In light of ongoing uncertainty around interest rate decisions, elections and economic data outputs, we held a live discussion about the buy- and sell-side firms trade around market events.
Joining us were Sean George, chief investment officer at Strukturinvest, James Athey senior portfolio manager at Aberdeen Standard, and Mattias Remnefjord, Product Manager for Fixed Income from FIS. In this three-part show we discussed pre-event planning; trading through an event; and post-event analysis. This is all three parts, in sequence, for you to enjoy.
Dan Barnes Welcome to Trader TV Live in conjunction with FIS. Trading around events is fraught with risk and opportunity. With uncertainty around interest rate decisions, elections and economic data outputs, we’re discussing how the buy- and sell-side plan for scenarios to minimize risk and maximize returns. Joining me today are Sean George, chief investment officer at Strukturinvest Fondcommission, James Athey, senior portfolio manager at Aberdeen Standard, and Mattias Remnefjord, fixed income product manager at FIS. Gentlemen, welcome to Trader TV Live.
All Thank you.
Dan Barnes James, can you start off by telling us, what sort of scenarios you have to plan for if, as a central bank, interest rate decision coming up?
James Athey Sure thing. Yeah, unfortunately Dan, gone are the days where it was a simple case of, ‘are they on hold? Are they going to cut? Are they going to hike?’ We now live in a world of overt, central bank communication, and that means we need to consider some of the options in between, which is to say, we have these slightly spurious sounding concepts, like a hawkish cut, or a dovish hold. So actually, the number of options is a little more complicated. But essentially our behaviors, the analysis that we have to do around those risk events, is a microcosm of what we’re trying to do the rest of the time. And that’s really around two key concepts; valuation and asymmetry. So essentially, what we need to understand is, ‘what are the market’s views of what’s likely to happen? What are the market’s views of the market’s likely response to those events? Where is market positioning?’ And therefore, we can try and understand where the risks are and positions that we may be running, which may be affected by the outcome of those decisions.
Dan Barnes That’s very good, thank you. And Sean, as a hedge fund, do you think about things differently in any way?
Sean George We go about things differently. Some of our positions are longer term like theirs, but at the same point in time, there can be a fair amount of alpha to collect after an event. But the way things have shaped out this year, there’s been the reaction function that we’ve assumed, when we’ve modeled what we think is going to happen in the different scenarios, and then we have a portfolio set up for multiple scenarios. And the reaction function is something completely different than what we had modeled. So, we are more patient at this point in the year, because we want to see the market reaction play out, and we’ve just let it run sometimes because we don’t agree with the market reaction, but it’s worked out with our position. But we generally try and collect alpha and be a little bit faster than other people. That’s the nickname, ‘fast money,’ for hedge funds.
Dan Barnes Absolutely, of course. And Mattias, how do you see sell-side counterparts potentially preparing to assist their buy-side clients and also, of course, in the interdealer market?
Mattias Remnefjord If you have an event like this, like a rate decision and the outcome of that, it’s very important that when it heats up, the sell-side banks have their trading system lined up, in terms of position management, but also that they have to figure out beforehand the risks with that sort of move. If there’s a rate decision, there might be a ‘steepner’ or a ‘flattener,’ or if there are some moves around the curve, some 2 to 5-year time flies, fx, it should not be such a surprise if there is a certain sort of a steep hill to curb the outcome of that. That’s the change of the curve, but then you also have the different ways to look at from the credit side, from the issuer. So, they need to keep track of what happens if the spreads are widening? If you have the CCC vs BBB, fx, to look at that from the insurer side. Nowadays, you need to keep track of the liquidity and the funding side to see these kind of basis risks that you might be exposed to. We saw at the end of September in the US, the liquidity squeeze in the repo market, but when things heat up, it is very important that the sales guys, the banks, can still provide the service to their buy-side. In terms of contributing prices to the extent that they want to, I mean, if it’s a shaky market, maybe they pull back, but we’ve seen that it can pay off if you’re out there in the market, even in a shaky situation, that you’ve been there when it’s heated up. From a pricing perspective, when you’re trading several different asset classes, it’s very important to have consistent pricing across different segments, e.g: if a trade is in corporate bonds government, but also if you mix that with things like on the swap-side, cross-currency swaps. So, you need to have a consistent pricing and a good view, but in terms of a decision, the impact should not come as a surprise, you should have done your homework before.
Dan Barnes That’s very good, thank you. And James and Sean, what sort of information do you use in the preparation phase for this from your bank counterparts?
Sean George I’d say it’s an ongoing dialog for us at least. Understanding market positioning is a big point. Understanding where are the weaknesses. Understanding, many accounts have had good years this year and we’re at the middle of November. The risk-taking appetite right now is not great, and it’s not great at the bank-side going into year round. And many banks have also had good trading years. So, just understanding the market dynamics and being prepared for further impacts on pricing. There’s been a lot of things this year that have reacted very strangely, but you have two central banks in the market as well, and then you have buy-side accounts like us, reacting to what they’re doing, agreeing or not agreeing. Those dynamics are not something that you get delivered to you; it’s an ongoing process of dialogue across the counterparties, or even some of my competitors, which I’m friendly enough and that I talk to.
Dan Barnes Sure. And James, what sort of information are you using in the long only position?
James Athey Yes. Sean’s hit the nail on the head. Essentially, we’re using the street because in aggregate, they see a heck of a lot of flow, if not all of the flow. And us, as a single buy-side firm, we don’t have access to that via any other means. So first and foremost, as Sean’s already said, there is an ongoing dialogue, but particularly when there are risk events, particularly when there are known events in the economic calendar, when there’s likely to be volatility in the aftermath, it becomes that much more important to have had these conversations, to understand who’s been buying, who’s been selling, where are the positions, and what might they be? Again, back to the asymmetry; where’s the asymmetry around potential market moves in the aftermath of the decision? So absolutely, that’s a key input for us in able to sort of build that deep, textured view of exactly how the market is positioned, and how it’s likely to behave under various scenarios after the event itself.
Dan Barnes And what’s the biggest risk, do you think you face in the planning stage?
James Athey Well, obviously, not having the right information is a huge risk. Markets have become incredibly complicated, not just in terms of central bank distortions, which are a huge issue, but also in the number of instruments and the potential uses for those instruments, because we have more liquidity in the system. Trying to make comparisons through history about the extremity of positioning is difficult, because you’re comparing under two different scenarios. It could be quite easy to have a view on positioning, which turns out to be somewhat false because the context isn’t right.
Dan Barnes Is that the same for you Sean?
Sean George Our problem, it’s exactly what I said. Our biggest position from the long side is CSPP bonds; bonds that the ECB will actively be purchasing and hopefully the exact bonds we own. But bonds that fit in the framework; modeling that is absolutely impossible. Like how is that asset, or how is that part of my portfolio going to perform going forward? Because, I have really, from June forward, with these particular bonds, and then I have the last time, but the last time they were in, it was a completely different scenario than it is now. Understanding and tweaking and using the right proxies, and then you get what we get back from the model, and then we have to actually haircut that, because the volatility is actually higher a lot of times than it should be in the model, because it is not taken into account that the ECB will be there, when the volatility picks up. I have a young quand with me who is very, very bright, but, when you haven’t seen these cycles, I’ve been doing this for almost 24 years now, volatility is. Understanding what the model says and what the actual volatility is, is different.
Dan Barnes Welcome back to Trader TV Live in conjunction with FIS. We’ve covered the preparation and investment managers, banks and risk managers, to make ahead of a known market event, such as a rate hike or an election outcome. So now let’s talk about trading. Obviously, everybody’s getting the same information at the same time in these events, Sean?
Sean George And it’s probably gets it a little faster than ours.
James Athey I wish that were true!
Dan Barnes Sean, let’s get back to you. What sort of pressure does that then create on your trading operations?
Sean George I mean, there’s been several of those occasions this year, where you’re just hit with something that that’s, a wow! And you want to – I mean I’m a hedge fund, so, I’m in the alpha collection business – to show that I’m outperforming, and we’ve been able to outperform on some of these events. Some part of it by, like asymmetry in our portfolio, like where we would have bought puts on the SNP that kicks in, but also trading the CDS indices after an event. Because the market is not as efficient as people like to think. All the information’s out there and immediately prices to where it’s supposed to be, but there’s people that are not pulling the trigger, thinking about pulling the trigger, then price forces people to pull the trigger and then you get the snowball effect. So, being quick and being right are not as easy or easier said than done. But I mean, that’s been a big portion of our returns this year; it’s being on top of things.
Dan Barnes And James, with long only positions, how is trading impacted during this period?
James Athey Sure thing, but just to pick up on Sean’s point there, when you’re dealing with macroeconomic downturns and risk events, you’ve got the very nature of interpretation. You’re not often dealing with yes- and no-fact and non-fact, you are dealing with nuance and interpretation, and that adds another layer of complexity. Specifically on the point of the dealing desk, again, we’re medium-to long-term investors, and my role is to build a portfolio which can benefit from as many possible future states of the world. I’m looking strategically, and the vast majority of cases, these risk events should not be sufficiently destabilizing or shocking, to blow too big a hole in terms of the strategy. I’d like to think that most of the time our dealing desk won’t be required to attempt to execute in the aftermath of an event. But on those cases where it is, I’d also like to believe that actually we’re taking profit from positions which have worked, and that means that we’re on the right side of the liquidity problem, because essentially that’s what we are dealing with, liquidity. If it is a situation where something has happened, which is so shocking, outside of a range of considerations for us going in, and therefore we’re having to say stop-out-of-a-position and therefore we’re going against the sort of liquidity tide, if you like, i.e. everybody’s a seller and so are we. it’s the job of the dealing desk to understand volatility, liquidity, the specific markets that we’re trying to execute a position in. And therefore, what is the right cost in terms of bid offer, and what is the right price for us to pay in order to to get out of that position?
Dan Barnes Very good, thank you. And in this particular scenario of a rates change, either up or down, does that impact across instruments? And how do you trade to take effect of that?
Sean George I’d say up until the beginning of this month, you had to synchronize rates are going to go to zero or never reflate again. And then in the span of a week, the US 10 year go from 1.60 to almost 2%, and then it’s come back in. Those things matter, because you have the growth vs value, and on the equity side, you have the real estate stocks vs banks. You have cyclicals in my world that are starting to perform. You have MTNA in the market today, which is vastly oversubscribed for a new issue. So, it does matter. The last week was the first auto-bond we bought all year. I’ve been short cyclicals and long CSPP bonds and it does matter. This rate move matters, because it’s telling us something, in a pretty synchronized fashion across different asset classes, or at least telling us. So, we have started to shift out of the short cyclicals into more of a balanced cyclicals position, based on that.
Dan Barnes Very good. And James, it depends on your mandates, doesn’t it, as to what you can trade and invest in?
James Athey Yeah, exactly. I mean, the bulk of mandates that I manage are sort of bond and FX mandates. Some have more freedom to use swaps and futures, for example. Largely that’s about efficient portfolio management, but obviously some opportunities do open up. But, you know, to echo Sean’s point, there as a macro thinker. You know, we’ve had instances in the last year or so, where you see dramatic changes in how assets are reacting to various interest rate changes. You know, Sean rightly touched on, in a bond proxy sectors within the equity market and how they’ve behaved like bonds and obviously in a rising yield environment, then suddenly you want to be in banks because the steeper curve is good for profits. If you go back to the back end of 2018, the whole year…
Dan Barnes Please don’t.
James Athey No exactly. It was scarring for me too, buddy. But, you know, the whole year really was about how everything was correlated in a positive fashion and had negative performance, and then Q4 was vastly different because of the perceived changes of monetary policy.
Dan Barnes Very good. And Mattias, I mean, during this live trading process, you have to capture and analyze data. How challenging is that?
Mattias Remnefjord Well, if it’s an event that occurs, it’s very important that the performance is OK in a trading system. Of course, the dealers need to also figure out where the market is going, that’s given. But they get asked a lot, a lot of inquiries, a lot of orders coming in. And they need to combine that with having reliable price feeds. They need to make sure that they’re gateways are up to venues and exchanges, and still serving their client activities for incoming RFQs and so on. So, the challenge is do that, but also, sometimes when these things happen, they’re flashing, but sometimes it can be good to take a step back and try to figure out where things are. Because maybe the first move in the bund is not the right one. And also, if there is a shaky market there are not many bids out there. So, the sell-side is sitting in the same boat, but they can end up in positions, because some of them are market makers, who have to market that market, so, they might end up in long or short positions that they haven’t really analyzed or wanted to do when they entered the office in the morning. So, they need to be on their toes and have a trading system architecture, that allows them to handle it. And this puts a lot of requirements on the performance side, to be able to handle the massive amount of trades. And when there is a lot of trade activity, you need to be able to calculate your credit sensitivity fx, at the same time as you’re serving the clients. So, the performance is always a topic, and that’s something that we at FIS are constantly improving.
Dan Barnes And of course, liquidity is poor in most fixed income markets at the moment. So, that’s becoming increasingly challenging. Is that something that the discussion between traders and portfolio managers, has that increased, as liquidity decreased in order to manage the risks for you in this process?
James Athey Yeah, and massively so, essentially the regulatory environment, the regulations which we’ve seen as a response to what happened in 2007-8, has absolutely changed the way that banks operate. And depending on which asset class you’re talking about, the hit to liquidity, the change in liquidity conditions, has been, broadly speaking, dramatic. When you then potentially throw in a risk event, an economic event, a volatility event, then what you see is that liquidity can drive absolutely dramatically. So, we want to lean on our dealing desk as much as possible for info all the time, because they’re in touch with the market on an ongoing basis, but particularly in the current environment.
Dan Barnes Welcome back to Trader TV Live, in conjunction with FIS. We’ve covered the trading that investment managers, banks and risk managers have to manage and engage in during a known market event. Now, let’s discuss, post event, how that is analyzed, because in terms of your review and reporting process for post-events analysis, what sort of processes do you have? To start with you, James?
James Athey Yes, sure thing. So, I mean, essentially what we’re talking about here is a sort of microcosm of the broad process, and that is to say that it needs to be robust, repeatable and iterative. And so, information that we can take from how markets have responded, how our portfolio has responded, our understanding going in, and how that compares to the reality coming out, that’s all useful information to us to feed back into the process, to make sure that, you know, essentially we’re being as robust and as careful and as diligent as we can. In that respect, we have a series of meetings on a weekly basis, where we can have these discussions, both in terms of what the future may look like, but also going over the past. How did events transpire relative to our views? How has that affected our portfolios? Does that require some adjustments along the way? So, absolutely, that fits into the normal sort of process. In the rare instances where something really has come out of the blue or shocked us or surprised us, we will have a conversation there and then, because we need to in real-time, truly understand, because obviously we have client money, you know, at risk, if you like. And we’re very careful about that.
Dan Barnes And that’s very good. And Sean, does your review process differ at all?
Sean George It differs, I mean, essentially, it’s the same process. But the difference is I have a larger toolbox being that leverage longs and shorts, multiple different markets. What we do, what I would add on to the process, we have a smaller team so that it’s more ad hoc, you know, discussing if he did the right thing or not. But we also go back and we look at what markets were tradable at the time, and did we execute the most efficient market to augment our view if we needed to do it at the time. So, just making sure that, I’d like to think that we do check all the markets, and make sure we’re shorting the richest thing and buying the cheapest thing. But sometimes it’s not the case. So, we do go back and review and, you know, it has changed a couple of things on how we’ve handled liquidity.
Dan Barnes That’s very good. And then how do you bring the sell-side and risk teams into that discussion? Because I’m guessing portfolio management and trading is an ongoing discussion, probably on a daily basis or at least weekly basis. So how do you bring those other factors in, including counterparts, James you can start?
James Athey Again, that’s a process, and you’re talking about, actually probably, two distinct sort of segments, one of which is, is the notion of best execution. We have a responsibility to provide the best execution that we possibly can for our client base. And that process is essentially ongoing. It’s always and everywhere. Now, depending on which asset class, some of them are more automatable and some of them are more sort of minute by minute, if you like, when you’re talking about OTC products and illiquid products, it can be a bit more nuanced. And there does need to be a bit of expertize in understanding market conditions, and where, what may look like a bad price is actually a relatively good price, because of the prevailing conditions at the time. And then obviously you have a separate conversation, a separate process and relationship with our counterparties, who are providing us that liquidity and execution as well as other services. And that process is certainly much bigger than our desk that covers all asset classes. We have specialist teams and specialist people that are involved in a kind of quarterly review process.
Dan Barnes And you have a quarterly review process as well, Sean?
Sean George Exactly. And since we’re an emerging manager, you know, it’s a give and take on how helpful we are to our counterparties and how useful we are. Our trading volumes matter to certain counterparties and maybe not so to others. I think at the end of the day, when you come in with the numbers and with the rankings, very seldom are people like, ‘oh, my God, I’m fifth!’ I mean, they kind of know if they’re hitting or missing out on things, but it is also a good check point to see, ‘the people that are providing me with the best service, are they also getting the same look on the volume because you want to reward good behavior?’
Dan Barnes Absolutely. And Mattias, you talked about the importance of systematic performance and system integrity in the trading process. What sort of data can be used to analyze that? And how do you see the review of operational performance?
Mattias Remnefjord It depends on our desks, but if I take an example; a bond desk giving prices to venues in RFQs, for example, it is a matter of publishing the relevant data for the traders. So, it can be like some liquidity score numbers that are provided out there with vendors, and also the composite price to do that. And the banks on the sell-side, as the buy-side, they are gathering a lot of data and using it. And it is a matter of presenting the right data in that moment, because if it is in a shaky situation, there might be a lot of RFQ pop-ups on the screens. So, it is a matter of showing the right data rather than just sort of showing a myriad of too much. So, that is also something that can be, of course, revised afterwards. OK, the right number, the right liquid scores and the right sort of composite price and so on. But on the sell-side it is also a matter of trying to explain the panels, for example. So reviewing processes, they also have the MiFID II requirements on the best executions, and some RTS, repo and all these things. But something that is common among all classes, that try to explain to the panel how you ended up in that one. So, they look at, OK, how much is coming from moves in a credit card? How much is on the panel is coming from time decay? If there is some shift on inflation currents, for example. So, it is a matter of trying to explain that and sort of try to understand it, but I mean to reviewing a certain sort of risk measurement on a sell-side. They have pretty robust rules from the beginning, so it’s not like the traders in sell-side, they just need to sort of stick to that. Of course, they are going to have inputs, but I mean, the process of reviewing these things is pretty, pretty massive at the bank, so, it’s not like they cannot change it over a short period of time.
Dan Barnes Sure. We’ve heard a lot about it in the press about transaction cost analysis, on the buy-side particularly, we’ve seen fixed income that’s challenging because there’s less market data, because there’s less liquidity. So, just to finish, could we perhaps talk about how valuable is that in the review process, do you think, at the moment? And to what extent do you think, is that art as well as science? Sean?
Sean George Yeah, I mean, we go through and score our liquidity on the on a weekly basis, and we produce our monthly report on that. And what we do is we gather, on the buy-side, we have the… One thing when you go from the sell-side to the buy-side, you’re amazed at how much more information you have. And so we take all the liquidity, we monitor our bonds and make sure they have the liquidity profile that we want. Because, you know, if the market were to turn for some macro reason, and I have a bond that I thought was liquid in an illiquid market, I won’t be able to sell that bond. So I need to stay more liquid and on top of my liquidity. And we do that review on a weekly basis.
Dan Barnes That’s great. We’re gonna have to wrap up there. So, Sean, James, Mattias, thank you very much. That’s been excellent.
All Thank you.
Dan Barnes The recording of the show will be available on this page, as well as TraderTV.NET. I’d just like to thank James, Sean and Mattias, and you for watching Trader TV Live. Please follow us on Twitter at Trader TV. And visit us at TraderTV.NET and ETF.NET. Thank you very much for watching.
