this totally took me back to my FIN1 and FIN2 days)  

Which brings us to hedge funds. As we discussed over the weekend (A hedge fund for you and me? The best move is to take a pass), we discussed how much of the investing profits were captured by fund managers for themselves. It is a similar situation in that they are taking performance pay for Beta, not Alpha.

A better fee structure? Replace 2% + 20% current structure with a 1% + 33% of Alpha.

How would that work? Well, the 2% fee gets cut in half, for the simple reason that 2% fee on million dollars plus is excessive. But the real change is when it comes to the performance fee/bonus. That 20% of gains as of late has not been performance, its been only Beta. If their benchmark is up 20% and the manager is up 15%, there is precisely zero Alpha generated. So why should the manager get a bonus or a performance fee? They under-performed.

Instead, I propose a 33% of Alpha as a performance fee. The manager gets a bonus performance fee ONLY IF THEY CREATE EXCESS ALPHA OVER BETA — only on the percentage of gains over the benchmark.

Lets use a simple example: Two hedge fund managers run funds. Assume the market (their benchmark is the S&P500) is up 10%. Manager 1 (Fund ABC) is up 20%, while manager 2 (Fund XYZ) is up 10%. We will use a million dollar fund as a nice round number.

Fund ABC:  FUND +20%, SPX +10%

Fund ABC sees the manager handily out performing the market. The fee comparisons are below.

Example 1:

2 & 20:   $20,000 + $40,000
(Twenty thousand dollars is the two percent management fee; forty thousand is twenty percent of the two hundred thousand dollar gain. Half of which is Beta, half of which is truly Alpha.

1 & 33:  $10,000 + $33,000
(ten thousand dollars is the one percent management fee; thirty-three thousand is thirty percent of the one hundred thousand dollar Alpha gain.

In our example of the out-performing manager, 2&20 generates a 6% fee versus 4.3% fee for the 1&33 structure.

Example 2:
Fund XYZ: FUND +10%, SPX +20%

Fund XYZ sees the manager under perform the market. The fee comparison is:

2 & 20: $20,000 + $20,000
(Twenty thousand dollars is the two percent management fee; twenty thousand dollars is twenty percent of the hundred thousand dollar gain.

1 & 33: $10,000 + $0
(ten thousand dollars is the one percent management fee; zero dollars is thirty three percent of the gain above the markets.

In our example of the under-performing manager, 2&20 generates a 4% fee versus 1% fee for the 1&33 structure.

In both examples, managers are being wildly overpaid for Beta; in the other, they are receiving a bonus based in part on Alphageneration. Hence, their compensation is more aligned with the client’s.

Note that fund manager of ABC makes less under 1 +33 when they generate Alpha — $43k versus $60k. But look at the enormous savings that come from an underperforming manager: Instead of making $60k for partial Beta generation, he makes $10k — a quarter of the fee generation for partial Beta.

I don’t expect fund managers will rush out to embrace this model — unless the institutional players, trustees, and endowments demand it.

Bloomberg to Provide Curated Twitter Feeds To Wall Street

In a move the underscores Twitter’s increasing power and use in breaking material company news, Wall Street professionals, most of whom use Bloomberg Terminals for real-time updates on market data and news, will now get a curated Twitter feed, courtesy of Bloomberg (the company, not NYC’s Mayor).

As William Alden writes on the NYT’s DealBook,

Bloomberg’s new service shows tweets sorted by company and topic, allowing users to search by key word and to set up alerts for when a particular company is getting an unusual amount of attention.

“We were getting requests from customers who were seeing news they wanted to be aware of on Twitter,” said Brian Rooney, core products manager for news at Bloomberg, who said that compliance officers from Wall Street banks had expressed an interest in allowing employees to see tweets.

But Mr. Rooney added: “This isn’t where you monitor The Onion or Ashton Kutcher.”

Rather, Bloomberg will show tweets from companies, chief executives and other news-makers, in addition to certain economists and financial bloggers. Mr. Rooney cited the economist Nouriel Roubini and Paul Kedrosky, the investor and blogger, as examples.

Interesting timing, coming as it does, in the same week that the SEC said breaking material company news via Social Media was OK.

But, how will Bloomberg decide whose feeds to include and whose to exclude, once they’ve worked their way through obvious ones like CEOs of public companies, hedge funds and PE firms?

Perhaps being on or off that list becomes yet another arbiter of your power and status in the Financial World. 

PS: Talking about Twitter, I just gained my 100th follower on Twitter today. For comparison purposes, Justin Bieber has 37 million followers, President Barack Obama clocks in at 29 million and Bill Gates comes in at 10.6 million. Consider becoming part of my next 100 followers at @BminusC if you’re not already enjoying my ultra-insightful tweets there. 

Bitcoins Explained (Kind Of) – In 60 Seconds

And a Washington Post article by Brad Plumer (which, in turn, links to three other articles on this subject) should make you an expert in a few short minutes.


Women in Finance: HSBC USA’s Irene Dorner

Perhaps in response to the spotlight being shined on corporate America thanks to Sheryl Sandberg’s new book and “Lean In” philosophy, or perhaps independently, The New York Times has been running articles on women in finance over the last few days, and they all make for interesting reading.

Today’s piece by Andrew Ross Sorkin profiles HSBC USA’s Irene Dorner. 

An excerpt:

But Ms. Dorner, too, says women on Wall Street need to advocate more forcefully for themselves. In many cases, she says, the problem of the glass ceiling is matched by what she calls the “sticky floor” — that is, women who remain in lower-tier jobs because they don’t proactively try to climb the corporate ladder.

“Women do funny things,” Ms. Dorner said. “They do things like work very hard and expect to be noticed for it — and they’re not, because it doesn’t work like that.”

Instead, Ms. Dorner argues that women need to take a page from their counterparts in pushing their own agenda and advancement. “I don’t think we need to suddenly flip and all be acting in a male way,” Ms. Dorner said, “but you can learn something from male behavior.”

“If you offer a woman a professional management opportunity or promotion — and I’ve had this happen to me — the first thing they do is produce a long list of pros and cons: ‘Oh, dear, what do I have to do with child care? I must and go tell my husband,’ “ she said. “If you offer it to a guy, he’ll just say: ‘Well, thank you very much. I’ll do the best I can.’ ”

Go read the full piece here

Goldman Sachs, 1999 and the eToys IPO

etoys

Companies use IPOs to raise money by selling shares to the public at a certain price. 

But one of the things about IPOs is that companies don’t (can’t?) sell all of the shares they want to sell to the public directly on Day 1, when the company “goes public”.

Instead, the underwriters, the ones that help said companies go public, take a chunk of shares being offered and divvy  them up amongst their prized clients at the offering or list price.

But as soon as the shares go on the market, on Day 1, investor demand can drive up the share price (or down too, as we will discuss later). The general public believes that if a company’s stock “pops” on opening day and closes at 200% or 300% of the list price, it indicates a “hot” stock. 

Perhaps…but from the perspective of the company that is going public (not its officers though), the higher the pop, the worse the offering price. Let us use a quick example to illustrate this:

1. Company offers to sell 1000 shares.

2. The underwriters advise the company, after a investor roadshow designed to gauge interest, to set the list price at $10.

3. The company will therefore raise $10,000.

4. But on Day 1 of the IPO, if the shares close at $30, the company would have still only raised $10,000. The difference, “$30 – $10″ times 1000 = $20,000 went to someone else. 

5. Had the shares been priced at $30 to begin with, the company would have raised $20,000 more.

Therefore, it is very important that the list price be set correctly.

And that’s where the underwriters come in…presumably, they have the expertise and the experience to advise the company going public on an appropriate list price.

And since the underwriters’ compensation is a % of the gross proceeds (excerpt from a PWC report on the costs of IPOs below), you would think that the list price is set as high as can be supported by the market. In other words, the incentive alignment is such that the underwriters profit from high prices.

PWC-IPO

In the case of Goldman Sachs, at least in the case of the 1999 IPO for eToys, strangely, that does not appear to be the case.

Documents unearthed by Joe Nocera at the NYT suggest this (pay attention to the 2nd paragraph):

What they clearly show is that Goldman knew exactly what it was doing when it underpriced the eToys I.P.O. — and many others as well. (According to the lawsuit, Fitt led around a dozen underwritings in 1999, several of which were also woefully underpriced.) Taken in their entirety, the e-mails and internal reports show Goldman took advantage of naïve Internet start-ups to fatten its own bottom line.

Goldman carefully calculated the first-day gains reaped by its investment clients. After compiling the numbers in something it called a trade-up report, the Goldman sales force would call on clients, show them how much they had made from Goldman’s I.P.O.’s and demand that they reward Goldman with increased business. It was not unusual for Goldman sales representatives to ask that 30 to 50 percent of the first-day profits be returned to Goldman via commissions, according to depositions given in the case.

And this matters because Goldman Sachs presumably set the list or offering price at $20 but on Day 1, the shares closed at $77. So priced right, instead of the $164 million the company raised, it could have raised ~ $631 million. so where did some of that “missing” $450+ million go? Into Goldman Sachs’ clients pockets – which the bank graciously requested a cut of…

The full article makes for an interesting read.

But that was 1999 and this is 2013, so is this still relevant? I think so, because

a. Underwriters still seem to wield an outsize influence on the list price.

A recent IPO that was famously mis-priced is Facebook, last year. In that case though, it appears that the stock was overpriced…Initially the underwriters seemed to be doing Facebook a favor and themselves a disservice by agreeing to only a 1.1% slice of the proceeds, in exchange for the opportunity to be associated with a red hot company, but the subsequent slide (to, what, $17, from $38?) seems to suggest that maximizing the slice of the proceeds may have played a large role in the mis-pricing. 

b. Sweetheart pre-IPO share allocation still seems de rigeur

Its not just Goldman Sachs seemingly egregious behavior above, but the process of allocating shares by the investment banks to their favored clients doesn’t really sound right. Does it? Admittedly, as part of the IPO underwriting process, the still-private company can do what it wants with its shares, but this seems like a distortion and an anachronism of sorts. If the underwriters are already getting their fees, what explains this practice?

c. Companies are being screwed. 

Especially when the IPOs are underpriced, the company that wanted to do an IPO to raise capital in the first place is not capturing a portion of the value that its IPO is creating. 

Perhaps the solution to all three problems is to set the underwriting fees as a % of the stock’s closing price 3 months after the IPO, barring any events outside of anyone’s control. But if the underwriting business functions as an oligopoly, who will break ranks first? 

 

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