Collateral Recovery

Who remembers EF Hutton?

When EF Hutton talks, people listen.  That slogan crafted by Hutton’s William Clayton, who died in 2013, and now-defunct advertising agency Benton & Bowles, wasn’t about a man but a firm. Ads ran in the 70s and 80s where characters would shout “EF Hutton!” over a din, and all clamor would stop as people leaned in to hear.

Edward Francis Hutton died in 1962. But his firm touched history via its brand, its merger with Shearson Lehman, and its subsequent mutations through Smith Barney, Citigroup and Morgan Stanley. The name lives today, in fact, through HUTN Inc., which owns the EF Hutton moniker.

In a sense the Hutton Effect today in capital markets is Amazon. Every time Amazon speaks, the market holds its breath.  From athletic apparel, to groceries, to pharmaceuticals and healthcare, the market has stopped midsentence, transfixed. Investors realize Amazon is so leviathan (searching for a synonym for “Amazon”) that it can sway the fortunes of industries.

Another mammoth in our midst seems to go unnoticed, a sort of antonym to EF Hutton and Amazon. Exchange Traded Funds.

NOTE: I’m on a panel tomorrow for the NIRI Virtual Chapter on Passive vs Active Investing and will serve as warmup or foil Thursday Feb 22 for NIRI CEO Gary LeBranche here in Denver at the Rocky Mountain chapter, on ETFs.  We’ll talk about ETFs.

ETFs have been loud about attracting $4.8 trillion of global assets and 50% of US trading volume, but dead quiet about what they really do. Were sellers of groceries thrown in a pit with a hulking sword-swinging Amazon, the cries would be shrill. A market tossed together with this beast called ETFs offers not a whimper, let alone a silence-deafening EF Hutton listen.


I’ve come to an answer.  We know how Amazon works.  Whatever you think of the Bezosian Beast, we understand its manners.  It’s among us without guile.

But I don’t think investors and public companies get what ETFs do. They are a permeating market presence of epochal significance and yet an idea persists that their influence is invisible. It’s not true with Amazon, or ETFs.

Suppose ETFs through the use of collateral drove these recent gyrations?  There’s a swamp around the way they work. Read the prospectus – not the summary but the full document – for SPY. Tell me what you learn.  Half of it is about taxes.

But I know this: ETFs don’t invest your money. They manage collateral. Big investors gather up shares in large blocks from who knows where, because there’s no transparency, and exchange them for ETF shares.

They then sell those ETF shares at a profit. Don’t believe me? Read an ETF prospectus.  What’s this got to do with market volatility?  Suppose big investors had pledged stocks belonging to others as collateral to gain access to ETF shares expected to rise in value – and then the collateral dropped sharply in value.

They’d have to sell assets to raise money to buy ETF shares to trade back for collateral that might well belong to somebody else (never pledge the mob’s donkey on your personal horse race).

Boy would that process produce volatility if it were Amazonian in scope. And volatility was leviathan. Collateral damage.

Theorizing this way, we warned clients last week (as those of you reading know): If this is sorting out who owns what, we’ll take a hit Tue-Wed Feb 20-21.

Okay, well, that happened yesterday.  A glancing blow but it was there. If collateral is sorted out, markets zoom anew now. If not, you’ll see trouble again today.

Lesson? We can see what Amazon is doing. ETFs are another story.  We don’t know what they use for collateral. That alone should make us more watchful. ETFs don’t behave like EF Hutton stilling the noisy room.

So stay tuned. If this is a collateral recovery, confidence may be shaken. And we all need to understand the Amazon of the capital markets, ETFs.