In recent times the world’s banking entities have been analyzing the finalization of the Volcker Rule portion of the Dodd-Frank Act. The rule, which includes the restriction of banks from engaging in proprietary trading of certain securities, derivatives and options, effectively bars these entities from behaving like hedge funds. One particular activity often associated with hedge funds is “risk arbitrage.” Is this note, we take a moment to consider that term which might seem to be an oxymoron: “risk riskless profit.” Arguably there’s no such thing.
The reality is that there can be something fairly close…but it takes real expertise and precision to profit. Webster’s dictionary defines “arbitrage” in finance as “the simultaneous or near simultaneous purchase and sale of the same or closely linked securities or commodities in different markets to make a profit on the (often small) differences in price.” But, in evaluating the profit opportunity, both financial costs and opportunity costs need to be considered as arbitrageurs would seek to make enough money to justify not working on other productive activities requiring an equivalent skill set.
As an example, risk arbitrageurs (a/k/a merger arbitrageurs) do indeed bring a unique skill set to their discipline. In a corporate merger, until the acquisition is completed, the stock of the target typically trades below the purchase price. If the arbitrageur buys shares of the target plenty of expertise is needed to assess the risks of the deal failing based on anything from the two parties ability to satisfy the deal conditions, shareholder approvals, antitrust or regulatory clearance etc. In other words, there’s plenty of risk in risk arbitrage. As is there in other hedge fund strategies such as convertible arbitrage, volatility arbitrage, and statistical arbitrage.
In considering a new kind of arbitrage, one which also leverages an important skill set, we suggest that “domain arbitrage” comes close to offering the promise of something approaching “riskless profit.” The skill set here would be the ability to recognize the value of intangibles. In particular, we argue that there is huge value in intangibles such as intellectual property, ideas, relationships, and collaboration. Domain names, or the sequence or words comprising an internet address, have real value. Words matter. The ability to combine words and create recognizable, memorable, meaningful spaces in the internet, and then make them available to others who would use them to their best and highest purpose is the essence of “domain arbitrage.”
At Cornerstone Capital Group we applaud the capitalist profit motive associated with creativity and innovation. We suggest that new ideas should be well-articulated, commercialized and protected…and given the space to prosper. The internet allows for this. We will proudly engage in the free exchange of ideas represented by “domain arbitrage.”