All posts by MarketsMuse Curator

Leveraged ETF, ETP and Risk-Parity Schemes: Caveat Emptor

In the wake of recent weeks’ volatility and pricing dislocations across the exchanged-traded product space, news media and Mutual Fund marketers are having a field day putting the feet to the fire–and those toes being torched are connected to the universe of juiced-up and levered ETF and ETN products, as well as hedge funds that specialise in so-called “risk-parity funds” that employ lots of leverage. Is it fair to bash these ‘alternative’ strategies, or should the SEC require that the prospectuses (or is it “prospecti”?) for these protein-enhanced products have a coverage page that displays Caveat Emptor in caps? For those not fluent in Latin, the phrase means: Buyer Beware.

NYT Dealbook columnist Landon Thomas Jr. poses that issue in his a.m. piece: “Investment Strategies Meant as Buffers to Volatility May Have Deepened It”–and before pointing MarketsMuse readers to that article, MarketsMuse editors remind our readers that ETF red flags are nothing new. Levered products, often in the form of ETNs (exchange-traded notes) that seek to either mitigate risk or enhance returns via the use of futures products are notorious for being fit for trading market professionals only; not retail investors and not even for so-called sophisticated institutional investment managers.

Corporate bond ETFs have also been put on ‘watch lists’ in recent months, even though they are all the rage for many of the right reasons, including offering exposure and ‘greater liquidity’ for those needing to allocate investment  funds to corporate debt issues across various industry sectors and ratings categories. That said, Apocalypse Watchers warn that when interest rates spike, corporate bond investors will all run for the exits together (to avoid mark-downs in their holdings) and the market-makers who specialize in ETF products connected to this asset class will be overwhelmed with nowhere to go–and no [reasonable] bid to offer to those sellers–simply because the glass-is-half-empty crowd contends those market-makers will be unable to find buyers for the underlying constituents as a means to hedge their purchase of the cash ETF product. That particular thesis has not yet been fully tested, but it does offer an agenda for spirited debate.

The Dealbook column does put context into the discussion with the following:

Defenders of risk-parity investing say that these investment styles are not set in stone and that portfolios can be recalibrated on fairly short notice to make them less vulnerable.

As for E.T.F.s, practitioners say that the funds to date have held their own despite some concerns over how portfolios were being valued during the very sharp market sell-off late last month.

Some of the more exotic E.T.F.s that rely on leverage to juice investment returns could in some instances be the “tail that wags the dog,” said Steven Schoenfeld, an early pioneer in E.T.F. investing and founder of BlueStar Global Investors.

“But the fundamental advantage of E.T.F.s — transparency, liquidity and variety — that remains,” he said.

What remains unclear, however, is how an investing community that has become accustomed to churning out safe and steady returns in a low interest rate, low volatility environment adapts to the new reality of wild market swings.

Such sharp ups and downs in the market are expected to become more frequent as the time approaches for the Federal Reserve to push interest rates higher.

People might as well get used to them, says Nicolas Just, a portfolio manager at Natixis Asset Management, a French fund company that oversees $904 billion in assets.

“These types of sudden market swings will become more and more frequent,” he said. “So you have to be prepared for them at any time.”

For the full story from the NY Times, click here

 

Oh My! RIAs: Forbes Advisor Playbook iConference-Sep 17-CE and CFP Credits

For RIAs who want to be smarter (and at the same time, earn CFP and CE credits, MarketsMuse points you to the Sept 17, Forbes Advisor Playbook iConference. Why? Well for one, Shark Tank shark extraordinaire Kevin O’Reilly a newbie ETF Issuer of exchanged-traded funds firm “O’Shares”  (whose first product is OUSA) will be a guest speaker, along with a list of other industry luminaries that include Schorders’ Head of US Multi-Sector Fixed Income Andy Chorlton, Tim Palmer, Head of Global Interest Rates for Nuveen, Luciano Siracusano, Chief Investment Strategist for WisdomTree.

What does the day long session include? 6 timely topics ranging from Capital Markets and Game Theory to debating Optimal Active vs. Passive Portfolio Construction. MarketsMuse knows this will be a must-attend simply because the program is being coordinated by Julie Cooling of RIAchannel and our favorite ETF journalist, Todd Shriber aka ETF Godfather will be one of the program’s moderators.

What’s In It For You? 6 CFP and 6 CIMA CE Credits!

How do you sign up? Click Here!

FinTech Dept: Banks Embrace Bitcoin’s Blockchain

It doesn’t take a “markets muse” who speaks in tech talk to know that Fintech is not only fashionable, its now mainstream. And, whilst the early “jibber jabber” surrounding Bitcoin was fodder for Wall Street naysayers, including JPM’s Jamie Dimon, “the worm has turned” according to NYT columnist Nathaniel Popper, a bitcoin expert and the author of “Digital Gold: Bitcoin and the Inside Story of the Misfits and Millionaires Trying to Reinvent Money.”

For earlier MarketsMuse coverage of the bitcoin and blockchain movement, click here

In Popper’s most recent NYT column profiling the cadre of banks, along with assortment of startups founded by banking expats, the fintech fascination is less about bitcoins as a currency, and all about the blockchain technology that powers the virtual currency.

MarketsMuse Editor Note: Though some of skeptics sitting on the MarketsMuse editorial stools suggest that these fintech applications should be targeting industries that actually embrace innovation, such as online gambling and adult entertainment, we won’t diss anyone by selling near-term straddles.

“…Nowhere, though, are more money and resources being spent on the technology than on Wall Street — the very industry that Bitcoin was created to circumvent.

“There is so much pull and interest on this right now,” said Derek White, the chief digital officer at Barclays, the British global bank, which has a team of employees working on about 20 experiments that explore how the technology underlying Bitcoin might change finance. “That comes from a recognition that, ‘Wow, we can use this to change the fundamental model of how we operate to create our future.’”

For people like Mr. White, Bitcoin isn’t just a digital token to use for online purchases. Instead, many of the top minds in finance have come to believe that the software that brought the virtual currency into existence also enables a fundamentally new way of transacting and maintaining records online — allowing people and banks to directly exchange money and assets like stocks and bonds without having to rely on a long chain of expensive middlemen…”

A few banks have gone public with their work, but most of the activity has been happening behind the scenes. At one private meeting, held in April at one of the Manhattan offices of Bank of America, executives from more than a dozen large banks gathered to confidentially discuss how the technology underlying Bitcoin could be used to change foreign currency trading, the largest financial market in the world, according to people who attended the meeting.

Central banks like the Federal Reserve and the Bank of England have their own teams looking at the technology.

“A year ago, it was more of an idea,” said Max Neukirchen, the head of corporate strategy at JPMorgan Chase. “Now, it is a real opportunity. You test it and realize that this can play a big role in our thinking about how our own infrastructure will evolve.”

Who are the players to watch? Aside from the secretive projects inside of each of the 6-pack shops (including JPM!), major exchanges including NASDAQ and NYSE owner ICE are actively throwing resources at blockchain technology applications. On the startup scene, Dave Rutter, a former inter-dealer broker who was a head capo at Prebon Yamane, and then CEO OF ICAP before starting electronic broker LiqudityEdge is now wearing two hats via his role at blockchain wannabe R3CEV LLC. Not to be outsmarted is Mark Smith’s “Smart Securities” product, created by his startup Symbiont. Smith is the former co-founder and COO of Lava Trading and a certified tech wonk with a keen FX markets expertise.  His company, with help from fintech merchant bank SenaHill Partners has so far outfoxed R3CEV by having already set the stage to facilitate the first corporate bond issuance using the blockchain technology.

For Nathaniel Popper’s latest commentary “Bitcoin Technology Piques Interest on Wall St”., please click here

Rule 48, ETF Dislocation: BATS CEO Says “No Humans Needed”

When ETFs were first launched in 1993, the ‘framers’ might not have fully appreciated what would happen to the respective ETF cash index in the event of a lopsided market opening when the underlying constituents had not yet opened for trading, despite the easy recall of October 1987..

Since that time, market structure experts and the cast of exchange characters regulated by the SEC have introduced a litany of steps, including NYSE’s Rule 48 that are designed to serve as circuit breakers to bring calm to the chaos caused by out-sized volatility, particularly during market openings. According to observations in the wake of the most recent market turmoil, when ETF market-makers stepped back and provided wide-as-a-truck pricing because constituent issues had yet to open, the CEO of BATS Global Markets, the electronic trading platform that has grown from the size of mouse to being one of the bid kids on the block, sent a signal to the media that led many, including MarketsMuse editors, to infer that he believes that humans are no longer relevant in the new age of Wall Street, computer horsepower and smart algorithms.

As noted by the WSJ in its Sep 1 story by Bradley Hope , “…in a strongly worded rebuke to its rival and NYSE operator Intercontinental Exchange on Tuesday, BATS Chief Executive Chris Concannon said that NYSE Group’s process for opening trading on stocks listed at the exchange was “broken” and that major changes needed to be made to protect investors from future problems. “No one on the planet operates that way, and no one should operate that way,” he said in an interview, adding that he sees “very limited value” in the use of humans on the trading floor

Some traditional market experts have since quietly suggested that Concannon “could have bets in his belfry if he believes that computers should be taken out of the equation.”

NYSE officials and floor brokers have argued for years that they serve a crucial role providing slower trading within today’s high-speed, electronic markets.

“The debate is about whether we need a slower market structure or a faster market structure on days with large systemic volatility,” said David Weisberger, managing director at market-analytics firm RegOne Solutions. The slower version is driven largely by people, whereas the faster one is controlled by computers and trading algorithms, he added.

The NYSE spokeswoman defended the exchange’s approach by contrasting it with a notable failure that BATS experienced itself with its own initial public offering.

Here’s the two points of Rule 48 and what the debate is based on.

  • IN A NORMAL MARKET: Market makers indicate where a stock might open. That helps investors modify buy and sell orders.
  • IN A VOLATILE MARKET: Market makers don’t have to indicate where a stock might open. That should make it easier for stocks to open quickly. But investors have less information about the market prices for securities.

Ted Weisberg, a longtime floor trader and founder of floor brokerage Seaport Securities Corp., said invoking Rule 48 can speed up the opening of stocks but leads to less transparency.

“When you invoke Rule 48, you’ve opted for speed over price discovery and speed over transparency,” he said. “‘What’s in the public’s best interest is transparency and time to react.”

An NYSE spokeswoman said: “Rule 48 allows us to expedite the opening of stocks on volatile days while maintaining the hallmark transparency that we are known for.”

BATS is accustomed to Donald Trump-style brashness  In prior MarketsMuse coverage ,they are strong advocates of “pay-to-play” kickbacks that provide rebates in exchange for orders sent to their electronic venue as opposed to sending to competing electronic trading venues. Here’s an excerpt from that story: Continue reading

Bitcoin ETFs: BIT Could Be “Balderdash” Says Sell-Side Seer

MarketsMuse.com ETF snapshot takes another bite into the topic of Bitcoin, the dominant digital currency that continues to gain traction with leading brokerdealers and many, [but not all] from across the ETF universe, despite the currency’s 74 percent decline since November 2013. Below is excerpted from 07 April coverage courtesy of NewsMax.com

Big-time traders and investors are starting to participate in the bitcoin market, The Wall Street Journal reports. The list of participants includes Citadel Securities, KCG Holdings and Wedbush Securities. Citadel is a heavyweight investment firm led by Ken Griffin. KCG is the massive brokerage firm formed by the merger of Knight Capital and GETCO.

Citadel, KCG and Wedbush have offered bids to buy shares of the Bitcoin Investment Trust (BIT) since it was listed on the OTC Markets in March, The Journal reports. The BIT holds bitcoin in a trust in which accredited investors can then buy shares. Trading could begin as soon as this week.

KCG is “actively exploring various opportunities related to” bitcoin, its spokeswoman Sophie Sohn tells The Journal.

Some experts say use of the bitcoin by investors and traders will help to further legitimize the currency and increase its usage throughout the economy.

mf_monkeymathTo be sure, there is some skepticism about the BIT. The fund’s manager, Grayscale Investments, charges a 2 percent annual fee for administration and safekeeping, CNBC reports. That’s more than what most exchange-traded funds (ETFs) charge. One skeptical sell-sider has this to say about that..

“BIT investors may end up paying 5 percent more for shares of the fund than if they simply bought bitcoin on an exchange”, Eric Mustin, vice president of ETF Trading Solutions at WallachBeth Capital, tells the news service.

“People who read tabloids deserved to get lied to, and that’s how I feel about someone buying a bitcoin ETF,” he notes. “If you’re confident in this currency that you want to buy it, but you can’t take the 30 seconds to set up a wallet, which is incredibly easy, then you deserve to pay the 5 percent or whatever. I’m not cynical about bitcoin, but I just think it’s a goofy way to trade it.”

non-transparent ETFs

SEC SmackDown of Non-Transparent ETFs-No Secret Sauces!

In an effort to reign in a powerful campaign to launch secret sauce ETFs that have no business being used by ordinary investors, the SEC scored a smackdown on the creation of non-transparent ETFs in a recent ruling that blocks plans by ETF giant BlackRock as well as Precidian Investments to issue ETFs’ whose underlying constituents would otherwise be, well, non-transparent.

The topic of non-transparent ETFs has been a focus of several MarketsMuse articles in recent months. As reported last week by Bloomberg LP, The U.S. Securities and Exchange Commission rejected plans by BlackRock Inc. and Precidian Investments to open a new type of exchange-traded fund that wouldn’t disclose holdings daily, setting back efforts to bring more actively managed ETFs to market.

The SEC, in preliminary decisions announced yesterday, denied BlackRock’s September 2011 and Precidian’s January 2013 requests for exemptive relief from the Investment Company Act of 1940. The move puts on hold plans by the firms to start the first non-transparent ETFs.

The Precidian proposal falls “far short of providing a suitable alternative to the arbitrage activity in ETF shares that is crucial to helping keep the market price of current ETF shares at or close” to its net asset value, Kevin O’Neill, a deputy secretary at the SEC, wrote in the letter.

The ruling hinders plans by asset managers to sell funds run by traditional stock-picking managers in an ETF package. Firms including Capital Group Cos. have asked for similar regulatory approval as they seek to expand offerings in the fastest-growing product in the asset-management industry.

Money managers have been discouraged from introducing active ETFs, which combine security selection with the intraday trading and some of the cost-saving features of traditional ETFs, because the SEC’s requirement for daily disclosure of holdings would make it easy for competitors to copy, and traders to anticipate, a manager’s portfolio changes.

‘Not Surprised’

“We want to work with the SEC — we believe it’s part of the process,” Daniel McCabe, Precidian’s chief executive officer, said in a telephone interview. “We’re not surprised by the fact that they have questions, but questions can be answered.”

ETF providers must disclose holdings every day to enable market makers to execute trades that keep the share price in line with the underlying value of the fund’s assets. Firms including BlackRock, Precidian and Guggenheim Partners LLC proposed structures that they say would allow the funds to remain priced in line with assets, without revealing specific positions.

T. Rowe Price Group Inc. in Baltimore and Boston’s Eaton Vance Corp. are also among fund firms seeking SEC approval for non-transparent active ETFs. None of the applications has been approved.

“We are still pursuing our own proposal to offer non-transparent active ETFs,” Heather McDonold, a spokeswoman for T. Rowe, said in a telephone interview.

Commercial Opportunity

Melissa Garville, a spokeswoman for New York-based BlackRock, and Ivy McLemore, a spokesman for Guggenheim, declined to comment. Robyn Tice, a spokeswoman for Eaton Vance, and Elizabeth Bartlett for State Street Corp. didn’t immediately respond to an e-mail and telephone messages seeking comment.

BlackRock was one of the first U.S. fund managers to ask the SEC for approval, after spending three years crafting the product. Their leading role in seeking approval for a non-transparent active ETF has spurred excitement within asset management for the product’s prospects, according to Todd Rosenbluth, director of mutual-fund and ETF research at S&P Capital IQ in New York.

Mark Wiedman, BlackRock’s global head of its iShares ETF unit, said in May that the firm was confident the products would work, “but we don’t actually think it will be much of a commercial opportunity.”

For the full story from Bloomberg reporter Mary Childs, please click here