Passive investors and insider traders
THIS week S&P Dow Jones Indices released its annual SPIVA scorecard measuring how mutual fund managers performed relative to indexes. Last year, "66.11% of large-cap managers, 56.81% of mid-cap managers, and 72.2% of small-cap managers underperformed the S&P 500, the S&P MidCap 400, and the S&P SmallCap 600, respectively," and The figures are equally unfavorable when viewed over longer-term investment horizons. Over the five-year period, 84.15% of large-cap managers, 76.69% of mid-cap managers, and 90.13% of small-cap managers lagged their respective benchmarks.
Meanwhile a lot of hedge funds have had a terrible start to 2016, though it doesn't seem to matter that much: "I think they are getting the benefit of the doubt," Dean Backer, global head of sales and capital introduction at Goldman Sachs, said of many of the biggest hedge fund managers, owing to their historical performance. "I'm not sure people know - if they took money out of hedge funds- where they would put it," he added.
Yes where can you invest other than in hedge funds? On the other hand, here is James Ledbetter wondering "whether, as passive investing grows, it is having harmful effects on the economy as a whole." The harmful effects here are pretty tenuous. Ledbetter worries that "a market with more passive investors than active ones will continue to push money into the largest firms, whether these companies are actually performing strongly or not"; Cullen Roche replies that "passive indexers rely on active arbitrageurs to set prices," and that in fact, "as indexing has grown, the number of members leaving the index has increased." One thing about index funds is that they don't trade that much; even if most investors are passive, most trading will nevertheless be active, and will presumably push prices in the direction that the fundamentals demand. Elsewhere: "Equity funds draw investors for first time in 2016." And "Meet Forcerank, the FanDuel for Stocks." I thought stocks were the FanDuel for stocks? David Ganek was the co-founder of a hedge fund, Level Global Investors, that was raided by the Federal Bureau of Investigation in 2010 as part of U.S. Attorney Preet Bharara's crackdown on insider trading. Ganek was never charged with insider trading, but his co-founder Anthony Chiasson was; Chiasson was convicted, and Level Global was fined by the Securities and Exchange Commission. And then Chiasson's conviction was overturned, and Level Global got its money back: Bharara's expansive theory of insider trading liability turned out to be all wrong.
This didn't do Level Global that much good, since the FBI raid and the attendant publicity -- the U.S. Attorney's office tipped off the Wall Street Journal about the raid so it could get some pictures -- is bad for business, and the fund shut down in 2011. So Ganek sued the FBI agents and prosecutors involved, claiming that they'd violated his civil rights, and yesterday a judge let his case go forward. Ganek's basic claim is that prosecutors knew from the beginning that hewasn't knowingly insider trading: Their main cooperating witness, former Level Global analyst Sam Adondakis, admitted to trading on inside information from Dell, and told the FBI that he had informed other people at Level Global about the source of the information, but said that Ganek himself never knew the information came from corporate insiders. But when prosecutors asked for a search warrant, they submitted an affidavit falsely claiming that Adondakis said that Ganek knew about the source of the inside information.
That is bad! You are not supposed to lie to the court! I don't really know what prosecutors were thinking there. But one possibility is that, the way they thought about insider trading, it didn't matter. The Preet Bharara theory of insider trading, circa 2010, was that if you ran a hedge fund and any inside information made its way to you, then you were guilty of insider trading, regardless of what you knew about the source of that information. The mere quality of the information might itself be a tip-off that it was illicit. We sometimes talk around here about one of the crucial lessons of the last few years of financial scandals, which is: Don't put it in writing. But taking that over-literally can also get you in trouble. Here is a strange little Securities and Exchange Commission enforcement action against the Westlands Water District for doing some accounting manipulations to meet the debt service coverage ratio in its municipal bonds without raising rates on customers.