Malt Liquidity 10
Speed Racing, markets edition
The Times are a-changin’
The days of Swiss bank accounts belonging in the pantheon of cliché rapper boasts of extravagant wealth along with mispronounced mainstays Patek Phillippe and Audemars Piguet seem to be long gone, replaced with…Pokemon cards? Nowadays, it seems that the suppliers of the old-money-turned-nouveau-riche traditional fantasy have to resort to salesmanship just like everyone else:
Credit Suisse Group AG’s new chief executive said managing rich people’s money will be a priority for the bank, setting a target to boost wealth-management profits by at least a quarter in the coming years.
Hmm, I wonder why Credit Suisse happens to have a new CEO?
To woo wealthy clients, Mr. Gottstein will have to overcome the reputational challenges he inherited. His presentation didn’t directly address the spying scandal and other mishaps that plagued the bank this year. It came under fire after its chief operating officer and security chief hired private investigators to follow two executives last year. The bank ousted Mr. Thiam for failing to contain the fallout
Oh, right.
It’s not so easy to be a banker nowadays. The days of being a rainmaker deal-maker seem to be mostly over as investment banking goes the way of retail and becomes oriented more towards fixed-fee industry rather than pinning expectations on outsized advising fees and volatile, fluctuating trading businesses that are becoming increasingly difficult and regulated. After all, why pay Goldman exorbitant fees to underwrite an IPO when you could just list directly? Thus you see the issuance of ETFs and ETNs (managed by Étiennes) proliferate, and wealth management prioritized, as it’s the ultimate industry of predictable returns relative to capital raised (as you’re paid a cut of the AUM.) The problem is, CS is already behind the curve:
The asset and wealth management unit at J.P. Morgan Chase saw third-quarter revenue increase 5% year-over-year, to $3.7 billion, as the bank continues to make moves to ramp up this side of its business, according to its earnings call Tuesday.
Moreover, assets under management were up 16% year-over-year, clocking in at $2.6 trillion, while client assets hit $3.5 trillion, a 15% increase year-over-year.
Investment banks have gotten plenty of deserved, if a bit misguided, scrutiny and loathing post-2008, but gone are the days of fantastical rogue traders making leveraged bets the size of a developing country’s GDP, and the days of Vampire Squid Goldman Sachs.
Goldman makes credit cards now. Its main product of the future is a vehicle for low fee loans and high yield savings. It’s kind of like growing up and finding out Rolex stole the design philosophy of Swatches so they can churn out more machine-made, artificially limited supply steel sports watches. The times truly have changed.
Speed Racers
Speaking of misled outrage, the low-latency arms race had another feature written about it:
High-frequency traders are using an experimental type of cable to speed up their systems by billionths of a second, the latest move in a technological arms race to execute stock trades as quickly as possible
The article goes on about various fiber optic cables being implemented to connect New York to Chicago (where the options exchanges are) to the tune of some $300 million only to be made obsolete a few years later, lasers to beam data between NYSE and NASDAQ, and now “hollow-core fiber”, the current iteration of the most blasé Skynet to ever exist. Whenever high frequency trading comes up, however, the narratives revolve around the ‘evil’ High Frequency Trading firm (as opposed to the poor innocent investment banks and broker-dealers of yore who were so fair in their facilitation of markets), and there is a constant supply of suggested changes, many of them misleading and flawed, that pop up every time. People far more ingrained in the industry have put out fantastic explainers, but market making and microstructure happen to be near and dear to my heart, so I figured I’d throw together a quick explainer.
At its core, all market making does is facilitate transactions when there isn’t necessarily a buyer matched to a seller at the best bid/best ask price. Every transaction has to have an “other end” - if I wanted to buy Ford stock and had to wait for someone to come along who wanted to sell it precisely at the price I wanted to buy it at, transaction volume would be much lower, and prices would be much choppier, cause buyer and seller are in no way guaranteed to match. So all the market maker does is provide a bid and an ask on both sides, and when they are “hit” - one of those orders is filled - they try to seamlessly pair off an opposing trade, and the difference - the “spread” they make - is what makes this service worth providing.
The key word here is try - this is by no means riskless, which is why I have a problem with “arbitrage” appearing so frequently in discussions about HFT. If the market moves against you suddenly, or people decide to stop trading, you’re going to be exposed to the market. “Trading” in this sense is not about speculating on price, ever - you just want to collect the spread between the people who want to sell who don’t have buyers and the people who want to buy but can’t find sellers. You might notice that I consistently refer to spreads ‘widening’ when markets are volatile - liquidity provision is a massive competition between market makers, banks, and anyone else competing for the “flow” of potential orders to execute. Volatility is just uncertainty - when people do not know what is going on, they are less willing to trade, which is reflected in prices as it’s not so clear what price people are even willing to offer to buy and sell at. If there are less people showing prices they want to trade at, then naturally the spread between the buyers and the sellers will widen.
However, this is where market makers are incentivized to tighten the spreads, so they can make money! A precipitous balancing act starts to occur, where each firm is concurrently trying to undercut the other liquidity providers, yet also expose themselves to as little price risk as possible, because, again, that’s not their job. This is by no means easy to do, and any edge - latency, better optimization of code, whatever - is huge. But the individual benefits from this! Imagine that we didn’t have Citadel making markets for all Robinhood order flow for a second, and instead you had to call a banker or a broker (who has other, larger clients who pay him to trade THEIR orders with minimum slippage) who is responsible for matching your order to an opposing one. The risk is quantifiably higher - computers are exponentially superior at doing this - and the price is more, as is evidenced by the archaic tradition of quoting bonds in fractions which used to have an 1/8th or a 1/16th of a dollar caked in for “spread cost”, far more than the pennies a Citadel or Virtu will make executing a trade. Not only this, your price can only improve! If I place a limit sell order at 10.15, I absolutely cannot sell for anything below that price - it won’t get executed. But if you pay close attention to your order execution notifications, you might sometimes see something called “price improvement” - though the market bid/ask may have moved a bit above your order, your order was executed at a higher price to provide less slippage for a buyer - is anyone really losing when you get to sell at 10.153 instead of 10.15, the market maker takes the spread, and the next set of buyers and sellers have tighter, more accurate prices?
High frequency traders are not the industry titans that investment banks, mutual funds, hedge fund managers, or even college endowments are - they’re service providers to make electronic markets more seamless. Virtu, one of the largest and most well-known market makers due to their propensity for never losing money during a trading day, probably has a revenue of around 4.5-5 billion in perhaps the most historically market-maker friendly year ever. Compare this to Harvard’s endowment alone, which is 42 billion, or Bill Ackman’s Pershing Square, which handles about 12 billion. The fees on these AUMs alone would translate to well into the 9 figures, if not well into the billions after performance incentives, which is pretty close to how much Virtu probably makes on that 5 billion in revenue. And that’s just one hedge fund! If all the hedge funds and banks are clamoring together to say something, one suspects it’s a bit more “picking on the people who managed to chip some profit off the block” than it is “concern for the individual trader.”
On that note…