Ben Gilbert: commitment

Transcript context

…And at the end of the day, I think these three pieces to me are the core of this tapestry of RenTech. One model that everybody collaborates on together. A super small team where we all know each other, and the financial impact that any of us make to that one model is great to all of us. Three, this LP-GP model with very high carry performance fees, that creates the right set of incentives both for new talent on the way in and old talent on the way out. I think that’s right. There are a few other parts of the story that we skipped along the way because there was no real good place to put them in. But these are objectively fascinating historical events that are totally worth knowing about. The first one is called basket options. The year is 2002. RenTech has 13 years of knowing that they basically have a machine that prints money. What should you do when you have a machine that prints money? Leverage. Now, there are all sorts of restrictions around firms like this and how much leverage they can take on. You can’t just go and say, I’m going to borrow $100 for every dollar of equity capital that I have in here. You need to get clever to borrow a whole bunch of money from banks or from any lender to basically juicier returns if again, you have a money printing machine that’s reliable. Most people don’t. Most people probably shouldn’t take leverage because they’re just as likely to blow the whole thing up as they are to be successful. So basket options. I am going to read directly from the man who solved the market because Greg Zuckerman just put it perfectly. “Basket options are financial instruments whose values are pegged to their performance of a specific basket of stocks. While most options are based on an individual stock or a financial instrument, basket options are linked to a group of shares. If these underlying stocks rise, the value of the option goes up. It’s like owning the shares without actually doing so. Indeed, the banks who of course loaned the money, who put the money in the basket option were legal owners of the shares in the basket. But for all intents and purposes, they were Medallion’s property.” This is very clever Medallion saying, well, the way we’re going to lever up is there’s a basket. We have an option to purchase that basket. Most of the capital in that basket is actually the bank’s capital, but the bank has hired us to trade the options in the basket. Then after a year when long-term capital gains tax kicks in, we have the option to buy that basket. Anyway, all day Medallion’s computers send automated instructions to the banks. Sometimes in the order of a minute or even a second. The options gave Medallion the ability to borrow significantly more than it otherwise would be allowed to. Competitors generally had about $7 of financial instruments for every dollar of cash. By contrast, Medallion’s option strategy allowed it to have $12.50 worth of financial instruments for every dollar of cash, making it easier to trounce rivals, assuming they could keep finding profitable trades. When Medallion finds an especially juicy opportunity, it could boost leverage holding close to $20 of asset for every dollar of cash. In 2002, Medallion managed over $5 billion, but it controlled over $60 billion of investment positions. David, this exposes something we haven’t shared yet on the episode, which is it’s not just that they could find $5 billion worth of profitable trades. trolled over $60 billion of investment positions. David, this exposes something we haven’t shared yet on the episode, which is it’s not just that they could find $5 billion worth of profitable trades. It’s that they wanted to lever the crap out of $5 billion and find $60 billion of profitable trades to make. Basket options gave them a legal way to have an incredible amount of leverage in a way that they felt safe about.…

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