July 2, 2018
What We’re Reading This Week
Star Fund Managers
More and more it seems like investment fund companies are turning to “quants” and data scientists to manage portfolios. Essentially, investment companies are banking on the idea that people will be more excited about “active” management if it’s offloaded to a bunch of computers, ostensibly because people may have more faith in big data than human discernment. A quant approach to a fund (or “smart-beta” as it’s referred to recently) essentially seeks to determine the why behind previous outperformance of a security and look for ways to replicate it in the future.
This is interesting from the perspective that it sort of implies that computers will be better at looking for patterns than people, which may or may not be true. The whole thing seems dumb because of the implication that it’s somehow different from what active managers have been doing the past 20 years. Both methodologies, letting a human look for patterns that can be exploited in the market versus letting a computer do it, have the same failure point. The past is not always a good indicator of what will happen in the future.
More importantly, if we let the computers do all the work, we will no longer get to find out things like this. Bill Gross, the star fund manager who (most notably) ran PIMCO’s Total Return Fund until 2014 is getting divorced. He is, as it turns out, somewhat petty. In a recent court filing, Bill’s ex-wife revealed that he had used “foul-smelling sprays” to make the house stink and left dead fish in the air vents. Allegedly, he did other things too, like pay people to follow her and her family around.
It’s unfortunate, but you must admit that reading about the personal life of a computer program will be much less interesting.
JP Morgan agreed to pay $65 million to settle claims that it tried to manipulate the U.S. Dollar International Swaps and Derivatives Association Fix. ISDAfix rates are used to value cash settlements of options on interest rate swaps. I mean, it’s the same story we’ve been reading about for years, big bank manipulated rate used in derivative pricing to make money.
It seems like we’re at the end of a long road here. As of this writing, the Commodity Futures Trading Commission has levied $6 billion in fines against banks and traders. Mistakenly, I assumed we had reached the apex of rate manipulation cased when Tyson Foods and Pilgrim’s Pride were accused of manipulating chicken prices.
What we learned over the past few years is that it’s really hard to determine when a bank is manipulating a rate, and when it’s just creating a rate. Like LIBOR, FX, and (even!) Euribor, the rates are (were, in some cases) legitimately set by banks submitting what they thought the rate should be. On the surface, this is the same methodology used in manipulating the rate. Meaning, manipulating and setting the rate both involve a bank saying a number. The difference is primarily the collusion (emails and chats) that prove the banks were saying numbers indicating what they wanted the rate to be. Without admission of guilt, or evidence, it’s really hard to say that the rates were manipulated in the first place. To wit, after reading about ISDAfix settlements, I was drawn to this piece from Clarus Financial Technology. The writer analyzed trade times and executions to look for potential signs of manipulation. The evidence was inconclusive that the rate was being manipulated. Clearly, more work needed to be done.
From CFTC Enforcement Director James McDonald, “This matter is one in a series of CFTC actions that clearly demonstrates the Commission’s unrelenting commitment to root out manipulation from our markets and to protect those who rely on the integrity of critical financial benchmarks.”
Yeah, that sounds about right.
Meanwhile, JP Morgan stated, “We’re pleased to have this matter behind us.”
Which, also feels accurate.
On a lighter note, this is fun. Harouna Traoré was training to be a day trader on what he thought was a dummy trading platform with Valbury Capitol.
This poor guy ran up more than €1m in loses before he realized he had placed real trades. Once he collected himself (and, I assume, changed his pants) he proceeded to trade out of the loss and into a profit of more than €10m.
A few days later he called the brokerage firm to describe what happened and they explained that he had breached his trading contract and his positions were “void and cancelled.” The battle will be fought in court and there are lots of different ways to look at this case but simply put, I hope he wins.
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