What We’re Reading (Week Ending 18 August 2024) - 18 Aug 2024
Reading helps us learn about the world and it is a really important aspect of investing. The late Charlie Munger even went so far as to say that “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” We (the co-founders of Compounder Fund) read widely across a range of topics, including investing, business, technology, and the world in general. We want to regularly share the best articles we’ve come across recently. Here they are (for the week ending 18 August 2024):
1. This Is How Treasury Really Funds Trillions of Dollars of US Debt – Joe Weisenthal, Tracy Alloway, and Amar Reganti
Tracy (08:40):
So when I think about debt issuance, I used to cover corporate credit, and so I think about, you know, being a treasurer at a large multinational like an Apple or a Microsoft or whatever, and the decision making process there where, you know, if I decide there are favorable market conditions, I might go out and work with my bankers and decide to issue some debt. What is the difference between being a treasurer at a big company versus being US Treasury?
Amar (09:19):
Oh, a vast difference, right? And I too started on the other side, as a corporate portfolio manager in the bond market. You’d look at companies coming to the market, they either needed cash or as opportunistic. For the US government and for the debt management office, it’s very different. It’s that, you are always going to be at various points on the curve, whether or not at that point it’s, what I would call, tactically a good thing. And you know, this goes into that regular and predictable issuance cycle. And the point there, and this is how we get to cost, which is again different from how corporates measure cost is that, by being consistent, by helping this ecosystem thrive, you’re going to create a liquidity premium, right? That, because there is this regular and predictable nature to your issuance cycle, people understand they’re not going to be surprised that the availability of securities is going to be well calibrated to what the environment needs.
And when I meant environment or ecosystem, I meant the entire ecosystem. You want to service as broad of and diversified group of investors as possible. And that includes people who will actively short your securities, right? Because that provides a supply outside of auction cycles for people to buy and also helps stimulate repo markets and so on. So you want to be sure that you aren’t attempting to use pure price on what’s on the yield curve as a point on why or how you should issue.
Now, I want to be a little careful. There is a quantitative framework that Treasury has and it’s a model that, you know, a number of people collaborated on. Credit goes to people like Brian Sack, Srini Ramaswamy, Terry Belton, Kris Dawsey, a number of others who built this model. And it sort of gives a sense of, okay, historically, based on a number of inputs, where has Treasury benefited the most by issuing. But that’s like an important guidepost, but the more important part is the qualitative feedback that Treasury hears from its dealers, from investors, from central bank reserve managers who hold vast amounts of Treasuries. And that all also feeds in, along with the [Treasury] Borrowing Advisory Committee (TBAC), into making issuance decisions…
…Joe (16:05):
Also, Tracy, just to add onto that, we have an inverted yield curve. So, theoretically, if you wanted to borrow at the low, you know, one could say ‘Oh look, it’s cheaper to borrow at the long end, why are you selling all these bills when actually the cheapness is at the end?’
Tracy (16:18):
So this is the very essence of the current controversy. What is happening — and I know you’re not a Treasury now — but what is happening when the Treasury comes out with that kind of decision?
Amar (16:28):
Okay. So the first kind of framework you want to think about is, and you had asked this initially, is how do they make these directional issuance decisions? Well, the first thing is that Treasury does look at long-term averages of where it is in its weighted average maturity, right? Like when you add all these securities together, what’s sort of the average maturity? And historically, it’s been around 60 [or] 61 months. Treasury is well above that right now. It’s around 71 months. So it’s actually pretty, pretty high up.
Tracy (16:57):
Which, just to be clear, most people would say that’s a good thing, right? You want to term out your debt?
Amar (17:02):
Maybe if you’re a corporate treasurer you might want to do that, but there’s a lot of arguments that you actually don’t want to term out your debt.
Tracy (17:10):
Oh, interesting.
Amar (17:10):
So, the first is, is that yes, the curve is inverted. That’s, if you decided to move issuance that way, chances are you could uninvert the curve. I’m not saying that’s a definitive, it depends on how much or or how likely, you know, what else is happening in markets. The second thing is that, as in a previous episode, I thought Josh Younger explained it really well, you could roll these three-month bills, you know, all the way out to 10 years or you could issue a 10 year.
And if you’re sort of risk neutral, there’s no savings, right? Or there’s no gain or savings. It just means that, forwards get realized and it’s effectively the same thing. So when Treasury does that, you’re saying that, over time, you’re effectively making a tactical rates call that somehow, that you think that 10 year rates or 30 year rates won’t go substantially lower. That’s the first thing. The second thing is that the sheer amount that you can put on the 10 and 30 year is going to be less than what you can put in the bills market. Now that’s just absent anything that the Federal Reserve is doing. That’s just generally true, right? Like it’s just a broader and bigger, it tends to be a broader and bigger market.
Joe (18:19):
The shorter end.
Tracy (18:20):
Yeah, there’s more demand for shorter-dated securities.
Amar (18:22):
Yeah. But the third thing is that what Treasury really is trying to do is look around across the ecosystem and say, ‘Hey, where should we be feeding securities to over time if we are kind of taking a risk neutral sort of approach to this? That we’re not extrapolating what forward curves are going to be. We don’t know any more than a typical rate strategist or someone. We know what we don’t know about how market rates evolve over time. So because of that, our job is to help issue securities to where the biggest pools of capital are, because that’s how you issue risk-free securities and keep up the health and demand for, and liquidity of, your asset class.’ So the biggest pool of money now, in particular, is still at the front end, right? The amount of reserves that have been created is really dramatic.
2. Investing success comes down to one word: focus – Chin Hui Leong
Buffett does the same thing. On his table, he keeps a tray labelled, in capital letters, “TOO HARD”, a strategically placed reminder that most of the opportunities which cross his desk belong in that tray.
Now pause and think about that for a moment. Buffett is widely lauded for his investment smarts and long investing experience. In other words, it would be ridiculous to suggest that he has trouble understanding any company.
But Buffett knows better than that. Despite his ability, he is smart enough to know that there are many companies out there that he does not understand and should not touch. We would be wise to do the same…
…There’s an unfortunate adage in news broadcasting: If it bleeds, it leads. Said another way, negative headlines tend to get almost all of the attention while positive news gets buried in the process.
It’s true in investing as well. When Facebook reported a loss of a million daily active users (DAUs) in early 2022, the reaction from news outlets and analysts was deafening, with some even suggesting Facebook is on its last legs as a social network.
But since reporting the loss, the social network has gained over 180 million DAUs by 2023. Do you hear about these positive gains in the media? No, you don’t.
This example tells you one thing: You have to be proactive in searching for positive trends within the company.
And that means looking past its current problems and honing in on the parts which are not said out loud. For instance, at the end of 2021, Meta was far from a dying business. In fact, the social media company had nearly US$48 billion on its balance sheet after generating US$39 billion in free cash flow during the year.
3. The Seven Virtues of Great Investors – Jason Zweig
Curiosity is the first investing virtue. It’s what enables you to find and develop all the others…. Ordinary investors are afraid of what they don’t know, as if they are navigating the world with those antique maps that labeled uncharted waters with the warning “here be dragons.” Great investors are afraid of what they do know, because they realize it might be biased, incomplete or wrong. So they never deviate from their lifelong, relentless quest to learn more…
…without independence, investors are doomed to mediocrity. What’s your single most valuable asset as an investor? Your mind! If you let other people do your thinking for you, you’ve traded away your greatest asset — and made your results and your emotions hostage to the whims of millions of strangers. And those strangers can do the strangest things…
…Making a courageous investment “gives you that awful feeling you get in the pit of the stomach when you’re afraid you’re throwing good money after bad,” says investor and financial historian William Bernstein of Efficient Frontier Advisors in Eastford, Conn.
4. Integration and Android – Ben Thompson
Yesterday Google announced its ninth iteration of Pixel phones, and as you might expect, the focus was on AI. It is also unsurprising that the foundation of Osterloh’s pitch at the beginning of the keynote was about integration. What was notable is that the integration he focused on actually didn’t have anything to do with Pixel at all, but rather Android and Google:
We’re re-imagining the entire OS layer, putting Gemini right at the core of Android, the world’s most popular OS. You can see how we’re innovating with AI at every layer of the tech stack: from the infrastructure and the foundation models, to the OS and devices, and the apps and services you use every day. It’s a complete end-to-end experience that only Google can deliver. And I want to talk about the work we’re going to integrate it all together, with an integrated, helpful AI assistant for everyone. It changes how people interact with their mobile devices, and we’re building it right into Android.
For years, we’ve been pursuing our vision of a mobile AI assistant that you can work with like you work with a real life personal assistant, but we’ve been limited by the bounds of what existing technologies can do. So we’ve completely rebuilt the personal assistant experience around our Gemini models, creating a novel kind of computing help for the Gemini era.
The new Gemini assistant can go beyond understanding your words, to understanding your intent, so you can communicate more naturally. It can synthesize large amounts of information within seconds, and tackle complex tasks. It can draft messages for you, brainstorm with you, and give you ideas on how you can improve your work. With your permission, it can offer unparalleled personalized help, accessing relevant information across your Gmail Inbox, your Google calendar, and more. And it can reason across personal information and Google’s world knowledge, to provide just the right help and insight you need, and its only possible through advances we made in Gemini models over the last six months. It’s the biggest leap forward since we launched Google Assistant. Now we’re going to keep building responsibly, and pushing to make sure Gemini is available to everyone on every phone, and of course this starts with Android.
This may seem obvious, and in many respects it is: Google is a services company, which means it is incentivized to serve the entire world, maximizing the leverage on its costs, and the best way to reach the entire world is via Android. Of course that excludes the iPhone, but the new Gemini assistant isn’t displacing Siri anytime soon!
That, though, gets why the focus on Android is notable: one possible strategy for Google would have been to make its AI assistant efforts exclusive to Pixel, which The Information reported might happen late last year; the rumored name for the Pixel-exclusive-assistant was “Pixie”. I wrote in Google’s True Moonshot:
What, though, if the mission statement were the moonshot all along? What if “I’m Feeling Lucky” were not a whimsical button on a spartan home page, but the default way of interacting with all of the world’s information? What if an AI Assistant were so good, and so natural, that anyone with seamless access to it simply used it all the time, without thought?
That, needless to say, is probably the only thing that truly scares Apple. Yes, Android has its advantages to iOS, but they aren’t particularly meaningful to most people, and even for those that care — like me — they are not large enough to give up on iOS’s overall superior user experience. The only thing that drives meaningful shifts in platform marketshare are paradigm shifts, and while I doubt the v1 version of Pixie would be good enough to drive switching from iPhone users, there is at least a path to where it does exactly that.
Of course Pixel would need to win in the Android space first, and that would mean massively more investment by Google in go-to-market activities in particular, from opening stores to subsidizing carriers to ramping up production capacity. It would not be cheap, which is why it’s no surprise that Google hasn’t truly invested to make Pixel a meaningful player in the smartphone space.
The potential payoff, though, is astronomical: a world with Pixie everywhere means a world where Google makes real money from selling hardware, in addition to services for enterprises and schools, and cloud services that leverage Google’s infrastructure to provide the same capabilities to businesses. Moreover, it’s a world where Google is truly integrated: the company already makes the chips, in both its phones and its data centers, it makes the models, and it does it all with the largest collection of data in the world.
This path does away with the messiness of complicated relationships with OEMs and developers and the like, which I think suits the company: Google, at its core, has always been much more like Apple than Microsoft. It wants to control everything, it just needs to do it legally; that the best manifestation of AI is almost certainly dependent on a fully integrated (and thus fully seamless) experience means that the company can both control everything and, if it pulls this gambit off, serve everyone.
The problem is that the risks are massive: Google would not only be risking search revenue, it would also estrange its OEM partners, all while spending astronomical amounts of money. The attempt to be the one AI Assistant that everyone uses — and pays for — is the polar opposite of the conservative approach the company has taken to the Google Aggregator Paradox. Paying for defaults and buying off competitors is the strategy of a company seeking to protect what it has; spending on a bold assault on the most dominant company in tech is to risk it all.
I’ve referenced this piece a few times over the last year, including when Osterloh, the founding father of Pixel, took over Android as well. I said in an Update at the time:
Google has a very long ways to go to make [Google’s True Moonshot] a reality, or, frankly, to even make it a corporate goal. It will cost a lot of money, risk partnerships, and lower margins. It is, though, a massive opportunity — the maximal application of AI to Google’s business prospects — and it strikes me as a pretty big deal that, at least when it comes to the org chart, the Pixel has been elevated above Android.
In fact, though, my takeaway from yesterday’s event is the opposite: Android still matters most, and the integration Google is truly betting on is with the cloud.
5. Signature Bank – why the 36,000% rise in 7 months? – Swen Lorenz
In case you don’t remember, Signature Bank had gotten shipwrecked in March 2023, alongside the other infamous “crypto-deposit banks”, Silvergate Bank and First Republic Bank. Its stock had to be considered worthless, at least by conventional wisdom.
However, between October and December 2023, the share price suddenly rose from 1 cent to USD 1.60. Buyers were hovering up shares, sometimes several million in a single day.
The stock then doubled again and reached USD 3.60, and with heavy trading…
…On 12 March 2023, New York authorities closed the bank. Because of its size, the US government considered a collapse a systemic risk, which enabled the FDIC to step in and guarantee all deposits after all. Whereas deposit holders were going to be made whole, those investors who held equity or bonds issued by Signature Bank were going to lose their entire investment. Within one week, the majority of the bank’s deposits and loans were taken over by New York Community Bancorp (ISN US6494451031, NYCB), which is the usual way to dispose of a failed banking operation…
…Not all of Signature Bank’s assets were transferred to New York Community Bancorp. When the bank closed its doors, it had USD 107bn of assets. Of that, only USD 47bn were transferred to New York Community Bancorp – basically, the part of the bank’s portfolio that was deemed a worthwhile business. A portfolio with a remaining USD 60bn of loans would remain in receivership, and it was earmarked for a gradual unwinding.
In September 2023, the FDIC sold another USD 28bn of the bank’s assets to Flagstar Bank.
The remaining USD 32bn of loans comprised mortgages made against commercial real estate and rent-regulated apartment buildings in New York – asset classes that are not exactly in favour with investors.
However, the FDIC knew that it was going to release more value from these remaining loans if it allowed them to continue to maturity. The government entity needed help, though, to get the job done, and it had to deliver some evidence that letting this portfolio run off over time was indeed the best way to minimise losses and maximise proceeds.
To this end, the FDIC put these remaining loans into joint venture entities. Minority stakes in these entities were then offered to private equity companies and other financial investors…
…These financial investors paid the equivalent of 59-72 cents on the dollar…
…For the FDIC to be made whole on the remaining USD 32bn portfolio of loans, it needs to recover 85% of the outstanding amounts. If the recovery rate of these remaining USD 32bn of loans comes out higher than 85%, there will be money left over to go towards holders of the bank’s bonds, preference shares, and ordinary shares.
How could any external investor come up with an estimate for the likely recovery rate?…
…It’s all down to the default rate and the so-called severity.
The default rate is the percentage of loans where the debtor won’t be able to make a repayment in full.
Severity is the percentage loss suffered when a debtor is not able to make a repayment in full. E.g., a debtor may not be able to pay back the entire mortgage but just 75%. In that case, the severity is 25%…
…The resulting estimate of an 8% loss on the loan portfolio means that 92% of the loan book will be recovered. Given that the FDIC’s claims only make up 85% of the loan book, this means there will be money left over to go towards the holders of Signature Bank’s bonds, preference shares, and ordinary shares.
This money is not going to be available immediately since most loans run out in 5-7 years. This gives the managers of these loan portfolios time to work towards maximising how much debtors can repay…
…The FDIC is first in line to receive the money that comes in. According to Goodwin’s estimate, the FDIC’s claims will be paid off in full at the end of 2027.
From that point on, the bonds, preference shares, and ordinary shares will have a value again, as they entitle the holder to a share in the remaining leftover proceeds.
For the ordinary shares, Goodwin estimates USD 600m to be left over, which will become available in about five years’ time. When discounting this sum by 20% p.a., Signature Bank has a fair market cap of of USD 223m.
Disclaimer: None of the information or analysis presented is intended to form the basis for any offer or recommendation. We currently have a vested interest in Alphabet (parent of Google), Apple, Meta Platforms (parent of Faccebook), and Microsoft. Holdings are subject to change at any time.
