Ep.99: Microsoft & Tesla Earnings And The Rise Of Citadel

Hey, hello and welcome to episode 99 of the Market Maker podcast. Just one more to go, Piers. We haven't come up with, uh, what's going to happen when we hit the 100 marker yet.

No, in true fashion, we'll think of an idea that, like, the morning of the recording, and then— no, we need to do it better. We need to do— we need to put some time into planning. Got any ideas?

Okay, well, what we'll do is we'll, um, If you sign up for the— shameless plug— if you sign up for the Amplify Me Market Maker newsletter, of which link you will find in the description of this video, maybe we'll share a little teaser and a comp, and then whoever wins gets a little shout out on episode 100. Or in fact, do you remember that— was it Bharti who joined us on episode— yeah, 30 or something?

Guest speaker, come on! I mean, people are probably a bit bored of me and you. So yeah, getting a third leg to the stool of the century.

Okay. Yeah. So I'll drop, I'll drop a little something in the newsletter and then the winner of which can join us next, next week. How's that? Okay. No shaving my head or anything like that this time for any of our regular listeners who will remember. But 3 things on the agenda for today. Earnings season obviously picks up quite a bit the next— well, this week and next week is over 50% of all the companies reporting. Um, and this week was the kickoff of big tech earnings. Microsoft, they were really the only one. The others, so your Meta, Amazon, Apples, and so on, they all come out next week. And then we also had Tesla, which we can talk about, and I'll do my best to talk them down like I always do.

I'm looking forward to the Tesla segment, this podcast.

Yeah, I really try.

Always their share price, it's up, up 45% this year. Did you know that?

Wow. You know, it's easy.

How'd you feel? What do you feel about that? Anyway, I just want to talk about— I'm going to explore your feelings around sharp upside on the Tesla stock. So yeah, I'm looking forward to that segment.

Okay. And then the, the second part is going to be Citadel. Who this week, yeah, they were crowned the new top hedge fund manager of last year, knocking, uh, Will's kind of man crush Ray Dalio, yeah, off the top of the charts for the first time, I think, 7 years. So yeah, meaningful shift in the powers that be in the hedge fund community. And then also going to explain what Morgan Stanley has to do with WhatsApp. Yeah. No more I'm going to say about that yet, so you have to stay tuned. So let's kick things off with, with Microsoft. And one of the things here when people talk about earnings is the first thing you hear is EPS this number, revenue that number. And I always have to sort of pinch myself and think, okay, it's fine, I've been looking at this stuff for like 16-odd years, like I kind of just know what I'm looking at, but very sure that not everyone does. And revenue, I think, is quite straightforward. But yeah, EPS, very briefly, what is that, if you can explain it in simple terms?

Well, in very simple terms, it's net profit divided by the number of common shares. So whatever, whatever profit— so net profit is your, your profit after costs, and then Um, yeah, before— in, you know, before— so it's like EBIT, so before interest and tax and all that kind of stuff taken into account. And so whatever money's left after all your costs is your profit. Divide that by the number of shares you've got equals earnings per share, which is the kind of headline figure. Um, I mean, the thing to be careful about here— so revenue is sales, right? Obviously. Now that figure, you can't mess about with that. Like, from an accountant's point of view, your— whatever your sales is, is your sales. You can't really engineer changes to your revenue. That's just solid. But when— so that's what we call the top line, right? Then we talk about the bottom line, which is your EPS, your profit. But as you work your way from the top line down to the bottom line, then your, your clever accountants can start to do their work, their little magic. And there's something called— most of these EPS figures that are announced are actually adjusted, right?

Of which Microsoft's were adjusted indeed.

So they're all adjusted. This is then where you can really see some interesting kind of tricks being done to make that earnings per— adjusted earnings per share figure higher, so therefore make it better in the eyes of the investment community.

So question then for the accountant: I'm going to slash 10,000 of my workforce. This is a one-time item that's not recurring. Can I adjust that out of the earnings per share?

100% correct. And so that any— so adjusted earnings per share, so basically saying, right, let's look at the costs then Because you remember, it's your revenue minus your costs equals profit. So what are those costs? And basically you're going through them and saying, what are— are there any one-off items in there that we had to pay this year that we wouldn't normally pay? And basically all they want in those costs are the rear— annually recurring costs. Okay, so anything that's not— anything one-off item, get it out. So do you know how much they paid to lay off their 10,000 Employees?

Well, it's funny you should ask me that because I know some people who got laid off from Salesforce. Ah yeah, and that was handsomely paid to leave. So I'm gonna guess it's a pretty chunky number to lay off that many people.

Well, so they laid off 10,000 people, 5% of the workforce, and that they, they had a one-off charge of $1.2 billion.

Nice.

So that gets taken out, right? Meaning their profit, their EPS figure goes up by $1.2 billion because they're essentially adding back on that one-off cost that's not going to be recurring. So you've got to be a bit careful with these profit numbers because, yeah, there's a lot of engineering to make things look as best as they possibly can without obviously you know, you can't commit fraud, you can't break accounting laws. I mean, obviously people have down, down the years, and it's all kind of come out and there's been scandals and whatever. But yeah, within the rules of accounting, you're kind of massaging these numbers to look as best as they can.

So just so I'm on the right page here, we are talking about Microsoft, not Tesla yet. You mentioned financial engineering for a second there.

Yeah, you know, Tesla have got— well, that, that ace card they've always used is their, uh, revenue from their tax credits, um, that they've always used to mask the underlying, um, fact that they couldn't make cars profitably.

Do you know what, that has changed now, by the way.

They are making profit.

Just to jump to quickly to Musk— I know we'll get there, but I can't help myself— you know what he's gonna do? He's gonna do like what Apple and all the rest do. He's gonna stop reporting how many cars he's producing. He's just gonna wing it. And then, and investors are gonna buy it. They're just gonna be like, yeah, that's fine. He's just gonna say demand is double what we're producing, and the market will go, where's the figures? And he'll go, we're not producing figures anymore because we don't have to. That's a guarantee. That's where he's gonna head.

Okay, we'll see. He's not heading there yet. That's a key measure. I don't think— yeah, you're not going to see him remove that kind of stat anytime soon, I wouldn't think.

Yeah, but he is the guy that could engineer, engineer that type of ridiculous scenario. But, um, back, back to, back to Microsoft then. So when you— one of the other things is when you look at these companies is looking at the different divisions.

Yeah.

And within Microsoft there's a few there's ones that are tied more to, say, personal computing, productivity, business processes, that sort of thing. So if you think about subscriptions to Windows and, and so forth, but yeah, you know, demand for that flagging the macro environment, so on. But then the most in focus, because this will be a recurring theme for next week with Amazon and obviously AWS, which is their cloud computing division, So yeah, first, what is cloud computing and why are these big tech firms so focused on that as a business division?

Um, well, I mean, yeah, cloud computing is the jewel in their crown, right? Um, it's the— well, I mean, I was going to say, I was going to use the word modern. It's the modern way of operating a business, but it almost feels like it's too old to call it modern anymore. It's just the way that the world has shifted in the last— actually, I don't actually know how old is AWS, how old is the Azure cloud. It's like, it's probably, I'm gonna guess at 20 years, right? And it was probably in its infancy 20 years ago. But over that 20-year period, over that 2-decade period, what's happened is almost the entire planet shifted to the cloud. I think the stat is, and it's a very rough, broad stat, but 90% of businesses— now hang on, now that I say this, I don't believe it as it's coming out of my mouth. But anyway, I'm going to say it anyway. 90% of businesses now have their computing in the cloud. I'm wondering whether that is true, thinking about emerging market economies. But anyway, maybe they're talking about the US perhaps. Let's just stick with that. That feels more comfortable. 90% of US companies compute in the cloud. It just means that like in the olden days, you'd, if you wanted a computer network for your business, you'd have to buy a load of servers, right? The physical units. And then you'd need, you need a whole room where you've put all these servers in and then you are kind of, physically wiring all of your computers in the office to these servers that are in this room at the back. And this room is really hot and needs air conditioning. And I mean, it feels so archaic now. And in fact, most people listening to this are probably thinking, what the hell is he talking about? But, um, we— it used to be that way, right? But of course now it's all in the cloud, which just makes it hugely cheaper for a business because all of that just now is virtual, right? So it saves a huge amount of money. You don't need this room with a load of servers in it. It's way safer and more reliable. And it's easier, it's more flexible, easier to collaborate. And especially in the post-COVID world, or COVID, during COVID of course, where everyone's working from home, it's fine. Right? You can just tap into your business's computer network anywhere, anytime, on any device. So obviously, you know, it's the modern— no, it's not modern. It's the way that the world works. So yeah, go on.

The definition then of how you've explained it and the kind of adoption it's had then, is that what makes it less prone to the economic conditions change, right? Comparative to say buying a computer and it's loaded with software.

So right, for Microsoft, the reason why it's so good, well, A, because it's the fastest growing part of their business and has been for a long time. B, it's got much higher profit margins, um, because it's, it's, it's virtual, right? It's not like making computers where you've got to actually have a, you've got to have a manufacturing plant, you've got production lines, you've got people, you've got materials, you've got shipping, you've got all the rest of it, right? So profit margins are way higher in their cloud divisions. And as you alluded to there, um, it's much, as a revenue stream, it's much more stable. I mean, businesses like Microsoft historically had a quite a cyclical revenue, where their revenue would be up and down in line with the economic cycle. Think about it, you know, when you're heading into a recession, businesses cut costs, right? Which means, yeah, you lay people off as we've just been talking about, but also, you know, you don't— you stop investing in new hardware or new software. It's not like, you know, I'm upgrading the company's computer systems, you know, I'm not buying everyone in the business a new laptop. When we're right in the middle of a recession. So you help— you hold back on these purchases as a business. And so if you're in the business of supplying this type of equipment and software, because obviously every laptop purchase comes with then a Windows operating system, uh, comes with a Microsoft Office, let's say, and this is then software revenue, right? But if there's less computers being bought, then there's less software subscriptions being purchased, and so your revenue is much more cyclical. With this cloud stuff, you can't operate as a business without it. You can't. So it's, it's not a cost that you immediately go to and try and reduce as a business in a recession. Um, so it's much more stable, it's less volatile, and as an, uh, as a revenue stream, therefore way more attractive and more valuable actually in terms of when you're valuing a business. So yeah, these cloud divisions are phenomenal, and the same goes for Amazon, right? So Amazon are the chief rival. So Microsoft have the Azure cloud and Amazon have their AWS. And of course, of course, for Amazon, you know, again, it perfectly offsets that much more cyclical, um, sort of retail side of the business. So yeah, it's the jewel in their crown.

Yeah, one thing I did see was that, um, what— as soon as the numbers hit, the shares spiked up, I think about 6%. However, in the conference call, a notable, um, comment specifically on cloud was that they said demand for cloud services fell noticeably during December. So just coming into the back end, they started to see a drop. And actually, uh, the company projected revenue would hit, and they basically downgraded by $1.5 billion their current quarter revenue outlook, and then the shares actually came off, um, a fair bit.

Yeah, it's the perfect example of an earnings result and, and how markets behave, right? So you get that first top line, those numbers, revenue, EPS, right? Um, and so you'll, you'll get an initial price reaction off that. And okay, with Microsoft, their cloud figures beat expectations. But that's backwards looking because this is about Q4 2022. Then you— so that you get initial reaction off that. And actually, I think Microsoft was up— I can't remember the percentage now, but Amazon shot high. Amazon's share price went up 3% off the back of this immediate reaction to the Microsoft numbers because Microsoft cloud figures were better than expected. So you're thinking, right, well, Amazon's cloud figures are going to be better than expected then. So look, let's buy Amazon in advance of their earnings, which aren't until next week. But then, as you say, it's more, you know, in the end, these share prices, it's more about expectations in the future that really underpins the value of these shares today. So whilst what happened in the end of last year is insightful, in the end, it's what we really want to hear about in these earnings reports is their guidance about how they think they're going to perform in Q1 of this year and and indeed in the full year 2023. And as you're saying, this is where they've downgraded expectations, and it's quite insightful, I think. Well, well, hang on, let me change that. It's not surprising that I, you know, that in December these cloud figures started to get eroded a little bit because I just said to you that, um, you know, cloud services as a business isn't really something you're going to look at trying to save costs on to start with. But unless you're shrinking your workforce, because then you need— so if you've got now less employees, well, then you've got less demand that you need to buy for your, your cloud services, right? So it's kind of at the very end point of this tip into recession where you start to get the job losses that then it starts to show up in these cloud figures as well. So yeah, it's all, you know, it's kind of not surprising. And I guess on the macro side, it's really insightful because whilst the GDP figures from the US that were released on Thursday, yesterday, were better than expected, right? Quarter 4 growth, better than expected, but it's a slowing trend. So as we went through quarter 4, it got progressively worse. And in December was the worst month of the quarter. And so you extrapolate that into January and February. And so yeah, we're getting the slowdown, and these figures from the likes of Microsoft really confirmed that.

Yeah, and the reaction function you explained with Microsoft, we had the mirror opposite in terms of when the GDP came out, it dipped and then rallied. Yeah, and so like, exactly like you said, I think you get the top level number, it's higher than expected, or high interest rates, that kind of initial sell-off in stocks, but then it's like, well, hang about, the, the direction of travel is the same and the outcome with rates is the same, hasn't changed for the Fed. And we just went exactly back to where we were, pretty much scratch, yeah, flat from where we were prior to where we are now. But, um, the other thing this week was they— Microsoft, to finish off with them, they announced $10 billion investment in OpenAI. And they plan to integrate GPT, the language model that underlines basically ChatGPT, into Teams and Office software. One of the things, um, that I was reading was about— it's quite notorious, uh, bank analyst put out a piece and he was talking about the firm basically missed out on the social media.

Yeah.

Um, period, like a decade ago. And they really are conscious that they can't miss out again. Hence they've gone quite aggressive in this AI race to get ahead of their rivals.

Yeah, Google, Google bought YouTube, you know, Facebook bought WhatsApp and Instagram, you know, they nailed it with the social side and my poor old dinosaur Microsoft weren't active enough, didn't see that social media trend.

They were left with LinkedIn.

Yeah, I forgot they own LinkedIn, don't they?

Yeah.

All right.

Yeah. But one thing that, um, he also went on to say was that the thing here though for Microsoft to be conscious of is I was reading a story and it was about way back when the internet was first in its infancy. Microsoft got, um, penalized by the US government for a monopoly because they would have their systems where you'd have to force onto one browser and it was within their software package. And that's what created an opportunity in the market for a Google.

Yeah.

And now what they're saying is, is it's now Microsoft's in the other, is in the ascendancy, in the driving seat on the AI issue. But now they've also initiated the arms race in AI.

Yeah.

And that's almost gonna act as a motivated motivating actor to accelerate now investment through all other competitors. So yeah, the race is on at the moment.

The race is on. And yeah, it's going to be really interesting to see what Google and DeepMind, you know, what, where are they on this? And are they anywhere near a direct competitor to ChatGPT? PT this year because they kind of need to be. And the longer it takes, of course, the more this kind of first mover advantage that OpenAI and therefore Microsoft have.

So yeah, the article I read, another one was talking about Google being very hesitant with the AI technology that apparently is quite advanced because of, because of its Sentinel capability and its ability, then therefore the risks associated with what the repercussions of that might be given how advanced it is. But I think that's talking your book to just keep a, uh, make sure you're not falling too far behind because of the, the viral outbreak of ChatGPT. Yeah, but one of the things here though is that OpenAI, obviously what drives AI is a phenomenal amount of computing power. Yeah, and what more do you need than cloud computing to—

Absolutely.

—act as the main engine to get that thing working. So yeah.

Yeah. Well, those of you that have been using ChatGPT, I mean, yeah, there's been real issues. It's improved. It's improving. But there's been real issues like trying to get onto the thing because, you know, often you're trying to get on it and it's like, actually, can't. There's— sorry, get in the queue. You know, our server capacity is maxed out. And, um, so some people have been having a lot of trouble getting onto it because there's too many users. So yeah, teaming up with the Azure cloud, yeah, that would be a perfect marriage. Yeah, cool. Well, look, let's, um, one more thing on Microsoft. Sorry, go for it, which is an interesting angle which we haven't mentioned yet, just from their earnings. So Their cloud services, right, they, they increased by 38%, okay, in Q4. So their services, that's the growth rate. Now that has declined from 42% growth rate from the quarter before, right? But that, that's what beat expectations though, because analysts were expecting a 37% increase, but it was 38%. But that's a slight slowdown from the quarter before. But when you— I just wanted to point out the dollar and the dollar's value and just how big of an impact it has on these giant multinational businesses. Because all those figures I've just said, 38% growth, that's before you include— that's an adjusted figure before you include, uh, the effects of the strong dollar. Once you take in the dollar's appreciation Um, that growth rate goes from 38% down to just 31%. Yeah, that's a huge— this dollar appreciation in 2022 has had a monster negative impact on, you know, these big multinational, these big US multinationals.

Yeah, I was just trying to find the Tesla impact. Tesla had a negative FX impact on revenues of $1.4 billion. Yeah, um, and hit their profit by $300 million. Yeah, so also not a small amount. And on that note, Tesla then. Yes, I want to keep Tesla down to at least just 2 minutes, please. No, no, no, I think the other topics are far more interesting. Like, no, no, no, I did—

I disagree. I think we should really delve in here. So let's look at— let's talk about that share price again. So did I say 45% up on the year?

Well, you know, things like Ponzi schemes and, and all these other, um, financial engineering enterprises always appear very charming on the surface, but, uh, I'm loving it. So hit me, what, what, what out of the earnings, um, stood out? Their shares then on the day popped a good 10%, 10% up.

Yeah. So when I say 45%, right, their share price bottomed at $106, $106, right at the start of January, right? It's now $160. So actually that's more than 45%. Um, so $100 to $160, that sounds awesome and amazing, but, um, that only puts it back at levels that were seen in mid-December. And of course they're all all-time high was above $400. So even though you've— in percentage terms, it sounds remarkable. What, up 60% in like 4 weeks? But yeah, when you look back over the last 12 months, they're still down whatever it is, 60% actually. So anyway, that's one thing to say. But look, what stood out? Well, obviously, Musk, he just loves it. He loves to be the center of attention. He came out like— he basically came out fighting because in December, which is when the share price of Tesla dropped from $200 down to $100, basically, um, a lot of that was due to the, uh, kind of information about the demand for Teslas dropping, and that we hit this pivotal moment where in December Apparently Tesla produced more vehicles than there was demand for their vehicles. So supply outstripped demand, and it was like, what? Hang on, this is supposed to be a revolutionary vehicle that's going to be winning market share year over year over year, and yet here we are and there's more supply than demand. And so Musk came out fighting, and what he said on the earnings call was, the most common question we've been getting from investors is about demand. So I want to put that concern to rest. He said, in January, so far we've seen the strongest orders year to date than ever in our history, and we're currently seeing orders at almost twice the rate of production. Now, the first part of that sentence, strongest orders year to date than ever in history— well, I should bloody well hope so. You're supposed to be a company that's growing. You're supposed to be a company that's got a strong growth rate. So if you don't have more orders now than 12 months ago, I mean, wow. I mean, it really would be a disaster, right? The second part though, orders twice the rate of production, but there is one word in there, almost twice the rate of production. So I, I don't know what that means, but I find it hard to believe that in December production was greater than demand, and now just a few weeks later demand suddenly double production. I mean, obviously they've had a massive price cut, um, and maybe, I don't know.

This is why I have to tip my hat that he is the master tactician, because he's just lying and he's created enough of a buffer. And I won't name politicians' names because I'll get in trouble. But it's a, it's a, it's a classic framing, um, strategy, and he's an absolute king of it. And so it's got to the point where he can say stuff like that and people just swallow it, and it's just like, okay, um, but for me, that's a, that's a road that will end at some point. I mean, the best one I saw was the automotive gross margins. Yeah. So they were the lowest figure in the last 5 quarters. You know what he said about that, Tom? He said our average selling prices have generally been on a downward trajectory for many years in a pursuit of improving affordability.

Yeah, improving affordability. Well, look, let's talk about— now you brought it up— gross margins. Yeah, let's, let's test your knowledge here. So basically, gross margin Well, hang on. So automotive gross margin, this is a really key metric for the automotive industry when you're thinking about profitability, because it's basically what, what profit do you have after you take out the costs of, costs of sale, right? So if you're a manufacturing business, your cost of goods sold is very high. And that's clearly, especially if you think about cars, right? It takes a huge amount of manpower, robotic power, raw materials, you know, fancy production lines and production facilities and all the rest of it, right? So a huge portion of your cost as a manufacturer is the cost of goods sold. It's the cost of building the thing that you're then selling. Okay. So gross automotive gross margin is revenue minus the cost of goods sold. Okay, so what are you left with is your gross margin. So Tesla's gross margin has been going down and down and down. Uh, at the start of 2022, their gross margin was 30%. Okay, in Q1. In Q2 of 2022, it dropped to 26.2%. In Q3 um, it was 26.9, so it went up a little bit, but then in Q4 it was just 24.3. So in that year it went from 30% gross margin down to 24.3% gross margin. Okay, and that mostly is because they've been reducing the price of the vehicles. So now I got two angles here though.

I know, I know where you're going to take this. You're going to say, well, the average gross margins for other automotive companies is like much smaller, and so they've got more buffer. So what—

yeah, well, what do you know what the average gross margins are? I knew this was coming.

See, come on, I know what you like.

Bulls are like, I've got, I've got 3 other big kind of US— well, Toyota in here as well, which is obviously not US, but I've got, I've got Ford, Toyota, and General Motors.

I'm gonna, I'm gonna— I reckon they're all single digits.

They're actually not. They're all double digits. Okay, but, um, so you remember that Tesla's at 24— well, actually, these figures I've got, I just realized now, are quarter 3. So at that point, Tesla was 26.6, right? 26.6. Um, Toyota's the next best at 17, then it's Ford at 15, and General Motors are below 13%. So actually Tesla has more than double the gross margin than General Motors.

And credit to them, you know, they have like positioned themselves as a— not premium, which they are, but technology. And I think that's the secret sauce to your product.

I was reading an Uber bull, long-term Uber bull Tesla analyst's thoughts on this, and he was like, yeah, you know gross margins going down because we've had to cut prices to try and shift some of this stock. But he's basically saying that as the economies of scale come through due to the ongoing ramping up of production— so on that front, they made 1.3 million cars in 2022, they're forecasting 1.8 million in 2023, although Musk on the call goes Yeah, could it— could easily be 2 million. Anyway, whatever. So, but they're ramping up production. With that comes more economies of scale. So what this analyst is saying is cutting price brings in a larger potential market on the demand side. So people who want Teslas but couldn't afford one, maybe they now will be able to afford one. So it's positive for demand. And then he's saying because of the economies of scale, that will come through despite a hit to the gross margin in 2022. We actually expect the gross margin to be able to recover even if we keep prices at their lower levels because the cost of production per unit will reduce.

But what, what about the market share being eroded over time as competitors bring out better— you said before, and you're definitely right, better, more advanced models. When you're positioning yourself as a technology company that's in an EV space but you don't have the best technology, well, you can't charge a premium and you don't have demand. I agree.

No, I'm on the fence here. I'm not a Tesla bull by any means, and I was certainly very, very skeptical of the Tesla share price like in 2021 and into 2022, and we have many conversations about it. But now the price has dropped by 70%. I, I actually think the value of this business is now possibly about fair, um, hence why it's gone up.

The share price has rocketed. You're always picking bottoms. You're picking Google's bottom, Tesla's bottom. I will qualify like this, like the shark in the water picking them up. I don't—

I unfortunately I don't own any Tesla shares. I wish I had bought them at the start of this month, obviously, uh, but I missed that one unfortunately.

Yeah, well look, we've got, we've got 2 more topics to go and, uh, just conscious of time, so let's crack on and get on to Citadel. Yes, and yeah, big, big really big news actually in the hedge fund space. However, I do wonder sometimes, do people even know who Citadel are? It's kind of like, I always think that hedge funds are always like the secret people in the background. Certainly that's how it's positioned on, on a lot of threads online. So who are Citadel? Maybe with us, let's start there before we talk about their overall— how do they generate money, what are their strategies, and How do they compare to other firms? Well, Ken Griffiths, he's—

that's who Citadel is. Kenny G. Yeah, he's the founder. And look, they go back decades. You know, in the 1980s, he kind of founded Citadel, um, the hedge fund. Um, and yeah, I don't know, they've kept— they've been under the radar compared to some of the more sort of Ray Dalio, Bridgewater types.

The guy who sells books. Yeah, well, exactly.

So Ken Griffiths doesn't— he's not a, you know, he's not a PR junkie. He's not, you know, doesn't want to put himself out there in the spotlight like Ray Dalio does. And so maybe that's one reason why Citadel isn't as well known. Um, but they were quite famous in the financial crisis because just before the financial crisis— I mean, genius in hindsight— they, um, managed— because of their success, they'd managed to agree a new set of rules with their investors. And basically, they set in place a new legal framework, which meant that investors had much less ability to take out their money. Right? Then the crisis hit, and Citadel got nailed. I mean, they did really badly in the crisis. Their clients couldn't pull their money out. So at least that saved them. Because if you're a hedge fund and suddenly you're getting a load of redemptions and withdrawals, and it's just a nightmare. So at least they were safe from that problem, which meant they had time to kind of sit tight, ride the wave back up after the financial crisis. And they got super leveraged, took some big bets down around the lows. And anyway, they came out of the crisis just rocketing. Um, and ever since then they've been on the climb, on this relentless march higher to now the top of the table. And now the biggest hedge fund in terms of profit. And actually they made $16 billion profit for their investors last year, which not only makes them now the biggest, overtaking Bridgewater, who had been top for many years— not only are they the biggest, that was actually the single biggest dollar profit year for any hedge fund in history. And that was overtaking John Paulson's record, which was $15.6 billion in one year, which was in 2007, because John Paulson took a massive bet against US subprime and got it amazingly right and smashed it. Well, Citadel have just broken that record. That's 20— that's 15 years old. Um, anyway, the thing about Citadel, all these stats like $16 billion profit in one year, best ever, biggest hedge fund— the thing is they're not just a hedge fund. They've got a whole other business that, that isn't included in these numbers, by the way. So that $16 billion profit is just from their hedge fund side. That's Citadel, okay? There's then this thing called Citadel Securities. Which is a whole different business, which is about market making and facilitating trade flow, basically. And that business is just phenomenal as well. And last year they were just a money printing machine. Um, I just— the one quick aside before we delve into their strategies and so on There's a correlation between Citadel's rise to the top, and there's a correlation with that and the, the simulation training provider that they use because they swapped provider back in 2020. You might have heard of them.

Well, so presumably they must get the best, the very best equipped, trained candidates in the world. I mean, to work.

Well, yeah, I mean, they're the best and the biggest hedge fund on the planet. So who do they call? Amplify. Yeah, we run all their internship programs, US, Europe, Asia, Australia. We also run their— well, we're off to Miami in February to run something for their hedge fund side for engineers that have been there for 1 or 2 years. So yeah, basically it's Amplify Simulations. That's the main reason. Why they're the best hedge fund on the planet.

Secret formula of Kenny G.

But yeah, like in terms of hedge funds, right? Because there were a lot of hedge funds that got absolutely killed last year. Worst year for years and years. On average was the worst year for returns for many a year. Okay? And yet Citadel delivered a 38.1% return on investment. So how is it that that's possible when everyone else got killed? Well, Most of the people that had a bad time of it were running one strategy, which is like equities and perhaps long only. And like, they're maybe taking big bets on the tech stocks, which was amazing in 2021, but then it was the opposite to amazing in 2022. The thing about Citadel is they run a whole range of different strategies, much more diverse. In terms of the strategies they employ. Um, one, we're running a sim for them, as I said, in Miami. What we're teaching their engineers to do is to run an equity long-short strategy around the earnings season. So what they'll do— and this is like a hedged strat, hence, you know, the word hedge fund, um, is born out of that original hedge fund, uh, that was back in the '60s I can't remember the name of the guy now, but anyway, the whole idea is you're supposed to be hedged. It's supposed to be a lower risk strategy, but the term hedge fund has just become this generic term for a part of the industry these days. And a lot of hedge funds are definitely not hedged when they're taking actually massive leveraged risk. Um, but this equity long-short strategy is hedged. This is where you're basically buying one stock and you're going short another. It's normally stocks in the same sector. So if you're running into an earnings season and you think that, um, Amazon's earnings are going to be much better than Microsoft's earnings, okay, then what you'll do is you'll go long Amazon and you'll go short Microsoft. Now that is a hedged position. It's what's called market neutral because now you're immune to macro ups and downs. So if there's macro news, well, Microsoft and Amazon will move in tandem and they'll be in sync. And so if you're long one and short the other, well, you're making a profit on one and you're losing money on the other, and they basically net off. So you're, you're zero, right? So any macro moves up or down, you're making nothing and you're losing nothing. You're hedged. So all the strategy is you're predicting a divergence between the two stocks based on micro news about their individual companies. Okay, so you're putting in place these big positions, and then if you're right— and obviously you've got to be right— but if then Amazon's shares go up by more than Microsoft's because their earnings are relatively better, well, then you're banking that, that kind of spread in the divergence. Um, so that's just one example of the type of more hedged strategies that are um, aren't correlated to the macro cycle. And so they're able to generate big, big profits. Doesn't matter if we're in a recession or in a booming economy, that strategy still holds and is, is applicable. So that's just one example, but you know, they do many other types of strategies across asset classes, so it's very diverse. Um, and yeah, they're just amazing at it, basically.

Well, I think you should say that exact phrase when you see Kenny G in Miami, and I'm sure you two will have a very good night on the town. So one thing I would say is keep any of your conversations off WhatsApp. Yes, because Morgan Stanley is a case in point. You could get fined up to $1 million for just having a conversation on WhatsApp. With a, with your client. So explain to me, like, how does that, how does that work? Because I think a lot of particularly young individuals looking to pursue these careers at an investment bank, perhaps they don't always think about the legal side of compliance and how that is incorporated and very much embedded into your activities day to day. I know from a trading perspective, a big job of automating trading systems is to satisfy regulation, right? It's like Now, because of various different rules and checks, you actually have to— but initiate one trade, you have to do like 10 different checks. The thing is that that can be done almost instantaneously with automated mechanisms. But this is, this very prevalent in certain things. And things that I were reading was like commodity traders always seem to be getting in trouble, and investment bankers typically, yeah, are also culprits that often get stuck in tricky spots having inappropriate conversations. So just explain to me, what's the premise here of why this is?

It's, yeah, it's basically going back over the years, it's basically to prevent insider dealing. You can't be having a conversation with your client that is not fully, that's not recorded, and, um, fully transparent, and that is a conversation the entirety of which is stored by compliance and is readily made available to the regulator, um, at the drop of a hat. Okay, it all has to be— it's gone so crazily over the top that this per— this is a great example. So Morgan Stanley And I— well, hang on, not just Morgan Stanley. So last year, um, Wall Street paid up $1 billion in fines to the regulator, um, because of, um, inappropriate use of personal phones and approved apps in communication between bankers and their clients. Okay, um, Now with Morgan Stanley's case particularly, they were the worst of the lot. They got the biggest fine. They paid up $200 million last— this is just last year, okay? And because it's such a big fine, I haven't heard of this before, and maybe other banks are doing it as well, but Morgan Stanley are now passing that cost on to their employees. Um, and I haven't heard of that anywhere else, but maybe it is happening. And their point is, and I Reading about it, it's kind of fair enough from Morgan Stanley's point of view, because basically Morgan Stanley operate with this points system, okay? And basically you get points, like negative points, for the number of messages you've sent to a client on an unapproved app like WhatsApp, for example. Um, it's based on your seniority, it's based on how many prior warnings you've received. And it's fair enough, right? If Morgan Stanley are over the top telling their staff, 'You can't do this, you can't do that, you can't do this, every conversation you have ever has to be recorded and submitted to compliance.' So if they've given them the guidance and then the member of staff just goes ahead and just ignores it, then— and then they get fined for it by the regulator, well, I don't know, maybe it is fair. That's one angle. There's an opposite because some of the stuff they've been fined for, right?

One example of one of these ridiculous fines. So this was Bank of America. Yeah. And, um, the suggestions were— it was kind of leaked that if you're at Bank of America and you, you were to text a client to say, with you in 5 minutes, I'm running late, you would fall foul of compliance and the bank's policy. Uh, so yeah, what, say if I have a phone call, am I supposed to record the phone call and then submit the MP4 file to the compliance team? I guess I am, right? Yeah, to say 5 seconds, I'm going to be late by 2 minutes, see you there.

So look, I think this is the media just grabbing something and Putting that example alongside the $1 million fine. Yeah. There's no way you'd get fined a million bucks for saying, I'm running 5 minutes late. Exactly. Right? But you'll get fined maybe, I don't know what the lowest fine, well apparently Morgan Stanley, the fines ranged from a few thousand dollars. Okay. Up to $1 million. So yeah, I mean it's got crazy and it's just something to be aware of if you want to go into banking, if you want to go, work for these big financial institutions, be prepared to have to kind of comply with this crazy oversight. And, you know, for a lot of people, it's the worst part of the job, and it's incredibly annoying and frustrating. Um, so you just got to be prepared for the compliance regulatory burden that you're putting on yourself when you enter into these institutions.

Yeah, and just hearing some of these quotes, it reminded me of the LIBOR scandal in 2008. Yeah, it came to light, all of the conversations about manipulating basically the lending rate that gets set in London every day. And I'm just gonna finish with a couple of quotes from what some of these people were saying at the time. So here's a couple. Could we please have a low 6-month fix today, old bean? That's just another one. Fixing as usual, monsieur. Or this one, just straight out, I'll coordinate the overnight in the same way we did last week, right? Wow. And then I think there's one, uh, just be careful, dude. There's another one, mate, you're getting bloody good at this live ball game. That's another one. Yeah. And then the last one, boys, well done, top work.

This is what you get put in jail for. Right. And actually on this note, I got one final thing, something I read in the— well, actually my one, one of my besties, I'll give a shout out to, uh, Jim Wright, one of my besties. He sent me a, he sent me a WhatsApp, um, with a little news story that I found highly amusing. That's very appropriate to the conversation we've just been having about insider dealing. It happens to involve a lady called Nancy Pelosi. Ah, oh yeah, she loves it. So she, she was the, um, the Speaker of the House, okay? Um, very, very prominent, uh, kind of US Democrat, okay? She's retired now, last year, but but she, well, her and her husband, while she was in office, pulled off some incredibly dodgy— Well-timed. Well-timed trades. For example, I got two examples. In March 2021, the Pelosi scored a $1.65 million profit on some Microsoft call options, which they bought. Okay. And 2 weeks later, the tech giant secured a $22 billion contract from the U.S. government to supply Army combat troops with augmented reality headsets. So obviously they got heavily criticized because basically Pelosi is government. She is involved with awarding these contracts. And just before it gets announced, oh, just buy a few of those call options please, banking almost $2 million profit. That's— that was one example. Another one was your favorite company of all time, Tesla, because she made a $1 million profit on Tesla call options which she bought Immediately prior to Biden announcing the big tax cuts and incentives to drive the electric vehicle sector. So yeah, anyway, she got heavily, heavily criticized, and there's a whole bunch of other trades, and there was— the Republicans were trying to get new legislation put through to block her from just blatantly taking the piss, and she would block it and block it being the Democrat side, she would say no, delaying it, not allowing it to be debated. Just a disgusting example of insider dealing, OK? Now, this week, Senator Josh Hawley has just introduced some new legislation, OK, to prevent this happening. And do you know what the legislation's called? No, this is genius.

It's gonna have— it's gonna be something with her name involved.

This is— it's, it's genius. This is what it's called, and bear in mind, I'll give you the long name, and you've got to think about the acronym that this is now being shortened to. The name is Preventing Elected Leaders Owning Securities and Investments. Oh, it's the Pelosi Act. It's abs— it's absolute genius. The funniest thing I've seen all week. Oh, that is classic. Love it. Josh Hawley, respect.

We'll wrap it up there. Um, as ever, if you enjoyed the, uh, episode, please do leave us a rating and review if you haven't already done so. Feel free to subscribe and turn on notifications to get the alerts when The latest episode goes out every week. Otherwise, take care, enjoy your weekend, and thanks, Piers. See you later.