Tagged: Vanguard

Story Versus Store

When you’re in a store, how often do you ask for help finding a product?

Now think about that, investor-relations professionals, and investors.  You former are in the business of telling the story – helping people in the store find a product.  You latter are the shoppers seeking products.

Before I go further, on Mar 10 the IR professionals in Silicon Valley are hosting the annual Spring Seminar with content assembled by crack practitioners Kevin Kessel, Kate Scolnick and friends, and it’s one of the most compelling IR agendas I’ve seen in my 22 years in this profession. We’ll be there (ModernIR sponsors). You should be too.

Back to Story vs. Store.  A hundred years ago farmers came to town and handed a list to the proprietor of the general store, who assembled groceries while buyers were at the livery or the brothel or whatever. 

Today you enter your list at Amazon.com or Jet.com or whatever and a couple days later – we had two shipments yesterday at the office – your stuff shows up (probably not while you’re at the livery or the brothel but follow me here).

Apply to investing. Once long ago, you went to Merrill Lynch and while you were at the livery or the brothel or whatever your financial advisor assembled some stocks for you. Today you go to Wealthfront or Betterment and you enter your criteria and algorithms assemble exchange-traded funds for you. 

The IR profession is founded on effective storytelling. As the impresario for Wall Street, you help it find you.  But the money asking for help finding products is plunging.  Active stock pickers cannot win (a separate story about structure over prowess).  The robots are crushing it. 

The IR profession is at a crossroads. Yes, keep telling your Story. But the STORE is the leviathan today.  Not the Story.  Amazon is massive. Call it The Store. Walmart bought Jet.com for $3.3 billion because people don’t need an impresario, the clerks on the floor.

Blackrock and Vanguard don’t use the impresario of Wall Street: Research from investment banks.  But you can click on the little icon for many Web apps and get customer service, most of it outsourced to somebody outside The Store. 

Do we want to be Amazon, or that little icon? We won’t be the Big Dogs in either IR or investment by being better impresarios. Success in the 21st century is ironically about minding the Store. for IR, that means data analysis is the vital key to the future.

And investors, the secret to success in this market is tracking what’s moving into and out of The Store – Blackrock and Vanguard and ETFs are the amazons of equities. 

I’ll give you a case in point. A big client was a juggernaut for two weeks – nothing but green metrics, hitting the forecasts every day. Then short volume doubled in two days. Investment tumbled.

That’s Store. Not Story. You can say you don’t care about the short-term. Well, the Store does. Management does. Who’s minding the store? IR professionals, that’s you.  Ignore the amazons, the leviathans, the temporal distortions at your own peril.

Let’s not be the “click here for support” icon, IR pros. Let’s be Amazon. How? Your equity is a product used by consumers wanting less help from clerks and impresarios. They’re renting it, sharing it, trading it, leveraging it more than you ever imagined. 

If you’re bewildered, ask us for help. But let’s not become little icons at the bottom of screens. That’s no strategy for Boardroom domination.  Let’s be amazons. Love The Store.


Follow the money. Or the currency.

Yesterday markets soared on queue with a Chinese currency devaluation in the form of lower bank reserve requirements (which increases money and reduces its value). For those who at the words “currency devaluation” feel like collapsing into catatonia, resist the urge. There’s a lesson ahead.

WSJ Intelligent Investor columnist Jason Zweig described Feb 19 how active investors are using Exchange Traded Funds (ETFs). He wrote, “Picking stocks has become so hard that some stock pickers have given up pretending to try.”  One manager told Mr. Zweig he keeps 50% of his assets in ETFs because with 90% of active money trailing the averages, “half of my fund will beat 90% of managers over time.” The winning half is polling the crowd.  It’s more convenient.

The crowd today is comprised of leviathan passive investment typified by the $8 trillion held at Blackrock and Vanguard.  But that’s not what moves daily.  It’s inconvenient for Blackrock and Vanguard to maneuver massive assets like a race car through less than ten big banks executing most trades now for large institutional investors.

But investing is supposed to be inconvenient. Value that lasts should take time. Warren Buffett is 85 and began investing in his teens.  The average holding period for Berkshire Hathaway shareowners is 27 years based on annual turnover. Rome wasn’t built in a day.

Yet today’s market sells convenience. Leveraged ETFs – those using derivatives like swaps to outperform underlying benchmarks – seek one-day outperformance. From Direxion, a sponsor: “The use of derivatives such as futures contracts, forward contracts, options and swaps are subject to market risks that may cause their price to fluctuate over time. The funds do not attempt to, and should not be expected to, provide returns which are a multiple of the return of the Index for periods other than a single day.”

In yesterday’s big market move, over half of the 25 most actively traded securities were ETFs, most of them trading more than stocks like Pfizer and GE.  Several were 3x leveraged ETFs – that is, trades designed for a single day to beat a broad measure by 200%. If your stock was up twice as much as the market, there’s your probable answer.

ETF sponsors hold assets, and big brokers called Authorized Participants create ETF shares for trading or remove them from the market to match inflows and outflows and fluctuations in underlying stocks and indices. That’s a derivative. What’s traded isn’t the asset but a proxy. A key reason why stock pickers struggle is because long-term investments are inconvenient, and the many parties in the market chasing one-day moves or short-term divergences drown out fundamental differences in businesses.

There’s a triune reason for volatility that’s getting bigger, not smaller.  First, the whale in the market is money tracking benchmarks like the S&P 500. Clustered next around the benchmarks are options and futures and ETFs. The ETF SPY yesterday traded nearly ten times the dollar-amount ($26.3 billion) of the nearest active stock (VRX, $2.7 billion). And last, every ETF has what’s in effect counterparties –authorized participants maintaining coherence between ETFs and indexes (to us it’s sanctioned arbitrage since the APs know which direction money is moving and can go long or short advantageously, which is ethically questionable). So also do counterparties back the options, futures and swaps fueling leveraged ETFs and trading schemes and index-tracking by big funds.

Line these up.  Money is tracking indexes. Leveraged ETFs are trying to beat them. Counterparties are supplying options and futures to achieve those returns. Every day it changes and the movements are like a freight train on a twisting track, picking up speed, as each gets a day or two out of step with the others.

At what point does it rupture? Making homes too easy to buy through loose credit led to mushrooming mortgage-backed derivatives and later mass demise. Making money too easy for governments to get through central banks is behind the creaking mountain of global debt that the private sector long ago largely stopped buying (so it’s instead held by central banks that pledged the full faith and credit of the same citizens refusing to buy in private markets).

We’d benefit from old-fashioned inconvenience. Investments taking more than a day to produce a return. What’s valuable – time, money, risk, production, thrift, prudence, diligence – shouldn’t be marginalized into a derivatives trade.  Alas, we humans seem to recognize mistakes only in hindsight.


Happy New Year!  There comes a time in life when, to quote a friend most adept at wordsmithing, “One hallmark of a great vacation is lying face-down in salt water, with snorkel and face mask, watching the peaceful, sparkling life of the reef.”

We love it any time and December took us to St Martin and a catamaran and a pleasant journey around Anguilla and down to St Barts, the sea waves a solace for body and soul.  If you’ve not yet been where the tradewinds are constant friends, go. It’ll remind you to appreciate life, and time.

As the Chambers Brothers would say, the time has come today (taking eleven minutes to make that musical argument in 1968, the year after my birth) to think about what’s ahead. I wrote a CNBC oped yesterday describing the risk in ETFs that your executives should understand as 2016 unfolds. A goodly portion of the nearly $600 billion of 2015 inflows to passive investment giants Vanguard and Blackrock went to these instruments, portions of which are likely laying claim to the same assets owned by active investors and the indexes ETFs track.

That’s no threat when more money is arriving than leaving, but as Warren Buffett once observed, you only find out who’s been swimming naked when the tide goes out (or something near that).

I don’t know if 2016 will be the Year of Swimming Naked.  Looking back, in Dec 2014 we wrote you readers who are clients: “There is risk that a strong dollar could unexpectedly reduce corporate earnings in Q414 or Q115, stunning equities.  The dollar too is behaving as it did in 2010 when a major currency was in crisis (the Euro, with Greece failing).  Is the Japanese yen next?  The globalization era means no nation is an island, including the USA.”

Money kept flowing but 2015 wobbled the orbits of multiple currencies. Switzerland dropped its euro peg, the euro dropped to decade lows versus the dollar (which hit 2001 highs), the yen became Japan’s last desperate infantryman for growth, and the Chinese yuan repeatedly rocked markets, most recently Monday.

These factors matter to the investor-relations profession.  Picture a teeter-totter.  Once, money was a stationary fulcrum upon which commercial supply and demand around the globe moved up and down.  Today, central banks continuously slide the fulcrum to keep the teeter-totter level. Into the markets denominating the shares of the companies behind commerce pours money following models: indexes and ETFs.

This is our world, IR folks. Fundamentals cannot trump passive investment or the perpetual motion of the money fulcrum. So we must adapt.  Our most important job is to deliver value to management in the market as it is, not as it was. Running a close second is to achieve the IR goal: To the degree we can influence the outcome, aim to maintain a fairly valued stock and a well-informed market – which decidedly doesn’t mean a rising stock.

Both what you can control and whether your stock is fairly valued in a dynamic market where price-setting is more quantitative than qualitative are measurable. But not with valuation models from when the preponderance of money setting prices was taking 10Ks home at night to find the best stocks.  IR must be data-driven in the 21st century.

As 2016 begins, are tides in or out? Our sentiment measures suggest a harsh January. The cost of transferring risk through derivatives is rising. The appreciation of stock-prices necessary to sustain the value of derivatives dependent on them is stalling. And currencies – the fulcrum for prices – show worrisome seismological instability.

Now maybe both January and the year will be awesome, and let’s hope so!  Whatever comes, great IR professionals stand out against a changing backdrop by providing management data points about the stock and the market that deliver calm confidence.

ETF Bubble

“We’re 90% in natural gas and natural-gas liquids,” said the investor-relations officer for a NYSE-listed master-limited partnership at yesterday’s NIRI luncheon in Houston, where I spoke on ETFs. “Yet we’re tracking oil.”

In Michael Lewis’s brilliant The Big Short, a small group of people come to believe mortgages are a bubble because they’ve been extended into derivatives treated as though of equal value and composition to the homes and loans backing the mortgages. No distinction then was being made between good mortgages and bad ones, the same woe afflicting our MLP above through models like ETFs. Thus began the big short – bets that a reckoning was coming.

In the stock market the core asset is stocks of public companies. There is a finite supply, which due to widespread corporate consolidation and share-repurchases isn’t increasing. But indexes that cluster stocks into convenient risk-diffusing groups have proliferated.

At the same time, brokers once carrying shares to mark up and sell to big institutional customers have been forced out by rules, and the intermediaries now, fast traders, often have but 100 shares at a time. Without ready stock, it’s gotten very hard for institutions to buy and sell big positions.

Enter exchange-traded funds. Through ETFs, institutions transfer the risk of finding mass quantities of shares to an arcane behind-the-scenes group of custodian brokers called in ETF lingo “authorized participants.” Think of firms playing this role as running the warehouses.

Here’s how it works. Blackrock creates an ETF tracking an index. The ETF must be comprised of percentages of each of its stocks. Blackrock turns to the warehouse, the Authorized Participant (AP), who gets the components off the shelves and packages vast amounts into what are called creation units. You can’t sell ETF shares back to Blackrock. Only the AP can. For investors, ETFs must be bought or sold on the “secondary market.” That is, just like stocks.

If money buys the ETF instead of the index, wouldn’t it rise faster? Thanks to special ETF rules, no. If investors want the ETF, Blackrock has its AP manufacture more ETF units to meet demand – so supply is theoretically infinite.

ETFs in effect cut out the middle man, the stock market. How? For one, ETFs can substitute cash or securities like options and futures for stocks (and they can hold but a statistical sample of the index).

Suppose investors are buying an underlying stock like XOM, and indexes containing XOM, and ETFs tracking energy and including XOM. The sponsor asks the AP for a lot of XOM and the other components so it can whip up more ETF shares. The AP checks the warehouse, and there is no more XOM. So it substitutes cash and futures of equal value.

Second, this “warehouse” concept reflects how APs, we’re led to believe, seem to have infinite access to shares of stock (which we know is impossible). You can’t find a list of APs but experts say they’re big banks getting special permission from ETF sponsors to act for them.

I have a theory. Often in 13F regulatory filings required by the SEC, holdings for the biggest investors like Blackrock and Vanguard barely change. Positions in 13Fs usually roll up to the parent. Maybe the parent’s subunits buy and sell from each other for indexes and ETFs through the APs. It’s an explanation.

Whatever the truth, ETFs are the biggest success in modern financial history because they make it easy for investors to do something that in reality isn’t: get big exposure without altering the market. Thus, ETFs are a form of credit-extension because they offer investors access to something they otherwise couldn’t buy.

Collateralized debt-obligations did the same for mortgages – turned them into something every investor could own regardless of the number or quality of underlying mortgages.

Bubbles manifest not through valuations but when values stop rising. Let’s theorize that the market stalls for an extended period.  Investors get nervous and sell XOM and the index and the ETF. The futures held in place of XOM are now worthless. To prevent panic, the AP sells assets to cover the loss.

Markets deteriorate further. Panic starts.  The AP is tangled up in swaths of valueless derivatives (just like the CDO market). Then it defaults because its balance-sheet no longer qualifies it to serve as an AP. Bear Stearns and Lehman Brothers were big counterparties that failed. A domino effect ensued as balance sheets laden with empty paper imploded.

Public companies, know what ETFs hold your shares and whether they’re big names (we can help you). Your management teams and Boards should understand ETFs and your company’s exposure to them (and the volume multiplier). Even better, you should be tracking every day what sets price (we can do that for you).

The risk I propose here probably won’t manifest. But in the May 6, 2010 Flash Crash, 70% of halted securities were ETFs. On Aug 24, 2015 when markets nearly imploded, there were 1,000 ETF volatility halts.

We might have an ETF bubble.

Boards Should Know

We thought we were going to need a boat.

Driving into Kansas City, a torrent fell in such proportion that the sky, the landscape, the topography of the roadway, disappeared into a pelting gloom that had our wipers humming on high amid the beating din on the roof for 40 minutes.  Rarely has the first sliver of cutting light seemed so blessedly hopeful.

It had me thinking how darkness about markets prevails in the Boardrooms of America and investor-relations holds the light and the capacity to chase it out.  Boards don’t understand the market.  Perception about equity-trading is disconnected from data reality.

Across our client base reflecting $1.3 trillion of market capitalization there isn’t a single member not held by both Blackrock and Vanguard.  In most cases, the two rank in the top ten if not the five largest holders.  Below these are a sea of fellow asset-allocators ranging from the Powershares Exchange Traded Funds (ETFs) offered by Invesco to the explosion in so-called robo-advisors like Betterment and Charles Schwab’s ETF-powered Intelligent Portfolios.

This community claims to be “perpetual owners” – they hold things.  But if an investment vehicle has inflows, it buys.  Redemptions, it sells. If it tracks a market benchmark like the S&P 500, it relentlessly buys and sells to track movements.  Combine those two and the result is uniformity around supine volatility.

With a lot of volume. Bloomberg in a July article on ETF trading described how these derivatives of indexes drive dollar-volume of $18 trillion annualized now. The market’s most active stock is the ETF SPY generating billions daily and $6 trillion annually. Three of the four most active stocks by dollar-volume are ETFs. Derivatives are pricing the underlying assets.

Thanks to Michael Lewis’s riveting nonfiction thriller Flash Boys (and more), many understand traders in the middle are distorting outcomes. It’s worse.  Intermediaries are half the volume. Nearly three billion of six billion daily shares are chaff.  No ownership-moves, just cash in a register drawer for making change.

What’s a reasonable commission for service?  Real estate agents split 4-6% on home-sales.  Hedge funds want 2% plus 20% of profits. Your waiter will like 20% on a restaurant dinner. The government takes about 30%.

Virtu (Nasdaq:VIRT), a high-frequency trader deploying its own capital, had revenues of $148 million last quarter and net income of $77 million, a 52% net margin. Having no customers they charge no commissions. But sitting between they keep half.

When trading firms, or exchanges, or members of Congress, or regulators tout the benefits of low-cost trading, the proper response is to ask how a market can be efficient in which the middle men are responsible for half of all sales.  Groceries stores as middlemen for producers and consumers have single-digit margins, often about 2%.

What Boards should conclude is that somebody is getting jobbed.  But they don’t know.

Finra oversees 4,400 brokers. Yet in trade-execution data, 30 control over 90% of volume.  The reason is that rules require brokers with customers to meet defined execution standards comprised of averages in the marketplace.

The biggest brokers are handling order flow for the most active sources of trades:  Indexes and ETFs. So the biggest brokers define the standards. Since Finra fines brokers for failing to meet standards, smaller brokers route their trades to big brokers, who roll them up in algorithms powered by the central tendencies defining the bulk of their trade-executions.  That’s again the Massive Passives – indexes and ETFs.

Here’s a key to why 80% of stock-pickers underperform indexes.  Their trades are not setting prices.

And there’s little true “long only money” in markets now, because everybody hedges macro uncertainty related to globalism, central-bank intervention and floating currencies.  Data from Sifma and the Bank for International Settlements show currency, interest-rate, commodity, credit, equity and other swaps total $630 trillion of notional value, ten times global GDP. Any currency ripple can become a splash in the S&P 500.

Risk Management, Asset Allocation and Intermediation converge around borrowing – the amount of shares short every trading day. That’s 43%. Nearly half of all market-volume comes from borrowed shares, lent by big owners through margin accounts at big brokers, often rented by intermediaries to reduce cost and risk.

Only investor-relations professionals can report these facts to Boards. This is how you get a seat at the table. The only actions worth taking are ones planted in fact (and we can help you on both counts –measures and actions).  It begins with casting a bright IR light that lifts the shroud and defines reality.


Happy New Year!  We trust you enjoyed last week’s respite from the Market Structure Map.  Now, back to reality!

CNBC is leaving Nielsen for somebody who’ll track viewer data better.  Nielsen says CNBC is off 13% from 2013. CNBC says Nielsen misses people viewing in new ways. Criticize CNBC for seeming to kill a messenger with an unpopular epistle but commend it too for innovating. Maybe Nielsen isn’t metering the right things.

I’m reminded of what we called in my youth “the cow business.” The lament then was the demise of small cattle ranches like the one on which I grew up (20,000 acres is slight by western cow-punching standards). Cowboying was a dying business.

And then ranchers changed. They learned to measure herd data and use new technologies like artificial insemination to boost output. They adapted to the American palate. Today you can’t find a gastropub without a braised short rib or a flatiron steak. On the ranch we ate short ribs when the freezer was about empty.  But you deliver the product the consumer wants.

Speaking of which, a Wall Street Journal article Monday noted the $200 billion of 2014 net inflows Vanguard saw to its passive portfolios, which pushed total assets to $3.1 trillion. By contrast, industry active funds declined $13 billion. That’s a radical swing.  The WSJ yesterday highlighted gravity-defying growth for Exchange-Traded Funds, now with $2 trillion of assets.

The investor-relations profession targets active investors. Yet the investor’s palate wants the flank steak of, say, currency-hedged ETFs (up about $24 billion in 2014) over the filet mignon of big-name stock-pickers. IR is chasing a shrinking herd. (more…)

The Recovery

It’s all in the recovery.

That’s the philosophy put forth by a friend of mine for dealing with unpleasant facts.

I think the chief reason for the recent swoon in stocks was not anemia in the job market but a sort of investor outrage. You can’t troll a trading periodical or blog or forum without wading through rants on why Michael Lewis, author of the bombshell book Flash Boys on high-speed trading, is either guilty of torpid whimsy (a clever phrase I admit to swiping from a Wall Street Journal opinion by the Hudson Institute’s Christopher DeMuth) or the market’s messiah.

What happens next? Shares of online brokerages including TD Ameritrade, E*Trade and Schwab have suffered on apparent fear that the widespread practice at these firms of selling their orders to fast intermediaries may come under regulatory scrutiny.

What about Vanguard, Blackrock and other massive passive investors? Asset managers favor a structure built around high-speed intermediation because it transforms relentless ebbs and flows of money in retirement accounts from an investing liability to a liquidity asset. Asset management is about generating yield. Liquidity is fungible today, and it’s not just Schwab selling orders to UBS, Scottrade marketing flow to KCG and Citi or E*Trade routing 70% of its brokerage to Susquehanna.

It would require more than a literary suspension of disbelief to suppose that while retail brokers are trading orders for dollars, big asset managers are folding proverbial hands in ecclesiastical innocence. The 40% of equity volume today that’s short, or borrowed, owes much to the alacrity of Vanguard and Blackrock. The US equity market is as dependent on borrowing and intermediation as the global financial system is on the Fed’s $4 trillion balance sheet.

Hoary heads of market structure may recall that we wrote years ago about a firm that exploded onto our data radar in 2007 called “Octeg.” It was trading ten times more than the biggest banks. Tracing addresses in filings, we found Octeg based in the same office as the Global Electronic Trading Co., or GETCO. Octeg. Get it? (more…)

Why Vanguard Likes High Frequency Trading

Editorial Note: This Market Structure Map first ran June 29, 2010. It’s reprinting because Tim Quast is following the lead of congresspersons by taking a “fact-finding junket” aboard a sailing vessel off the coast of Belize. It’s in the public interest.

Oscar Wilde said that illusion is the first of all pleasures. Of course he also wrote that anyone who lives within his means suffers from a lack of imagination.

Buttressed on either side with those brackets about illusion and means, let’s look today at what’s afflicting our market and why some institutions like transient trading when others don’t.

Vanguard, an institutional investor focused on passively managed funds, supports high-frequency trading. George Sauter, CIO for the Vanguard Group, wrote in the firm’s comment letter to the SEC on market structure that high-frequency volumes reduce trading costs through competition and tighter spreads. He quantifies the benefit to investors at roughly 10% over a decade. A passive fund providing 9% returns per annum would deliver only 8% returns without HFT. (more…)