Watching this version of tech bubble unwind has been very interesting. The hedge funds pulling out, the markdowns on unicorn value. If this is a typical cycle it means that the oxygen(cash) will be depleted for a few years while the losses are absorbed. The lack of investment will recharge funds as new money comes in, and everyone will wait for some breakout hit to come out. Then cursing themselves for having "missed" it by being to hesitant they will once again start opening the money taps. Circle of life in the valley.
I don't think housing will be affected the way you think it'll be affected.
Hedge funds are buying lots of real estate, Single Family Homes included [0] [1] [2]
It's a flight to safety, and with jobs moving to cities, millennial preferences with them, and restrictive zoning/NIMBY, real estate is the perfect landing place.
I think that is well answered by the other responses but felt I could add some insights from previous downturns.
First, a friend of mine made a bit of extra cash by driving u-haul trailers and trucks back to the bay area. He did this on a case by case basis by showing up at the various u-haul places and offering his services. Generally they would rent him the equipment for "free" and pay him expenses plus a small fee when he returned with the item. Personally I don't think it covered the mileage on his truck but he enjoyed the drives.
Second, a lot of storage places "filled up" with excess inventory from people who rent furniture. I'm not sure if they learned their lesson and now have a warehouse standing by or what.
Third people who had some runway would hang around looking for new/different work for a reasonably long time, so the impact on their freeing up housing was diffuse.
And finally, the impact on traffic was the most notable. Improvment projects that had added efficiency in the dot com boom were now over provisioned for the traffic they carried. It was actually pretty reasonable to drive up and down Highway 101 and I-x80 at "rush hour."
Anecdotally, a significant number of houses that had been built on spec in my neighborhood, and took bids in 1999, fell out of escrow in 2001 before they could be occupied. One sat unoccupied for 5 years. Because the company that owned it could not sell it for what they paid and they were unwilling to take on the expense/complication of leasing it out. That would be harder to happen, the primary reason the houses fell out of escrow is that the down payments were in "stock" which became worthless. And the lack of liquidity in this downturn means that fewer people could sell their equity to fund a down payment and eventual balloon payment. My "test case" is the set of new houses that were built at the corner of Iowa and Taffe in Sunnyvale. They seem to have similar timing.
I got some awesome furniture for my home office last time around.. a nice desk, office chair, a couple filing cabinets, and even a large whiteboard. I think it was $40 total.
I still have the whiteboard. Those things are stupidly expensive.
FYI, you can buy 8x4 ft sheets at the chain hardware stores for about $10 that will last a ~year depending on usage, before they have 'ghosting' issues. I think they call it shower board.
Average SF commercial rents lags about 2 years after NASDAQ dips, so we've seen a pretty good dip, so maybe 1.5-2 years.
This is overall though, not what people are offering now.
I'm in the market and don't see rents coming down, but SF-proper inventory I'm looking at (more industrial "PDR" / mixed-use) is all many months old, so unsure if prices will come down soon to make them move.
Paragon has been releasing some data lately that suggests a weakening of the high-end market in SF. In particular, it looks like luxury condos are becoming overbuilt:
It's still early, though. Their March 2016 market report is inconclusive on what's happening with prices. However, this could really put the lie to the people who believe that indiscriminate building is the solution to high rents. Folks are likely to find out that when developers overbuild at the high end, they don't just keep building and let the new units go for a steal -- they stop building entirely.
The market will crash. For exactly the same reason that others have said it won't. Hedge funds are buying up real estate.
And then they'll stop. Then who will buy?
See how that works?
Housing and rents in the Bay are unsustainable. You'd have to have a lot more highly paid professionals than we do to support these values over the long term. I don't see that happening. Already a lot of developers are looking for jobs outside of the Bay Area.
Exit value volatility was a known risk when the hedge funds started investing in the Valley.
Exit timing volatility is a new phenomenon. It's one thing to say, "within 5 years they'll be publicly traded/acquired and I'll have liquidity at an unknown value." It's another entirely to say, "in an unknown amount of time the company will be publicly traded/acquired and I'll have liquidity at an unknown value."
The latter prevents the hedge fund from actually creating hedges.
yeah, we need a different name for these things, like FAM, "flexible asset managers", or AIMs, alternative asset managers. The key point is that they can do whatever they want, not that they "hedge" anything.
The business of a lot of them amounts to sticking 80% of the money in whatever's trendy, 20% in the managers pockets, roughly. Not a bad deal for the managers if you can pull it off.
Could you elaborate? My first inclination is to strongly disagree having worked on hedges before, but if you know something I do not I'd like to hear about it.
Edit: You can create hedges on unknown time-horizons with unknown returns but rather quickly the cost of maintaining the hedges should drastically outpace their value as hedges. Time volatility on the order of years is harder (read much more expensive) to deal with than revenue volatility with a known time-horizon.
So, while you can create a theoretical hedge instrument, the application of such an instrument is untenable as a profitable hedge in practice. (from my personal experience, would still love to be proven wrong here)
You seem to have more experience hedging in the real world than me but I'll bite anyway...
"So, while you can create a theoretical hedge instrument, the application of such an instrument is untenable as a profitable hedge in practice"
There is an infinite amount of hedges that can be created with synthetic financial instruments. Some instruments haven't been invented yet and even if they have been invented you have to convince somebody else to take the other side of any trade. Credit default swaps, options and just about any other instrument were new, unproven and potentially secret at some point. Right now there could be somebody who has figured out a way to do some kind of time horizon hedging and is going to make bank when some startups do/don't IPO.
I actually think it's quite likely.
Edit: Having read some of your other comments on here I would rephrase my answer as this: why would a time-horizon hedging strategy be any less successful than any other hedging strategy?
The framework I'm operating from includes the time-value component of the fund. If a fund has a target rate of return of 10% per annum, each additional year they wait for a liquidity event requires an additional 11% (1 / 0.9) in returns in order to hit their target.
So a valuation drop of 20% is comparable to ~2 years delay in liquidity. My strong suspicion is that the price volatility is small relative to the time volatility in these startups. There's a lot more knowledge around addressing the pricing volatility issues than the liquidity issues (an unexpected liquidity issue in the short-term markets is what caused both Bear Sterns and Lehman Bros to fail). In the end I believe that delayed liquidity events, in the market we are entering, are going to be strongly correlated with reduced IPO value.
To directly answer you question : the challenges of hedging for the time horizon of liquidity events will also include price volatility issues as well. So essentially if you're worrying about liquidity you still have to worry about price, where in saner times there are vehicles where you only have to worry about price. More hedges means more carry cost and less-profits. So what I meant by the "untenable" is that I don't expect the cost-value to be there in those circumstances.
Definitely possible that I'm wrong here, I just think the odds are against anyone dealing with those types of problems.
I have zero experience in this area, but regarding the price volatility, I was under the impression that a lot of the massive late-stage investment rounds had been structured more like debt. So something like 2-3x liquidity preference, with a cap on returns[1]. Not sure if this is what the hedge funds are doing, but if so, seems like they are controlling the price and taking a risk on the time horizon. Of course the fact that they are heading towards the exits (according to this article) implies it's not going as expected.
Would you mind giving an ELI5 explanation of how hedge funds currently handle exit value volatility (minus the unknown time-horizons aspect) for those of us who haven't worked on hedges before?
Lets assume no fundamental issues with the economy, e.g. we're only worried about companies competing with eachother not a financial crisis.
The expectation of a startup is typically that it will disrupt an existing industry or fail to do so. If it disrupts an existing industry, existing market participants will lose marketshare.
Knowing who the competitors are in a given space, and how they contribute to the overall market, allows the hedge fund to model what the long-term revenue streams of a startup could look like. More importantly, they model how much money competitors and contributors to the space will make or lose due to the market change. Having these expectations they can then acquire futures contracts (contracts that allow them to fix the price and date they pay or receive for a publicly traded security) opportunistically during normal market fluctuations.
If the hedge is working perfectly they will make money back regardless of whether the company succeeds or fails. Trains vs. Buses vs. Cars with inputs of fuel is a classic hedge model example (although rather simplistic).
Lately hedge funds (and other early investors) are building their hedges into the investment itself with liquidity preferences which are creating their own sets of problems. Basically, liquidity preferences can be thought of as a hedge on their investment but they lose a lot of hedge value when they don't know when the liquidity event will occur.
Sorry if that isn't ELI5 enough, hedges are a pretty complex animal and it's hard not to jump down every rabbit hole detail.
In a completely theoretical way what you say is possible. But in practice does anyone actually do this?
What's the time frame you'd be willing to stake your career on for a startup (event a fairly mature one) to be meaningfully impacting the overall profitability of it's astronomically larger competitors? And you'd be simultaneously betting against overall bull markets and that the incumbents won't adapt, whether in the market directly against the startup or in any of the other markets they're in.
To my knowledge you can't even trade in stock futures with sufficiently distant expiration dates to do this.
"To my knowledge you can't even trade in stock futures with sufficiently distant expiration dates to do this."
To put this as politely as possible, you are incorrect. When you have more than $1 billion under management there are numerous counter parties more than willing to design bespoke financial instruments to suit your needs. My first role in finance involved modeling the risk associated with the bespoke instruments that people were asking my tiny (<$1 billion) firm to create. If you watch 'The Big Short' 1/3rd of the movie is devoted the creation, acquisition, and distribution of a bespoke financial instrument traded upon layers of bespoke instruments (Credit Default Swaps, Credit Default Obligitions, rolled bond instruments, etc.) Remember when Christian Bale's character gets chewed out for losing so much money a month? It's because he's paying to maintain his bespoke put options on mortgage backed securities.
"What's the time frame you'd be willing to stake your career on for a startup"
I left the industry, I find it pretty disgusting to be quite honest. However you're missing the fact that these hedge funds don't invest in one startup, they invest in dozens in an effort to diversify their risk. Furthermore, if you think a fund manager is "staking their career" by making these bets you missed two important facts:
* 2 and 20, they're taking home 2% under management even if they lose it all.
* By the time someone is in the position to manage that many investments they are both able to retire and sell themselves into any position. There's as many, if not more, investment managers that lose money as make it. Their job is to quantify and tolerate risk, quite often that entails losing money on some investments.
Anecdotally, when I first started in the industry we had a director who lost $30MM in the course of 2 weeks on an investment. We had hit a risk case that exceeded the 99th percentile on an investment strategy he had developed. A month later we had recouped the $30MM with an additional $60MM of profit. He took an educated risk and it could have made us take a loss for the year. Importantly, all of our other investments performed wholly within expectations during that time frame. So, while we were losing money hand over fist during those weeks it was never an existential risk to the company.
But does anyone really do this? Are there published examples of people doing this or talking about doing it? I can find plenty of examples of hedge funds betting on single mid or late stage startups but not doing what you're suggesting here.
What you're suggesting is incredibly interesting so I don't intend to be rude but the concept strikes me as ludicrous. The assumptions that would go into a financial model for something like this seem ridiculous to me. You'd be betting/guessing/hedging on countless company, industry and macro-economic variables over a long, long time frame.
I very much doubt that they do it in the exact methodology I described but I assure you that market participants do this.
There is probably published material available on 70's and 80's hedging techniques but now that they are known the market converges. The problem with what you're asking now is that anyone privy to modern strategies would be sued out of existence for divulging them. A successful hedging strategy is very much classified as a trade secret.
The only thing of value a hedge fund provides, if it does indeed provide any value, is it's investment strategy. There are no perfect hedges because they'll typically be arbitraged out of existence but the logic that goes into hedging is the reason liquidity preferences exist now.
The finance industry has a wholly different outlook on things than normal people so I understand the confusion here, it took me a bit to fully grasp why and how to do things even once I was immersed in the industry.
Also, I should emphasize here: the theory behind the concept looks pretty but in application the assumptions can completely obliterate the success of the investment. The book "A Random Walk Down Wall Street" by Burton Malkiel covers a lot of the finance industry from an academically rational perspective.
If you read that book you'll take away the counter point to everything I've said here. Which is, there is no evidence in advance that a hedge fund can successfully hedge. After the fact, survivor bias may mislead us into believing that what appeared to be a sound strategy may have just been luck.
At the end, the challenges to hedging aren't obtaining the appropriate instruments or taking on the risk, these are problems that all major financial entities are comfortable dealing with. The challenge in hedging is that you don't know how accurate your assumptions are until the hedge is complete.
Essentially when crafting a hedge you are playing a binary scenario (A wins and B fails, or A fails and B wins). The problem is that the input assumptions also need to hedged, and then you have assumptions on those hedges, and so on.
Thanks for all of your insights here, this was very interesting to digest.
I just started reading "A Random Walk Down Wall Street" and it is solid so far. How good of an investing primer would you say it is for a novice? Are there other good books you'd recommend?
Also, I do modeling for advertising as part of my day job, but I've always been curious how much of that analysis/optimization skillset is applicable to trading and risk modeling. Are there any good introductory primers you'd recommend?
Lastly, in The Big Short movie, how accurate is the scene where they first have discussions with Goldman about the bespoke instrument? It looks like the quant sits there listening, the two Goldman folks whisper a bit, and then they say they'll do it under XYZ terms. I'm guessing in real life they'd meet, Goldman would go back and model stuff on their end to determine the terms, then come back with what they'd be willing to do and it wouldn't happen in the span of a conversation like that. Can you shed any light?
For finding good resources on personal investing (these sites will have the standard suggested reading):
www.reddit.com/r/personalfinance
www.bogleheads.com
If you want to apply your abilities to investing it's a little harder. The theme of Malkiel's book is that there is no way to regularly beat the market, and I agree with him. There are opportunities but they require a great deal of effort, resources, and risk tolerance. Look into George Soros shorting the pound (I think that's the story), what I typically do now is follow along with what the big boys are doing publicly, evaluate it on my own, and then make an investment there. I avoid leveraging, futures, or going short because I will never be able to devote as much time to valuing them as other market participants. I have recently purchased a fair amount of Alcoa based on some "activist investor" market theses.
What you want to do is learn the basics (how to invest personal money in the standard fashion, based on Malkiel and Bogle). Then come up with a riskier strategy on top of that that either leverages someone elses analytical hard work or requires minimal effort on your part. There are hundred of people you'd be competing with working hundred hour weeks if you were to try to play the leveraged game (doesn't mean you can't win thought).
I never worked with Goldman or their ilk so I can't speak from personal experience. My guess would be that there was no personal meeting, just an email exchange followed by some quant analysis, followed by negotiation (in person, over phone, or over chat). You're definitely right that that scene was a hollywood fiction.
If you want to chat more feel free to email me at iawHackerNews at gmail dot com.
Easy -- for an "imperfect hedge", find a comparable company and sell an opposite instrument. If you are holding illiquid stock in VenMo for example, buy puts on either a the NASDAQ or PAYPAL. As the value of one goes up, the value of the other generally goes down, you are generally even.
For a "perfect hedge", find a counterparty willing to bet on the price of what you own (perhaps they have an opposite exposure) and have them take the opposite side of a forward or swap for your illiquid stock.
Good explanation, but maybe use Dwolla instead of Venmo (Paypal bought Braintree a few years ago, which had bought Venmo prior to that -- So Venmo is now a subsidiary of Paypal).
It's unreasonable to assume that the faucet for investment money will be open indefinitely, especially when investors don't get the benefits they would have with a public company: liquidity, transparency, etc.
Staying private indefinitely is not just regulartory arbitrage, it's also maintaining significant control and information assymetry between managers / early investors and the rest of the investors and employees.
Oh man, I'm so going to be downvoted on this, but...
"I’m done with intangible valuations, unknown exits, unknown liquidity, and I want something that if I put my money into it now, I’m not going to hit a grand slam, but I’m going to get something that’s immediately yielding."
Since when has a combination of intangible valuations, unknown exits and unknown liquidity every been anything other than an extremely high risk proposition?
These things are going to happen anyways, a feature of anti-fragile systems is that they can handle and deal with volatility and stressors, so we're going to be fine.
The easy times can't always be in, and you will never catch the next good times if you're not in it well beforehand.
yaaawn more misleading titles. 'Pulling out' would imply lower valuations, of which there is no evidence for startups like Snapchat, Pinterest or Uber. Instead of selling, what is happening is that we're seeing a flight to quality, which is something I predicted months ago.
when in the end of 2013 and in 2014 pension funds and similar money from out of state started to be 'absorbed' [through hedge funds of course] into the Valley, it kind of was pretty clear that this is the last, the 'IPO' wave, ie. the last fools who will be holding the bag (which is sold to them by Valley's VCs). The Valley has got these money now, will catch the breath and will be getting ready for the next wave...
The thing can become interesting if somebody happened to have sold/bought a good [leveraged] amount of bonds and CDS on all those startups around - i mean it is pretty obvious that pooling startups together into a bond would make it an AAA bond the same way like pooling subprime mortgages before 2008 produced AAA bonds :)
