Tuesday, July 16, 2013

The real big money is run by a physicist ;-)

From Physics to PIMCO to China's SAFE.
WSJ: At an official Chinese New Year's party earlier this year, a former bond trader named Zhu Changhong was hailed for the smart choices he made investing the world's largest stash of cash: China's $3.5 trillion in foreign reserves.

... A 43-year-old former physicist, Mr. Zhu has made one surprising turn after another in his career. At 20 years old, he moved from impoverished Anhui province to the University of Chicago to study quantum physics, but he then chucked a promising academic career to become a bond trader. He eventually ended up as the right-hand man to investor Bill Gross at Allianz SE's Pacific Investment Management Co., the giant investment firm, according to people familiar with Mr. Zhu's work.

... Mr. Zhu had to persuade his superiors to take risks investing China's reserves, which are viewed as national patrimony and routinely described as xue han qian— money earned by "the blood and sweat" of Chinese workers. Adding to the pressure, China's big sovereign-wealth fund, China Investment Corp., was criticized in China for taking losses on bets on Wall Street firms before the global financial crisis of 2008, and SAFE didn't want to open itself to similar criticism.

As a result, SAFE tries to limit its investments outside Treasurys to amounts small enough to hide from the public in case the bets go bad, said a person close to SAFE.

With Mr. Zhu's endorsement, SAFE was an early investor in bonds issued by the European Financial Stability Fund, according to those involved, and has invested regularly since then in the bailout fund.

The amounts of the investment aren't disclosed but are likely to be substantial. As the European crisis deepened in early 2012, European officials held brainstorming sessions with Mr. Zhu and other Chinese government officials about how to interest China in bonds that might be used to bail out Italy or Spain, according to individuals inside and outside China who are familiar with the sessions.

Brussels officials wanted to learn what returns Beijing would expect from investments compared to the risk the Chinese might be willing to accept, they said. Mr. Zhu gave "clear indications" of what the Chinese would want, said a person familiar with the talks. In the end, the Europeans didn't issue the new instruments as the crisis ebbed.

Mr. Zhu's transformation into investment guru still surprises some old acquaintances. His 1995 dissertation from the University of Chicago, "Inter-Landau Level Polarization and Wigner Crystal," examined circumstances where electrons strongly interfere and become entangled with one another, a hot area in physics now that may someday lead to breakthroughs in quantum computing.

"Those with an entrepreneurial drive went to Wall Street," said physicist Paul Wiegmann, Mr. Zhu's thesis adviser. He said he thought the fast pace of a trader fit his former student, who finished his dissertation in two years, half the usual time.

"I thought he'd do well, but doing so well, that's a surprise," Mr. Wiegmann said. "He came from a foreign country, from a rural area, with no experience in the culture and the operation of [U.S.] society. He's literally self-made."

Meanwhile, Renaissance pays long term capital gains on HFT trading profits?
Bloomberg: James H. Simons, who became a billionaire when he turned his extraordinary mathematical ability from defense work to investing, has deployed an unusual strategy at Renaissance Technologies LLC to skirt hundreds of millions of dollars in taxes for himself and other investors, said people with knowledge of the matter.

The U.S. Internal Revenue Service is challenging the technique, which it called “particularly aggressive,” without identifying the hedge fund in the dispute. It is demanding more tax payments from investors in Renaissance’s $10 billion Medallion fund, the people said.

Renaissance sought to convert profit from Medallion’s rapid trading into long-term capital gains, said the people, who spoke on condition of anonymity because the dispute hasn’t been made public. The top federal rate on long-term gains is about half that on short-term.

... As described in the memo and by people with knowledge of the matter, the transaction worked as follows: Barclays bought a portfolio of stocks and other instruments that fund managers at Renaissance wanted to trade. The bank hired the fund managers to oversee the portfolio, paying them a nominal fee. 
Then Medallion bought an option with a term of two years, whose value was linked to the worth of the portfolio. Renaissance had full discretion to trade the securities in the portfolio.

Medallion could claim it owned just one asset -- the option -- which it held for more than a year, allowing any gain to be treated as “long-term” when its investors reported the income on their personal tax returns.


Larry Darrell said...

Long term cap gains tax on long term derivatives is an example of unintended consequences. Derivatives are never investments. The long term/short term distinction was an attempt to define investment vs speculation. "Pay your taxes and don't complain", said Buffet. Simons is the anti-Buffet in more ways than one.

Is Simons a sociopath?

RagnarDanneskjold said...

The physicists usually have a huge blind spot when it comes to human nature, they were a big reason why 2008 happened because all of the models showed that housing prices don't drop. Most of the firms employing these models only exist because of government bailouts. Eventually there will be no bailout, and physicists will go back to doing important things.

I'm already expecting the Chinese reserves will be severely depleted in a crisis, this just makes me a little more confident that it will all blow up spectacularly.

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