Longreads + Open Thread

Longreads

• From Scott Alexander of Astral Codex Ten, the heartwarming story of a random blog commenter who made a $100,000 bet that he'd win an argument about the origin of Covid, and then won. This is a great object-level overview of the evidence—it remains extremely suspicious that the outbreak happened in a city containing a lab that studied these kinds of viruses and was interested in gain-of-function research—but stranger things have happened. And the debate is very focused on determining the exact magnitude of the required strangeness, comparing it to the typical base rate for such strangeness, and fitting together the probabilities.
• Steven Sinofsky has a detailed breakdown of the Apple antitrust complaint. Part of what he focuses on is the fuzzy distinction between what Apple does as deliberately anticompetitive behavior, and what they do as sensible product decisions that customers actually like. One fun note: "What the DOJ is trying to do is turn the iPhone into Android, which is exactly what the marketplace does not want." If that happened, it would actually be a reduction in consumer choice; you can opt into the Android with a robot mascot or the Android with an Apple logo, but if you'd prefer to trade more seamless interoperability for less choice about how you use your device, you're out of luck.
• Ronan Lyons writes in Works in Progress about why housing prices in Ireland rose so fast in the 2000s and fell so far after. The core argument is that the bubble gets blamed on a laissez-faire approach to housing itself, but the strongest predictor of housing price changes was from widespread credit availability (which itself was partly a function of banking systems getting de facto deregulated as they globalized—when a bank can tap a global liquidity pool rather than a local one, it can expand faster , but overnight credit provided by financial intermediaries is less sticky than deposits from individuals made at local branches). There were also internally-contradictory policies: in some cases, new housing was subsidized but its quantity was restricted. This is a good reminder that it's hard to affect housing prices without doing something to supply: making credit more available does make it easier to afford homes at a given price, but that also means that someone with a given monthly budget can afford to pay more for a home. If the number of homes doesn't go up, or if they aren't being built in places where people want to live, the ultimate impact is that affordability doesn't change but the financial system gets less stable.
• From Kim Bhasin and Alessandra Migliaccio in Bloomberg, a story of surprise-attack deals, busted mergers, and possibly burglary, all in the high-stakes world of sports memorabilia. This kind of business is usually a repeat game: treat counterparties badly in a deal, and it's harder to land the next deal. But when a company is aiming for dominant market share, it can switch to a single-shot game: sharp dealing pays off if it results in being the only game in town.
• Van Spina in Wall Street Fintech has a nice history of private credit, which has represented two kinds of shifts: first, larger lenders getting comfortable with high-risk loans, and second, banks' capital requirements squeezing them out of the market. The result is that private credit is less regulated, but also less of a systemic risk; it can't be completely firewalled from the banking system, of course, but if it's undertaken by firms that are supposed to be in the business of risking investor capital rather than preserving depositors' assets, all sides know what they're getting into.
• In this week's episode of The Riff, we talk Austin real estate, Duolingo's marketing, and the joy of identifying spurious correlations. Listen with Spotify/Apple/Substack.
• And in Capital Gains, we look at why it's so annoying to compare the returns of equity indices to those of hedge funds. Yes, it can be perfectly reasonable to pay literally 1000x higher fees for a 10% or so return from a multi-manager hedge fund than you'd pay for an equity index fund.

Books

Merger Masters: Tales of Arbitrage: Risk arbitrage—betting on whether mergers will go through, and whether or not there will be a competing offer—is a fun discipline that's right at the intersection of trading and investing. If you think of "investing" as selecting assets that will passively generate returns with the appropriate amount of risk, and think of "trading" as getting a read on near-term supply and demand by understanding the psychology of market participants, then merger arbitrage has both. There's a small set of participants—the buyer, seller, competing bidders, regulators, other arbitrageurs—so arbitrage can be all about looking around the table for tells. But what's being traded is a real business, and the price at which it will be bought, or the odds that the deal will be blocked, are a function of real-world economics, not just high-stakes bluffing.

The book profiles several arbitrageurs who were active from roughly the sixties to the 2010s, and it's interesting to watch the evolution of both the arbitrage business and finance generally.

For example: the business looked extremely ethically dubious until about the 1990s. Not that there couldn't be honest arbs, but there was immense temptation to trade on illicit information. The Boesky case is infamous, of course—giving investment bankers literal suitcases full of cash is not exactly in line with most compliance policies. (Incidentally, a good practical reason not to get involved in this kind of thing is that someone who was willing to betray trust for cash is about equally willing to do so to avoid prison time—the banker in question was quite cooperative and got a two-month prison sentence). Just about everyone interviewed loathes Boesky, because he made arbitrage famous before becoming infamous. But there are older precedents! One of the interviewees says that a well-known approach was for two different companies to each have an investment banking division and a risk arbitrage desk—bank A would tip off bank B about pending deals, and vice-versa. That certainly makes things easier. But the practice still made investors plenty of money when they weren't breaking the rules.

Risk arbitrage is cyclical; mergers happen when stocks are up, so the arbs have more deals, and more competitive deals, when the market's doing well. Many of them have, in response, expanded into distressed debt—in year one, you make money from a company selling to private equity, and in year three, you make money buying the acquirer's bonds in the bankruptcy reorg. But there's another cycle at work: one thing many of the arbitrageurs say is that they prefer strategic acquirers to financial ones, and they like to bet on the completion of deals that genuinely make sense. But that heuristic creates a risk factor—the deals that make financial sense to Wall Street are exactly the ones that worry the FTC and DOJ! And, as The Diff has noted before, that creates a correlated risk—a portfolio betting that twenty different mergers succeed is also making the same political bet twenty times over (albeit in varying size). Meanwhile, trailing returns and total capacity will look best at market peaks, so the strategy's dollar-weighted returns will be worse than its time-weighted returns.

Risk arbitrage remains a viable strategy, and is still a great training ground for investing talent, with Goldman's arbitrage team as a standout performer ($). It's a quick education in probability and psychology, and an event-driven excuse to do deep dives on one industry after another—if this month's big deal is oil, last month's was a bank, and next months is a biotech company, any arb analyst paying attention to fundamentals is going to end up with a wide range of knowledge about different industries. But it's like so many other strategies in that it mean reverts, and it wouldn't mean-revert if it didn't look like a good idea to sophisticated investors with significant financial resources at exactly the worst possible time.

Open Thread

• Drop in any links or comments of interest to Diff readers.
• Arbitrage turns out to be a good training ground for investors (less so than it used to be as the market’s gotten more efficient). Do other fields have a similar job where there’s some specialty that helps train exceptional generalists?

Diff Jobs

Companies in the Diff network are actively looking for talent. See a sampling of current open roles below:

• A seed-stage startup is using blockchains to enforce commitments and is in need of a fullstack developer with Solidity experience. (Remote)
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• A company building the new pension of the 21st century and building universal basic capital is looking for a frontend engineer. (NYC)
• A fintech company using AI to craft new investment strategies seeks a portfolio management associate with 2+ years of experience in trading or operations for equities or crypto. This is a technical role—FIX proficiency required, as well as Python, C#, and SQL. (NYC)
• A CRM-ingesting startup is on-boarding customers to its LLM-powered sales software, and is in need of a backend engineer to optimize internal processes and interactions with customers.

Even if you don't see an exact match for your skills and interests right now, we're happy to talk early so we can let you know if a good opportunity comes up.

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