Bill Ackman's Hong Kong dollar play; Boaz Weinstein on lottery tickets and two interviews with him; Alex Pack and Jason Choi on Sam Bankman-Fried; Video from the World's Toughest Mudder
1) Last week, my friend Bill Ackman of Pershing Square Capital Management tweeted this about his latest investment:
The media coverage has been harsh, with the Asia Times writing Bill Ackman's HK dollar play a certain losing bet and the Financial Times piling on (Bill Ackman, macro tourist, is back), with this funny graphic:
This is actually Ackman's second bet that Hong Kong would de-peg its currency from the dollar – the first was when he gave this 151-slide presentation at an investing conference in September 2011, in which he concluded: "The only effective way to mitigate inflation and a potential real estate bubble is to allow the HKD to appreciate."
Ackman was wrong then – and, in all likelihood, he's wrong now.
But I don't think it's a bad investment – nor does famed investor Boaz Weinstein of Saba Capital, who tweeted:
In a subsequent tweet, when asked how he structured the trade, Weinstein replied:
ATMF put costs 1.85 vol, or 70c. There are very few things not worth 2 vol especially in a time where "impossible is nothing."
I don't have an opinion about this trade, but I'm sharing it because there's an important investing lesson here: It's okay to make wagers in which the most likely scenario is that you lose all of your money... if the payoff is high enough from the less likely scenarios.
That's why Weinstein calls the bet he and Ackman are making a "lottery ticket."
But, of course, Weinstein thinks it's much better than an actual lottery ticket, which has a negative expected value. He probably thinks there's, say, a 5% chance that this bet pays off – but if he makes 200 times his money on it, that's a 10 times expected value!
2) Speaking of Weinstein, he did two interviews with Bloomberg. Here's a link to a 38-minute one he did recently with Barry Ritholtz: Boaz Weinstein on Investors' Unknown Risk.
And here's an article that grew out of an interview he did in August: Boaz Weinstein Reveals the Secret Trade That Helped Make Him Famous. Excerpt:
As fears of recession and inflation have pushed volatility higher, Weinstein is having one of his best periods ever. His firm, which manages $4.8 billion, returned 28.7% this year through August, according to an investor. He expects to profit – and for thousands of other funds to suffer – as the Federal Reserve and other central banks move from flooding the markets with money, so-called quantitative easing ("QE"), to mopping up the money supply, or quantitative tightening ("QT").
Here's the part where he discusses for the first time the trade that ultimately led him to his legendary "London Whale" trade:
Katherine Burton: What's a moment that you are proud of? Was it finding JPMorgan's London Whale?
Boaz Weinstein: There was another incident that's never been reported on, as far as I know. It was a year before the London Whale, and it was Morgan Stanley that took the hit. The "whale" was the exposure management group at Morgan Stanley. The bank had enormous counterparty risk to MBIA, and the company's creditworthiness was an open question.
But in aggressively buying more and more CDS, Morgan Stanley drove the price to levels that were super distressed and implying a near-100% chance of default. Our estimate was that they owned more than 80% of the open interest on MBIA CDS. Even today, almost no user of CDS looks at changes in net open interest to assess if there's something major going on. We do.
I went to go see Morgan Stanley to warn them. The head of risk for the bank said: "I don't get it. MBIA has wrapped exposures for every bank on the Street. Are you telling me none of the other banks have bought MBIA protection? We're the only ones?"
KB: Wait, why weren't the other banks buying?
BW: It was cost-prohibitive. The MS trader was concerned that the wrap would be worthless if MBIA went down, so they nearly singlehandedly drove up the cost of insurance to absurd levels.
From there, as a thank you, they worked with me for weeks to help them unwind as much as they could. It was our most profitable investment in 2011 – garnering more than $75 million for us that year. So I was very primed to find the London Whale a year later. That being such a successful trade for us emboldened us to continue to look at the changes in NOI that added detail to our London Whale thesis.
Weinstein argues that playing high-level chess and especially blackjack has helped him be a better investor, but poker hasn't:
KB: How do your skills in games help you invest?
BW: Chess requires great creativity. There are people who are very mechanical about it, and then there are combinations that have a flourish to them that are more aesthetic – chess can be considered beautiful. So I think, in finding unusual combinations, maybe chess played a role in that.
The thing about blackjack is you're going to win like 50.5% of the hands, so you have to become accustomed to losing. In investing if you could be right 55 out of 100 times over a long enough time, you'd be Warren Buffett.
For people who literally spent K through college winning, it is very difficult for them – for real investors, it's about how they handle losses. In blackjack, there's no creativity. It's about precision. What is the exact count, and what is the exact right play? What is the right bet amount?
There's an idea from blackjack that I learned from my third summer at Goldman from David Rogers, who was the partner in charge of equity derivatives, called the Kelly criterion.
If I told you a coin had a 60% chance of being heads, and we will play as many times as you want, and I give you $100 to play with, how do you optimize the advantage and minimize the risk of ruin? One thing that blackjack helped me with is, when you have a really big edge in something, you have to make a considerably larger investment in it.
Blackjack gave me a great framework for getting exposure to losing and understanding probability and statistics and investing your edge. Poker didn't help me with investing.
Lastly, he warns that "the market is going to be tough the next five years for managers who relied on beta":
KB: What aren't people paying enough attention to?
BW: We haven't even felt the first drop of the environment where this book becomes relevant again. Because we were in a QE world, and people had tail risk protection from the Fed.
The absence of quantitative easing is very different from quantitative tightening. It is a little bit like being on the treadmill when the incline has suddenly shot up. With QE the wind is at your back, and no QE means the wind shuts off. With QT you've got the incline and the wind in your face.
From 2009 to 2019 it was too easy. Companies didn't have to make money. Bad news was good news. QT is going to be a giant problem for thousands of hedge funds that have not realized how much they benefited from QE, and now they have to face that incline without having the wind at their back. I can't overemphasize how much I think the market is going to be tough the next five years for managers who relied on beta .
3) I've been giving hat tips to those who saw that Sam Bankman-Fried ("SBF") was a con man early on – here's another: Cryptocurrency investor says he saw serious 'red flags' with FTX founder Sam Bankman-Fried. Excerpt:
- In 2018, Dragonfly Capital was in discussions with Sam Bankman-Fried to invest millions in his quant trading firm, Alameda Research.
- Alex Pack, now managing partner of Hack VC, says he saw obvious "red flags" after conducting a due diligence review. The deal didn't go through and Pack says his experience foreshadowed recent revelations about Bankman-Fried.
- "After spending months with him, we realized his risk-taking was catastrophic," Pack says.
Here's Pack's Twitter thread about this.
4) Two weeks ago, I linked to a post by Jason Choi entitled The Definitive Thread on FTX, which has more than 12 million views. Here's his latest update: The Definitive Post on the FTX Scandal. Excerpt:
I'll share my account as an insider in the industry as to what led us to this point, which hopefully services as a cautionary tale for founders and investors for spotting future fraud...
The story of Alameda and FTX can best be summarized by SBF's philosophy of betting big. Every major decision they have made is related to acquiring more leverage – via deceptive fundraises, financial engineering, and ultimately, outright fraud...
5) I'm still achy and my fingers are peeling like crazy from the 24-hour World's Toughest Mudder I did last month. Here's a short (3:38) video with highlights from the race.
Best regards,
Whitney
P.S. I welcome your feedback at WTDfeedback@empirefinancialresearch.com.