Friday, 20 July 2018

Penny wise and pound foolish

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THERE WAS A time, not all that long ago, when the scariest guys around for those of us working in fixed income were the hedge funds. No longer. A pal of mine was recently talking to a big cheese at a bulge-bracket house who let slip his view that dealers no longer fear hedge funds as they once did. In fact, he said, the knee-weakening big trading risk is now with the senior real-money investment firms.

Am I surprised? No, of course not. The world has changed since the financial crisis and the real-money guys are now the biggest players. The problem is, though, that too many investment firms seem to care little about the need to keep the Street profitable.

Whatever else you say about hedge funds in the fixed-income world they at least have an understanding of their counterparts working for the dealers.

Let’s face it, in the fixed-income world, as opposed to the equity space, hedge fund managers are more or less all former front-book traders. Indeed, over the years, I have seen one trader after the other pack up the market-making malarkey and cross the floor into the hedge fund world.

I have also watched one front-book trader after the other take on to the book huge risks when facing hedge funds in order to prove just how clever they are and just what large cojones they have. In fact, there was a time before the financial crisis where it was easy to gain the impression that every trade done by a market-maker with a major hedge fund was in effect a job interview.

This, of course, led to hedge funds enjoying disproportionally easy and cheap liquidity. Asset managers were, at least in those days, always shooting out of the second row unless they had the power and prestige of a Pimco or the like (in terms of aggression, it has to be said, that particular house could give any hedgie a run for their money).

But it also meant that the hedge funds, by way of their principals and portfolio managers, could at least empathise with the guys and gals who took over the desks they left behind.

The world has changed since the financial crisis and the real-money guys are now the biggest players

INVESTMENT MANAGERS, ON the other hand, are a very different kettle of fish. Although they pay lip service to being concerned for the health of the sellside, in reality they don’t give a fig and, even if they did, their control and compliance desks would pretty swiftly stop them doing anything about it.

The old rules of “live and let live” and “always leave something on the table for the next guy” have been regulated away and in the struggle for every basis point and every cent – things reflected in the microscope of comparative performance – there is no room to take prisoners.

We now have an environment where asset managers regard skinning dealers as proof of manhood and where rewarding people for their ideas – rather than for their prices – is deemed to be contrary to the interests of retail clients and thus something of a breach of fiduciary duty.

IT WAS A rule of thumb in the FX markets where I began my career (shortly after the dinosaurs died out) that whoever bought the lowest and sold the highest had the smallest P&L because of the many opportunities missed in between.

In the same vein, the assertion that any institutional investor who needs to split hairs over a cent here and a cent there probably has some serious issues on the asset allocation front. How many opportunities are missed while chasing bid-side offers and offer-side bids?

The bottom line is this: if you get your trades right, a penny this way or the other on execution should really not make too much of a difference to the total performance of a fund.

It is nonetheless not unusual for a dealer to present a trade to an investor who loves it, does it in a sensible size, only to come back later and ask to do it again because another portfolio manager has decided that he likes it too and then to come back again and again, expecting to be given the same terms long after the original longs and shorts that drove the attractive terms have been arbitraged out.

OF COURSE, IF real-money managers carry on in that vein, they will soon find they are running out of people to trade with.

Take Credit Suisse’s decision to withdraw from government bond markets. Not many out there still remember CS buying First Boston in 1990. Back then First Boston was what Goldman Sachs is today, the unassailable powerhouse on Wall Street where the like of Hans-Joerg Rudloff and Ossie Gruebel scared the living daylights out of the rest of us.

The decline and fall of one of the behemoths of the industry should serve as a reminder to institutional investors that you can’t roast the beef and still expect to have the milk.

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