Money Stuff: Everything Is an ETF Now

There is a market for insurance against stock market crashes. Most investors are more or less long the stock market — they own diversified portfolios of stocks — and some of them worry that they will lose money if the stock market goes down. They would like to buy long-term black-swan-type insurance against a disastrous market crash.

But who wants to sell that insurance? Well, Warren Buffett, occasionally. [1] But in general, this sort of insurance is not that appealing for the seller: The trade is “you get paid a little bit each year when times are good, but you lose a ton of money when the stock market crashes.” That’s the worst time to lose a ton of money! Also, if you are the buyer of that insurance, you might worry about credit risk: If you are buying insurance that pays off if the market crashes, how can you trust that the seller will pay you? Again, most investors are long the stock market, so if you buy crash insurance from some investor, and then the market crashes, she will probably have lost a ton of money herself and might be unable to pay you.

An important discovery of modern finance is that a good source of crash insurance is retail investors who want yield. You can offer retail investors the following product:

1. They put $100 in a box for a year.
2. If the market crashes, you keep their money.
3. If the market doesn’t crash, you give them back $110.

This product is, roughly speaking, called a “put option,” though perhaps that is not obvious. More technically it is “a put option wrapped in a structured note.” [2] The retail investor has sold you $100 of insurance against a market crash, and because you do not entirely trust the retail investor to be around in a market crash, you take the money up front. If the market crashes, you keep it. If the market doesn’t crash, you give the money back, plus $10, which you probably think of as “put premium” (insurance premium, the price you are paying for the put option) and which the retail investor probably thinks of as “interest” (yield, a nice 10% return on her money).

This solves the two problems of crash insurance supply. First, you have transformed the story from “you are selling me insurance against a market crash” (scary!) into “you are getting a high yield on your money” (everyone likes yield!). Second, you have taken the money up front, so you don’t have to rely on the credit of the put seller: If the market crashes, the money will be there. [3]

And then, if you are a bank, you do two sides of the trade. On the one side, you buy puts from retail investors in the form of structured notes. On the other side, you sell puts to big investors who want protection against a stock market crash. The big investors want crash insurance, and you do not want to provide that insurance yourself, because you do not want to have a big loss when the market crashes. But you can source that insurance for them, from your retail clients.

In practice, banks do a slightly more sophisticated form of the trade:

1. The retail investor puts $100 in a box for a period of up to five years.
2. The retail investor gets paid, say, 10% a year ($10) in “interest” for each year her money is in the box.
3. If the market goes down by, say, 40% or more, the interest stops and the investor gets back $60 or less (that is, she experiences the full market losses: It’s as if she had put the $100 in stocks).
4. If the market goes up, then the trade ends after one year and the investor gets her money back (plus the 10% interest). (If the market is down, but by less than 40%, the trade stays on for up to five years. [4] )

This product is called an “autocallable.” Here is a good 2022 FT Alphaville article by Russell Clark about “the mechanics and mayhem of autocallables”; he writes that “I like to think of autocallables as a distributed portfolio insurance market.” [5] Big investors want insurance on their portfolios, and retail investors provide it.

I say “retail investors,” but that’s a little loose. You can’t just buy autocallables in your Robinhood account. In the US, at least, structured notes tend to be high-net-worth products; they are “sold, not bought” by brokers and financial advisers to wealthy customers. 

But one long-term theme of this column is that, eventually, every possible trade will be packaged into an exchange-traded fund. The ETF is a perfect wrapper for retail-oriented stock trades. I wrote last year:

There are lots of trades that retail investors want to do, and/or that someone wants to market to them, and ETFs exist to package those trades into convenient formats. This can be helpful for brokers and advisers: Instead of coming to customers and saying “here’s a trade you can do,” explaining the trade in detail, and then working hard to execute the various legs of it, the brokers can go to customers and say “here’s a trade you can do in ETF format,” point the customers to the ETF’s disclosures to explain it, and then just buy the ETF to execute the trade. Everything is efficient and neatly packaged, so the brokers don’t have to do their own work in explaining and pricing and executing the trade.

And it’s even more convenient for self-directed investors: Instead of having to go to a stockbroker to put on some weird derivatives trade, you can buy it yourself, in ETF form, by pushing a button on your phone. The fun pizzazz trades that people want from their brokers, and that brokers pitch to their customers, get turned into ETFs so that anyone can buy them directly.

Autocallables are both a trade that retail investors like (everyone likes yield! [6] ) and also a trade that people want to market to them (banks want “distributed portfolio insurance”!), so obviously they should come in ETF format. And here’s a press release:

John Koudounis, President and CEO of Calamos, a leading alternatives manager, announced the planned launch of the Calamos Autocallable Income ETF (Ticker: CAIE). The Fund is designed to provide high stable monthly income through exposure to a laddered portfolio of autocallables, transforming a complex institutional market into an accessible, liquid, and tax-efficient ETF solution. J.P. Morgan will serve as primary swap counterparty, MerQube Indices as index provider and Calamos as the issuer and portfolio manager of the ETF.

"Through our heritage of innovation, we're democratizing access to a premier income strategy that has historically been the exclusive domain of high-net-worth investors," said Koudounis. "I'm excited to unveil CAIE—a sophisticated autocallable strategy that seeks to deliver consistent, high monthly income to our investors through the efficiencies of an ETF." ...

"For those new to autocallables, think of it like a bond whose income and par value depend on the stock market not falling below a protective barrier. For investment professionals already familiar with autocallables, CAIE is simply the 'easy button,'" said Matt Kaufman, Head of ETFs at Calamos. "Our laddered approach is designed to diversify exposure, reduce timing risk, and potentially smooth out income, while the ETF structure adds daily liquidity, tax-advantaged distributions, and no minimums."

Here is a more detailed description. “Attractive high stable income derived from equity market parameters rather than credit risk or duration—providing a genuinely diversified income source,” etc. The product is slightly more complicated than what I have described: Instead of buying one autocallable, you buy a”52+ laddered autocallables, staggered weekly,” to smooth out your yield, though presumably if the market crashes most of them pay out. The description advertises recent yield of 14.7% on autocallables (higher than my 10% toy example). You lose money if the index falls by 40%, but the index is a levered version of the S&P 500 — roughly the S&P 500, but with a 35% volatility target — so really you are selling insurance on something closer to a 20% market crash. [7] People want to buy that insurance, and now anyone can sell it.

Elsewhere in fun ETF products, here’s a prospectus (from last month) for the Permuto Capital MSFT Trust I:

Permuto Capital MSFT Trust I (the “Trust”) is a Delaware statutory voting trust that issues units (“Trust Units”), each Trust Unit represented by one “Dividend Certificate” and one “Asset Certificate” (collectively, the “Certificates”). Each Dividend Certificate evidences a beneficial interest in the economic rights of a holder of an Underlying Share (as defined below) solely with respect to the receipt of dividends with respect to such Underlying Share, while each Asset Certificate evidences a beneficial interest in all other economic rights of a holder of an Underlying Share (i.e., other than the right to receive dividends with respect to an Underlying Share), including with respect to increases and decreases in the market price of such Underlying Share. ...

The assets of the Trust consist solely of shares of common stock, $0.00000625 par value per share, of Microsoft Corporation, a Washington corporation (the “Subject Corporation” and, such shares, the “Underlying Shares”), which Underlying Shares are held by a custodian on behalf of the Trust. For every one Underlying Share deposited into the Trust, as described in this prospectus, the Trust will issue one Trust Unit, comprised of one Dividend Certificate and one Asset Certificate. ...

The Dividend Certificates and the Asset Certificates are not attached or stapled together as a unit and will trade separately. …

The Trust’s objective is to give all investors the capability to choose their amount of exposure to Microsoft common stock through either the dividend or the capital assets of the stock, or both, while retaining their voting rights which, for most matters, will be apportioned between the two types of Certificates, as applicable. 

That is: You can buy one share of Microsoft Corp. stock for $486 (as of yesterday’s close). In exchange for that $486, you will expect some amount of income and some amount of capital appreciation. Specifically you will get:

1. Quarterly dividends of $0.83 per share, or whatever higher or lower number Microsoft’s board decides on in the future (common stock dividends are not contractually fixed), for as long as you hold the stock; plus
2. Some amount of money that might be higher or lower than $486, when you eventually sell the stock.

Some companies pay large dividends, creating a lot of income for their shareholders. Other companies pay low or no dividends and reinvest their earnings in growing the company. [8]  There is some approximate equivalence between those two approaches: The shareholders can get cash today or growth tomorrow or some mix. If you have a certain cast of mind, you might think: “Why shouldn’t I get to pick my own mix of dividend and reinvestment? If I want a 10% yield on my Microsoft investment, why shouldn’t I be able to buy 15 units of dividends and one unit of capital appreciation? I will get less capital appreciation than if I just bought the stock, but I will get more yield, and that’s what I want. Microsoft won’t give me that, but a complete market would.” [9]

And so here’s that. You can buy 15 units of Microsoft dividends and one unit of Microsoft capital appreciation, or vice versa, or whatever, if that’s what you’re into. [10] It’s like Treasury STRIPS: You take a well-known liquid benchmark security (a Treasury bond, a Microsoft share), deposit it in a box, and issue separate slices of the box referencing the income and principal components of the underlying security.

Anyway, we have talked a lot about how every possible investment combination will eventually be an exchange-traded fund. There are ETFs for various combinations of 100 or 500 stocks, but there are also ETFs that are just one stock, and other ETFs that are two stocks, and eventually everything in between will get filled in and you’ll be able to buy an ETF for every combination of, like, “long 14 stocks and short 11 different stocks” or whatever. But for absolute completeness you will need to move beyond integer numbers of stocks, and this is the first ETF that I’ve seen that is a fraction of one stock.

You know the deal: The US stock market will pay at least $2, and perhaps $10 or more, for $1 worth of crypto. If you combine (1) a tiny US public company that isn’t doing much but has a stock-exchange listing and (2) $100 million of Bitcoin, the resulting combination will trade at a market capitalization of at least $200 million on the stock exchange. Same with $100 million of Dogecoin, Solana, Trumpcoin, whatever else you’ve got.

This robust, utterly magical arbitrage has attracted a lot of attention from crypto fund managers who would like to make a lot of money. And for the most part it keeps working. There are companies that have announced disappointing crypto-treasury-company pivots, but they are special cases, companies that already had other stuff going on. If you find a more-or-less disused public company and pump $100 million of crypto into it, it will reliably be worth $200 million. 

Anyway:

A team of crypto hedge fund executives are in advanced talks to raise $100 million for investing in a token linked to Binance Holdings Ltd. through a publicly listed company they control, in the latest spin on the Bitcoin treasury blueprint pioneered by Michael Saylor’s Strategy.

Former Coral Capital Holdings executives Patrick Horsman, Joshua Kruger and Johnathan Pasch are behind the pitch, according to an investor document reviewed by Bloomberg News. They aim to complete the fundraising this month and then rename the unidentified Nasdaq-listed company Build & Build Corporation and start accumulating the BNB token, the materials show.

Of course?!? BNB is the fifth-biggest crypto token by market capitalization, but Binance has, uh, a somewhat checkered regulatory history in the US, so you can see why “sell a BNB treasury company to US stock investors” was not the very first thing that anyone thought of. But it’s not the last thing either, and we are going to keep going down the list.

Anyway, here are some things that seem to be true:

1. These crypto guys have “a publicly listed company they control.” It is “unidentified” and “Nasdaq-listed.” 
2. The company is probably small and doesn’t have much of a business. This could be wrong, but given that they plan to rename it when they launch the BNB treasury strategy, it probably doesn’t have much of an existing strategy. It’s a company that can pretty easily pivot to being just, or mostly, a BNB treasury company. 
3. They plan to announce a $100 million BNB treasury strategy in the next month.
4. When that happens the stock will go up 1,000%, because the stock always goes up 1,000% when small US listed companies announce their crypto treasury strategies.

And they’re going around shopping this! I don’t know what this company is, but surely someone does. If you know, it must be awfully tempting to buy a million shares for a penny each, or whatever the price is, and make several million dollars when the deal is announced. This is neither legal nor investing advice but, man, if it was legal it would be investing advice! 

Elsewhere! Last week we discussed a teeny public toy company that pivoted to being a Tron treasury company. Here’s a Bloomberg News story about that pivot:

A tiny investment bank where Donald Trump Jr. and Eric Trump work as advisers helped an obscure toymaker pivot into crypto this week, sending its shares up more than 500%. The run-up generated more than $120 million in gains on a stock bet the same bank helped arrange last month.

The quick profit is the result of two transactions that the bank, Dominari Holdings Inc., handled within four weeks. First Dominari helped an investment fund run by one of its senior executives buy a stake in money-losing toymaker SRM Entertainment Inc. Then on Monday, SRM unveiled plans to transform into Tron Inc., bringing on cryptocurrency entrepreneur Justin Sun as an adviser and building up a stash of virtual tokens in another transaction handled by Dominari. The toymaker’s stock jumped past $9 on Monday, up from less than $2 at the end of last week. It’s now above $7.

The rapid run-up generated steep gains for Dominari, its executive Soo Yu, and most of all the investment fund she runs. The fund acquired its stake in May for $5 million. By Tuesday evening, it was worth $127 million.

Yes right obviously buying a bunch of stock in the teeny company before it announces its crypto treasury pivot will quite reliably make you a lot of money.

I wrote once that I got into finance because I read Barbarians at the Gate at an impressionable age. Barbarians at the Gate is, perhaps most fundamentally, the story of a public-company auction: The managers of RJR Nabisco had “put it in play” by offering to do a leveraged buyout of the company, so the company held an auction in which several private equity buyers competed to buy the company. What made the biggest impression on me, when I first read the book, was the gamesmanship of that auction. You do not buy a public company by clicking the “buy” button on your brokerage app. You submit a “best and final” bid to the company’s investment bankers, and then you call them five minutes later and say “how are we looking,” and they say “we have a lot of strong interest,” and you say “if we are behind I can see if we have any room to go up,” and they say “if there is any room to move you’d better do it now,” etc. Or you say “we will pay $80, but that offer explodes in an hour and is no good if you call the other bidders,” and they say “we understand, but we have to go to the bathroom,” and you say “you’d better not be calling the other bidders from the bathroom,” and they say “how could you say such a thing,” etc. There is financial stuff going on — your bid is the product of a valuation model — but there is also high-stakes, uncertain, interpersonal drama.

Later I worked on a sell-side auction of a public company where we really did have two sets of bidders sitting in two different conference rooms on two different floors of our office, each not knowing that the other was there, and I had the most powerful sense I have ever had of “oh yes, this is what I signed up for, this is Barbarians at the Gate.” 

Now I am old and I no longer think that the most important and glamorous skill in high finance is saying you’re going to the bathroom so you can run out of a conference room to shop one bidder’s offer to another bidder. But. I mean. I kind of still do. 

Private equity firms mostly want to hire people who can build good financial models and make good investing decisions and negotiate and structure deals. But they also, at least a little bit, want people who thrive on the gamesmanship of high-stakes, time-pressured auctions. How do they find those people? Well, structuring private equity recruiting as a high-stakes, time-pressured auction probably helps. Here is a … delightful? horrifying? … first-person account of “on-cycle recruiting” from an anonymous private equity employee writing at Business Insider:

The interview went till 2:30 a.m. I got the offer but didn't accept it right away. During the interview, another firm was texting me, saying, "Hey, come now. We're interested in you, come now." …

So at 2:30, I finally left the first firm's offices with an offer in hand. I had to finesse my way into being able to leave the office without signing it, and I immediately called the headhunters from the second firm. I'm like, "I've just freed up. Can I come?" And they're like: "Oh yeah, we'll have you at 7 a.m." …

Meanwhile, the first firm starts hitting me up, pressuring me, saying, "Hey, anything you need to talk about? Anything you need to consider about the offer?" So they must have known. I had like an e-sign offer, and I hadn't signed it. They were concerned.

I texted back. I said I just needed some time to talk to my family and my mentors, and I had to call my mom. I said she was only available in the afternoon, and I wanted to wait until she could double-check everything — I was basically making up whatever I could while sitting in the office of the second firm, going through that interview. So I said, "Can I call my mom later and get back to you?" The first firm was quick to respond — no. They weren't going to wait that long. They wrote me to call them right away.

And so on. Ducking into the bathroom at one firm to call another one, that sort of thing. “This was, without a doubt, one of the most stressful, roughly 12-hour periods of my life and career,” he writes, but arguably it’s good preparation for the rest of his career.

Private Funds for Retail Investors Jump to $350 Billion, Morningstar Says. Big Banks, Worried About Being Trump’s Next Target, Race to Appease Republicans. Elizabeth Warren Blasts Regulators’ Potential Bank Leverage-Rule Changes. US Congress plots big tax cut for private credit investors. Stablecoins ‘perform poorly’ as money, central banks warn. Polymarket Nears $200 Million Fundraising at Valuation Over $1 Billion. “Ifty Ahmed was a very good venture capitalist, albeit a corrupt one.” Elon Musk’s Lawyers Claim He ‘Does Not Use a Computer.’

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