Bring Back the Vinyl

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Back in the day when we liked a song we would buy things called albums or CDs. This, for an 80’s era teen, was a risk when disks were $9-$14, so we had to determine if we could live with the album to justify the cost. Fast forward to today it costs $0.99 for one song you know you already like, at least at the moment. However, with songs becoming more commoditized due to so many downloadable options, musical trends can change so quickly that your “cheap” purchase could be a waste of money.

This reminds us of the equity market today. With artificial intelligence and high frequency trading becoming such an important part of market volume (approximately 50-70%) and quote activity (perhaps as high as 90%+), it has had a notable downward impact on average holding periods and likely impacting market volatility, an extreme example being the “flash crash”.  This makes me tell myself every day when I enter the office “chances are I am not trading with humans, but with algorithms and I have no idea how those algorithms are structured.”

Therefore, I tend to do far less short-term trades of individual securities than I once did because of investment horizon risk. Because of these algorithms, my belief is that my risk/reward tradeoff may be neutralized by a computer that can establish correlations and execute risk arbitrage strategies more often, more accurately, and much more quickly than I could ever imagine. This in my opinion adds an element of risk that was not there before. Namely the impact of algorithms impacting market moves more than I anticipate during my investment horizon.

But what about valuation, doesn’t it matter even in shorter-term trades? Yes I believe it does, but likely beyond the investment horizon of my trade. By definition a trade is a very short term holding. It is not an investment. By the time the market does adjust itself, the time horizon for my trade may have passed and I could be stuck with negative alpha longer than planned.

Therefore, like me buying a song that I enjoy for the moment but quickly becoming a thing that takes up bytes on my IPod, short term trading in my view is riskier than it once was due to computerized trading algorithms. That’s why I tend to gravitate to names that I can live with longer than a moment—like my Elvis Costello records.

St. Paul Book Club Notes: “Dark Pools” by Scott Patterson

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The book received uniformly positive reviews from the group. Despite the title, the book had little to do with dark pools—private trading centers that allows certain investors to avoid placing orders on centralized exchanges. Rather it had to do with the evolution and growth high frequency trading and artificial intelligence on investing. Each of the book club members had personal experience with high frequency trading, artificial intelligence or both—some even had friends that personally knew people in the book. This made the “Dark Pools” more enjoyable for the group. Some of the time was spent discussing the impact on markets from the book’s subject. Most agreed that in the short-term it’s hard to beat the electronic traders, but the group’s opinion was “trading strategies work until they don’t” and that “information is not the same as knowledge.”

What people liked about the book:

  • It did a good job distilling how high frequency trading works.
  • People appreciated the fact it went into detail how high frequency trading evolved and that there were “heros” in the book; somewhat unusual for non-fiction.
  • It’s a classic Wall Street story about how a new concept evolves into widespread practice; investor denial, gradual acceptance, and then investors piling on and mercilessly beating what was a working strategy into oblivion.
  • People liked that the author mostly reported, and did not offer grandiose opinions.
  • There was an interesting science angle to the book and it made some wonder if Wall Street firms were becoming tech firms.

What people did not like about the book:

  • Most commented more on what the subject of the book was doing to investing rather than the book’s shortcomings. Again, the book got uniformly good reviews.

Our next meeting will be on May 14th in St. Paul and our book will be “The Panic of 1907” by Robert Bruner and Sean Carr. Email Kris if you are interested in joining the discussion support@cfamn.org.

Flight of Icarus

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The new issue market was on fire this week.

There was nearly $55 billion in total supply, including the quasi sovereign deals. We remember when that was a whole month’s worth of new issue in the Investment Grade Corporate Bond Market.

The amount of supply is all the more surprising in the face of saber-rattling in the Ukraine, though some people think that’s what created the opportunity. Interest rates dipped a little bit, and a lot of companies jumped in. We expected the market to adopt a more cautious tone at the beginning of the week, but that seemed to last for about 45 minutes before we were off and flying. There were three – three­– $4 billion issuers. Mckesson Corp brought $4.1 bill across 5 tranches, Bank of Tokyo – Mitsubishi brought $4 billion across 5 tranches, and Gilead Sciences simplified their issuance with $4 billion across three tranches. Mckesson and Gilead were both funding acquisitions, so had been expected to come to market sooner or later.

It all seems to come back to M&A. The availability of cheap debt to fund shareholder friendly activity is pushing the market along. And we have cheap funding thanks to Central Bankers around the world, which will come to an end eventually – just not yet. Credit spreads were a little shaky this week, mostly on the ever-volatile long end, but it looks like they’ve ended the week pretty much unchanged. That is pretty remarkable performance in the face of that much supply, which generally creates a secondary flow of paper as investors make room for the new deals. So go ahead and strap on your wings.

Fly as high as the sun.

CFAMN Compensation Survey Follow-Up: Equity Portfolio Manager One-Pager

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2013 marked the first time in nearly seven years that an industry-wide compensation survey was orchestrated in the Twin Cities.  The data collected via the survey, which was designed and deployed by CFA Society Minnesota, yielded compensation data specific to the Twin Cities and upper Midwest for financial professionals. These efforts led to the publication of “The 2013 Financial Compensation Survey Findings and Results.” 2013 CFAMN Compensation Survey Results White Paper

Response to this publication produced demand for detailed analysis of compensation practices by position title. The resulting analysis is a series of one-page compensation snapshots for the most popular titles from the survey, the first of which is the One Page Analysis – Equity Portfolio Managers. Check back to Freezing Assets as the additional one-pagers will be released over the following weeks.

…and the winner is….

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Investment Grade Credit had a really solid week. It might not win best actor in the market, but it turned in a really nice performance, generating total returns of around 70 basis points for the week (our best guess right now, before all the data is in…), and excess returns compared to treasuries of about 8 basis points. The long end was once again the star – for the month of February, long Corporates were up close to 2%, with excess returns of over 1%. Credit overall was up around 1% in February, with excess returns of around 60 basis points.

What’s interesting is that there was a lot going on this week – both on the economic front and the geopolitical front – that could have derailed the market for credit. But after a run of weak data which has been mostly discounted due to weather, we ended up with strong housing numbers and durable goods orders, which helped support spreads. And the saber rattling over the Ukraine seemed enough to keep a lid on rates. Finally, Janet Yellen’s weather-delayed testimony on Thursday seemed to give both rates and risk a bit of a boost. We know she’s not saying anything much different than her predecessor – asset purchases will be reduced at a measured pace, they are continuing with their program, but they will react to any significant change in the outlook. There’s just something soothing about how she says it. Janet Yellen definitely gets our vote for best actress.

The new issue market responded with about $30 billion in supply this week – the biggest week since early January. Cisco was by far the largest issuer, bringing $8 billion across 7 tranches; bonds were well priced, and we think they were among the better performers this week. 3 year bonds did especially well, tighter by 11 basis points, while the 10 year was tighter by 3. Goldman Sachs, Williams Partners, Juniper Networks, Fifth Third Bank, and CMS Energy were all in the market this week, and all performed well, but our vote for best supporting actor goes to Cisco based on the sheer audacity of their performance.

Next week we are expecting to see another $20 billion in supply; that number may go higher if this week’s drama has a happy ending.  And for best screenplay, the winner is…