Trade ideas This is sort of satisfying: Using a novel database, we show that the stock-price impact of analyst trade ideas is at least as large as the impact of stock recommendation, target price, and earnings forecast changes, and that investors following trade ideas can earn significant abnormal returns. Trade ideas triggered by forthcoming firm catalyst events are more informative than ideas exploiting temporary mispricing. Institutional investors trade in the direction of trade ideas and commission-paying institutional clients do so earlier than non-clients. Analysts generating trade ideas are more established and are more likely to produce ideas for stocks with high dollar trading commissions in their coverage universe. That is from a paper titled "Are Analyst Trade Ideas Valuable?," by Justin Birru, Sinan Gokkaya, Xi Liu and René Stulz. Analyst "trade ideas" are short-term recommendations (usually about some event in the next one to three months) that sell-side research analysts issue in addition to their formal long-term Buy or Sell or Hold recommendations and price targets. If you think a company has good fundamental long-term business prospects that are not fully priced by the market, you issue a Buy recommendation; if you think it's going to announce a big stock buyback at the end of the month that will push the stock up temporarily, you put out a trade idea. The most obvious intuitive model of what analysts do might go something like this: - They cover a bunch of companies and write a few formal research reports, deep dives on a company and its valuation, each year. They also write occasional brief updates after big events like earnings.
- This doesn't take that much time, really.
- What do they do the rest of the time?
- They spend some of their time talking to the companies they cover, getting to know the executives and the business, trying to understand how it works and what might be coming in the future.
- They spend some of their time talking to the investors who, ultimately, pay their bills: Investment banks provide sell-side research as a service to their institutional investor customers; if the customers get good quality research coverage from a bank, then they are more likely to do more trading with that bank and pay it more commissions. (Or, in Europe, they will just pay for the research directly.) Good quality research coverage means good written research reports and Buy/Sell recommendations, but that is just the most basic level of coverage, the stuff that any retail customer can get. The big customers want to be able to call up the analysts and ask questions, talk about the companies, exchange ideas, learn something.
- They spend some of their time just setting up meetings between the investors and the companies so they can talk to each other directly. (This is called "corporate access" and we talk about it occasionally.)
- Something happens in all of those meetings and phone calls. When the analysts talk to the companies, they learn something. When the analysts talk to the investors, the investors learn something. When the analysts introduce the investors directly to the companies, the investors learn something. None of these are purely social events; people are talking to each other to learn things, and if they keep doing it it must be because it works.
This model would predict (see points 4 and 7) that analysts will sometimes have good ideas about "forthcoming catalyst events": By getting to know a company and talking to its executives frequently, they may know more than the average investor about what the company is likely to do and when. And in fact: Our results document that trading buys (sells) are associated with significantly positive (negative) risk-adjusted returns. In terms of economic magnitude, the buy portfolio generates a daily DGTW alpha of 4.5 basis points, which corresponds to about 90 basis points on a monthly basis. Magnitudes are about twice as large for sells. There is no reason to think that this means that CEOs sometimes tell analysts "hey we're gonna do a buyback, pass it on." That definitely used to happen, and there are arguments that it is a good mechanism for diffusing information, but it is more or less illegal now. Still if you spend a lot of time paying attention to a company and talking to its executives, you may get more clues about what it is going to do, and be better at reading those clues, than an average generalist investor will be. The model might also predict (see points 5 and 7) that big commission-paying institutional customers will get good trade ideas from analysts before everyone else. And in fact: When we focus only on trading activity by institutional clients of the broker generating the trading call, we find that commission-paying institutional clients exhibit statistically significant increases in trading activity as early as three days ahead of the announcement of trading call. What does that mean? There's a simple possible explanation, which is that, when an analyst has a good trading idea, she first calls up her big institutional clients and gives it to them, and then she calls up her smaller clients and gives it to them, and finally she writes it up and publishes it to all of her clients. This sort of multi-tiered service, with better service for better customers, is common in, um, every industry—have you ever boarded an airplane?—and it wouldn't be that surprising to see it here. But it is, for reasons that I have always found a bit baffling, sort of illegal-ish in investment research; analysts are not supposed to tell big clients about research recommendations before publishing them. That doesn't mean it doesn't happen, though, and in fact banks periodically get in trouble for doing it.[1] But it's worth saying there are other possibilities. Remember the analyst's job is, among other things, to talk to the big clients. Those clients are also in the business of thinking about the companies she covers, and they also employ smart people who are good at that. Maybe sometimes they give her ideas, and she likes them and decides to publish them. Maybe her conversations with those big clients stir up or clarify her ideas, and she and the clients both go off afterwards and come to the same conclusions about trade ideas. This is not, just, the naked trading of factual tips; it is an intellectual process, an exchange of ideas; of course the clients who participate in that exchange will get better ideas out of it. Also here's a good paragraph on how analysts think about their jobs: We examine the incentives for an analyst to issue trading calls. Compared to other analyst outputs, a trading call is riskier for an analyst as it is much easier to assess whether a trade idea is correct or not than it is to assess whether a stock recommendation is correct or not. A recommendation has a long investment horizon and is generally based on fundamental analyses, so that a recommendation may not pay off for a host of intervening factors that the analyst could not have foreseen. The same argument applies for target prices. With a trade call, the investment horizon is short, and the call is based on a specific trading opportunity. While a successful trading call could make an analyst's name, an unsuccessful one may damage her reputation with investors. ... In our setting, the evidence likewise suggests that analysts with more established reputations are more likely to issue trading calls. As expected, we find that these calls are more likely to be issued by more experienced analysts (i.e., longer general forecasting experience, industry experience, or stock-specific experience) and all-star analysts. We also find that trading calls pay off for analysts who make them. Analysts who produce such calls are more likely to be subsequently included in the All-American Research Team roster. When you are starting out as a research analyst, you do a lot of fundamental financial analysis and industry research and try to develop a good long-term model of how your companies work. When you've been doing it for long enough you can be like "they're gonna do a buyback next month, buy some stock quick." Some of that is just the value of experience: When you've been doing it long enough, you can spot patterns with enough specificity and confidence to make specific actionable short-term predictions. Some of it might be access: When you've been doing it long enough, maybe you have more frequent or informative conversations with management than you did when you started. Some of it is just confidence: When you've been doing it long enough, getting a specific short-term call wrong is less damaging to your career, so you can take more risks. Deutsche Bank Oh man, Deutsche Bank owns a big and valuable ice cube, and then the temperature rose, and now it is just standing next to a bonfire juggling the ice cube while trying to convince BNP Paribas to pay for it: When Deutsche Bank AG said it was exiting the business of servicing hedge funds as part of its historic retreat, French rival BNP Paribas SA seemed poised to benefit. The reality is more complicated. The two European banking giants are discussing how to transfer 150 billion euros ($168 billion) of balances linked to hedge funds at Deutsche Bank's so-called prime-brokerage unit along with technology and potentially hundreds of staff, people familiar with the matter said. Yet the German lender's clients have been pulling about $1 billion of funds per day and going elsewhere as the firms iron out the details, placing pressure on them to complete a deal soon, said the people, who requested anonymity as the talks aren't public. We talked about this situation a couple of weeks ago, before Deutsche Bank announced that it was getting out of the prime brokerage business and handing its clients over to BNP Paribas. Back then clients were running away on the rumor that Deutsche Bank was not interested in being their long-term provider of prime brokerage services. The lesson, I suggested, was that if you're thinking about selling a big and valuable but non-core business whose clients can easily leave, you gotta do it quick, because if it just sits around being non-core for too long it stops being valuable. Now that it's official, yeah, $1 billion per day. "Potentially hundreds of staff!" There are a lot of people working at Deutsche Bank right now whose job is to support and service prime-brokerage clients, and who are hoping to continue doing that job at BNP Paribas, and who are doing their best to keep the clients there long enough for that to happen. I suppose some of the clients are happy with their service at Deutsche Bank and confident that they'll get a similar level of service when the group moves to BNP Paribas, and other clients just really like their Deutsche Bank coverage teams on a personal level and don't want to abandon them, and other clients have just somehow not been paying attention. If you're a Deutsche Bank prime brokerage customer relationship person, are you … marketing? Are you drawing up targeting lists and getting on planes to meet with potential new clients? Are you showing them a deck about your capabilities and then saying at the end "oh also it'll probably all still work at BNP Paribas"? How are those meetings going? Fannie and Freddie One put that I am short, in my pontificating career, is that I keep saying that Fannie Mae and Freddie Mac will never be re-privatized and will remain forever in conservatorship for the benefit of the U.S. government. Actually I don't exactly say that, or even believe it really, in so many words. All I think is that people will keep talking very sincerely about how important it is to return Fannie and Freddie to private ownership, and will keep announcing plans and blueprints to do that, and the optimal time to do it will perpetually be a year or two in the future. One day this delay will probably collapse and something will happen, but I keep confidently predicting that that day is not soon, and I keep being right. It is really inevitable that one day I will be wrong, so I am sorry in advance for that, but today is not that day: The Trump administration is growing wary of taking bold steps toward freeing Fannie Mae and Freddie Mac from federal control before the 2020 election, said people familiar with the matter, in part because of the political risk of potentially upending the U.S. mortgage market. While White House and Treasury Department officials are eager to end the companies' decade-long conservatorships, they see the task as arduous, slow-moving and extremely complicated, said the people who asked not to be named in discussing internal deliberations. Before this you could occasionally read articles saying that they were planning to take bold steps to free Fannie and Freddie, or that their eagerness to end the government-sponsored enterprises' decade-long conservatorships might lead to some actual action to do so, but I was not fooled. We'll just check back in 2020 when there will be no distractions and the mechanics of privatizing Fannie and Freddie will undoubtedly be at the top of the political agenda. Incidentally there is another way to look at this situation. The old, pre-2008 Fannie and Freddie were private companies that took on the default risk of a large chunk of U.S. mortgages, in exchange for a fee, and were backed by a nudge-and-wink informal guarantee from the U.S. Treasury. Then in the financial crisis they were taken over by the U.S. government, at which point they took on the default risk of U.S. mortgages for a fee, and were backed by a much more formal (though still not quite absolute) guarantee from the U.S. Treasury. The (quasi-)private guarantee became public. But since 2008, Fannie and Freddie have gotten a lot more aggressive about selling off the default risk of the mortgages they guarantee: Fannie and Freddie, backed by the Treasury, guarantee the mortgages against default (and package default-risk-free mortgage bonds and sell them to investors, etc.), but then they sell "credit risk transfer" securities to private investors who want to take on the default risk. They are no longer ultimate guarantors of mortgages against default; they are just conduits for packaging that default risk and selling it to investors. (I mean, partly.) "Credit Risk Transfer and De Facto GSE Reform," is the title of this paper from the New York Fed. The reform—returning the default-guarantee function of Fannie and Freddie to private hands—is already happening, just without returning Fannie and Freddie to private hands. If that's what is happening, maybe the right way to think about Fannie and Freddie is that they are a sort of administrative agency, in charge of setting the rules and running the mechanics of the mortgage market. They decide the best way to run the mortgage market, how the default risk and interest-rate risk and prepayment risk of mortgages should be split up, and then they parcel out those risks in market transactions to investors. They administer the market, but the actual work of funding and guaranteeing mortgages is (increasingly though not entirely) done by private capital. If that's the right way to think about it, then maybe government should be in the business of declaring victory, announcing that private capital has returned to the mortgage business, finishing the job (by doing more risk transfers until you've transferred all of the risk[2]), and accepting that Fannie and Freddie are government agencies for supervising the market for mortgage default risk, rather than businesses—businesses that will one day be re-privatized—for absorbing that risk. I am not sure that this is right, and I certainly don't expect it to happen soon. But the longer Fannie and Freddie spend as arms of the government, and the more they pass their economic risk on to private investors, the more it makes sense to think of them this way. If they stay in government hands long enough, they might become government. Efficient markets If I told you that a loan fund was an "enhanced" loan fund, would you guess that it: - Holds higher-quality loans than a regular loan fund, or
- Holds lower-quality loans than a regular loan fund?
"Enhanced" is a good word, so you might naively guess 1, but of course no the answer is 2: Since November of last year, three different money managers have issued $1.6 billion of so-called enhanced collateralized loan obligations that are set up to hold a much larger amount of loans with extremely low credit ratings than typical CLOs. At least two more managers are expected to follow suit in the coming months. The enhancement is not in the loan quality; it's in the interest rate: "Because they can hold lower-rated loans, the structures pay higher interest rates on the bonds they issue." Enhancement![3] There is something rather lovely about this, the deep acceptance of the relationship between risk and return, the confidence that flaws can always be compensated with price. In finance, the way to enhance something is to make it worse. Big gold coin I dunno, this sounds like a challenge: Richard Hayes plans to leave a $45 million coin on the streets of Manhattan all day Tuesday, but he isn't particularly worried about a thief carting it off. The coin—with Queen Elizabeth's profile pressed onto one side and a mid-hop kangaroo on the other—is beyond the wiles of the average pickpocket. It measures nearly 32 inches in diameter and is almost 5 inches thick. Oh, and it weighs about 2,200 pounds. Really if you're in New York today and feeling adventurous, you should mosey up to the coin, get to chatting with Hayes about cricket, and then, when his guard is down and he's feeling pretty smug about how unstealably heavy his gold coin is, bam, your accomplices swoop in with a big crane—and striped shirts and burglar masks and little mustaches, why not—and carry it away. Not legal advice, but so little of modern finance is this tactile and cartoonish. So many of the things worth stealing these days are, like, data sets, Swift keys, email addresses, entries in cryptographic ledgers, different sequences of zeroes and ones in a computer somewhere. This is a colossal gold coin with a picture of a kangaroo on it! You don't get to steal that every day. Things happen Goldman Stock Traders Buck Wall Street Trend on Revenue Jump. JPMorgan Falls as Lending Outlook Suffers From Fed Reversal. Facebook Called 'Delusional' Over Crypto Plan as Senate Digs In. A Leveraged Loan Collapses and Reveals Key Risk in Credit Market. The Next Big Thing in ETFs: Less Transparency. Fidelity Steps Up Fee War With Vanguard by Adding Low-Cost Funds. Santander offered a €52m sign-on to Andrea Orcel. Corzine Accepts Prop Trading Ban in His Wall Street Resurrection. Cantor Tightens Ban on Windhorst, Tells Brokers 'No Exceptions!' Jeffrey Epstein discloses assets of $560m in court filing. 'Bagel Guy' Chris Morgan signs deal to fight other viral celebrities. Drug smugglers are using Tesla's Autopilot to dodge the police, Pablo Escobar's brother claims. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] But now that European regulation requires explicit pricing for investment research, banks have started explicitly charging for different tiers of access: "While there's often a set price for reading reports, everything else -- analyst calls, bespoke financial modeling, conferences -- is mostly up for negotiation." Surely if you're paying extra for phone calls with analysts, you expect to get something out of them. [2] One element of a lot of proposals to re-privatize Fannie and Freddie is that they contemplate an official guarantee fee paid by the GSEs to the Treasury in exchange for an explicit government backstop. (Other, more libertarian proposals don't have this.) You could do the credit-risk-transfer approach with or without this: You could transfer every last bit of credit risk to private investors, or you could retain the super-senior tranche for Fannie/Freddie/Treasury. Existing CRT approaches are much more in the latter category: "The top roughly 96 percent of the structure, the 'senior tranche,' is entirely retained by the GSEs to cover catastrophic losses," the New York Fed explains about one representative deal. [3] It can also be in structure: The extra interest effectively allows more overcollateralization of senior tranches, so that they can end up safer than the equivalent tranches of a CLO that holds higher-rated debt. |
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