June 18, 2014

An audit of the Chinese Sovereign Wealth Fund has brought an amusing nugget:

Auditors also found irregularities at Beijing-based CIC’s domestic units. Among them, Central Huijin Investment Ltd. lost 1.26 billion yuan ($202 million) in potential investment gains in 2011 by selling a stake in a local securities company at the cost price and not conducting an asset appraisal as required, according to the report.

It would be most interesting to learn who the buyer was!

Today’s FOMC statement was ‘steady as she goes’:

nformation received since the Federal Open Market Committee met in April indicates that growth in economic activity has rebounded in recent months. Labor market indicators generally showed further improvement. The unemployment rate, though lower, remains elevated. Household spending appears to be rising moderately and business fixed investment resumed its advance, while the recovery in the housing sector remained slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.

The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in July, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $15 billion per month rather than $20 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $20 billion per month rather than $25 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation.

Thoughts of how the Great Moderation ended are causing some nervousness:

The Chicago Board Options Exchange Volatility Index, a gauge of S&P 500 swings, fell to the lowest since early 2007. Foreign-exchange volatility also has slowed, falling to an almost seven-year low.

Low financial-market volatility has stirred concern among some policy makers. New York Fed President William C. Dudley said last month it may signal investor complacency about risk, making him “a little nervous.”

… and has a notable effect on the Treasury market:

Just because U.S. Treasuries (USGG10YR) look more and more stable doesn’t mean they are.

With trading volumes plunging, the lack of volatility may be more a result of the market becoming less liquid as the Federal Reserve hoards trillions of dollars of bonds and banks pull back from debt trading, not because there’s less risk.

Historically, lower volatility has meant more — not less – – trading. What’s happening instead is unprecedented central-bank stimulus has sent everyone into the same risk-on bets, while it’s also becoming more difficult to trade as banks shore up their balance sheets in the face of new regulations.

“We blame the wave of central-bank liquidity, which has pushed up asset prices irrespective of fundamentals,” Citigroup Inc. (C) strategists led by Matt King in London wrote in a note today. “This creates a vicious circle: ever-higher prices, ever-less trading and liquidity.”

Lower volatility used to lead to more trading before the 2008 financial crisis. The opposite has been the case since then, as the Fed has held its benchmark rate near zero and bought trillions of dollars of Treasuries and mortgage debt.

The average volume of Treasuries traded each day has fallen to $504 billion this year from $545 billion in 2013 and as high as $570 billion in 2007, according to data compiled by the Securities Industry and Financial Markets Association. From 2002 to 2006, U.S. government-debt volumes rose 43 percent.

The drop in trading comes as a measure of volatility in Treasury yields has fallen 69 percent since 2008, according to Bank of America Merrill Lynch’s MOVE Index.

The explosion of fixed-income derivatives trading also speaks to the difficulty investors are having buying and selling bonds. As bond trading has slumped, the notional value of over-the-counter futures contracts has soared, based on the latest data from the Bank for International Settlements compiled by Deutsche Bank AG.

Meanwhile, yields on riskier assets are dropping faster than those on safer securities as investors pile into already crowded trades. The gap between yields on junk bonds and investment-grade notes has shrunk to 2.99 percentage points, the least since 2007, Bank of America Merrill Lynch index data show.

Apparently we may soon see the reappearance of Bank Sub-Debt New Issues:

The banks are also getting ready to issue a type of subordinated debt. In March Royal Bank of Canada chief financial officer Janice Fukakusa said she and her counterparts at rival lenders are working with regulators to determine what triggers should be used to determine when these issues are converted to common shares, and how the resulting shareholder dilution should be managed.

The big question is: will these non-bonds get foisted into the indices, so little Granny Oakum can contribute to bank capital with her $5,000 investment in a bond ETF? I’ve warned about the potential for this. Hmmm … let’s see … I should lobby the main index-maker to ensure that only bonds are in the bond indices … even better, lobby the owner of the index maker … so the main pension performance target indices are the PC Bond Canadian Debt Market Indices … that’s a division of the Toronto Stock Exchange … and the Toronto Stock Exchange is owned by … well, never mind. Thanks for the equity, Granny!

A Bloomberg editorial lauds the batch-auction idea:

Fixing the problems will require more than a tweak here and there. One idea that’s winning converts would replace the 24-hour, continuous trading of stocks with frequent auctions at regular intervals.

The idea has a good pedigree. It has been around at least since 1960, when Milton Friedman proposed a version for the sale of U.S. Treasury bonds. Researchers led by the University of Chicago’s Eric Budish refined the concept in a paper last year.

Under their system, orders would be sent to the exchanges, as they are now, but instead of being processed immediately, they’d be collected into batches, based on when they arrived at the exchange. A computer would then use an algorithm to match the orders. Auctions would take place at least every second (for 23,400 auctions per day, per stock), matching supply with demand at the midpoint, or the uniform price. Orders that don’t get matched — either because they exceeded the volume of shares available or because their buy or sell quotes didn’t conform to the uniform price — would automatically be included in the next auction.

Goldman Sachs Group Inc., among others, is interested enough in frequent batch auctions that it’s working with Budish to find an exchange that will conduct a pilot program and a regulatory agency that will monitor the results. Mary Jo White, the Securities and Exchange Commission chair, indicated in a June 5 speech her interest in batch auctions. She should make it a priority to conduct a test program. It’s a promising idea.

This editorial contains two assertions that surprise me:

As well as prioritizing price over speed, this approach would make another flash crash less likely. That’s because it would stem the flood of buy, sell and cancel commands that high-frequency traders issue every second in their efforts to probe the market.

I have never seen any evidence at all that a ‘flood of buy, sell and cancel commands’ had anything to do with the Flash Crash.

Auctions would also reduce the need for dark pools, because the orders of institutional investors wouldn’t be visible to other participants. The fear among big investors such as mutual funds — that placing an order will move the price against them — is the reason dark pools caught on in the first place. The result should be lower transaction costs and higher investment returns for 401(k) owners and other savers.

Lower transaction costs … well, maybe. It could well be that a small (retail) market order to buy enters the same auction as a major sale – we could assume that this will force the price down to bid levels, and so Granny gets to buy her shares at the bid. Maybe. And frankly, I fail to see how making the exchange dark – by not publishing resting limit orders (of institutional investors only?) – will assist in price discovery. This is all a little strange.

The paper by Budish, et al, was discussed on PrefBlog on March 19.

More immediately, it looks like maker-taker exchange pricing is in trouble:

Executives from exchange operators and fund companies are starting to join lawmakers and regulators in warning that the world’s largest equities market is beset with conflicts that can harm investors and undermine confidence.

Support for a solution increased yesterday at a hearing led by Senator Carl Levin as representatives from New York Stock Exchange owner Intercontinental Exchange Inc. (ICE), IEX Group Inc. and Vanguard Group Inc. said trading rebates and payments to brokers for investor trades warrant greater government scrutiny. The systems, embedded in market plumbing over the last two decades, were cited as one of the reasons high-frequency firms now account for about half of volume.

“Hopefully the regulatory agencies are going to take action,” Levin, a Michigan Democrat, said at the end of the half-day hearing of the Senate’s Permanent Subcommittee on Investigations. “There are steps which must be taken either by regulators or by Congress to deal with conflicts and to deal with the other kinds of problems which exist in the current market, because it’s clear there can be improvements.”

I’ll have to give the question some thought; I feel quite certain there are wheels within wheels here. It may be simply that this is the just another battle in the struggle of established market-makers to defend their turf against HFT, much of which profits a lot by maker-taker pricing. You know, by actually making a market. A better one than the big bank smiley-boys.

There’s a shake-up at Harvard’s captive investment manager:

After years of subpar results at Harvard Management Co., three high-level managers have exited the $32.7 billion endowment and the university is searching for new leadership.

Apoorva K. Koticha, 48, among the highest-paid traders at Harvard Management in 2011, has left, according to two people familiar with the matter. News of his departure comes a week after Jane Mendillo, chief executive officer of the university’s investment company since July 2008, said she will resign at the end of the year. Mark McKenna, 43, a money manager at the endowment, moved to BlackRock Inc. (BLK) this month to start an event-driven hedge fund. Since April 2013, Harvard Management has also parted ways with two heads of its private-equity unit.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts up 15pb, FixedResets winning 19bp and DeemedRetractibles gaining 9bp. Volatility was quite good, all winners, dominated by FixedResets. Volume was well above average.

PerpetualDiscounts now yield 5.27%, equivalent to 6.85% interest at the standard equivalency factor of 1.3x. Long Corporates now yield a little under 4.4%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 245bp, a slight (and perhaps spurious) tightening from the 250bp reported June 11.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.0705 % 2,476.8
FixedFloater 4.41 % 3.66 % 30,344 18.01 1 0.8895 % 3,894.9
Floater 2.96 % 3.09 % 44,507 19.52 4 0.0705 % 2,674.2
OpRet 4.38 % -8.89 % 24,060 0.08 2 0.0585 % 2,710.0
SplitShare 4.81 % 4.21 % 61,014 4.11 5 0.1353 % 3,118.2
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0585 % 2,478.0
Perpetual-Premium 5.51 % 1.52 % 81,231 0.09 17 -0.1106 % 2,403.0
Perpetual-Discount 5.26 % 5.27 % 116,059 14.97 20 0.1457 % 2,552.8
FixedReset 4.49 % 3.71 % 211,485 6.69 79 0.1928 % 2,540.5
Deemed-Retractible 4.99 % 0.45 % 139,543 0.12 43 0.0910 % 2,534.5
FloatingReset 2.66 % 2.42 % 126,471 3.95 6 0.0660 % 2,492.3
Performance Highlights
Issue Index Change Notes
ENB.PR.P FixedReset 1.04 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-18
Maturity Price : 22.96
Evaluated at bid price : 24.40
Bid-YTW : 4.10 %
IFC.PR.A FixedReset 1.18 % YTW SCENARIO
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.10
Bid-YTW : 4.08 %
ENB.PR.N FixedReset 1.26 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2018-12-01
Maturity Price : 25.00
Evaluated at bid price : 24.98
Bid-YTW : 4.08 %
FTS.PR.J Perpetual-Discount 1.28 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-18
Maturity Price : 23.45
Evaluated at bid price : 23.80
Bid-YTW : 5.01 %
ENB.PR.T FixedReset 1.28 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-18
Maturity Price : 22.97
Evaluated at bid price : 24.46
Bid-YTW : 4.08 %
BAM.PR.X FixedReset 1.63 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-06-18
Maturity Price : 21.51
Evaluated at bid price : 21.88
Bid-YTW : 4.07 %
Volume Highlights
Issue Index Shares
TD.PF.A FixedReset 283,330 Recent new issue.
Maturity Type : Limit Maturity
Maturity Date : 2044-06-18
Maturity Price : 23.18
Evaluated at bid price : 25.14
Bid-YTW : 3.71 %
FTS.PR.H FixedReset 122,663 Nesbitt crossed blocks of 73,000 and 40,000, both at 21.35.
Maturity Type : Limit Maturity
Maturity Date : 2044-06-18
Maturity Price : 21.40
Evaluated at bid price : 21.40
Bid-YTW : 3.63 %
ENB.PR.B FixedReset 111,447 TD crossed 50,000 at 24.45. Scotia crossed 45,000 at the same price.
Maturity Type : Limit Maturity
Maturity Date : 2044-06-18
Maturity Price : 23.20
Evaluated at bid price : 24.50
Bid-YTW : 4.01 %
BMO.PR.T FixedReset 102,825 Recent new issue.
Maturity Type : Limit Maturity
Maturity Date : 2044-06-18
Maturity Price : 23.17
Evaluated at bid price : 25.07
Bid-YTW : 3.72 %
ENB.PF.C FixedReset 78,623 Recent new issue.
Maturity Type : Limit Maturity
Maturity Date : 2044-06-18
Maturity Price : 23.13
Evaluated at bid price : 25.02
Bid-YTW : 4.19 %
MFC.PR.L FixedReset 55,140 Scotia crossed blocks of 10,000 and 25,000, both at 24.91.
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.99
Bid-YTW : 3.85 %
There were 41 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
MFC.PR.F FixedReset Quote: 22.92 – 23.57
Spot Rate : 0.6500
Average : 0.5030

Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 22.92
Bid-YTW : 4.24 %

PWF.PR.P FixedReset Quote: 23.57 – 23.98
Spot Rate : 0.4100
Average : 0.2784

Maturity Type : Limit Maturity
Maturity Date : 2044-06-18
Maturity Price : 23.16
Evaluated at bid price : 23.57
Bid-YTW : 3.51 %

IAG.PR.A Deemed-Retractible Quote: 23.13 – 23.48
Spot Rate : 0.3500
Average : 0.2330

Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.13
Bid-YTW : 5.55 %

RY.PR.F Deemed-Retractible Quote: 25.77 – 26.07
Spot Rate : 0.3000
Average : 0.1860

Maturity Type : Call
Maturity Date : 2014-07-18
Maturity Price : 25.50
Evaluated at bid price : 25.77
Bid-YTW : -4.79 %

MFC.PR.D FixedReset Quote: 25.00 – 25.25
Spot Rate : 0.2500
Average : 0.1415

Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 25.00
Bid-YTW : 6.20 %

IFC.PR.C FixedReset Quote: 25.71 – 26.00
Spot Rate : 0.2900
Average : 0.2042

Maturity Type : Call
Maturity Date : 2016-09-30
Maturity Price : 25.00
Evaluated at bid price : 25.71
Bid-YTW : 2.86 %

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