Tagged: Janus

Two Faces

In Roman mythology, Janus is the two-faced god of beginnings and endings.  In Denver, Janus is the god of investing. In the news, Janus is merging with UK money manager Henderson.

The move reflects the two faces of the stock market, beginnings and endings and gates and doorways, like the figure from Rome’s old religion.  Today’s market is the inverse of the one prevailing when Tom Bailey launched Janus from a one-room Denver office in 1969, choosing the front-range town over New York to avoid Wall Street GroupThink.

For the next three decades, Janus boomed through a culture of camaraderie built around proprietary financial modeling to find the most dynamic, well-run companies. Janus was a stock-picker of the highest caliber with a penchant for bucking the crowd and going long, big.  Star fund manager Tom Marsico epitomized the Janus style with his Focus Fund backing typically 20 stocks.

Janus embraced the New Economy and chased technology. Though Marsico left in 1997 in a dispute with management, Janus, which was then owned by Kansas City Southern before spinning out publicly as part of Stilwell Financial, became the best mutual-fund company in the business, peaking at $330 billion of assets in 1999.

Then the Internet Bubble burst. In latter 2000 as tech stocks cratered, Janus was losing $1 billion a day in asset-value. In 2001, the firm cut half its staff and saw assets under management dip below $200 billion. The name Stilwell, a moniker fashioned to honor rail tycoon Arthur Stilwell, went away and the two-faced god returned as a public firm.

But the US stock market emerged from the 20th century fundamentally altered, a National Market System. Well, there is no “market system.” It’s one or the other. A market is organic commercial interaction – a dynamic environment where shrewd analysis and the search for the best is a recipe for the success that bred Janus. A system is a process and method. Success in a system turns on stripping out cost and following a model.

The National Market System today is a process and method. GroupThink. Exactly what Janus eschewed. Blackrock and Vanguard have roared past yesterday’s stock-picking heroes like Janus by stripping cost out and tracking averages, thriving at GroupThink.

It’s remarkable testament to the state of the market that being average is the key to being best. And how did we get a market where average is king? Process and method. Rules.

The Order Handling Rules in 1997 decreed that stock markets must display prices set by Electronic Communications Networks, which obliterated a fixture of exchanges back to the 1792 Buttonwood Agreement that brokers not undercut each other on price.  Regulation ATS required all trades to occur through brokers or exchanges, putting the brokers who created exchanges into competition with their progeny. Decimalization in 2001 wiped out the market-making spread necessary for investment banks to fund small-cap stock research (small-cap IPOs plunged by 90%).

Then Regulation National Market System, a product of Congressional legislation, crafted a single marketplace functioning like a data network around the best national bid or offer. A network of linked nodes isn’t competition. It’s a system. The process and method for navigating the network determines success. Machines navigate it best, so the biggest source of volume today is Fast Trading, which writes no research, carries no inventory, underwrites nothing.

In the decade ended Dec 31, 2015 spanning the creation of the National Market System, 98% of all stock-pickers have failed to beat the average – the S&P 500.  The reason isn’t prowess from passives but how indexes and ETFs strip out cost and construct portfolios around the average prices that now securities regulators require (“Best Execution”).

If you’re looking for outliers like Janus, this market is the wrong one for you (and if you seek that money as the investor-relations profession does, it’s stacked against you too). So money is rushing with great sound and fury from them and into indexes and ETFs.

Mergers are driven by effort to strip out cost.  Henderson is paying $2 billion for Janus to form a manager with $300 billion of assets – smaller than Janus in 1999. Ironically, the amount Henderson is paying equals the investment outflows from the two in 2016.  Janus CEO Dick Weil will co-head the company with Henderson CEO Andrew Formica and will move from Denver to London.

Regulators: Is there not one of you paying attention? You did this. You are wrecking the market for stock-picking, for small-caps, for American capitalism. Now you’ve driven Janus out of Denver.  We don’t need a two-faced market where just one smiles.  Keep this up and you’ll foster the mother of all backlashes.

Janus ETFs

Everybody adapts, including institutional investors like Janus.

Rattle off a top-ten list of the best active stock pickers visited by teams of company execs and investor-relations pros trundling through the airports and cities of America, and Denver’s Janus likely makes the cut.

Ah, but.  In 2014 Janus bought VelocityShares, purveyor of synthetic exchange-traded products.  Just as a drug manufactured in a laboratory rather than from the plant that first formed its mechanism of action is a replica, so are these lab-made financial instruments. They replicate the act of investment without actually performing it.

It’s neither good nor bad per se, as I explained yesterday to the NIRI San Diego chapter. But synthetics are revolutionizing how public stocks trade – without owning public stocks. Describing its effort at adaptation, Janus says on its website that it’s “committed to offering distinctive strategies for today’s complex market environment. Leveraging almost a half century of investment experience, we are now pleased to make our expertise available through Exchange Traded Funds.”

Janus says it’s intending to offer a range of returns beyond simple capital-appreciation, including “volatility management” and “uncorrelated returns.” Janus’s VelocityShares directed at volatility aim to produce enhanced or inverse returns on the VIX, an index called the “fear gauge” for reflecting volatility in forward rights to the S&P 500.

But traders and investors don’t fear volatility. They invest in it.  On Monday May 16, four of the top 20 most actively traded stocks were exchange-traded products leveraging the VIX.  Those offered by Janus aren’t equity investments but a debt obligation backed by Credit Suisse. Returns derive from what is best described as bets using derivatives.

The prospectus for the most active version is 174 pages, so it’s hard to decipher the nature of wagers. It says: “We expect to hedge our obligations relating to the ETNs by purchasing or selling short the underlying futures, listed or over-the-counter options, futures contracts, swaps, or other derivative instruments relating to the applicable underlying Index…and adjust the hedge by, among other things, purchasing or selling any of the foregoing, at any time and from time to time, and to unwind the hedge by selling any of the foregoing, perhaps on or before the applicable Valuation Date.”

Got that?  Here’s my attempt at translation: “We’ll do the exact opposite of whatever return we’ve promised you, to keep from losing money.”

During the mortgage-related financial crisis there was a collective recoil of horror through media and into Congress that banks may have been betting against their clients. Well, come on.  It’s happening in equities every day!  Exactly how do we think somebody who says “sure, I’ll take your bet that you can make double the index without buying any assets” can possibly make good without farming the risk out to someone else?

In the mortgage crisis we learned about “credit default swaps” and how insurers like AIG were on the hook for hundreds of billions when real estate stopped rising. Who is on the hook for all these derivatives bets in equities if stocks stop rising? It’s the same thing.

Last Friday the 13th, five of the top 20 most actively traded instruments on the Nasdaq and NYSE were synthetic exchange-traded products attempting to produce outsized returns without correlating to the market. That’s 25% of the action, in effect.

For stock-picking investors and public companies it means a significant contingent of price-setting trades in the stock market are betting on moves uncorrelated to either fundamentals or markets. You’ll find no explanation in ownership-change.

What do you tell management and Boards about a market where, demonstrably, top price-setting vehicles like TVIX owned by conventional stock-pickers aren’t buying or selling stock but betting on tomorrow’s future values using derivatives?

In fact, everyone is betting against each other – traders, banks, investors. I take you back to the mortgage-backed securities crisis. The value of underlying assets was massively leveraged through derivatives the values of which bore no direct connection to whether mortgages were performing assets.  That by any definition is credit-overextension. A bubble.  A mania. Then homes stopped appreciating. The bubble burst two years later.

Look at stocks. They’ve not risen since Nov 2014. Is anyone out there listening or paying attention to the derivatives mess in equities?