Thursday, 25 July 2013

Welby and Wonga; Why APR is a meaningless number for small short term loans.

APR; Annual Percentage Rate. In theory, a useful measure to compare the cost of a loan. In practice almost meaningless.

What is a reasonable cost for a short term loan? 
Ignoring the term (length) of the borrowing, for a company to lend money it incurs administrative costs, such as transferring money, keeping records, performing a credit check, chasing up payments, running the website, etc.

This is before considering the cost of capital (ie how much money costs Wonga to borrow) or the likelihood of borrower default (ie the chance that a borrower will not repay the loan).

If one goes to Wonga's website, and looks at the cost of  borrowing just £1 for 1 day, the fees and interest are £5.57.

Now if you were a moron you would conclude that this was an outrage because the APR is;


OR you would wake up and realize that it is an utterly stupid measure.

There is an absolute cost of lending money and performing transactions that has no relation to the size of the loan, is £5 for a loan really outrageous?

Welby would perhaps say that a credit card APR is more "fair", that would mean that the cost of borrowing £1 overnight would be 0.05p ie less than one twentyth of a penny. Nobody in their right mind could think that you could make a loan and record a transaction, check a credit score and transfer money for that price.

I could go into more detail, obviously Wonga lend to people with poor credit quality, that means they are exposed to high number of people that will default on their loan, and as such they need to charge more to just breakeven. Even if 5% of customers failed to repay a one week loan, that would necessitate an APR of over 1000%, before you consider any administration costs, or heaven forbid the cost of capital or the firm's profit.

I hope that people will stop being "outraged" by numbers that are meaningless and inappropriate.

Wednesday, 24 July 2013

"Layering", Spoofing, Spiving & "false" market orders

The FCA recently fined a trader for "layering" ; fca pdf link

Details are incredibly important when discussing the mechanisms of trading.

A brief synopsis of Mr Coscia's strategy; to buy a contract, he'd place a small bid at the best bid, and simultaneous a larger sell order above the best offer, then he'd place further sell orders in the order book above the best offer, when he got filled on the bid he'd pull his sell orders.

In essence the charge is that he is manipulating the order book and giving a false impression of the "real" demand and supply.

As Mr Coscia’s large orders were so unlikely to be executed (due to their short 
resting time on the order book and inevitable cancellation once the small order 
was executed or they were partially executed) they created false impressions of 
liquidity rather than genuine market supply and demand.

The market participants who were most likely to trade with Mr Coscia and be 
impacted by his trading strategy were HFT market participants or traders using 
algorithmic and/ or automated systems rather than manual traders.

At least one significant market participant withdrew from ICE during the Relevant 
Period directly as a result of Mr Coscia’s trading pattern which reduced liquidity 
for other market participants as well as resulting in the loss of trading 

 I have a serious problem with this sort of charge. An order is an order, you have no obligation to leave it in the market for a certain length of time. The reason that other market participants like resting orders is because they provide the opportunity for profit for other traders.

For example a large and stationary bid is a great opportunity for "pennying", resting or leaning on. say a trader put in an order to pay 51.50 for 3000, and the order book is 3000 x 51.50 / 51.60 x 100. This allows other traders to bid 51.51, when they get filled they have almost a guaranteed stop loss of 0.01 and can offer out the stock they've picked up at 51.60, ie to make 9c profit only risking 1c.

The other way to see the cost of this latency, is to imagine that you had to leave your order for a long period of time, you'd suffer from a serious amount of adverse selection.

Anyone placing an order whether they "want" it to be filled or not, is taking risk. It makes no difference whether you trade with a "spoof" order or a "real" order the transaction is the same.

Market participants that are trading on the information in the order book are not liquidity providing. If when you see a large sell order you are "spoofed" into selling on the bid, then you are taking liquidity out of the market, I don't think Warren Buffett is there smashing the bid in KO every time he sees a thousand lot offered up two ticks above the best offer. If anything spoof orders can only help long term investors and retail traders as they provide cover for their resting orders and provide additional bid and offers that they may agress against.

Friday, 24 May 2013


The Conservative party appears to want to fight a civil war.

I think this analysis is interesting;

Mr Ganesh makes an interesting point; that the modernizers in the Conservative party were right, that the reforms were not enough. He suggests that by making austerity such an integral part of the election campaign the Conservatives did the right thing in the medium term, but that it has hurt them in the polls.

I disagree.

They did play up the tough stance they were going to take.  Budgets were to be "slashed", "swingeing cuts", blood curdling calls for swinging and axe, etc.

I didn't understand it at the time, and I still don't. Because there have never been any plans to do anything as radical as that. The budgets that Osborne wrote kept spending flat in real terms, they just didn't increase at the boom era rate that Labour had been planning, and hoped to close the budget deficit when tax income increased during the recovery.

That plan has failed.

The euro crisis has delayed the recovery, there has been no rise in tax revenues, and we therefore still have a large budget deficit.

Now they have a terrible mismatch between the rhetoric and the reality. The public believe that spending has been brutally cut, yet the reality is that it is higher in real terms than two years ago.

Every piece of negative economic data is evidence that the cuts have hurt the economy, and every time public services don't live up to expectation it can be blamed on cuts to their budgets.

The problem is that Osborne has left the Conservatives without any achievement for all of this, the budget deficit is still gaping. It is absolutely the worst of all worlds, they have the reputational damage of being the party to have slashed services, but are unable to claim any particular achievement.

I think the political analysis of the party's reform is still being viewed through a 'third way' Blairite prism. That the party that sits on the centre ground wins the most votes, because they win the votes on their side plus the centre they now occupy. I have a strong hunch that this actually doesn't work for the Conservative party. I don't think the Tory brand is popular enough to actually win under those conditions.

If you ran an election with identical personalities and policies for both the Labour and Conservative party, I think Labour would win a hefty victory. For the Conservative party to win an election, they'll need to actually want to change the country, rather than just administer it with a New Labour + 1degree to the right policy booklet.

Osborne has been the biggest let down. His budgets have been tremendously Brownite, tweaking, tampering and trying to score headline victories without really doing much. They just aren't likeable enough to win like that.

Friday, 3 May 2013

Why Austerity?

AusterityUK and AusterityEU are two different animals.

They often get lumped together although they are very different.

Peripherals really only have a few choices;
1) "austerity" - where they show some budget constraint and agree to try to close their budget deficit in the short to medium term, with the implicit financial support of Germany and support of their banking system from EU institutions.
2) default/restructuring with or without euro exit
3) euro exit and devaluation (which is a de facto default)

To be clear, a country like Spain or Italy already have a bond market strike. 

The market is not willing to loan money to these countries without there being implicit backstops and ECB support. 

Germany allows ECB and EU support under the condition that there is fiscal constraint. People can argue whether Germany's policy is correct or not, but unless you pay taxes in Germany and are a voter you really have little right to comment.

Many commentators say austerity is failing, and that peripherals should take a different course. That is easy to say, but meaningless.

They refuse to be explicit on the alternative given the constraints. ie. closed bond markets and German finance on conditions of restraint. If politically they are unwilling to leave the euro or restructure, then there really is no other option.

To argue that Germany should agree to fiscal transfers regardless is either naive or dishonest. For fiscal transfers to have any legitimacy there has to be democratic support in both countries. It also means giving up fiscal sovereignty. 

Unless peripherals are willing to have their budgets agreed at an EU level and impose reforms to bring them into line with Germany then  pleading for transfers without conditions is really are just pie in the sky/begging.

Peripheral politicians need to be bold and take responsibility. Blaming Germany and the markets while they have depression level unemployment is feeble. They need to give up fiscal sovereignty or leave the euro.

Tuesday, 9 April 2013

$JCP update

The stock traded 90mm shares today. there are only 220mm shares outstanding. PS own ~40mm of them.

The stock fell ~12%.

That isn't surprising given the recent pounding. Bad news already baked in there.

Most of the volume was earlier in the day and tailed off. I expect it to be heavy tomorrow. People will have taken liquidity in the stock.

If there is a bigger seller out, they will have backed off when the price gave way.

The fundamentals are awful. Chatter today of further sales decline.

Ron Johnson leaving and being replaced by the old CEO Ullman. Although "news" this isn't really new information/insight.

The last few quarters have shown that RJ's strategy was floundering, he didn't have the humility to understand or accept that. His loudest cheer leader has thrown him under the bus.

I'm not saying it can't ever happen, I just don't think it will. I don't think this is a firm that is going to get bought out. Too much risk, not room to leverage the balance sheet (if you were mad enough to want to put financial leverage onto a recovery story that has a tonne of operational leverage at this point).

Why pay a premium to get control?

Thursday, 28 February 2013


$HLF +7.5%.

$JCP is -17% today.

Ackman is short the former and long the latter.

Zerohedge blogged Ackman's position list according to his 13F filing.

If I were Bill Ackman's, I would be bricking it.

JCP's move is fundamental. The company's results were very poor. 

It seems as if the superstar manager that Ackman spent so much time praising suffers from the same blindspots as he does. Massive overconfidence and an apparent unwillingness to change course even when data and events contradict their model of the world.

As a manager this is bad. As an investor this is lethal. 

The biggest and most dramatic blow ups occur when overconfidence and a stubborn reluctance to change your view meet the market.

The market is telling Mr. Ackman he is wrong.

You can't change your mind every time a position ticks against you, but there should always be a fixed regular periods in both price and time that one re-evaluates the investment thesis. Buying a stock that falls 25% before it begins to rise, is not "early", it is wrong. And looking at Ackman's investment record it appears he's made plenty of mistakes, yet seems to leave himself no room for error.

Being a concentrated investor has its merits, however if you are shorting and using leverage then that concentration becomes a weakness. Other traders and investors are now talking about what he holds, that is chilling. 

I've bought Herbalife today, because I think he is wrong, the chart looks good and it makes a lot of sense that other investors begin to see that too. 

The more noise and adverse price action he faces the tougher his position becomes and the more likely he is to face redemption requests and be forced to liquidate.

Time to buckle up, it's about to get bumpy.

Friday, 25 January 2013

Herbalife - bet sizing

I don't have much to add that hasn't been said already better by other bloggers and media outlets.

to summarize;
1) Bill Ackman is short ~20mm shares (#113mm shares outstanding) ie 17.7% of the company at current price of $45 that is a $900mm short.
2) Dan Loeb is long about 8.9mm shares.
3) John Hempton was (I don't know if he still is) long shares. He's done some digging on Ackman's short thesis. (bronte capital commentary)
4) One suspects that Icahn is long.

I've read most the the secondary commentary on the stock and have done no work on it on my own. Ackman's short thesis should be on the web, I've linked to Hempton's comments which I think work well as a rebuttal. Loeb's description can be found in Third Point's investor letter from last quarter.

The major point I wanted to make one of appropriate "bet sizing".

I believe Pershing Square (PSCM) has an AUM of ~$9bn.

Shorting $900mm of a stock, ie 10% of AUM is just too big. Way too big.

Shorting 18% of a company is too big a position.

I guess they have sized this position based on number of days volume, because on this metric (looking back) it is 10days volume.

That is terrible, naive risk management.

Being short is a different risk profile to being long, and being publicly short increases the risk.

Icahn, although rude, is right, what is Ackman going to do if there is a short squeeze, or if the company starts to use FCF to buy back shares??

Conservatively the volatility on the stock is 50%, it is not hard to see it moving up ~30% in a month to $60. That is a $300mm loss.

~3% of aum.

But then you haven't even started trying to get out of your position, which you are likely going to have to at that point. I think the slippage on trying to get out is going to be horrific. I wouldn't be surprised if it was 5-10%.

This is the sort of position that would give me ulcers. This size trade is the sort that you can lose your company and name with when it goes very badly wrong.

Volkswagen shares traded as high as €1000 during their short squeeze in 2008 ie a squeeze of 600%. PSCM would have been liquidated long before it got close to that.

Even if he was proved to be eventually right, there are many potential paths where he loses hundreds of millions of dollars and gets stopped out. Personally I would never want a short to be more than 2.5% of AUM. In fact I'd much prefer to bet on something like this shorting credit or buying options, where one's downside is fixed and limited.