Risk_Arb_For_A_Better_Life
00:00:00.000 | Hello, everybody.
00:00:00.840 | It's Sam from Financial Samurai.
00:00:02.680 | And in this episode, we're going to talk about risk arbitrage
00:00:06.360 | investing and why if we practice risk arbitrage or arbitrage
00:00:11.760 | in our lives, we can lead better lives going forward.
00:00:14.920 | So risk arbitrage is an investment strategy
00:00:17.080 | that speculates on the successful completion
00:00:19.400 | of mergers and acquisitions.
00:00:21.160 | This is the classic definition of risk arbitrage.
00:00:23.960 | An investor that employs the strategy
00:00:26.020 | is known as an arbitrageur.
00:00:28.720 | While risk arbitrage is a type of event-driven investing
00:00:31.660 | in that it attempts to exploit pricing inefficiencies caused
00:00:35.520 | by a corporate event.
00:00:37.080 | So during my 13 years on Wall Street,
00:00:39.080 | I covered hedge funds that deployed the risk arbitrage
00:00:41.560 | strategy.
00:00:42.800 | And their bread and butter trade would be to go long a stock
00:00:45.400 | they thought would be a potential acquisition target
00:00:48.040 | and then go short either the company they thought
00:00:50.320 | would overpay or competitors that would
00:00:53.020 | be hurt from the acquisition.
00:00:55.760 | Or maybe they would buy competitors
00:00:57.440 | who they thought would also get acquired.
00:01:00.560 | There's a multi-combination of risk arbing going on.
00:01:03.800 | And here's a classic example.
00:01:06.000 | Suppose Financial Samurai is trading at $40 a share.
00:01:09.680 | Then CNBC announces a plan to buy Financial Samurai,
00:01:13.560 | in which case holders of Financial Samurai stock
00:01:15.760 | get $80 in cash.
00:01:18.360 | Then Financial Samurai stock jumps to $70 a share.
00:01:22.040 | It doesn't go to $80 since there is some chance
00:01:24.520 | the deal will not go through.
00:01:26.960 | The $10 spread is what an arbiter is playing for.
00:01:30.480 | In this case, the arbiter can purchase shares
00:01:33.280 | of Financial Samurai stock for $70.
00:01:36.160 | He will gain $10 if the deal is completed
00:01:39.120 | and lose $30 if the deal is terminated,
00:01:42.800 | assuming the stock returns to its original $40 in a break,
00:01:46.720 | which may not occur, which usually actually doesn't occur.
00:01:50.160 | So according to the market, the probability
00:01:51.920 | that the deal is consummated at its original terms
00:01:55.440 | is about 75%.
00:01:57.320 | That's what the studies have shown
00:01:59.200 | in any kind of mergers and acquisitions.
00:02:01.040 | Once it's announced, 75% of the time, mergers happen.
00:02:05.600 | And the probability that the deal will be terminated
00:02:07.840 | is therefore 25%.
00:02:09.840 | So the arbiter has three choices.
00:02:12.640 | Purchase Financial Samurai stock at $70.
00:02:14.680 | He would do this if he believes the probability
00:02:16.920 | that the deal will close is higher than or in line
00:02:20.640 | with the odds offered by the market.
00:02:22.980 | Short Financial Samurai stock at $70.
00:02:25.760 | She would do this if she believes the probability
00:02:28.320 | that the deal will be terminated is higher than the odds
00:02:31.460 | offered by the market, or simply not to get involved.
00:02:35.400 | So that's an example of a risk arbitrage investment.
00:02:40.000 | And the reality is you can practice this type
00:02:42.720 | of risk arbitrage investing in your life
00:02:46.400 | by identifying arbitrage opportunities.
00:02:49.320 | For example, as an elementary schooler in Taipei, Taiwan,
00:02:52.800 | I would buy Nerds Candy at the US Commissary for $0.25
00:02:56.720 | and then sell them for $0.50 to my classmates.
00:02:59.640 | Does that sound good?
00:03:01.160 | Well, it was 100% profit.
00:03:03.480 | Was that morally right?
00:03:04.560 | Well, I was able to make some money,
00:03:07.120 | and actually all my classmates were happy
00:03:08.760 | because they would actually probably pay $0.75 or $1
00:03:12.280 | because Nerds Candy was the number one candy
00:03:15.320 | on campus at the time.
00:03:17.040 | But eventually, other candy stores opened up
00:03:19.520 | and my profits were competed away.
00:03:22.040 | Now, it wasn't just other stores that hurt my profits.
00:03:25.880 | It was my classmates.
00:03:27.320 | They were the ones who got smart and realized, hey,
00:03:29.440 | if Sam can make some money, we too can make some money.
00:03:32.960 | So every time my classmates went back to America
00:03:35.480 | during the summer vacations or winter vacations,
00:03:38.320 | they would bring back lots and lots of other candy
00:03:41.840 | and sell it to their classmates, who
00:03:44.400 | couldn't have the same opportunity going back
00:03:46.160 | to America.
00:03:47.380 | And then what happened was inventory flooded the market,
00:03:50.800 | and then again, profits were whittled away.
00:03:53.640 | So if you are smart, you will be able to identify
00:03:56.520 | what other people are doing and try
00:03:59.120 | to compete for that remaining profit as well
00:04:02.080 | until it disappears.
00:04:03.720 | And then what you want to do is continuously look
00:04:05.960 | for new arbitrage opportunities.
00:04:08.760 | So the current obvious no-brainer arbitrage
00:04:11.200 | opportunity, in my opinion, is going long online savings rates.
00:04:16.200 | So online savings rates are paying higher
00:04:18.520 | than bricks and mortar savings rates
00:04:21.000 | because they have less overhead.
00:04:22.320 | So a pure online bank, for example,
00:04:24.000 | like CIT Bank or Ally Bank or Synchrony Bank,
00:04:27.440 | all these banks have higher interest rates
00:04:29.440 | than a Citi Bank or Wells Fargo and so forth
00:04:32.880 | because they have less overhead.
00:04:34.840 | And therefore, they can pass on their cost savings
00:04:37.280 | to consumers.
00:04:39.120 | If you can get an online savings rate higher
00:04:41.840 | than the risk-free rate of return, which is the 10-year
00:04:44.000 | bond yield, which is currently at about 1.55% to 1.75%
00:04:50.200 | at the end of 2019, that, to me, makes a ton, a ton of sense.
00:04:56.040 | Back when the 10-year bond yield was at 3.21% in October 2018,
00:05:00.760 | one of the best online savings rate I could find
00:05:02.760 | was CIT Bank at 2.45%.
00:05:05.840 | I track CIT Bank closely because they are not only
00:05:08.880 | one of the best banks offering the highest rates,
00:05:11.120 | but they are also an affiliate partner.
00:05:12.720 | And I get all their updates via email.
00:05:15.560 | So 2.45% online savings rate back then
00:05:18.240 | was competitive because the yield curve was upward sloping.
00:05:21.720 | Getting a higher risk-free rate would
00:05:23.920 | require owning a longer-term treasury bond until maturity.
00:05:27.640 | The reward for locking up your money
00:05:29.280 | for 10 years in a treasury bond was therefore 3.21%--
00:05:33.360 | that's the 10-year treasury bond yield--
00:05:35.480 | minus 2.45% what you could get at an online bank.
00:05:40.320 | So that reward was 0.76% a year.
00:05:44.040 | And if you think about it, that is not that big of a reward.
00:05:47.880 | To lock up your money to earn a guaranteed 0.76% a year
00:05:52.640 | for the next 10 years--
00:05:55.200 | not too enticing, but it is what it is.
00:05:58.800 | Given the 10-year bond yield is now down to about 1.65%
00:06:03.000 | since its 2018 peak at the time of this recording,
00:06:06.640 | you would think that CIT Bank's savings rate
00:06:08.520 | would be down a similar amount.
00:06:10.680 | In fact, that's not the case at all, because as we know,
00:06:13.240 | the yield curve is kinked or inverted.
00:06:16.400 | The latest savings rate for CIT Bank
00:06:18.480 | at the time of this podcast recording
00:06:20.120 | is 2.2%, a decline of only 0.25% since its 2018 peak.
00:06:26.920 | Again, the 10-year bond yield declined by 1.65%.
00:06:31.160 | In other words, 10-year treasury bond owners today
00:06:35.000 | are being negatively rewarded by 0.76%.
00:06:39.880 | Not only is the online savings depositor now earning about 0.64%
00:06:45.160 | more than the 10-year treasury bond holder,
00:06:47.720 | but there is also no lockup period and no risk up
00:06:50.520 | to the FDA-insured $250,000 per individual and $500,000
00:06:54.880 | per couple.
00:06:56.320 | I think this is one of the greatest risk-free arbitrage
00:06:58.840 | trades in modern financial history,
00:07:01.000 | because eventually, after CIT Bank and other banks
00:07:03.800 | providing a similar online interest rate
00:07:06.040 | have received enough inflows of deposits,
00:07:08.880 | they will lower their interest rates,
00:07:10.440 | and this opportunity will disappear.
00:07:13.280 | Now, if you want to take on more risk
00:07:15.240 | to potentially make more money, you
00:07:17.240 | can open up a high-interest savings account
00:07:19.440 | and then short long-term treasury bonds
00:07:21.280 | through an ETF like IEF.
00:07:23.800 | The idea is to make money as rates go up
00:07:27.640 | on the 10-year or the long bond, because at 1.5%, 1.6%,
00:07:33.040 | I would say the chances are greater than 50%
00:07:35.400 | that interest rates are going to take a little bit higher.
00:07:38.240 | But again, who knows?
00:07:39.840 | You're going to take that risk, and you've got to weigh the risk
00:07:42.520 | and reward yourself.
00:07:44.320 | So let me share some more history
00:07:46.440 | of money-making arbitrage opportunities
00:07:48.360 | that went on in my life, and I think
00:07:50.480 | it'll be really pertinent for you in your life
00:07:52.960 | or your children's lives.
00:07:54.800 | So one, I went to a public university
00:07:57.120 | for $2,800 a year in tuition.
00:07:59.440 | I saw my older sister attend a private university
00:08:01.880 | for $22,000 a year and saw no noticeable benefit.
00:08:06.040 | In fact, attending a private university
00:08:08.040 | was probably a detriment, because my parents
00:08:10.360 | didn't make that much money as government employees.
00:08:13.560 | So the max arb here was going to one
00:08:15.320 | of the cheapest public universities
00:08:17.080 | and then getting a job in one of the most lucrative industries,
00:08:20.440 | which is finance.
00:08:21.960 | Even back in 1995, $2,800 a year sounded like a bargain,
00:08:26.560 | because I could cover the tuition working at my $4
00:08:29.760 | an hour minimum wage job working at McDonald's.
00:08:33.040 | And now, more than 20 years later,
00:08:35.360 | it's funny to see that people still
00:08:37.400 | believe there's a positive spread in attending
00:08:40.200 | a much more expensive private university
00:08:42.800 | than a public university.
00:08:44.920 | You heard about the college admissions scandals, where
00:08:47.080 | already very privileged and very wealthy people and parents
00:08:51.680 | are buying their kids' way into these schools that really
00:08:54.320 | mean nothing.
00:08:55.800 | I don't want to denigrate private universities,
00:08:58.680 | but I'm saying, unless you're already rich
00:09:02.000 | or you have huge scholarships, please do the right thing
00:09:05.680 | and save your money and go to the best public school possible
00:09:08.240 | or the best value school possible.
00:09:10.840 | The reason why there's so much student loan debt,
00:09:13.800 | not only is because interest rates are higher than they
00:09:16.100 | should be, it's because parents and students aren't thinking
00:09:18.760 | about the ROI of going to school as much as they should.
00:09:22.520 | They're seeing private school education, or maybe even
00:09:26.280 | college education as a whole, as some type of status symbol
00:09:29.760 | nowadays that's really, really not as necessary as it once
00:09:33.320 | was.
00:09:34.000 | So please, be prudent in your higher education decision.
00:09:38.320 | Two, buying property in San Francisco in 2003.
00:09:42.400 | I came to San Francisco with a raise and a promotion
00:09:44.560 | after two years in New York City.
00:09:46.840 | At the time, the finance industry was thriving,
00:09:49.280 | and I realized plenty of other people
00:09:50.820 | were making just as much money as people in New York City.
00:09:54.280 | Yet San Francisco real estate was 30% cheaper on average
00:09:57.240 | than New York City real estate.
00:09:59.240 | This massive valuation discount was
00:10:01.120 | odd because I also found that the lifestyle in San Francisco
00:10:03.960 | to be much better.
00:10:05.600 | The weather was pleasant year round, not just six or seven
00:10:08.120 | months a year.
00:10:09.280 | The city was more beautiful and less stressful.
00:10:12.360 | And after going snowboarding in two feet of powder
00:10:14.880 | on a Saturday in Lake Tahoe, three hours away,
00:10:17.840 | and then playing tennis in 70 degree weather on a Sunday,
00:10:21.260 | I was sold.
00:10:22.080 | It was a no-brainer to live and own in San Francisco.
00:10:26.680 | And today, that price difference has basically
00:10:30.000 | narrowed or has gone away.
00:10:31.960 | And now, it's not unheard of to hear reports
00:10:34.200 | that San Francisco real estate is now equal to or more
00:10:36.560 | expensive than New York City real estate.
00:10:39.000 | Three, starting Financial Samurai in 2009.
00:10:42.060 | After finishing up business school in 2006,
00:10:44.560 | it became more and more apparent that having
00:10:46.420 | an internet-based business with unlimited scale was the future.
00:10:50.660 | I just didn't know what to start.
00:10:52.760 | But when the financial crisis hit in 2009, I was like, OK,
00:10:56.200 | let's start Financial Samurai and try
00:10:57.920 | to make sense of the chaos.
00:11:00.000 | I didn't recognize at the time any personal finance sites
00:11:03.080 | written by someone who actually had a finance background.
00:11:06.840 | This was really odd to me.
00:11:08.560 | And so as someone who had 10 years of finance experience
00:11:12.360 | at the time, starting my own site seemed like an opportunity.
00:11:16.200 | 10 years later, in 2019, there are still
00:11:19.480 | very few personal finance sites that
00:11:21.440 | are written by people with financial backgrounds
00:11:23.600 | for some reason.
00:11:24.920 | Maybe the people in finance realize, you know what?
00:11:27.280 | It's much more lucrative to just continue to work in finance.
00:11:30.640 | For me, I was burnt out, and money
00:11:32.400 | wasn't the big driver anymore.
00:11:34.320 | I just wanted my freedom.
00:11:35.400 | So hey, I thought this would be a good idea
00:11:37.600 | to do something new with something
00:11:40.080 | that I'm quite familiar about.
00:11:42.320 | Therefore, there are still opportunities
00:11:45.000 | for finance industry folks to engineer their layoffs
00:11:47.840 | and start a finance website.
00:11:49.920 | If you have experience in a field that
00:11:52.240 | is dominated by people without relevant experience,
00:11:56.080 | it behooves you to fill that hole.
00:11:58.340 | You must fill that hole, because that is
00:12:00.520 | massive arbitrage opportunity.
00:12:03.240 | If you keep at it for a long enough period of time,
00:12:05.760 | I'm positive you will enjoy incredible rewards.
00:12:09.920 | Four, buying Panoramic Ocean View property in San Francisco.
00:12:14.520 | To me, this is one of the biggest, biggest opportunities
00:12:17.400 | for real estate investors anywhere.
00:12:20.040 | In no other major city in the world
00:12:21.680 | do Panoramic Ocean View homes trade at a discount.
00:12:24.680 | And I've been everywhere.
00:12:26.920 | They all trade at hefty 30%, 100%, 200% premiums
00:12:31.260 | to the median price.
00:12:33.000 | The discount has since narrowed from about 30% in 2014
00:12:37.320 | to about 15% in 2019.
00:12:39.640 | But I still see plenty of opportunity
00:12:41.400 | to buy property with views on the western side of San
00:12:44.060 | Francisco.
00:12:44.960 | San Francisco is one of the cheapest international cities
00:12:47.640 | in the world.
00:12:48.440 | We have six-figure jobs that are a dime a dozen,
00:12:51.840 | because there are so many massively profitable companies
00:12:54.960 | here that's just generating huge amounts of cash flow.
00:12:57.960 | You know them all--
00:12:59.000 | Facebook, Apple, Google, et cetera.
00:13:02.480 | It's just crazy how much you can make here
00:13:06.240 | if you get one of those jobs.
00:13:07.560 | Whereas if you look at places like Vancouver,
00:13:09.360 | where the median price is quite similar to San Francisco,
00:13:12.400 | I don't know a single large international company that
00:13:16.120 | will pay that much money.
00:13:17.920 | I mean, can you name an international huge company out
00:13:20.240 | of Vancouver or out of Canada, for that matter?
00:13:23.360 | It's hard to name it.
00:13:24.640 | And maybe it's because we're just dumb Americans.
00:13:26.700 | I'm not sure.
00:13:27.600 | But there is some valuation problems out there,
00:13:30.720 | in my belief.
00:13:32.360 | By 2025, the discount window for San Francisco View-based homes
00:13:38.000 | should narrow to 0%.
00:13:40.000 | That's my opinion.
00:13:41.120 | We're talking about a 240,000 arbitrage benefit
00:13:43.600 | based on the median priced home of 1.6 to 1.7 million.
00:13:47.480 | In other words, 1.6 to 1.7 million times 15%
00:13:52.100 | is about 240,000.
00:13:54.200 | And that's not considering any upswing in the real estate
00:13:58.100 | market by then.
00:13:59.840 | And by 2030, Oceanview Homes in San Francisco
00:14:03.280 | should start trading at a premium,
00:14:05.240 | just like every single other international city
00:14:08.360 | in the world.
00:14:09.760 | I encourage you to drive around all around your city
00:14:12.320 | one weekend and see if you can find some neighborhood gems.
00:14:14.980 | I'm sure there will be places you will have never
00:14:16.980 | seen or heard of before that will blow your mind.
00:14:20.440 | Five, investing in heartland real estate.
00:14:23.560 | Although there is a micro arbitrage opportunity
00:14:25.840 | to buy homes in SF with Oceanviews,
00:14:28.280 | there's a macro arbitrage opportunity
00:14:30.440 | to buy real estate in the heartland of America,
00:14:32.920 | mainly due to cost and technology.
00:14:36.220 | Think about it.
00:14:36.880 | If it really takes $343,000 in household income
00:14:40.000 | to buy a median priced $1.6 million home in San Francisco,
00:14:43.840 | I don't know how many people are going to buy these homes
00:14:46.080 | or come to San Francisco.
00:14:47.840 | And I think the San Francisco based companies
00:14:49.740 | are going to get squeezed.
00:14:51.680 | I have a close friend who employs 4,000 people in San
00:14:54.600 | Francisco.
00:14:55.320 | It's a publicly listed company.
00:14:57.240 | And he constantly tells me it is impossible to be competitive
00:15:00.760 | because the guys like Google and Facebook and Apple,
00:15:04.240 | they're paying such big bucks that it's just causing wage
00:15:07.320 | inflation for the rest of us.
00:15:09.600 | Speaking of Google, they announced in early 2019
00:15:12.280 | it'll spend $13 billion to expand in Nevada, Ohio, Texas,
00:15:17.280 | and Nebraska.
00:15:19.040 | Sounds like heartland real estate to me.
00:15:21.120 | Meanwhile, Uber in late 2019 announced
00:15:23.800 | it has leased an office building in Dallas for 3,000 employees.
00:15:28.480 | 3,000 employees.
00:15:29.960 | That's huge.
00:15:30.740 | And if that goes well, they're probably
00:15:32.320 | going to continue to expand.
00:15:34.440 | So the key really is to find the next San Francisco, Seattle,
00:15:38.160 | New York City, and Washington DC.
00:15:41.280 | It's only logical that thanks to technology also,
00:15:45.240 | people are just telecommuting more.
00:15:47.040 | You don't have to live in a city center that costs--
00:15:50.080 | where a two bedroom costs like $4,500 a month
00:15:53.200 | when you can live in a much lower cost area of the country.
00:15:56.800 | So I believe there's going to be a multi-decade migration
00:15:59.400 | shift inland or simply to lower cost areas of the country.
00:16:03.760 | And you need to find that arbitrage trade.
00:16:06.880 | Finally, if you're a parent or you're a student,
00:16:09.840 | there's another great arbitrage for Americans.
00:16:12.320 | And that's to take advantage of the Canadians.
00:16:14.800 | A top Canadian university has an acceptance rate
00:16:17.520 | of between 35% to 50%.
00:16:20.320 | Literally half the people get in.
00:16:22.760 | Whereas a top 10, top 20 university in America
00:16:25.560 | has an acceptance rate on average of 10% or below.
00:16:29.640 | So that acceptance rate spread is huge.
00:16:32.760 | It is really, really huge, folks.
00:16:35.000 | So universities like UBC, McGill, University of Waterloo,
00:16:40.680 | if you don't want to kill yourself as a student
00:16:43.120 | or you want to hedge your bets when applying to college,
00:16:46.000 | apply to the top Canadian universities.
00:16:48.320 | Because once you get in, the reputation of these universities
00:16:52.640 | is pretty good.
00:16:53.520 | They're pretty good.
00:16:54.800 | And you're going to get the similar types of opportunities
00:16:57.000 | and jobs as you would if you went
00:16:58.360 | to a top American university.
00:17:00.280 | And if you get Canadian residents,
00:17:02.720 | the cost is 80% to 90% cheaper.
00:17:05.040 | Now, international students have to pay much higher costs.
00:17:08.920 | But the costs are still about 10% to 20%
00:17:11.400 | cheaper than the most expensive private universities.
00:17:14.680 | So hopefully you guys realize that after all these examples,
00:17:18.240 | there are arbitrage opportunities every single day,
00:17:21.880 | large and small.
00:17:23.360 | Take some time out of your week and dedicate at least one hour
00:17:27.120 | to figure one out.
00:17:28.680 | At the very least, everybody should take advantage
00:17:30.720 | of risk-free arbitrage opportunities,
00:17:32.360 | such as a higher online savings account with your excess cash.
00:17:36.960 | My immediate focus now is paying attention
00:17:39.200 | to the San Francisco real estate market, which
00:17:41.520 | has softened in 2019.
00:17:44.520 | And I think there's a great opportunity
00:17:46.760 | to buy before a wave of tech IPO liquidity
00:17:49.680 | gets unleashed at the end of 2019 and in early 2020.
00:17:55.000 | I've spoken to dozens and dozens of employees
00:17:57.160 | from Uber, Lyft, Pinterest.
00:17:59.960 | Some of them are happy.
00:18:01.280 | And actually, a lot of them are kind of disappointed.
00:18:03.560 | If you think about Uber in particular,
00:18:05.440 | there were talks pre-IPO of $100 billion market cap valuation.
00:18:09.560 | And right now, the stock is putting it
00:18:12.080 | at a valuation around $56 billion.
00:18:14.560 | So all those mental calculation models
00:18:16.560 | of thinking how rich you'd be after IPO,
00:18:19.640 | has really got to be changed, because a lot of employees
00:18:22.240 | are much less wealthy than they think they are.
00:18:24.520 | And they're disappointed.
00:18:26.080 | And I want to go through this exercise and think,
00:18:28.680 | what would I do if I was an Uber employee who
00:18:31.560 | thought I was going to be worth $3 million,
00:18:33.400 | now I'm only worth, I don't know, $1 million, right?
00:18:36.640 | While also taking a pay cut for four years.
00:18:39.480 | And I think I'd probably diversify and sell
00:18:41.440 | a little bit in 2019, and then sell a little bit more in 2020
00:18:45.520 | to diversify my net worth, and also my tax liability.
00:18:51.120 | So for everybody else in America,
00:18:53.160 | I think there's a win of opportunity to buy property
00:18:55.360 | right now when rates are down, fears of recession are high,
00:18:59.800 | and a flood of money will be looking for a more stable
00:19:02.160 | asset.
00:19:03.400 | I hope everybody enjoyed this podcast.
00:19:05.760 | It really has made me think about other opportunities
00:19:08.480 | instead of just being passive and sitting back and letting
00:19:11.240 | things come to me.
00:19:13.000 | Where I've gained the most amount of wealth
00:19:15.200 | is by taking action.
00:19:17.080 | So if you enjoyed this podcast, I hope to hear from you.
00:19:20.080 | And please leave a positive review.