Goldman Sachs has a piece of research out today on ETFs, billed as sort of “ETFs for dummy portfolio managers who need to start understanding them.” It’s worth a read if you can get it, with a decent overview of questions that it is probably possible to think too hard about, like whether 400% short interest in many big ETFs is worth freaking out about (short answer: nah).
Particularly useful is a cautious but intelligent stab at the question of whether increased correlations are being driven by increased ETF use:
A substantial debate exists among investors about the cause of increased correlation. Namely, are correlations high simply because the environment is dominated by the macro? Or, are they due to the increasing use of index-level products, such as ETFs and futures? And most importantly, how do these forces interact? Given the nature of the cause-and-effect relationship of the two sides of this debate, we find our highest value in becoming more granular in our approach to these questions by specifically focusing our work on sector-based observations rather than index-level ones.
For those who like charts, here are two charts: Continue reading »
Ooh look a chart:
That’s from this quite punchy paper by Patrick Slovik of the economics department at the OECD. It shows you that, in 1992, big banks had risk-weighted assets, which determine how much capital they’re required to have, of over 65% of their total assets, which measures how much lending and investing and trading and financing-their-governments they actually do. In 2008, the ratio was under 35%. What’s special about those dates?
When the first Basel accord was implemented in 1992, risk-weighted assets represented close to 70% of bank total assets, which means that bank regulatory capital was calculated based on a large share of bank total exposures. In the years following the introduction of the Basel accord, the ratio of riskweighted assets to total assets (RWA/TA ratio) gradually decreased and reached about 35% in the immediate pre-crisis period, which means that the regulatory capital of systemically important banks was calculated based on only a small fraction of their total exposures. … [T]he drop in the RWA/TA ratio has been very smooth since the implementation of the Basel accords without any significant deviations from the trend line until the crisis. This trend suggests that innovative engineering of regulatory risks and the move to unconventional business practices by systemically important banks has been a consistent trend for almost two decades and was not limited to a few years preceding the financial crisis. The trend reached its lowest point at the onset of the financial crisis when the capital requirements of systemically important banks were determined based on the historically lowest amounts of risk-weighted assets (relative to total assets). Risk-weighted regulation leads to unintended consequences as it encourages innovation designed to bypass the regulatory regime rather than to serve non-financial enterprises and households. Strengthening capital requirements based on risk-weighted assets may further contribute to these skewed incentives and their profitability.
This is a theory that has been sloshing around the internet for a good long while but this is neatly expressed and – that chart! It is – pretty stark, no?
That chart is worth the price of admission, but Slovik goes on to argue that risk-weighted capital requirements lead to a decline in lending activity: “One of the main reasons why non-loan-related activities have become so important for banks is the relatively high regulatory risk weights on loans relative to other types of assets, which puts them at a comparative disadvantage in the profit-seeking strategies of banks.” The numbers look … not totally unlike the risk-weighted-to-total-assets chart: Continue reading »
The Fed has three basic functions: central banking, bank regulation, and calling down police brutality on Occupy Wall Street protesters. While the first function is getting all the attention today, the New York Fed’s blog is spending some time on the second. Specifically, they’re trying to figure out how bankers should get paid.
Optimal design of banker compensation is a thing that people like to think about, and that regulators like to regulate. We’ve talked about it before, and I’ve suggested that the right way to reward bankers is not to give them mostly equity or extra-levered equity, which encourages asymmetric risk-taking, but rather to give them exposure to their firm that roughly matches that of their main stakeholders. Which, for a bank, means basically various flavors of creditors. So a bank CEO whose net worth consists 20% of equity of his firm and 80% of unsecured debt of his firm, like Brian Moynihan, in theory has better incentives to do the right thing by bondholders, depositors and the financial system than someone who’s 100% in out-of-the-money stock options. And a banker who is paid in structured credit products that can’t be foisted on to clients has incentives … well, he’s an interesting case study at least.
I like the NY Fed researcher-bloggers because they’re pretty sober people who want to optimize banking regulation but don’t spend their time freaking out about stupid popular things like how CDS will kill us all, banning short selling, or just generally hating on bankers. So I’m pleased to see NY Fed researcher Hamid Mehran is with me on this whole comp thing: Continue reading »
Today seems to be the day of banks praising each other with faint damns, what with James Gorman handing out copies of a Credit Suisse report lowering estimates for Morgan Stanley. Goldman equity research is also out with a mammoth and interesting note on French banks, which against this market backdrop actually manages to sound pretty chipper despite warning of increasing risks, reducing earnings estimates and downgrading Soc Gen from buy to neutral. They also think that French banks will need to improve capital ratios, but aren’t sweating it too much. Here’s how they think that goes:
Continue reading »
Goldman Sachs Portfolio Strategy Research has a fascinating research piece out today on equity correlation markets. It does good work as a piece of research because (1) if you like equity derivatives, it’s got all sorts of fun charts and technical stuff and (2) if you don’t, it’s got a hard sell: trade equity corr with Goldman!
There are many market participants that are affected by the level of equity correlations but are not yet trading correlation actively. So far, the market has been primarily one-way; banks selling correlation and hedge funds and proprietary trading desks buying it for the positive carry. We believe that the correlation market can become a new area in which institutional investors could add alpha.
The equity correlation market, which is pretty niche-y, lets investors bet on how dispersed the returns of stocks will be in the future. And the trade to make now, Goldman thinks, is to sell correlation, which “appears attractive,” meaning that current implied correlation is much higher than they think realized correlation will be in the future: Continue reading »
Someone is not happy at the House of Pandito.
To: DealBreaker
From: [redacted]
Subject: Citi Overpaying for Research Analysts w/ TARP Money
Count Vikula, drunk on TARP funds, just kicked off week three of a research department hiring binge that has unemployed sell-side analysts partying like its 1999. One stunning example of their recent largesse: signing a mid-cap software analyst (formerly of a Piper-Jaffrayesqe boutique) to a groin-grabbing multi-year, multi-million dollar guaranteed package.Is expanding their coverage universe to industry juggernauts like CVLT really the best use of taxpayer money? At least Andrew Hall (castle aside) was accretive to Citi’s EBIT.
Update: According to a spokesman for Citi:
1) We do not give multi-year guarantees.
2) We don’t cover CVLT.
3) In the US, we have hired only one analyst since September–hardly a binge. (We did hire one Latin America equity analyst who is based outside US and hired a head of Latin America research based in NYC. But he is a manager, not an analyst.)
