June 27, 2012

Window Dressing

Here’s a riddle:

Name a four-letter word that describes why currencies fluctuate and why money in equities modulates around options expirations and the ends of months and quarters.

While you’re thinking about it, I’ll tell you a story. I was in freshman college speech one morning many long years ago when a guy in class began his address by picking up a piece of chalk and announcing: “I am going to write on the board a four-letter word meaning intercourse.” We all cringed (it was a Christian college). He turned, scratched on the board, and then stepped out of the way.

He had written “talk.”

So the word we’re after is “risk.”

Occupants of the IR chair: We’re coming to the end of a quarter, and money is transferring risk now. It transferred risk with options expirations June 15 and June 20 and with Russell rebalances June 22.

We used to call this “window dressing for the period,” where institutions might take profits in places and buy laggards in others. But that’s investment activity. Today, window-dressing is more about minimizing risk to assets. That’s why your price continually fluctuates. Money is toying with risk-exposure – to fixed-income, currencies, equities, commodities – simultaneously. Money may transfer risk in metals to your stock. It may transfer currency risk out of your stock to metals.

We’re schooled in the IR profession and the executive suite to think money invests in things on the hope they become more valuable over time. The notion isn’t wrong. But the objective has been complicated today by…what? Right. Risk.

Risk transfer – an insurance term that describes what one does to reduce the threat of the unknown and unexpected – has always existed in modern capital markets, but not to the sweeping degree it does today. What’s made it worse now? We can wade into the weeds of why. But it’s money. Global currencies float – they constantly change and they have no redeemable value. So all prices, of all assets, are to varying degrees amorphous.

Asset managers respond by hedging exposure. It becomes more pronounced in equity trading at mid-month options expirations (because hedges expire then) and at the ends of months and quarters (because money strives to lock any tidbit of return-on-investment while transferring risk away).

It’s happening now. Trades clear in T+3 days (trade day plus three more). Most clear in a day or less – but money has up to four days to complete the settlement process (great for intermediaries, like using check proceeds four days for free before posting the cash to the intended account). So if you absolutely gotta have your trade cleared by the last trading day in June, when do you try to complete your movement? Yup, yesterday.

Lessons, IR folks? Avoid giving money reasons to transfer risk out of your stock in the last 3-4 trading days of a quarter. And realize that moves up or down at quarter-end may be risk-driven more than investment-driven.

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