Money Stuff: Be Liquid When Others Are Illiquid

Money Stuff this week has mostly been about capturing the illiquidity premium. On Tuesday, I argued that pooled retirement savings vehicles like pension funds and annuity companies have predictable cash needs and can lock up a lot of their money for the long term to earn high returns, while individual retirement savers can never be sure they won’t need their money back tomorrow and so demand more liquid investments.

On Wednesday, we discussed how those individual savers withdrew a lot of money from a Blackstone Group Inc. private credit business development company called BCRED, in part because of credit worries (loans might default, etc.) but also in part because of liquidity worries (people are suddenly paying attention to the fact that it is sometimes hard for individual investors to get their money out of private BDCs). I argued that, if you are a professional investor who thinks the credit worries aren’t too serious, this could be a good buying opportunity.

It is conventional to assume that there is such a thing as an “illiquidity premium”: Investors who lock their money up for a long time sacrifice some flexibility, and thus should demand a higher return than investors who can get their money back whenever. We have occasionally discussed Cliff Asness’s clever argument that actually it’s the reverse — that investors love to own assets that don’t trade, because then they don’t have to stress out all the time about the assets’ prices, so they should accept a lower return for illiquid assets — but surely this week there is an illiquidity premium. Right now, individual investors in private BDCs seem to be reacting to headlines about how BDCs might be limiting redemptions; they think “hmm I don’t want my redemptions to be limited” so they try to take out their money. [1]  They are demonstrating a demand for liquidity, and if you are willing to provide that liquidity — to give them their money back and lock up your own money for a while — then you should be able to get paid.

For legal and marketing reasons, a lot of the big private credit firms can’t do exactly that — they can’t just go out to their own BDC customers and say “hey I see you want out, that’s fine, I’ll cash you out at 80 cents on the dollar” — but other people could. Specifically, last month Saba Capital Management and Cox Capital Partners announced an opportunistic tender offer for a Blue Owl Capital Inc. BDC called OBDC II, as well as a few other Blue Owl BDCs, “with an offer price that’s expected to be at a 20% to 35% discount” to net asset values.

This strikes me as a smart trade: You can’t measure it exactly, but intuitively it sure seems like the illiquidity premium in private BDCs blew out over the last few weeks, and Saba and Cox might reasonably think “well, we’ll sell liquidity high, and the premium will come down and we’ll make a big profit.” (The risk here is not so much “the liquidity premium will keep going up” as it is “actually the credit is worse than we think.” It is hard to isolate the illiquidity premium, though I guess you could hedge out the credit.)

It is also a good bit of trolling; the implicit message is something like “Blue Owl won’t give you your money back but we will, for a price.” I don’t know if they’ll actually get any shares in their tender offer. Blue Owl is giving OBDC II investors their money back over time, and it previously offered them the chance to get all their money back at a 20% discount, but they said no to that; why would they say yes to Saba and Cox? 

Anyway this is partly a story about Blue Owl and Blackstone and private credit and the structure of non-traded BDCs, but more broadly it is a story about the illiquidity premium as a market-wide factor, about individual investors’ general demand for liquidity. The Saba and Cox trade is not just about trolling Blue Owl; it is structurally a bet on the illiquidity premium. You could scale that trade up and buy retail illiquidity wherever you can get it. Bloomberg’s Loukia Gyftopoulou and Patrick Clark report today: 

Boaz Weinstein’s Saba Capital Management and Cox Capital Partners have started a tender offer for Starwood Capital Group’s real estate investment trust, less than two weeks after the firms proposed buying shares of some Blue Owl Capital Inc. funds.

Saba and Cox are offering to buy about 5.4% of the outstanding Class S and Class I shares of Starwood Real Estate Income Trust, at discounts of 28.6% and 24.4%, respectively, from their Feb. 12 price, according to a statement Thursday.

SREIT, as it’s known, tightened limits on investors’ ability to pull money from the fund in May 2024, at a time when higher-for-longer interest rates had ground real estate markets to a halt. It lifted the restrictions slightly in June. The $8.2 billion fund was part of a wave of non-traded REITs that attracted capital from wealthy individuals and invested in warehouses, apartments and other commercial property. 

Here is their announcement. SREIT is not a private credit BDC — it’s non-traded real estate investment trust — but it’s the same basic problem. Starwood raised money from individuals in a structure that mostly locked up their money, but allowed them to withdraw some of it in some circumstances; then those individuals got nervous, they asked for more money back than SREIT could really give them, and the headlines got bad.

One way to put it is that, when big asset managers raised money from individual investors for semi-liquid non-traded REITs and BDCs, the illiquidity premium was low. “Ehh I’ll probably be able to get my money back if I need it,” the individual investors thought, because (1) those vehicles do offer some liquidity, (2) everyone wanted in on the private-market action and (3) people don’t read the prospectus and probably weren’t paying that much attention to the liquidity terms. Now, some investors do want their money and can’t get it, or can’t quite get it, or at least are reading headlines about how they might not be able to get it. They value liquidity more than they used to. The big asset managers bought liquidity cheap when they launched these funds, but now liquidity is valuable. The big asset managers can’t quite sell it back, because opportunistically trading the illiquidity premium against your own customers is pretty icky. But Boaz Weinstein, maybe, can.

By the way! The standard story here is that individual investors are getting nervous and trying to take their money out of private credit, but institutions are untroubled. My Bloomberg Opinion colleague Paul Davies writes:

A saving grace is that insurers and pension funds — institutional investors that by nature take a longer view — continue to put money into private credit. Indeed, Blackstone had record institutional inflows in the final quarter of last year.

And this makes some intuitive sense, both psychologically (professional investors should be less flighty and take a longer-term fundamental view) and structurally (insurers and pension funds really can  bear more illiquidity risk than individuals). I occasionally mention the old stereotype that retail investors are prone to panic and to selling at the worst time. 

But that is famously no longer true, these days, in the stock market. Retail investors now love buying when the market crashes. The Wall Street Journal reports:

War in the Middle East. Artificial-intelligence jitters. A “SaaS-pocalypse” that wiped billions in value from software stocks. Whatever fresh shocks have rippled through markets, individual investors have fallen back on the same strategy: buy, buy, buy. 

Fears of economic disruption from AI and the conflict with Iran have sent stocks on a roller-coaster ride in recent weeks—but the everyday traders who play an increasingly pivotal role on Wall Street have remained the market’s most loyal buyers. February was one of the strongest months for retail buying since the meme-stock frenzy of 2021, according to a report from Citadel Securities, and the fifth-biggest month on record.

And on Monday, as major indexes slid in early trading during the first session since the conflict’s outbreak, individual investors poured $2.2 billion into stocks and exchange-traded funds, according to analysts at JPMorgan Chase. Stocks finished almost flat. Dip-buyers also helped pare Tuesday’s early drop.

This is an interesting stock market story: Are retail investors the ultimate value investors in the stock market? Does the constant retail buy-the-dip bid insulate the market against volatility? If you are a professional equity investor or market maker or options trader, are your models evolving because markets now can’t go down much before retail investors flood in and push them back up? Just a strange new way to think about stock markets, that passionate individual investors prevent crashes.

It also might make you wonder about all the retail investors who want their money back from OBDC II and BCRED and SREIT. These days retail stock investors have nerves of steel and love to buy when the professionals are panicking and selling. But retail private credit investors are the reverse.

Two weeks ago, I would have said that there are two main theses about the US stock market:

1. “Artificial intelligence will eat everything.” Every company in every industry will be replaced by AI, and trillions of dollars of revenue that previously went to software companies or financial services companies or whatever will be redirected to a handful of companies — AI labs, electric utilities, Nvidia — in the AI supply chain.
2. “Artificial intelligence is a bubble.” The companies in the AI supply chain are raising umpteen gazillion dollars of debt to build data centers and power plants with no clear business model and with lots of circular deals, it is all overhyped, and eventually it will collapse.

These theses are basically opposites, so it is tempting to assume that they cover 100% of the possible outcomes. Also, “AI companies” in some loose sense represent a huge chunk of US equity market capitalization, so you might casually make some assumption like “either half of the market will go up a lot and the other half will go down a lot, or else the first half will go down a lot and the second half will go up a lot.”

Either way, the overall market might not change too much, but there will be a lot of dispersion: These are not generally theses about the overall level of stock prices, but rather about which particular stocks will have high prices and which will have low prices.

The nice thing about this schematic description is that you can bet on dispersion directly. You don’t have to choose a thesis, “AI will be big” or “no it won’t.” You can bet on “either AI will be big or it won’t.” That is, you can make a bet of the form “some stocks will go up a lot, and other stocks will go down a lot, and they will offset each other so that the overall stock market doesn’t go up or down all that much.”

This is called a “dispersion trade.” The normal way to do it is to sell a lot of index stock options (which become more valuable when the stock index moves up or down a lot) and buy a lot of options on all of the individual stocks in the index (which become more valuable when those individual stocks move up or down a lot). You can do this in a hedged way so that you are not betting on the overall price level of the stock market, or on the overall volatility of the stock market.

Instead, it is a bet on correlation: If the individual stocks are all very volatile but in different directions, then the single-stock options will be worth a lot (high volatility) but the index will not be volatile (the moves will cancel out), the index options will not be worth much and you’ll make money. If the individual stocks all move together, though, then the index will be just as volatile as the individual stocks (all of the moves will reinforce each other), the index options will be very valuable, and you will lose money.

We have talked about the dispersion trade generally as a sort of structural feature of the stock market: Some real-money end-user investors like to sell single-stock options (buy-write strategies, etc.), others like to buy index options (crash insurance), so hedge funds step in to take the other sides of those trades, effectively betting against correlation.

But of course you could also do the trade as a fundamental bet on the scenario I laid out here: “Some companies will do well from AI, some will get crushed, I don’t know which is which but they will largely offset each other.” That’s a fundamental bet against correlation, and the dispersion trade is an obvious way to implement it.

And so last week the Financial Times had a story about how “investors are embracing so-called dispersion trades” and “exploiting the divergence in sectors tipped to be either winners or losers from AI’s advance.” This week, the Wall Street Journal had a story about how stock-market dispersion in 2026 through Feb. 13 has been “the largest since at least 1994, signaling a market with unusually high divergence in returns between different companies.”

Through Feb. 13, though. Since then things have changed, and the AI-will-or-won’t-eat-everything theses have some competition for the market’s attention. Bloomberg’s Bernard Goyder reports today:

The escalating conflict in the Middle East has jolted a popular hedge fund strategy, threatening a spillover into broader markets if volatility persists.

The dispersion trade — which uses options to exploit the difference between the volatility of a broader index and that of its individual components — has been a favorite with investors. The bet pays off as long as the S&P 500 Index continues edging higher while stocks keep churning beneath the surface, a market dynamic that has persisted for months.

But investors received a jarring wake-up call earlier this week, when the war in Iran sparked a bout of risk aversion. A measure of implied one-month correlation jumped to its highest level since November on Tuesday, with single stocks and indexes both tumbling. ...

“We could be at an important inflection point,” said Amy Wu Silverman, head of derivatives strategy at RBC Capital Markets. “One thing geopolitical events can trigger is a spike in correlation.”

The thesis today might be more like “AI makes dispersion go up, but war makes correlations go up,” and it’s not clear which effect wins.

A theory that you sometimes hear about crypto is that typical crypto tokens — Bitcoin, Ether, etc. — are fungible. [2] One Bitcoin is the same as any other Bitcoin, just like one dollar bill is just as good as any other. The point of money is that it is fungible, and Bitcoin is “peer-to-peer electronic cash.” 

Now, this is not exactly true. Most people who use Bitcoin intend it to be fungible, and do not think much about the identity or provenance of their individual Bitcoins. But in fact every Bitcoin (or fraction of a Bitcoin) is individually identifiable and fully, permanently, immutably traceable on the Bitcoin blockchain. And so if you had some reason for thinking some Bitcoins were better than others, you could discriminate between the good Bitcoins and the bad ones.

And people do! Not most of the time, but a little. We have talked about people who collect “rare sats”: Certain satoshis (indivisible 100-millionths of a Bitcoin) are valuable to collectors, because they were “produced in the year bitcoin was created” or “part of transactions made by bitcoin’s inventor” or “correspond with a particular transaction milestone.” On the other hand, certain other Bitcoins — the ones stolen from exchange hacks, for instance — are in a practical sense less valuable than normal Bitcoins: Regulators and prosecutors can track where they go, so a lot of exchanges and counterparties will be wary about accepting stolen Bitcoins and/or will report them to the police. 

In this sense, arguably, Bitcoin is not like cash: It is traceable, so it is easy to discriminate between “good” and “bad” Bitcoins.

Except that this is kind of true of cash too? Most countries’ bills have serial numbers, so if you had some reason for thinking some dollar bills were better than others, you could discriminate between the good and bad ones, by looking at the serial numbers.

And people do! Not most of the time, but a little. “Non-sequential unmarked bills” is a cliché in movies about bank robberies for the same reason it’s hard to launder stolen Bitcoins. And people do collect dollar bills with cool serial numbers; a reader once sent me this Reddit post about a $100 bill, encased in plastic, with the serial number LF 694208008, which is presumably worth considerably more than $100 to the right collector.

With Bitcoin and with cash, you cannot expect everyone to discriminate perfectly between good and bad money: It is so culturally and practically important that money be fungible that most people are not going to check their Bitcoin’s provenance, or their bills’ serial numbers, against the Index of Forbidden Money. Generally speaking you shouldn’t have an Index of Forbidden Money. If you do, that is going to make commerce slower and less certain. Fungibility really is the point of money, and if you make your money nonfungible then it becomes less useful.

Bloomberg’s Marcelo Rochabrun and Sergio Mendoza report:

A military cargo plane filled with new bills for Bolivia’s central bank crashed near El Alto International Airport on Friday afternoon, killing at least 22 and injuring at least 37. ...

The deadly crash also unleashed some 17 million bank notes into the highly populated city of El Alto, according to figures released by central bank president David Espinoza, totaling 423 million bolivianos ($62 million). People raced to the area of the crash to try to collect as many bills as possible, while authorities rushed to look for survivors and also burn the bank notes as fast as they could. The central bank estimates about 30% of the bills have been stolen from the crash site.

In a large rich country you might just let that go — just some accidental redistribution of wealth — but Bolivia did not:

The new currency was legitimately printed, but the central bank has voided its serial numbers to prevent its use. While thousands swarmed the site to pick up the banknotes in one of Latin America’s poorest nations, authorities have tried to burn and destroy the new cash, arresting dozens and raiding homes in a rushed hunt for the missing bills.

That has sent Bolivians into a frenzy. No longer able to quickly tell if a banknote is valid or voided and fearing the crackdown, businesses don’t know what bills to accept anymore, leaving customers frustrated and panicked that their real money is now worthless. ...

The bank has said that all the bills being carried by the plane — which were denominated in 10, 20 and 50 bolivianos — belonged to a Series B that include 9-digit serial numbers. Initially, the central bank suspended the use of any Series B bill for 48 hours. Now, it’s released a mobile app for vendors to manually input the serial numbers to verify if a bill is legitimate or voided.

“It doesn’t matter if the serial number is valid, they won’t take it,” said Sonia Queveriano, 50, who sells fresh juices in La Paz but has not been able to buy fruit for her business using Series B bills. “It’s unfortunate that we have to pay for this, as if we had gone to steal that money.”

Vendors acknowledge they’re being extra cautious and would rather avoid Series B bills altogether. The risk of a voided bill is one thing, but there’s also a chance that other sellers won’t take any Series B bills themselves.

Yes if you have to type the 9-digit serial number into an app to decide if the money is good or not, it becomes less useful as money.

BlackRock Slashed Another Private Loan Value From 100 to Zero. Morgan Stanley Lays Off 2,500 Employees Across All Divisions. Judge Orders Government to Begin Refunding More Than $130 Billion in Tariffs. Iran war triggers aluminium supply crunch and shutdowns across Middle East. CEO of Collapsed Lender MFS Spent on Artwork, Parties, Rapper. Elon Musk battles Twitter market manipulation case in court appearance. Wealthy Dubai residents race back to UAE to avoid tax bills. Robinhood Adds $695 ‘Actual’ Platinum Card to Compete With Amex. Pizza Hut Classic. “The real problem with findom is that somewhere around much less than a tenth of the time it involves *interesting* financial instruments.” Your morning can’t be as bad as the finance guys photographed for Interview.

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