Tesla had a year

I was planning to spend this week writing about stories that I missed since going on parental leave in August. Possibly half of them were about Tesla Inc.? Tesla, as always, kept doing stuff while I was out. There was a 5-for-1 stock split at the end of August, taking the stock price down from over $2,200 per share to a more manageable $440-ish. (It closed yesterday at a split-adjusted all-time high of $735.11, for a market capitalization of $697 billion.)

Stock splits are probably financial media’s most infamous category of non-news: You have one share worth $2,200, then you have five shares worth $440, nothing has changed about the expected future cash flows of the company, you have the same amount of water in a different number of buckets, there is nothing really to say. “Ignore Stock Splits, Even Those of Apple and Tesla,” my colleague Nir Kaissar wrote at Bloomberg Opinion. When Apple Inc. has done stock splits I have struggled mightily to try to say something interesting about them, and I don’t claim any particular success.

It’s a little weird, I guess, that Tesla Chief Executive Officer Elon Musk would do a 5-for-1 split. Supposedly splits are friendly to small retail shareholders, but fractional-share trading is pretty normal now (so you don’t need $2,200, or $440, or $735, to buy some Tesla stock) and Tesla does not exactly have trouble attracting retail investors. You could imagine Musk really liking having an enormous dollar price for his stock, as a status symbol, and not wanting a split. You could imagine him wanting some sort of purely logical newfangled pricing system for his stock, like “we won’t have ‘shares’ but you can trade any decimal fraction of the company and we’ll register it on the blockchain.” You could imagine … look, the post-split price was about $440, which is so close to his favorite number; you could easily imagine him announcing “we will split each share of our stock into a number of shares, expressed to six decimal places, such that each post-split share will be worth exactly $420.69 based on the closing price of our stock on Aug. 28.”[1] But instead blah whatever normal stock split. 

Then in December Tesla was finally added to the S&P 500 index. This too is non-news for the expected cash flows of Tesla’s business, but of course it is a big deal for the price of the stock, because there are a lot of index funds that buy all the stocks in the S&P 500 index, and they did not own Tesla and had to buy it when it was added to the index. The S&P 500 is largely based on market capitalization, so roughly speaking a company will usually join the index when it becomes the 500th-biggest company on the stock market. But the S&P also has a profitability requirement, and despite its enormous and growing stock market capitalization Tesla had never been profitable over four consecutive quarters until last June, so it was not eligible to be added to the index until then.[2] The result is that, when it was finally added to the S&P, it was not the 500th-biggest public company in the U.S., but the sixth-biggest, and by far the biggest ever to be added to the index. The result is that index funds had to buy something like $80 billion worth of Tesla stock, all at once, to continue to track the new index. (And sell $80 billion of other stuff.)

Along with these two events, or non-events, Tesla did big at-the-market stock offerings: Right after the stock split, and again a few weeks before the index addition, Tesla sold $5 billion of stock in market transactions on the stock exchange. I have in the past made the obvious point that if people want to give Tesla money at ever-increasing stock prices that even Elon Musk thinks are too high, then Tesla should probably take their money, and, uh, I stand by that. (Similarly, the Wall Street Journal said in December that “the sale is a no-brainer for Tesla’s long-term health.”)

But these offerings are a little unusual. It is not uncommon for a company that joins the S&P 500 to do an “index add offering.” The idea is that all the index funds need to buy a lot of your stock on one day (the day you’re added to the index), and they tend to benchmark themselves against the closing price on that day. If you want to raise money, you can sell them that stock, in an organized book-built offering, priced off the closing price that day. You call banks to do an offering, the banks call the index funds to buy it, it’s all very tidy. You get to sell a lot of stock at a good price; the index funds get to buy a lot of stock efficiently and predictably without pounding up the price by all rushing to buy it in the market. They need liquidity, you need liquidity, there is a mutually beneficial deal.

Tesla didn’t do that: Its index add offering happened two weeks before it actually joined the index, and it was an at-the-market offering, meaning that its banks quietly sold shares in anonymous stock-market transactions over time[3] rather than in big blocks to identified funds at a fixed price at the end of the day. (At-the-market, or ATM, offerings are a clever bit of branding by capital markets bankers: “Any time you need cash, you can take some out of the ATM—the ATM offering that is!”) That is not necessarily the most efficient way to get stock into the hands of big index funds that will need it later, though it did help those funds by increasing supply.

The last time we talked about an ATM offering around here, it was for Hertz Global Holdings Inc., which famously (1) went bankrupt in May and (2) sold stock in June. The stock was quite explicitly worthless—Hertz was bankrupt and the expected recovery for the stock was zero—but it kept trading on the stock exchange, and the price kept going up. Hertz figured, look, other people are selling Hertz stock on the stock exchange, and someone is buying it, so we might as well sell some stock on the stock exchange, because that will raise money for us. A bankruptcy court approved this, but the Securities and Exchange Commission quickly shut it down, though not before Hertz sold $29 million of stock.

Obviously Hertz did an at-the-market offering. If Hertz had hired bankers to call institutional investors and say “what price would you pay for a block of our worthless stock,” the clearing price would surely have been zero. But somebody—day traders on Robinhood, was the near-universal consensus—was buying Hertz stock all day, for positive amounts of money, and Hertz didn’t have to identify those people and call them up: It could just offer shares on the stock exchange, and whoever was doing the buying would buy those shares. The lesson is that if you are looking to tap into exuberant retail sentiment to sell your stock, the ATM offering is the way to do it. I do not know if, two weeks before the largest index add ever, that lesson was relevant to Tesla. 

Tesla shorts

Even before I left, back in July, Tesla hit two pretty big milestones. First, it became the world’s most valuable car company. Second, it became the world’s most shorted company ever, with over $20 billion of short interest. I wrote at the time:

When a lot of people want to buy a thing, manufacturing that thing is a good business to be in. If you can manufacture Tesla stock right now, you can sell it for a lot of money. There are two sorts of people who are in the business of manufacturing Tesla stock. One is Tesla. It’s a company, it can just sell shares in itself. 

(And it did.)

The other people who are in the business of manufacturing Tesla stock are short sellers. If you are a short seller and you short Tesla stock to me, what happens is that I have bought a share of Tesla stock that you created. … Since there is a lot of demand for Tesla stock, and since Tesla is only occasionally and halfheartedly stepping up to meet that demand by selling more stock, other sellers—short sellers—have stepped up to meet some of the demand.

To celebrate the latter milestone, Elon Musk, who is obsessed with short sellers and never seems to have more pressing business to attend to, created a line of red satin shorts:

Sporting a gold Tesla logo, the “short shorts”, as they are branded, were dreamt up by the carmaker’s founder Elon Musk as a way to mock investors betting against the company’s shares.

And it turns out there is a short short shortage? I’m sorry. Here’s the Financial Times in early December:

The shorts sold out almost immediately when they were offered online in early July, but as Christmas approaches, some customers say they have yet to receive them.

“Tesla can’t even deliver a pair of shorts in over five months,” one customer told the Financial Times. “What did they do with all that money?” …

Some who got the shorts are now selling them with a huge mark-up on auctions sites such as Ebay.

One buyer who owns a Tesla but has yet to receive the shorts, said they ordered them as a “fun idea” and is not surprised at the delay.

“Each of these one-off Tesla merchandise offers are instant collectors’ items and not at all essential to Tesla’s business, so this is kind of expected,” they told the Financial Times. 

Surely Tesla shorts should short Tesla short shorts into the shortage. I’m sorry. If you think that Tesla shares are overvalued, you presumably also think that Tesla shorts are overvalued. Order a thousand red satin shorts, slap a counterfeit Tesla logo on them, sell them on EBay, no? Naked shorting! Phantom shorts! I’m sorry. When a lot of people want to buy a thing, manufacturing that thing is a good business to be in. If you’re a Tesla skeptic in the business of satisfying other people’s irrational (to you) demand for Tesla shares, why not also satisfy their irrational demand for Tesla shorts? I’m sorry.

You can make your own index

Here’s another story about Tesla’s index addition, sort of, from November:

When the world’s most-famous electric car maker finally joins the S&P 500, it will be bittersweet for investors with about $11 trillion in funds tied to the gauge. Their benchmark-hugging bets get some Elon Musk magic at last, but they pay seven times last year’s price for the privilege.

Given the chance, how many would have added Tesla Inc. to their index exposure in January? Or even June, when the shares had merely doubled?

Customization is at the heart of a red-hot investing strategy driving two of the biggest deals in asset management this year. Known as direct indexing, it blurs the line between stock-picking and benchmark-following and now commands about $300 billion after its popularity surged in recent years.

The idea is simple: Instead of buying shares in a fund that slavishly holds all the companies in an index, investors buy those stocks directly. The index exposure is broadly the same, but the investors are no longer wedded to it. They can make tweaks — like adding a skyrocketing automaker well ahead of the S&P 500, for example.

We have talked about direct indexing before and I love it. Loosely speaking I would say there are three kinds of investing:

  1. In passive investing, you buy all the stocks in the index.
  2. In active investing, you buy the stocks you want.
  3. In direct indexing, you buy (1) all the stocks in the index, (2) except for the ones you don’t want, (3) plus any other ones that you do want.

As a matter of formal logic it is easy to prove that direct indexing is exactly equivalent to active investing: If you start with the index, delete the stocks you don’t want and add the stocks you do want, you end up with a list of stocks that you want, which is where you end up in active investing too. But of course “want” is a vague word. In traditional active investing, you buy stocks where you have an investment thesis, the stocks that you understand and like and can make a case for. The implicit default is not buying; you have to overcome some burden of proof to decide to buy a stock. In direct indexing, you just buy all the stocks (in the index) unless you have a thesis that you shouldn’t. The default is buying everything; there is a burden of proof to delete a stock. I wrote in 2019:

This strikes me as completely correct! There are thousands of stocks and you only have the time and attention to make, like, five decisions, tops. Also even those probably won’t be particularly good decisions. Choosing five stocks not to buy and then buying the rest will probably get you close to the return of the average investor, which is fine; choosing five stocks to buy and then skipping the rest is pretty much a gamble.

In a way this demonstrates the intellectual triumph of the passive indexing revolution even more than actual low-cost index funds do. The message of direct indexing is that, for most investors, active investing should start from the premise of indexing—that you should own the whole market, weighted by market cap—and delete from there, rather than starting from a blank page and adding stocks. Or rather, the message is that the “blank page,” for investors, is owning the market portfolio, that the actual decisions that investors make are choices to deviate from the market portfolio. The default is the index.

With Tesla the tweak is the other way, something like “I want to own all the stocks, so I own the index, but the index forgot Tesla, which is very much a stock, so I will own Tesla too.” Presumably now that Tesla is in the index, some direct indexers will take the other side: “I want to own all the stocks, so I own the index, but Tesla is overvalued so I’ll skip it.”

Meanwhile, here is a December report from Norges Bank Investment Management, which runs Norway’s giant sovereign wealth fund. It’s titled “Investing in equities: The 20-year history,” and it begins:

This story is about investing in the equity market. It is about buying and holding the entire global equity market, not about selecting specific companies. Few know what it entails to “buy the market”. This book provides that insight as it tells the story of how we started buying equities two decades ago and gradually built the world’s largest single-owner global portfolio of listed companies.

Well it’s not exactly about buying and holding the entire global equity market. By page 116, the report says, delightfully, “The fund’s indexing strategy is active fund management.” 

Our indexing strategy has forced us to be active, as we choose which risks need to be reduced, and which risks we are comfortable keeping to avoid trading. This means that we are constantly faced with choices about which stocks to trade, and which deviations to keep in the portfolio. 

And so Norges Bank runs a series of “enhancement strategies” on its more-or-less-index-ish portfolio, including “active management, but with a low tracking error,” “smart beta strategies,” and approaches that “assumed inefficiency in pockets of the market in special cases.” Later in the report there is a case study of that last strategy:

Through screening of the universe and subsequent accounting analysis, we uncovered multiple companies that were likely to be manipulating their accounts, and sold them out of the portfolio. We further developed the strategy, screening new additions to the equity index for accounting irregularities or other suspicious signs. This strategy has proven to be very successful in Asian emerging markets, as many of our suspicions were subsequently highlighted by other investors or investigated by the authorities. However, the stocks in question are significantly more volatile than others. This has forced us to manage our underweight positions actively, and sometimes limited our capacity to sell out the fund’s entire holdings, as we sought to diversify the contribution of single situations to our relative risk. …

In 2019, our work led us to uncover a significant fraud in Europe: Wirecard AG, a German digital payments company. We first invested in the company as it was included in the equity index in September 2007. In 2019, the Financial Times published a series of investigative pieces about the company, accusing it of fraudulent activity. Meanwhile, one of our corporate credit portfolio managers uncovered what were signs of significant accounting fraud, where the company had falsified its profits to give an impression of strong growth, when in reality the company’s business was underperforming. In December 2019, we established a significant underweight position in our indexing mandate, which we reinforced in April and May 2020 as a forensic audit report by KPMG was made public, further strengthening our conviction. As the case progressed, we collaborated closely with fundamental equity and credit portfolio managers to gain clarity, and several active portfolio managers also sold their holdings in the company. On 18 June 2020, the company announced that its auditor had not signed off on the annual accounts, as a significant amount of the cash on the balance sheet was missing. As we received this news, we were able to sell the fund’s remaining holding before the market value collapsed completely. In total, our actions contributed 3 basis points to our indexing strategy in 2020.

We have found that engaging in a strategy focused on finding companies with a high risk of underperformance plays to one of our competitive advantages, i.e. our wide portfolio. As we do not sell short, we can only be underweight stocks that are in the equity index. However, while hedge funds need to borrow a stock to sell it short, we can achieve the same relative positioning by selling what we have in the portfolio – without needing to borrow the stock from other investors.

What a great story. In effect Norges Bank runs a short-selling hedge fund that uses forensic accounting to identify likely frauds and short their stock. Only instead of actually shorting those stocks, it just deletes them from its index holdings: For a fund whose default approach is “holding the entire global equity market,” not owning a stock is the equivalent of short selling.[4] Also sure it saves on stock borrow costs.[5] But it is a little philosophically different. A pure short selling strategy is in effect “I can make more money betting that frauds will collapse than I can owning stocks.” A passive indexing strategy is in effect “I can make more money owning all of the stocks than I can making any specific stock bets.” If you combine the two, you get Norway’s Wirecard approach, roughly “own all the stocks except the ones we figure out are frauds.”

By the way, we talked a couple of years ago about Jim Chanos’s Kynikos Associates, which runs “the lone short-selling hedge fund of any size.” Chanos is very good at short selling, which means that his main short fund, Ursus, “has lost 0.7 percent annually” from inception in 1985 through the end of 2017. Losing 0.7 percent annually by shorting stocks is great when you consider how much stocks went up over that period, but it is terrible when you consider, um, how much stocks went up over that period? Like, losing 0.7 percent betting against stocks as stocks go up is an impressive performance, but you’d have made a lot more money just betting on stocks.

But the point is that Chanos did. Institutional Investor reported:

The secret to Chanos’s longevity as a short-seller is Kynikos’s flagship fund, the vehicle where Kynikos partners invest, which was launched alongside Ursus in 1985. Kynikos Capital Partners is 190 percent long and 90 percent short, making it net long. Unlike most long/short hedge funds, however, the longs are primarily passive, using such instruments as exchange-traded funds, as the intellectual effort goes into the short side. 

And that fund was up 28.6% annually. If you squint it’s the same strategy as Norges Bank’s: Get long everything passively, but find some frauds and short them.

Bitcoin salary

Sure, “NFL’s Russell Okung to Get 50% of His $13 Million Salary in Bitcoin”:

Here’s how it works: The Panthers will continue to pay the tackle in dollars, but Okung will convert 50% of his $13 million salary to Bitcoin using Zap’s Strike product, according to a report from CoinDesk, a crypto and blockchain news site. Strike facilitates payments that are translated into Bitcoin from ordinary currency.

“NFL players are paid in U.S. dollars,” a league spokesman said. “He is then converting that to Bitcoin.”

And I get 15% of my salary in a mix of index funds. I get a portion of my salary in groceries, too, in the sense that Bloomberg continues to pay me in dollars, but I convert some of the dollars into groceries using the supermarket’s self-checkout function. The amazing thing about dollars is that they are a general medium of exchange that you can convert into lots of other things that you might want, which is, uh, less true of Bitcoin.

Bitcoin gambling

Sure, “Gamblers Could Use Bitcoin at Slot Machines With This New Patent”:

International Game Technology Plc, the world’s largest maker of slot machines, may be looking at offering cryptocurrency as a payment option on casino games like Megabucks and Wheel of Fortune.

On Tuesday, the company received a patent for a way to transfer cryptocurrency between a player’s gaming-establishment account and an external cryptocurrency account. That means players could move Bitcoin into their virtual wallets on a slot machine using their phones.

If you want to move your money into a safer asset class! If Bitcoin volatility is getting to be a bit too much for you, you can put it into a slot machine instead! I kid a little but honestly I feel like owning Bitcoin ought to be exciting enough for most people that they will not want the tiny additional thrill that comes from gambling it on the slots?[6]

Legal realism

We talk a lot about legal realism around here. Often this is in the context of what Elon Musk is getting up to on Twitter, but not always. Back in November 2016, I wrote: 

The Constitution, separation of powers, religious liberty, freedom of the press, an independent judiciary, the rule of law, equality of all citizens: There is a complacent sense in America that these things are independent self-operative checks on power. But they aren’t. They are checks on power only as far as they command the collective loyalty of those in power; they require a governing class that cares about law and government and American tradition, rather than personal power and revenge. Their magic is fragile, and can disappear if people who don’t believe in it gain power. 

I have to say it feels like I was insufficiently pessimistic? Anyway today we will find out, maybe, if the person who loses a presidential election gets to keep being president, just because he wants to. Weird times. 

Things happen

NYSE Reverses Again With Plan to Delist China Telecom Firms. Poshmark, Petco Set Terms for IPOs, Joining 2021 Rush to Market. GE Won’t Try to Claw Back Jeff Immelt’s Pay. Neil Young joins music rights gold rush after striking Hipgnosis deal. COVID Is Killing the Cocaine Market, But People Are Smoking More Weed. Bridgerton is a show about newsletters. Influencers Feuding After Both Naming Their Babies ‘Baby.’

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[1] Or combine the last two approaches: “At the end of each trading day from now on, the number of Tesla shares will be adjusted, via split or reverse split, such that each day’s closing price is $420.69.” A share of Tesla could represent a variable percentage interest in the company, but always be worth $420.69. Elon you can live this dream if you want it enough.

[2] There are other criteria; the official methodology is here. It is subjective enough that “insider trading on index inclusion” is a thing, as we discussed yesterday: A committee meets to decide what stocks to add or subtract to the index, and their decision is not fully determined based on public objective factors, so if you know the decision before it’s announced you can (illegally) make some money.

[3] In this case, one day, though its earlier ATM offering (after the stock split) went a bit longer.

[4] It even risk manages this position like a short seller: It doesn’t want to get *too* underweight any one very volatile stock, because it wants“to diversify the contribution of single situations to our relative risk.” Not owning *any* of one possibly-fraudulent stock would be *too risky*, as a matter of “relative risk,” because the stock might go up and the fund might miss out. 

[5] No it doesn’t! Not really. Norway’s fund owns a gigantic pile of stocks. It can lend out stocks that it’s long. It can collect stock-borrow fees from that lending. If one of those stocks is in high demand to borrow—because a lot of people want to short it—the fund will be able to lend it easily, and will receive high fees. If the fund then *sells* that stock, because it concludes it’s a fraud, it will no longer receive those fees. The other side of “selling short requires you to pay stock-borrow costs,” for a giant institutional fund, is “selling out of a long position means you no longer receive stock-borrow fees.”

[6] That said my understanding is that serious poker players all keep their money in Bitcoin, so I can see value in a casino/Bitcoin connection. But slots, really?

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.



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