Month: July 2023

Chart of the Day – Shorting is Hard Part Two

This will never work (Vol. 6, No. 24)

Five months ago, we wrote about how hard “shorting” stocks are. Even if the thesis is right, stocks do not go down in a straight line. Short squeezes can result in painful margin calls that force short sellers to close positions.

We did not mention it at the time but the reason for our post (included below) was the release of a short report on a local investor darling.

So far, things have not been as tough for the shorts. As shown in the red line above, the short report had a sharp immediate impact. The target’s share price fell 19% on the first day. It made up some ground in the following three months. Even at its worst point, the 23% correction was only 4ppt lower than the 19% correction after the first day. At this point, roughly 150 days later, the target has clawed back nearly all of its decline, sitting only 3.9% below where it traded prior to the short attack.

Before one draws any conclusion on who’s right and who’s wrong, history shows these things take a long time to play out.

For us, this goes into the interesting but too hard pile.

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The markets can remain irrational longer than you can remain solvent.

John Maynard Keynes

Short-selling is hard.

The above chart is from a company that was the target of a short-seller’s report. If one were to look at its share price performance over the long term, the short seller was right. Since the publication of its report, the target’s share price has corrected by -80% plus.

However, before one takes their victory lap, it was wrong/painful for a very long time.

Initially, when the short-seller released its negative report, the correction was swift and severe. The target fell 26% in the first six days but having been an institutional darling, investors gave it the benefit of the doubt. By Day 69, roughly two months after, the target had managed to claw back all of the correction and began to turn the tables on its short-seller. In the ensuing four months, by Day 180, it had put on a massive squeeze on the shorts, driving its share price +64% above the level when the critical report was released. To put proper context on the extent of the short-squeeze, going from -26% to +64% is equal to a gain of +116%.

Ouch!!

Assuming the shorts managed to meet margin calls and bear with the pain, it took them 430 days, or roughly 1 year and 2 months, before their original position turned profitable again. Of course, if they had managed to add fresh shorts at+64%, then more power to them but one can just ask Melvin how easy it was to do that.

Investing is hard but shorting is even harder.

Deposit Rates for Small Frys and Giant Whales

This will never work (Vol. 6, No. 23)

What is your relationship with your bank? Do you like your bank?

When it comes to opening a bank account or taking out a mortgage, the process is like a reverse beauty pageant. You are not picking the best bank but the least terrible.

For most of the past decade when cash was trash, we mostly cared about the user experience. How easy is it to move money around? How long are the lines? How secure are the bank’s online platforms?

While these are all still important, over the past 12 months, another important consideration has returned – What can you earn on your deposit?

Cash is No Longer Trash

At the individual level, bank deposit rates are pretty transparent. This is an issue that Mom and Pops care about so the local press does a good job highlighting where the highest time deposit rates are.

At Hang Seng Bank (traditionally one of the stingiest local banks), three months HKD time deposits have risen from 3.1% in mid-May 2023 to 3.6% currently. If one were to swap to USD, the rates are even better. Hang Seng Bank currently offers 4.6% (3-month) while parent HSBC jams you with only 3.7%.

Although these rates are much improved compared to last year (zero), considering current Fed Funds (USD) at 5.0-5.25% and HIBOR is at 5.2% (HKD), the banks are still screwing you.

Hibor back to mid 2000 level but deposit rates have hardly budged

Banks Are Still Stiffing Depositors

Even though us little guys have it bad, the big guys have it worse. Say you are a limited company and have some spare cash lying around, what do you think the banks will pay you? Surely, it must be higher than what they pay small individual depositors.

Nope.

Corporates get screwed even worse. For the privilege of lending the bank your business’s hard earned cash (that’s what deposits are, you are lending the bank your money), they will pay you 1.0%. This is no where close to the 3-4% that they pay individuals.

Is it because we are small frys? Maybe the banks don’t care about our millions but they must pay better if we are talking about billions of dollars?

We do not have billions but we know someone who does. Specifically, we know of a public company that is sitting on HK$40+ billion net cash. Surely, for a corporate with an 11-digits cash balance, the banks must care about where they choose to park their cash.

Nope again.

The Bigger You Are, the Worse the Treatment

In the 12 months to June 2022, this listed corporate earned HK$337mn interest income. Not bad until you see that its average cash balance was HK$44.5bn, this works out to an interest rate of 0.76%. Ah, but that period only covered three months of the current rate hike cycle, surely its earned interest rate has picked up.

A bit.

In 2H 2023, our cash rich developer earned HK$605mn, an effective interest rate of 2.71%. This is better but still low considering that 3month hibor had ranged between 1.86%-5.29% in 2H 2022.

During 2H 2022, what aligns best with our corporate’s interest income turned out to be one-month Hibor but this was only for that six-month period. For most of the past decade, our corporate was able to earn a consistently higher return on its cash but the bigger its cash pile grew, the smaller the spread it was able to earn on its cash.

Although we still do not know why the local banks don’t care about its depositors, we can draw comfort that us small frys have it better than the whales.

Banks are equal opportunity businesses, they screw everyone.

This will never work.

Rascal Does Not Dream of Outperforming Funds

This will never work (Vol. 6, No. 22)

What makes stocks go up? What makes stocks go down? Bottom up value investors would say that it’s all about earnings and cash flows. Macro traders would say it’s all driven by interest rates.

The real answer is simpler. Are there more buyers than sellers or the other way around?

When there are more sellers than buyers, prices goes down. When buyers outnumber sellers, price goes up.

Since our blog began some six years ago, we have made a ton of mistakes. In addition to just saying “no” to China property and structured products, another lesson we learnt is that if you are ever asked to invest in a fund (equity, bonds, hedge, private equity, private credit), the only thing that matters is fund flows.

Inflows <=> Outflows = Virtuous <=> Vicious Cycle

When money is flowing in, fund managers have to invest. This bids up the price of the underlying investments, marking up its NAV. The strong performance and the fear of missing out draws in more investors, creating a virtuous cycle.

For the early birds, this is great. But for the average Joe, by the time, we hear about a particular theme, its probably closer to the eighth inning.

The virtuous cycle works until it doesn’t. As early bird investors start to exit, the virtuous cycle turns vicious. In order to raise cash, the fund sells some of its positions. This depress share prices. The marked down NAV reduces performance, causing more investors to ask for their money back.

How a fund performs has very little to do with the manager’s skills. More often than not, it’s just down to whether the tide is coming in or going out.

That’s our rant. Here is a live case.

This chart shows the performance of a certain equity fund (blue line) that focuses on the Chinese market. As benchmark, we have added MSCI China (red) and the HSI (yellow).

The first thing to note is just how awful the HSI has been over the past five years. It never went up and is down 35% since the start of 2019.

The China fund did better initially. In 2019 and 2020 when MSCI China rose 40%, the stock fund gained 57%.

Performance Chasing – Don’t be the Last Marginal Buyer

Although all fund brochures caution that “past performance is not indicative of future returns”, their real message is don’t miss out.

Take a look at the following chart which shows NAV (i.e. performance) against AUM (fund flows). This is what performance chasing looks like.

Between November 2020 and February 2021, AUM more than doubled from $472mn to $1,019mn. This drove NAVs up 18% in two months but it also marked the top.

When we compare the monthly fund flows with monthly performance, it is painfully obvious why retail investors always lose. Mr. Lee took eight months to see if the recovery was for real before deciding to increase their allocation to the China fund.

By the time Mr. Lee was fully invested, it was the top. In the subsequent 29 month, the China fund only saw eight months of positive returns. Having bought at the top, our poor retail investor stuck with the decision for close to two years, enduring a 56% draw down in the process. By October 2022, it was too painful and they wanted out.

As funds started to flow out, “active” management turned vicious. Just before outflows began, the maximum drawdown for MSCI China and our China fund were -59% and -56%. In the ensuing seven months, facing redemption pressure and the need to raise cash, our fund manager was forced to sell at the low and could not enjoy the rebound.

At end-May 2023, this active fund was down 62% from its peak, some 11ppt worse than MSCI China. As for our perennial underperformer, since the HSI never enjoyed any gains, it did not have as much to fall, drawing down a milder -38%.

The lesson here is that unless one has the know how and patience to track fund flows, you should just say “no” to”active” or “thematic” funds.

Schrödinger’s Cat but With High Fees

Investing is hard. Until you put on a position, the investment is simultaneously good and bad. But with an “active” fund that charges 2% base and 15% performance fees, there are very few timelines that have a positive outcome.

But in all scenarios, fees are non-refundable.

This will never work.