Tag Archives : business of investing


FX Antitrust Litigation Settlement 1

Disclosure: Cable Car is party to a referral agreement described below. Long RTRX.

As mentioned frequently over the past few years, Cable Car is a long-time shareholder of Retrophin (RTRX). Following events in 2014 that are well known, RTRX reached a modest settlement in a shareholder derivative action last year. Claims were due last June, and 15 months later, in October of this year, a few Cable Car clients from 2014 finally received a distribution from the settlement fund. After proration, the recovery was less than $0.02 per share held at the time, but it was better than nothing!

At three years from event to disbursement, the RTRX settlement was relatively quick by the standards of securities litigation. However, there was still a great deal of paperwork and effort involved in securing even such a modest recovery. As a result, I took more than passing interest in a recent solicitation from a claims recovery service offering to file similar claims on my behalf. To be frank, it wasn’t really a great use of time to file the RTRX claim. I was also intrigued because claims recovery services have an appealing business model: in exchange for dealing with the headache of filing and managing long-duration litigation claims, the service works entirely on contingency, retaining a percentage of the eventual recovery (usually 25%). That seems like a mutually beneficial proposition, especially for smaller claims. The firm that reached out to me is a public company subsidiary, and I was interested to learn more about the approach.

The most significant opportunity at the moment is a $2.3 billion antitrust settlement regarding foreign exchange rate-fixing allegations against 15 major investments banks covering expansive conduct from 2003-2015. Cable Car did not have significant activity that qualifies, but I did go through the exercise of submitting a claim for a handful of personal futures trades from 2009-10, just to see how the process works. Sure enough, it was a lot of paperwork for a claim that will most likely result in only a $15 de minimis recovery, so I can see the appeal of working with a third party.

Most large investment firms are likely to have had at least some transactions covered by the settlement. To my readers who manage investment firms or work at funds: you should look into this or mention it to your CFO. If you traded any foreign exchange derivatives or spot whatsoever (whether OTC directly with the defendants, on-exchange, or through an ECN) from 2003-2015, you are likely to have eligibility to file a claim, which could be significant.

To learn more and file a claim yourself, visit www.fxantitrustsettlement.com/index.

If this is the kind of thing you don’t want to bother with, there is also the option of engaging a third party to do it for you. When I spoke to the claims recovery service, they offered a referral fee for introductions from my network. If we already know one another and it’s something that might be of interest to you, let me know and I’d be happy to introduce you. To reiterate, you can and should file a claim yourself if you are eligible. However, if you prefer to have assistance, this post is just to somewhat sheepishly say that I’m willing to accept a modest referral fee to introduce you to someone who can help.


Luck and Lakshmi 2

Disclosure: Long one Lakshmi coin.

My wife and I recently returned from a visit to India over the holidays. The trip capped a very eventful year for Cable Car and left me in a reflective mood, despite the tumultuous start to 2016 in the markets. Although experiencing a different culture is invariably educational and I had the small thrill of trading from airport lounges on several continents, this was leisure travel. Due to regulatory restrictions, Cable Car is not able to invest in domestic Indian equities, and there are only a few US-listed ADRs available. We elected to watch the popular Bollywood film Bajirao Mastani in theaters rather than meeting with its controversial distributor, Eros International (no position).

Ashtalakshmi

At the risk of relying on what Amartya Sen termed an “exoticist” lens to understand India, I thought I’d share a serendipitous anecdote from the trip not entirely unrelated to investing.

On our second day in Chennai, which has a long coastline on the Bay of Bengal, we asked an auto-rickshaw driver to take us to the beach. The route passed through Besant Negar, a neighborhood that suffered significant damage during last month’s flooding and which I’m pleased to report has rebounded strongly. Many of the street vendors displaced by the floods had returned, and there was a hubbub of rebuilding activity. We arrived at the southern tip of Elliot’s Beach, in front of a large temple we hadn’t planned on visiting.

We had come unexpectedly to the Ashtalakshmi Temple, which is dedicated to the eight incarnations of Lakshmi, goddess of prosperity. The temple is open to all and was uncrowded, so we wandered inside. As we worked our way up the stairs, we passed shrines for each of the eight incarnations, each representing a different form of prosperity in turn. The Dhanya Lakshmi represents the bounty of a good harvest; the Vijaya Lakshmi symbolizes success in the face of adversity; the Vidya Lakshmi stands for the wealth of knowledge. At the very top of the temple, with panoramic views of the Bay to the east, sits the Dhana Lakshmi, bringer of money and gold.

Lakshmi coin

Lakshmi coin from Ashtalakshmi Temple, Chennai

Hindu temples serve an important charitable function in the local community, collecting funds for the temple itself as well as alms for the poor. At each shrine, a priest sought a small donation, but the Dhana Lakshmi’s pandit was different. In keeping with Dhana Lakshmi’s association with money, he had a uniquely convincing pitch. In asking for the donation, the pandit stated that it was not to be viewed as a gift, but as an investment. What you give to the goddess, you shall receive many times over in return. I think the analogy to investing is quite apt. We gave generously, and soon found ourselves garlanded in flowers and given a small coin as a token of good fortune.

 

Fortune

I am not a particularly superstitious or religious person, but I am quite fond of ritual and spirituality. A more cynical type might not have enjoyed the experience, but from my perspective, a shrine on a beautiful beach in Tamil Nadu is as good an avatar of good fortune as any.

Visiting the Ashtalakshmi temple left me contemplating the role of luck in investing. As I look back over a very successful year for Cable Car, I am keenly aware of the importance of luck. 2015 felt at times like a constant parade of potential pitfalls—whole sectors moving suddenly out of favor, precipitous repricing of currencies and commodities, comedowns by investors others look up to—to have avoided some of the year’s worst outcomes was the just reward for healthy skepticism, but in other instances it was a mere case of (not) being in the right place at the right time. Investing provides constant reminders that there are many factors influencing each investment that cannot be hedged and are totally outside an investor’s control.

However, I am firmly of the belief that for investors, the saying “You make your own luck” is a truism. Not by donating to Hindu shrines, although perhaps that will help in some small way, but by creating a universe of attractive potential outcomes. We are fortunate in the investing business to be given the opportunity to specify our preferred probability distribution. The task of portfolio construction is the luxury of assembling a collection of only those investments where research suggests the odds are favorable. I approach investing by trying to minimize the consequences of mistakes and misfortune, while maximizing the likelihood of good luck.

Yet ultimately we cannot control outcomes, only the research process, and the best investors will retain their focus on research irrespective of the market’s gyrations. I’m not immune to Schadenfreude, but I do not enjoy seeing famous investors in the headlines for a tough year. There but for the grace of Lakshmi, perhaps, go I. It is far too soon to count out some of the boldface names who had a difficult go of it in 2015.

Often, I feel that the timing of returns is the most significant element of randomness. When taking the view that the market has mispriced a security, it is difficult to predict when and if that will change. We can try to influence market perceptions and corporate actions through activism, but there is an element of uncertainty to every investment. Returns are path dependent—the opportunity to redeploy capital from a positive outcome can be a powerful contributor to future performance. I consider myself fortunate both when the market agrees with my positioning and when volatility provides an opportunity to adjust exposures.

Just as it can feel like a stroke of luck to have avoided pitfalls in the marketplace, it can feel like a blessing to be able to obtain borrow on an obviously overvalued stock, or to be unable to obtain it on a stock that later squeezes higher. I have had occasions to be fortunate to be at my desk during breaking news, and fortunate to be away during moments when others have acted rashly.

Most of all, I feel fortunate to be entrusted by my clients with their capital in a role that I love. Whatever your personal Dhana Lakshmi, I wish you good fortune and many happy returns in the year ahead!


Is your high water mark net or gross of fees?

Cable Car does not deduct previously earned incentive fees from the high water mark. Most of the industry does.

A few recent conversations with current and prospective clients reminded me to clarify one area in which Cable Car’s standard fee structure is differentiated in favor of clients. Cable Car already offers qualified and non-US clients an unusually aligned fee model, with no management fee and a 30% incentive fee. This performance-based fee is typically crystallized quarterly, subject to a high water mark of previous performance.

The way in which the high water mark is calculated can have a material impact on the net returns received by clients. For example, suppose a $100,000 investment had gross returns of 20% during a period, for a gross account value of $120,000. After deducting a 30% incentive fee, the client’s net return would be 14%, for a balance of $114,000.

In this example, Cable Car’s high water mark for future periods would be $120,000, the gross amount before fees. By contrast, many hedge funds calculate the high water mark only after deducting the performance fee. The high water mark for these funds would be $114,000.

Cable Car Calculation Example

Period Starting Value Gross Return Fee Ending Value New HWM
1 100,000 20,000 6,000 114,000 120,000
2 114,000 2,000 - 116,000 120,000
3 116,000 (10,000) - 106,000 120,000
4 106,000 24,000 3,000 127,000 130,000

Industry Standard Example

Period Starting Value Gross Return Fee Ending Value New HWM
1 100,000 20,000 6,000 114,000 114,000
2 114,000 2,000 600 115,400 115,400
3  115,400  (10,000) - 105,400 115,400
4 105,400 24,000 4,200 125,200 125,200

With the same $36,000 in gross returns over 4 periods, Cable Car’s total incentive compensation would be only $9,000, versus the headline figure of $10,800 under a fee structure with net compounding.

For a concentrated and relatively volatile strategy, Cable Car’s approach limits the risk to clients that performance fees are crystallized at inopportune times. Cable Car is not compensated until it has “earned back” the prior incentive fee. In practice, this means that for positive gross returns, the total incentive fee over a long period of time may be significantly less than the headline fee as a proportion of the gross returns earned in the account. Depending on the actual pattern of returns and timing of fees, a 0/30 model may offer a significant long-run discount when compared to the traditional 2/20 fee model. Due to the effect of compounding as an investment grows, the absence of management fees under this structure results in the potential for significantly better net returns for clients over time.

For example calculations, questions, or comments, please don’t hesitate to contact Cable Car for more details. Depending on client needs, management fees may be more appropriate in the future to support investments in additional infrastructure as the firm grows. Cable Car’s fee structure is negotiable for large, long-term capital commitments.


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What fees does Cable Car charge?

For US investors who are not qualified clients, Cable Car charges a flat annual management fee equal to 3% of the account value, billed daily in arrears by the custodian.

For non-US investors and qualified clients, Cable Car waives the management fee and charges a 30% incentive fee, computed quarterly by the custodian on the net profit and loss in the account and subject to a high water mark of previous performance.

Please see Item 5 in the firm’s brochure on Form ADV for more information.

Management fee Incentive fee
Non-Qualified 3% None
Qualified None 30%


Covestor

I am pleased to announce that a model portfolio from Cable Car Capital is now available on Covestor pursuant to a licensing agreement.

I have been managing a model portfolio for Covestor since August 2013, prior to establishing Cable Car. Performance has been strong* since inception, benefiting in part from the broad-market rally in 2013. Covestor has selected Cable Car to join its platform of over 100 active managers with a variety of styles and investment philosophies.

Covestor is an investment adviser that constructs multi-manager portfolios for individual investors using real-time trade replication. Outside managers, including Cable Car, license a portion of their trading data to Covestor using a model portfolio. Cable Car’s Hedged Value model on Covestor is a long/short portfolio limited to liquid, US-listed stocks. Cable Car continues to offer its broader investing approach directly to individuals and institutions. Due to its narrower mandate, the Covestor model may not have the same performance as Cable Car’s broader strategy.

I am excited to join the Covestor platform and hope to help support their continued growth. Covestor is a venture-backed startup with a compelling approach to the asset management marketplace. In recent years, several new investment advisory firms have attracted retail investors by providing online, automated asset allocation tools. Most of these so-called “robo-advisers” focus entirely on passive strategies, while Covestor fills an important niche by offering active strategies in managed accounts. While Cable Car does not recommend third-party advisers, I believe their model may present a good alternative for individual investors who value active management and managed accounts but would like exposure to multiple strategies.

In order to better explain the Covestor relationship and Cable Car’s other third-party distribution arrangements, I have added a new FAQ section regarding distribution, which is reproduced below.
 
* As of May 21, 2014, the Hedged Value model portfolio returned 18.7% net of fees for the 9 months since inception on August 22, 2013. Past performance may not be predictive of future results.

 

Distribution

Are Cable Car’s services available from third parties?

Yes. While Cable Car encourages prospective clients to establish a direct relationship, certain of its services are available to clients of third-party, unaffiliated investment advisers. Access to Cable Car’s services through a third party may be more appropriate for investors who have established, broader advisory relationships or prefer a more diversified, multi-manager portfolio. Cable Car may act as a subadviser to funds of funds and wealth managers. Cable Car has also entered into a limited licensing arrangement through which it provides trading data to Covestor Ltd. Cable Car’s relationships with third-party investment advisers are non-exclusive and are subject to negotiated terms that may differ from Cable Car’s general mandate. As a matter of policy, Cable Car does not select or recommend third-party investment advisers.

Who is Covestor?

Covestor Ltd is an investment adviser that operates a multi-manager managed account platform. Covestor licenses trade data from investment advisers in exchange for a portion of the management fee charged to its clients. Covestor is a third party unaffiliated with Cable Car that was acquired by Interactive Brokers in 2015.

What is Cable Car’s relationship with Covestor?

Cable Car licenses a subset of its trading data to Covestor on a non-exclusive basis for use in managing Covestor’s client portfolios. Clients of Covestor can subscribe to the Hedged Value model portfolio on Covestor’s website. Cable Car maintains a profile and occasional portfolio commentary on Covestor’s website.

What is the difference between Cable Car’s Covestor model and its primary strategy?

Cable Car licenses only a portion of its trading data to Covestor. At this time, Covestor models are limited to highly liquid stocks listed on US exchanges and do not include non-equity securities. Cable Car’s investments in smaller-capitalization securities, stocks listed on international exchanges, derivatives hedges, bonds, illiquid special situations, and other unsuitable investments are not included in the Covestor model. Covestor, under its sole discretion, may replicate trades in the model portfolio for its clients.

Within these constraints, the investment approach is the same, and the Covestor model portfolio managed by Cable Car is included in the Cable Car Composite. Larger-capitalization, US-listed equity positions held by Cable Car clients will generally be held in the model portfolio, although Cable Car undertakes no obligation to license any particular trade opportunity to Covestor. The performance of the model portfolio since August 22, 2013 includes personal account history that predates the formation of Cable Car Capital LLC. Cable Car’s principals have a beneficial interest in the model portfolio used to transmit trading data to Covestor. In keeping with Cable Car’s trade allocation policy, trades in the model portfolio are placed only after being executed for Cable Car’s other client accounts.

Who should consider subscribing to Cable Car’s Covestor model?

Cable Car manages separate accounts open to individual investors in part out of the belief that all investors should have access to hedged strategies. Covestor has a unique approach that is helping to democratize strategies traditionally limited to private pooled vehicles by offering individual investors access to multiple active managers in a single managed account.

As a matter of policy, Cable Car does not select or recommend third-party investment advisers. However, for investors who desire exposure to other managers or strategies, subscribing to Cable Car’s model portfolio as part of a broader asset allocation strategy could be appropriate.

Are subscribers to Cable Car’s Covestor model clients of Cable Car?

No. Cable Car’s relationship with Covestor is a licensing arrangement. Cable Car’s fiduciary duties are to its clients only. Subscribing to a model portfolio on Covestor does not create a client relationship with Cable Car. Client relationships with Covestor are governed by Covestor’s client agreement.

Can Covestor clients establish a direct relationship with Cable Car?

Yes. Please clearly indicate your status as an existing Covestor client when expressing your interest.


What happens when you short a stock to zero? 12

Disclosure: This post contains details of historical trades made in a personal account prior to the establishment of Cable Car and does not represent recommendations by Cable Car.

The short answer is that it may not be worthwhile.

One motivation I have for blogging is to discuss elements of investing I wish I’d been able to learn about more easily when I first encountered them. There is a surprising paucity of information online regarding the mechanics of trade settlement and clearing, although the details can be relevant to the outcome of an investment, particularly a short sale. Much of what you might read on the topic is incomplete and potentially misleading. The handful of times I have been short a stock all the way until the bitter end, I was surprised at the unforeseen costs. Note that this post is specific to my experience with Interactive Brokers, but it is likely similar to the process at other brokerages.

It turns out that when a stock is delisted, short positions are not necessarily closed immediately. Short sellers are exposed to the risk of an indefinite, high-interest stock loan until shares are cancelled. For this post, I’m focusing on shares that are cancelled after a bankruptcy proceeding and expire worthless. However, other delisting events can lead to similar issues. For example, if a stock is the subject of a takeover offer, the shares may have appraisal rights. If the short position is assigned against shares that exercise these rights, the short seller would ultimately be responsible for the court-ordered compensation months or years later. More on that another time, perhaps.

Bankruptcy

When a company exits bankruptcy protection in the US, the plan of reorganization or liquidation specifies what will happen to the stock. Usually, but not always, common equity is cancelled and becomes worthless on the effective date of the plan. Prior to this, shares of bankrupt companies are traded on the pink sheets with the ticker suffix -Q. Although primarily the province of speculators and day traders, these securities sometimes still have significant market cap and liquidity, presenting a tempting short sale candidate. Sometimes this residual equity value is the result of optionality, reflecting the chance the equity ends up with a recovery. Indeed, there are many examples of how shorting a bankrupt company that is not certain to go to zero can be a very dangerous proposition:

American Airlines (AAMRQ) stock price during bankruptcy

American Airlines (AAMRQ) stock rose more than 40x from its close of $0.26 when it filed on November 29, 2011 to emergence on December 9, 2013.

However, in other situations, this option value is illusory. In the case of a pre-pack bankruptcy, for example, stakeholders have already agreed upon a plan of reorganization in conjunction with the initial bankruptcy filing. Court documents may clearly indicate that shares will be cancelled, and no near-term improvement in operating results could possibly salvage any value for shares. Up until a plan of reorganization is confirmed by the bankruptcy court, there is theoretically a risk that a proposal could emerge that would result in an equity recovery. Yet even after a plan has been confirmed, soon-to-be-worthless shares may still exhibit a great deal of volatility. These are situations where it may be desirable to short the stock (or maintain an existing short position) until the shares are ultimately delisted and cancelled.

Process

Although this post is about the trade mechanics, I’m no expert on what happens behind the scenes at the brokerage. But as I understand it, after shares are delisted, short positions are matched against long positions held at the same brokerage through a process called assignment. Opening the short position may have required the prime broker to borrow shares from another broker-dealer. If the broker can locate shares in its own inventory (from another client) to offset the short position, or if the loan was internal to begin with, then the short position can be closed immediately. The broker returns the borrowed shares to the long holder, the short position is closed, and the shares are marked to zero. The short seller keeps the short sale proceeds and the long holder the cancelled security.

On the other hand, if the stock loan was from a third party and the broker cannot assign the short position internally, the short position remains open even after shares stop trading. This is where things get problematic. If shares are available for borrow before a delisting at all, the interest rate is typically very high due to high demand. A short seller may be paying well over 100% APY on the loan and posting significant margin on the position. In the US, stock positions are settled by a central clearing house, the Depository Trust & Clearing Corporation (DTCC). While exchanges will typically suspend shares from trading after the company emerges from bankruptcy and shares are extinguished by court order, the shares do not actually cease to exist until DTCC marks them to zero. DTCC is a large organization, and the process can take a while.

I have had two very different experiences in these situations that illustrate the process.

Source Interlink (SORCQ)

Source Interlink (SORCQ) shares during bankruptcy

Source Interlink (SORCQ) filed for a pre-pack bankruptcy in April 2009 and emerged 60 days later.

Source Interlink is a periodicals distributor that restructured in 2009, after an ill-timed acquisition of a CD and DVD distribution business. The company filed a pre-pack, consensual bankruptcy that called for equity to be cancelled. Although an equity committee was formed, it was pretty clear (and had been for some time) that the enterprise value was less than the value of the outstanding debt. I shorted shares at an average cost of $0.12 and added to my position after the plan was confirmed on June 19. Shares were delisted on June 24, 2009.

Unfortunately, SORCQ was a low priority for DTCC, and Interactive Brokers was not able to assign the position internally. On June 25, the position was marked to zero but remained open. DTCC did not process the cancellation until September 3, 2009, 9 weeks later! Additionally, the SEC has a margin requirement for securities priced under $5, requiring a minimum of $2.50 in margin per share short. Due to these requirements, I had to post margin per share for the entire 9-week period, making it impossible to initiate new investments with the capital during this time. There was no way to close the position because SORCQ no longer traded, and nothing to do but wait. Given the large number of other interesting ideas in the marketplace at that time, it was probably not a worthwhile endeavor in the end.

K-V Pharmaceutical (KVPHQ)

KVPHQ shares during bankruptcy

Shortly before its plan of reorganization was confirmed, K-V Pharmaceutical (KVPHQ) shares spiked on false hope of an equity recovery.

More recently, I was intrigued by a pitch on K-V Pharmaceutical. The company is a pharmaceutical manufacturer whose sole product, Makena, has a much cheaper generic alternative made by compounding pharmacies. Despite FDA approval of Makena, sales disappointed due to lower-priced competition and the company filed for bankruptcy in 2012. K-V had nearly completed its bankruptcy proceedings when a bill in Congress last summer offered a sliver of hope to equity holders. The bill, a response to a widely publicized meningitis outbreak at a compounding pharmacy, could have limited competition from compounding pharmacies, which in turn would improve Makena’s prospects.

That may yet be the case if legislation passes in the future, but at the time of the bill’s introduction, Congress was about to go on a recess, and stakeholders had already agreed to a plan of reorganization. I shorted KVPHQ, covering after the brief entrance of Glenview Capital with a large stake, indicating possible formation of an equity committee. Surprisingly, Glenview appeared to change its mind after only a few days. Later on, KVPHQ was still available to short at $0.10 share even after the plan was confirmed on August 28.

Borrow was widely available on KVPHQ throughout the final weeks of trading; however, it was very expensive. Interactive Brokers charged an indicative rate of 120% APY; however, like many brokerages they have a policy of rounding up the collateral to the nearest $1.00. For a 10-cent stock, this meant the effective cost to borrow was a stratospherical 1200% effective rate. In other words, shorting at $0.10 would have cost more in interest charges than the short sale proceeds earned if DTCC took more than 30 days to cancel the position. Ultimately, I decided not to carry a position past the delisting, given the high borrow cost. I later learned that DTCC acted within a day of the delisting, perhaps given the higher profile of K-V relative to Source Interlink.

So is it worthwhile?

DTCC may have gotten more efficient, but there remain some short positions which stay open for months or years on end, pending action by the depositary. This presents an unacceptable risk of indefinitely tying up capital for most short sellers. The main reason to maintain such a position would be for tax purposes. If a short seller had a much higher basis from before the company became distressed in the first place, then waiting for the position to be closed would defer the short term capital gain until the position were ultimately extinguished.

Otherwise, seller beware.


Upcoming content 3

Hi, this is Jacob.

I’ll be using the first person on the blog, and all content represents my personal opinions, not necessarily those of Cable Car. I plan to discuss interesting investing-related topics, including investments I’ve made for my clients as well as companies I’m still researching. I expect the format and content of posts to vary; they may include everything from brief observations on market events to commentary on the business of investing to detailed, full-length investment write-ups. My hope is that this platform will eventually evolve into a useful forum for discussion and refinement of my ideas. I’ve been inspired by the work of John Hempton at Bronte Capital, though I doubt I’ll ever match his sense of humor.

I most likely won’t end up writing about every position I hold, but to get started I have a few historical topics to address in my first few posts. These will include:

  • A real-life arbitrage example that persisted for a few years
  • What happens when you short a stock to zero
  • Why I love odd-lot tender offers
  • A series on the investment adviser registration process

If you’d like to follow the blog, please use the RSS link in the footer. (In some browsers, you will need to copy the RSS link into your chosen RSS reader). You may also subscribe to investor letters and news updates (much less frequent than blog posts) from Cable Car using the checkbox on the comment form or the short form on the right sidebar.

Please be sure to read the disclaimer below and do not make investment decisions on the basis of what you read here. Thanks for visiting.