Traders’ forex chatroom banter exposed

The traders that attempted to manipulate the foreign exchange markets used chatrooms to share information about currency orders and gave themselves macho pseudonyms such as “The players”, “the A team” and “the 3 musketeers”, the UK financial watchdog’s investigation has revealed.

On Wednesday, the Financial Conduct Authority published chatroom messages showing how traders worked together to manipulate the benchmark, including “how can I make free money with no fcking heads up” [sic] and “cheers for saying you were same way helped me go early”.

Foreign exchange dealers usually quote two prices – for buying or selling a particular currency pair – making their money from the spread between the two rates. But banks offering a fixing service guarantee their clients the market mid-rate at this point in time. Traders with big orders to process therefore risk losing a significant amount if the market moves against them in the run-up to the fix – and the incentive to collude and try to make the exchange rate move in their favour is strong.Other messages showed the traders’ fear of being found out: “[don’t] want other numpty’s in mkt to know [about information exchanged within the group] but not only that is he gonna protect us like we protect each other.”

The shared information allowed them to match up orders and align trading strategies at and around the fix. A fix is a benchmark rate based on trades taking place in a given time window; and certain fixings, especially the WM Reuters rate used in calculating key global bond and equity indices, are popular with asset managers who want to trade at the same rate used to value their portfolios.

Citi

The FCA detailed one example of how some traders at Citi were able to manipulate the 1.15pm daily fix of exchange rates by the European Central Bank.

On the day in question, Citi had net buy orders of €200m and would benefit if it was able to move the ECB fix rate upwards.

Traders were able to “build” this order to €542m by using chatrooms to co-ordinate with traders at other firms who transferred their buy orders to Citi.

Furthermore, traders in a chatroom with net orders in the opposite direction to the desired movement at the fix sought to transact before the fix with traders outside the chatroom. The FCA said this practice was commonly referred to as “leaving you with the ammo”, building the volume of orders held by the traders in the chatroom in the desired direction and increasing their potential influence on the fix.

Having netted off its sell order with another party, one trader commented in the chatroom: “U shud be nice and clear to mangle”. The FCA said: “We read the word ‘mangle’ in this context as an attempt to manipulate the fix.”

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In the 15 seconds before the ECB fix, Citi placed four buy orders of increasing size and price which were priced at a level above the prevailing offer price. The FCA said Citi’s trading in this case generated a profit of $99,000.

After the fix, traders in the chatroom commented: “impressive”, “lovely” and “cnt teach that”.

HSBC

The FCA gave an example of how on one day it believed HSBC was involved in the manipulation of the 4pm WM/Reuters fix for the sterling-dollar rate. It allegedly colluded with traders from at least three other banks who, like it, were wanting to drive the rate lower.

From transcripts of chatroom conversations, about half an hour before the 4pm fix, a HSBC trader says “Let’s go”. Reply from Firm A: “yeah baby”, then: “hopefuulyl a fe wmore get same way and we can team whack it” [sic].

A trader from Firm D tells the trader from Firm A to “bask the fck out of it”.

Firm A then tells HSBC that a deal has been done with Firm E, which is buying. “Taken him out . . . so shud have iot rid of main buyer for u . . . im stilla seller of 90 . . . gives us a chance” [sic].

In depth

Forex trading probes

After the manipulation of Libor is rigging foreign currency markets the next big scandal to hit some of the world’s biggest banks?

Further reading

HSBC ended up selling £70m between 3.32pm and the start of the fix window. The FCA said these early trades were designed to take advantage of the expected downwards movement in the fix rate following the discussions within the chatroom.

In that time, the rate fell from $1.6044 to $1.6009.

HSBC then sold £311m during the fix window. HSBC and Firms A-C accounted for 63 per cent of the value of sales on the Reuters platform that day. The fix price was eventually $1.6003.

After the fix the traders said the following in the chatroom:

“Nice work gent . . . I don my hat”, “dont mess with our ccy [currency]”, “loved that mate . . . worked lovely . . . pity we coldn’t get it below the 00” and “we need a few more of those for me to get back on track this month”.

HSBC’s profit in this trade was $162,000, the FCA said.

JPMorgan

The FCA gave an example of a day when it says JPMorgan attempted to manipulate the 4pm WMR euro-dollar fix rate.

JPMorgan had net buy orders of €105m and wanted to move the fix rate up.

In a chatroom conversation, it offers to transfer this order to Firm A. Firm A says “maybe”. Firm A is buying €150m at the fix “for a top [account]”, adding “i’d prefer we join forces”. JPMorgan replies “perfick . . . lets do this . . . lets double team em”. Firm A replies “YESsssssss”. Later Firm A says to JPMorgan; “I got the bookies covered”, referring to dealers in the interdealer broker market.

By the fix, JPMorgan had built orders of €278m while Firm A’s orders were €240m.

We were EPIC at the fix yest

- Firm A

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JPMorgan bought €57m in the two minutes before the fix window. The FCA said these trades were designed to take advantage of the expected upwards movement in the fix rate following the discussions within the chatroom.

During the fix window, JPMorgan bought €134m and Firm A bought €125m. Between them they accounted for 41 per cent of the euro-dollar trade.

‘So couldnt have been that $hit a week!!

- Firm B

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JPMorgan’s profit in this trade was $33,000.

RBS

The FCA used an example of RBS attempting to manipulate the WMR GBP/USD fix on a day when it had net client sell orders at the fix and would benefit if it was able to manipulate the WMR fix rate lower.

Ahead of the fix, RBS shared information with other traders in the chatroom causing two of them to “net off” their buying and selling orders. Another firm responds by netting off part of its sell order with two other parties outside the chatroom.

The FCA said this practice was known as “clearing the decks” as traders netted off their orders with third parties outside the chatroom reducing the volume of orders that might otherwise be transacted at the fix in the opposite direction.

In a separate chatroom, RBS told three other traders: “We getting a lot Betty at fix” which the FCA said was trader slang for sterling/dollar, coming from “Betty Grable” which rhymes with “cable”.

‘We fooking killed it right’

- Trader

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In the period leading up to the 4pm fix, RBS built the volume of currency it sold to £399m which the FCA said “was designed to take advantage of the expected downwards movement in the fix rate following the discussions within the chatroom”.

The FCA said that RBS made $615,000 profit on this trade.

UBS

The FCA gave an example of an occasion when it says UBS attempted to manipulate the 1.15pm ECB euro-dollar fix. UBS was a net seller and wanted to move the rate lower.

Ahead of the fix UBS had net sell orders of €250m, Firm A was selling €200m, while Firm B was selling €100m. Firm A’s order’s dropped to €100m but it said “hopefully taking all the filth out for u . . .”, meaning it had netted off some of its orders with people who might have traded against UBS.

Firm A and UBS then said they had done short trades, each of €25m. Firm B then indicated that these short positions should be held for only 12 minutes, i.e until the ECB fix.

Firm A says it is now selling €50m at the fix. “I getting chipped away at a load of bank filth for the fix . . . back to bully [meaning €50m] . . . hopefully decks a bit cleaner”.

By the fix, UBS had sell orders of €200m and had increased its short position to €50m. Firm B had a short position of €50m. Firm C, a buyer, netted off with Firm A and Firm B, leaving it with €10m to buy at the fix.

Firm B then advised Firm C to “go late”, when the rate will be lower. Firm B copied into the chat a note from UBS, which said an earlier fix was “the best fix of my ubs career . . .” Firm B then added: “challenge”. Firm C replied “stars aligned”.

UBS’s net sell orders were €211m at the time of the fix.

At 13.14.59 UBS placed an offer to sell €100m at 1.3092, 3 basis points below the prevailing best bid. The ECB subsequently published the fix rate for euro-dollar at 1.3092. UBS’s order accounted for 29 per cent of the orders at the 1.15pm fix.

UBS’s trading in this example generated a profit of $513,000.

.............................................

In the US, the Commodity Futures Trading Commission also published transcripts from chatroom conversations between traders:

Three traders from Citi, JPMorgan and UBS discuss whether to invite a fourth into their private chatroom:

“Will he tell rest of desk stuff . . . or god forbid his nyk [New York office],” one trader asks. “That’s really imp[ortant] q[uestion],” another trader responds, adding: “dont want other numpty’s in mkt to know [sic] . . . is he gonna protect us like we protect each other against our own branches?”

A trader from HSBC visits multiple chatrooms in an attempt to manipulate the 4pm WMR fix, declaring he is a net seller in “cable” (a slang term for GBP/USD currency pairing):

“Hopefully a [few] more get same way and we can team whack it,” one trader responds. “ill do some digging”, says another prompting others to disclose their positions.

Simultaneously, in a separate private chatroom, the same HSBC trader informs other traders they should buy “cable” at the fix:

“Get lumpy cable at the fix ok” he said. A second trader replied “ta mate”. As the 4pm fix period closes, the HSBC trader comments: “I sold a lot up there and over sold by 100 hahaha”.

In another private chatroom, the HSBC trader discloses his position with traders at other banks before the closure of the fix period. The traders then share information about the size and direction of the orders at the fix period:

“You getting betty [Betty Grable, rhyming slang for cable] on the mumble still? We have nowt,” one trader asks. He then says: “Get it up to 60/70 then bash the fck out of it”.

Traders from Citi and JPMorgan co-ordinate within a private chatroom in an attempt to manipulate the EUR/USD fix:

“OK, I got a lot of euros,” says the first trader. A second trader responds: “ill take it if u dont want it”. The first trader replies: “lets double team it . . . how much u got?” and they jointly agree a trading strategy. Just after the 4pm fix, the first trader reported he was “hosed” and the second trader responded “ditto”.

Traders from UBS share their “scores” in a private chatroom:

Traders from UBS and three other banks exchanged their positions leading into the WMR 4pm fix. Once all four determined they were going to be trading in the same direction, one asked if “we gonna be able to get it to 05” to which another responded: “is that the royal fkn we?”. After the fixing window had closed, the chatroom members gave their “scores” or profits from the fix each claiming they made between $60,000 and $220,000 prompting one to add: “nice call”.

http://www.ft.com/cms/s/2/47c32ec4-6a34-11e4-8fca-00144feabdc0.html#slide0

This Is What Central Bankers Think Of Retail Investors

We previously covered the recently burst mega-Ponzi scheme fraud, Ezubao, the biggest in Chinese history which conned more than 900,000 investors out of $7.6 billion in less than two years under the guise of being a P2P lending platform, in this is what happens when "Chinese Investors Find Out They Got Fleeced By A $7 Billion Ponzi Scheme" and in "We Need To Rise Up": Bilked Chinese Investors Call For Nationwide Uprising After Massive Ponzi Uncovered." 

Of course this being China, even the Ponzi schemes are next level: as we noted before, police had to use two excavators and dug for 20 hours to unearth 80 bags of evidence that Ezubo executives had buried six meters underground on the outskirts of Hefei, a city in the eastern province of Anhui.

Then overnight, Reuters added some more juicy details to this epic fraud: executives at Ezubao's parent company, Yucheng Group, now say it was "a complete Ponzi scheme", which used investor funds to support a lavish lifestyle, the official Xinhua News Agency reported this week.

Among gifts that Yucheng Chairman Ding Ning gave his president, Zhang Min, were a $20 million Singapore villa, a $1.8 million pink diamond ring, luxury limousines and watches and more than $83 million in cash, Xinhua stated.

Amazing, but the real question is just how many other Ezubao are lurking. The short answer: many.

China's P2P and the online finance industry also serve as a critical channel for the emerging small business and consumer market, which is often ignored by banks and mainstream financial institutions. iResearch predicts China's unsecured consumer finance market alone will triple in size by 2019, reaching outstanding loans of over $1.7 trillion.

By November, there were over 3,600 P2P platforms as the industry raised more than 400 billion yuan, according to the China Banking Regulatory Commission (CBRC). More than 1,000 of those were problematic, it said.

The consequences when these schemes fail can be devastating, said Yang Dong, vice-dean at Renmin Law School and an expert on finance and securities law. "The harm is obvious. It's going to damage financial reforms, cause social unrest and destabilize the regime to some extent," he told Reuters.

400 billion yuan means as much as $60 billion in investor funds may have been Corzined from millions of soon to be very angry Chinese investors: we eagerly wait to discover their reaction when they learn the news.

But how could China's regulators be so asleep at the wheel? How could they allow such massive Ponzi schemes, which all guaranteed double digit returns and promised investors they would "get rich quick" at a time when the economy is foundering, to proliferate so easily for so long?

The answer brings us to the punchline of this post.

According to Reuters, it all has to do with the utter disdain that China's ruling echelon has for its upwardly mobile middle class, and specifically those tens of million of Chinese retail investors who have now been burned so badly in just the span of one year participating in a market which everyone warned for months is an epic bubble waiting to burst and which, well, burst and has been crashing ever since last summer.

Here it is:

A report on China's stock market crash authored last year by former senior officials, including former central bank vice governor Wu Xiaoling, said Chinese retail investors are short-sighted, have a weak investment philosophy and a herd mentality.

And there it is: central bankers who abuse the naive stupidity and herding of those who are "short-sighted" enough, to put trust in the system.

But the real problem is that this is not just a Chinese issue: this is prevalent across the entire world, in both Emerging and Developing countries, as a result of the hubris, the arrogance and the megalomania of the tenured economist class and its sycophant media enablers, who as a result of centrally-planning the world for the past 7 years, are convinced they can treat those whose money they desperately need to preserve the status quo as cattle.

In China, they are in for a very rude awakening. And soon, once the hypnotic spell of central banker omnipotence finally wears off, the outcome will be the same around the globe, an outcome which anyone who lived through even a few years of Soviet central planning, knows how it ends.

http://www.zerohedge.com/news/2016-02-03/what-central-bankers-think-retail-investors

Saudi Arabia’s Big Mess

Oil’s continued plunge is vying with China for the early financial headlines in 2016.

Yet many U.S. investors are missing the most important aspect of oil’s collapse: the dramatic effect oil’s falling prices are having on Saudi Arabia.

In November 2015, I speculated that the Saudis may have to devalue their currency, the riyal, versus the U.S. dollar for the first time since 1986.

Today my prediction looks prescient, as this supposed long-shot, black swan event is now becoming a distinct possibility.

Saudi Arabia’s Gigantic Budget Problem

The low price of oil – caused in part by the Saudis’ market share war – has blown a hole in the country’s budget.

Saudi Arabia announced at the end of 2015 that it ran a record budget deficit of $98 billion. That’s 15% of the country’s gross domestic product. To stem the bleeding, the Saudi government slashed its 2016 budget by 14%, and increased domestic fuel prices by two-thirds, even though it’s still only around $0.20 per gallon.

Meanwhile, the Saudis have also taken other measures to right the ship.

A few months ago, their sovereign wealth fund began repatriating funds from overseas money managers. This served to drain liquidity from global financial markets and hurt stocks. The Kingdom also sold sovereign bonds for the first time since 2007, and plans to sell at least $32 billion in sovereign bonds in 2016.

Finally, the Saudi Arabia announced that parts of its crown jewel – Saudi Aramco – will be sold in an IPO. Of all the recent moves made by the Kingdom, this is surely the most telling.

Saudi Aramco dwarfs any other oil company and will fetch a pretty penny. But it would’ve gotten a lot more if the sale had occurred when oil prices were high. That’s why I think the juiciest parts will not be part of this IPO.

Thinking the Unthinkable?

Even selling part of Saudi Aramco is unlikely to get the country out of the hole it has dug itself into with the oil share war. Bank of America estimates that $30-per-barrel oil will balloon the Saudi budget deficit to nearly $180 billion this year.

Thus, the smart money is betting that the Saudis will break the riyal-dollar peg, which has been set at 3.75 riyal to the dollar since 1986. The 12-month forward contracts on the riyal-dollar rate are trading at a 17-year high.

The Saudis have begun blowing through their massive reserves in trying to defend the peg. Sounds a lot like the Chinese problem, doesn’t it?

Reserves have declined from a peak of $746 billion in August 2014 to $635.2 billion at the end of November 2015.

Even the former head of asset management at the Saudi central bank, Khalid Alsweilem, thinks the peg will be history. He told the U.K.’sTelegraph, “If the reserves keep going down as they are now, they will not be able to keep the peg.”

If the Saudis opt to not devalue the riyal, they’ll have to cut oil production to get the price back up. I believe they’re too far down the path of trying to eliminate their competition to suddenly reverse course, and end up saving the U.S. shale producers from bankruptcy.

Any devaluation would have global implications and upset stock markets again.

Alsweilem said, “The consequences will be dramatic.” After all, the dollar peg has been the anchor of Saudi economic policy and global credibility for the past three decades. A change would surely stir up turmoil within the royal family, and give a boost to those opposed to the regime (such as the Iranians).

Let’s just hope the Saudis can control any devaluation and this doesn’t spiral out of control.

Good investing,

Tim Maverick

http://www.wallstreetdaily.com/2016/01/26/saudi-arabia-u-s-dollar/

ILQ Investor, Harald McPike, Backs UK Banking Startup Starling with $70M Investment

Alongside the centuries-old banks in the UK is a new crop of digital-only banking startups poised to enter the market. Licensed from the Bank of England last year were Tandem Bank and Atom Bank, with Mondo Bank and Starling Bank aiming to become fully regulated this year.

Among these digital startups, the common denominator is that they have been built from the ground up, and are banking solutions catering to the online and mobile based world. As such, in place of bank branches are multi-feature mobile apps that provide banking solutions as well as other tools focused on personal finance. However, traditional banks have also shown that they are evolving with the times with many firms having created digital brands of their own.

With the race for digital banking supremacy on, startups are battling their larger banking brethren to both acquire a new generation of customers as well as grab market share from existing account holders seeking innovative approaches to banking. Gaining a larger cash chest for this battle is Starling which has announced that it has raised $70 million from investment manager Harald McPike.

Founded by CEO Anne Boden, previously the Chief Operating Officer of AlB, Starling will be using the funds to help it enter the UK market and solidify its team as it finalizes its offering and awaits regulatory approval. In addition to the new funds, Starling announced its Board of Director appointments. The board will be chaired by former Standard Bank non-executive director Oliver Stocken, and include Victoria Raffé formerly of the FCA, as well as Marcus Traill and Craig Mawdsley as non-executive directors. The four join Mark Winlow and Steve Colsell who were appointed in 2015.

For McPike, the investment in Starling Bank is his latest in the financial field. Operating the QuantRes group of companies, McPike’s endeavors include algorithmic trading and quantitative investments. A previous investment for McPike was US-regulated online forex broker ILQ for which he also served as a company principal. Operating under the NFA’s jurisdiction, McPike was noted for providing material financing to help ILQ meet minimum capital requirements for operating a forex broker which are higher in the US than anywhere else in the world.

Regarding the investment, Anne Boden stated: “It was important to us to have an investor with not just the financial strength but who also shared our ambition of empowering people with meaningful insight into their own financial information. With his background in algorithmic trading, risk management and technology, Harald sees the significant potential of technology in the retail banking sector. His commitment of $70m is the catalyst needed to propel Starling’s launch.”

Harald McPike, Founder of QuantRes, added: “Starling Bank will provide people with the kind of innovative leaps in their financial lives that they have experienced in transportation and video streaming, so this is an investment opportunity I could not pass up. I share Starling’s vision of creating genuine positive change in peoples’ lives and will enjoy seeing a revolution in the banking experience. Mobile technologies continue to alter fundamentally our lives and expectations of how we manage them, but it seems that traditional banks are not able to adapt fast enough. Anne and her team bring strong capabilities, passion and determination to finally provide people a modern, mobile-first bank.”

http://www.financemagnates.com/fintech/news/ilq-investor-harald-mcpike-backs-uk-banking-startup-starling-with-70m-investment/

JOHN W. HENRY – AN AUTOPSY OF ONE OF THE GREATS

We’re starting to get a little morbid around here – first with the “Is Trend Following Dead?” piece a couple weeks back, and now an “autopsy” of sorts on what went wrong at John W. Henry’s self-named firm. Some of the sales teams in the industry may prefer to avoid discussing such subjects, probably thinking something along the lines that doing so will “scare away the customers,” but to hear that John W. Henry was shutting down his eponymous managed futures shop was the kind of news that draws us like a moth to a flame.

Here was an industry stalwart in every sense of the word. A man who helped put managed futures on the map, and helped his pocket book to the tune of becoming a billionaire. He is a literal Hall of Famer, having received the Futures Hall of Fame award (whatever that is) from the Futures Industry Association. This isn’t quite Paul Simon hanging up his guitar, or Steven Spielberg deciding to get out of the movie business – but it’s close in terms of shock factor in the managed futures space.

This raises one huge question - well, actually, it raises hundreds of questions - but the big one is this: what in the world happened? We don’t just mean this week in the announcement that he was done, either. What happened in the past 8 years to transform a behemoth into a blip on the radar? Where did John Henry go wrong? Eight years ago he was managing $3 Billion and on top of the managed futures world, with a hot young upstart called Winton measuring in at only about 1/3 the size of Henry’s managed futures empire.

Why was 2004 the top for Henry, yet just a launching point for Winton and other billion-dollar managers?  But most importantly for investors - how can we learn to identify when a top-tier managers’ best days are behind them?

Did he take his eye off the ball?

Excuse the all too easy baseball pun here – but the easy answer for many is to say things started to go downhill when Henry started to stray from his managed futures roots and dabble in sports, buying the Florida Marlins, then Boston Red Sox, a Nascar team and an English soccer squad. If he had only spent less time analyzing pitchers and trying to hire the next Billy Beane – and instead spent more time researching new models and risk parameters for his CTA – then things might have been different… or so the logic goes. 

This would be exactly the kind of shift that an ongoing due diligence program is designed to catch, and something we wrote about not long ago in a newsletter. The general idea is that by staying in close contact with a manager, you can get a feel for when things might be going awry in a way that might impact performance. There is never a guarantee that you'll see the curve ball coming, but you've always got a better chance of it if your eyes are open. 

The problem is that this logic starts to fall apart when we look at just when Henry started these other business ventures, which, according to the Disclosure Document for the JWH programs, began as early as 1987:

“Since the beginning of 1987, [Henry] has devoted, and will continue to devote, a substantial amount of time to business other than JWH and its affiliates.” 

Even if we use the later date of 1998, according to a great 2007 blog post (they had blogs back then?) from the now-deceased Greg Newton (as if this story wasn’t morbid enough already), the shift of focus to include a sports empire doesn’t appear to have affected the performance (which held up until the end of 2004).

His heavy-duty distractions did not begin until he became involved in major league baseball… Henry bought the Florida Marlins in 1998. 

Maybe it’s the Boston Red Sox curse, which Henry supposedly lifted by bringing a World Series title to Beantown? He became involved there in 2002, and things have been bad on the managed futures side for most of the time since.

So while the brains of the operation shifting his focus to baseball seems like an easy due diligence red flag, the numbers don’t really support it as the cause of the decline. Regardless, any investor after the year 2000 would have known of this concern.

A more nuanced “taking his eye off of the ball” argument – and something to consider when conducting due diligence on a manager – is the number of programs in the stable. For JWH, the answer is: quite a few. There are 17 different “capsule performance” tables in the JWH D-Doc. This can be another worry in the due diligence process – can a manager run 17 world-class programs at once? And if not, which would you rather see: 17 mediocre programs, or 1 excellent one?

It’s a plausible story, but in this case, perhaps a more likely culprit in terms of “who’s minding the store” is the high manager turnover.

Manager turnover

So if the boss isn’t always running things, you had better have a very high level of confidence in whoever is picking up the slack. Leadership transitions are often due diligence red flags, but as it turns out – this one isn’t all that straightforward, either.

We’ll borrow heavily from Greg Newton in parsing the Disclosure Document and news clippings on Henry company hires here:

Like those stomach-churning drawdowns, management turnover is nothing new at JWH. Before Rzepczynski’s record tenure ended in January [Others shown the door at much the same time as Rzepczynski included long-time marketing executive Ted Parkhill; Bill Dinon, head of sales; and Andrew Willard, director of technology], past holders of the president title included Verne Sedlacek, now president and chief executive officer of Commonfund; Bruce Nemirow, now a principal of Capital Growth Partners, a third-party marketing company; and Ken Tropin, who, after a distinctly less than amicable split with Henry, went on to found Graham Capital Mgt Inc in 1994. That firm’s assets passed JWH’s several years ago.

Between Nemirow and Sedlacek, Peter Karpen, a former chairman of the Futures Industry Association; and David Bailin, now head of alternative investments at US Trust, held similar responsibilities, without the title of president.

It’s easy to look back on it in hindsight and say that a bunch of people jumping ship in 2007 was a bad sign, but consider how it looked in the moment: the person leaving had been there 9 years, while the person replacing him had been there 12 years. That certainly doesn’t look so bad, especially when compared with a program (Winton) which is just getting started or a management team with 5 years or less of experience.

Adapt or Die (but careful with those adaptations)

Did hubris play a part? Again, from Greg Newton:

JWH generally has not changed the fundamental elements of the portfolios due to short-term performance, although adjustments may be, and have been, made over time. In addition, JWH has not changed the basic methodologies that identify signals in the markets for each program. JWH believes that its long-term track record has benefited substantially from its adherence to its models during and after periods of negative returns; however, adherence to its strategy may lead to prolonged periods of market losses and high risk, according to its current disclosure document.

Did a stubbornness to adhere to the models which had worked in the 80s, 90s, and start of this century cause those models to become outdated? That seems doubtful. As we say around here, “Systems don’t break, they just become more risky.” It would appear that this is exactly what happened to JWH. Of course, some on the risk management side of a successful CTA might say that a model becoming more risky is the same thing as that model breaking. After all, the risk is the most important part. And we wouldn’t argue too much there.

In the end, it looks like it may have been the worst of both worlds for Hentry: sticking with the base models but tweaking the position sizing. Per page 34 of the JWH D-doc, we learn that the position sizing has been changed 16 times across 9 programs since 2003.  And these weren’t all position size reductions – many were increases. On one hand, if you are taking losses at a high trading level, then trying to gain those losses back at a reduced level, it’s going to take much longer to return to profitability. But if those losses we due to unresolved flaws in your trading method, raising your position sizes is just doubling down on a losing strategy.

Live and Die by the Volatility

Most of those in the industry will tell you John W. Henry was simply too volatile for modern tastes, and you can see when taking a look at his programs’ track records some big numbers on both sides. Take the financials & metals 36% annualized volatility for example, or the multiple years with above 40% gains or more than -17% losses, and you can see that Henry’s model was one of high risk for high return.

But it’s more than just the fact that the JWH programs were volatile – what stands out is how much more volatile they were than “normal” and the fact that they were getting more volatile compared to the competition.

The above look at the ratio between the JWH composite’s rolling 12mo annualized volatility and that of the BarclayHedge CTA Index shows that the JWH programs were about 2.25 times more volatile, on average, than the index during their boom times (the first 20 years), and had jumped to 3.49 times more volatile, on average, in the past 8 years.

Again, this is something more easily seen with hindsight, but this is easy enough to analyze in real time. It’s especially concerning how volatile a program is not just in absolute terms, but in relation to its benchmark as well. And if it’s 5 times more volatile – as JWH was a few times in 2008 – you had better be sure you are getting 5 times more the return as well.

Which brings us to…

You have to make money

At the end of the day in this business (or any other), no amount of name recognition nor bulletproof due diligence can make up for the failure to make money for your clients over a five year period, and that, more than anything else, led to John W. Henry closing up shop.

Consider the Financials & Metals program again. Heading into 2005 the program had never experienced back-to-back losing years. In fact, only once had the program suffered more than 1 losing year in any 7 year period (losing two out of three between 92 and 94). The program then saw losses in three consecutive years between 2005 and 2007, and when including this year’s down performance, the program has now lost money in 5 of the past 7 years.

 The three years of losses ending in 2007 are likely what led to Merrill pulling the plug in that year (right before the program experienced a big bounce back, but that’s a topic for later), but the table above shows that something is materially different in the past eight years when compared to the first 20 for the Financials & Metals program.

A CTA’s job is twofold. First, to generate absolute return performance, so that a customer who gives the program at least three years to do its job will be rewarded with positive performance. And second, to stay ahead of the competition.

It’s no easy task, to be sure, and John Henry’s gold-lined trash cans are probably filled with the brochures of contenders who tried and failed. But since 2004, it has been Henry’s programs which have failed on both counts. They haven’t remained positive across the bulk of the rolling three year periods, with some of the rolling three year returns falling below -20%. And while those years haven’t been kind to many other CTAs, JWH failed to stay ahead of the competition. They spent most of the past eight years with rolling 36 month returns below that of the BarclayHedge CTA Index.

Henry was lagging the index and seeing large negative 36 month returns as early as 2005, meaning there were chinks in the armor that appeared well before Merrill pulled the plug in 2007.  But pulling the plug on an underperforming advisor has to be one of the hardest things to do for the individual investor. Especially when you are considering pulling the plug on a Hall of Famer.

It’s all Relative

It’s a zero sum game, as managed futures detractors like to say. But the reality is that it is not that black and white. There isn’t always one clear winner and one clear loser. It’s more like a few thousand winners, a few thousand losers, and many more in between.

The job of the investor, then, isn’t necessarily to find the winner and avoid the loser, but to find the one doing a better job of winning than the others. What does that mean? Providing return with less volatility, more consistency, experiencing smaller drawdowns, shorter drawdowns – the list goes on.

Which brings us back to Henry. You see, while he is up (big time) in the zero sum game overall, the biggest takeaway for us following this pseudo-autopsy on the John W. Henry programs was in how the program started to become one of the worst winners according to our ranking algorithm.

The biggest warning flag to us was seeing how his ranking fell despite the program going on to make new equity highs.

You see, we don’t just rank on performance – we rank on comparative performance, across many time frames, and incorporate risk metrics to normalize the performance across programs. So you not only have to do well – you have to play the game better than the next guy in terms of controlling risk, delivering consistency, and more.

The fact that the John Henry programs started to fall in our rankings after their 1999 drawdowns is a sign of poor relative performance. In other words, they weren’t just doing poorly because of a bad managed futures environment – they were doing poorly AND performing worse than their peers were in that same environment. You can get away with rough years, but you can’t do worse than your peers for an extended period of time and hope to stay in the game.

Lessons Learned:

Don’t cry for Henry – he’s doing just fine: still worth $1.5 billion, and the 389^th richest person in the US according to Forbes.

But do pay attention to the potential lessons within this story:

1.       Past performance is not necessarily indicative of future results. It’s not just a disclaimer, and the performance of the Henry Financials & Metals program shows the reality of that – with winning years in 17 out of its first 20 years followed by losing ones in 5 out of 7.

2.       Know what sort of program you are getting involved with. John Henry’s programs were notoriously high volatility, and willing to take larger losses in exchange for home-run type years - meaning  losses of -20% and more shouldn’t have surprised anyone.

3.       Beware the big brokerage house (Merrill Lynch types) selling a big brand name managed futures program. While Henry was a poster child for managed futures as late as 2004, there were warning signs for his programs well before that.  The big brokerages believe they are being conservative when selecting the well-known program with a long history of success, but they could be better served identifying lesser-known programs with the risk and reward profile their clients want. They are often late to the party and late to get out.

4.       Henry is still a Hall of Famer. Yeah, we know… we said there were warnings, his main program has our lowest ranking, and we wouldn’t recommend a JWH program for our clients. But having said all that, he also made a lot of money for a lot of people in his early days (and knowing how these things cycle he’ll likely go on to make himself another small fortune just by trading his own money). We’ve never met him, and don’t know what sort of person he is – but we’re willing to bet that many of the clients involved with him during the ‘80s and ‘90s still think he’s worthy of that hall of fame distinction. 

http://www.attaincapital.com/alternative-investment-education/managed-futures-newsletter/investment-research-analysis/496

Norway's Biggest Bank Demands Cash Ban

The war on cash is escalating faster than many had imagined. Having documented the growing calls from the elites and propagandist explanations of the "benefits" to their serfs over the last few years, with China, and The IMF entering the "cashless society" call most recently, International Business Times reports that Norway - suffering from its own economic collapse as oil revenues crash - has joined its Scandi peers Denmark and Sweden in a call to "ban cash."

By way of background, as we explained previously, What exactly does a “war on cash” mean?

It means governments are limiting the use of cash and a variety of official-mouthpiece economists are calling for the outright abolition of cash. Authorities are both restricting the amount of cash that can be withdrawn from banks, and limiting what can be purchased with cash.

These limits are broadly called “capital controls.”

Why Now? Why are governments suddenly so keen to ban physical cash?

The answer appears to be that the banks and government authorities are anticipating bail-ins, steeply negative interest rates and hefty fees on cash, and they want to close any opening regular depositors might have to escape these forms of officially sanctioned theft. The escape mechanism from bail-ins and fees on cash deposits is physical cash, and hence the sudden flurry of calls to eliminate cash as a relic of a bygone age — that is, an age when commoners had some way to safeguard their money from bail-ins and bankers’ control.

Forcing Those With Cash To Spend or Gamble Their Cash

The conventional answer voiced by Mr. Buiter is that recession and credit contraction result from households and enterprises hoarding cash instead of spending it. The solution to recession is thus to force all those stingy cash hoarders to spend their money.

And the benefits of a cashless society to banks and governments are self-evident:

1. Every financial transaction can be taxed.

2. Every financial transaction can be charged a fee.

3. Bank runs are eliminated.

In fractional reserve systems such as ours, banks are only required to hold a fraction of their assets in cash. Thus a bank might only have 1 percent of its assets in cash. If customers fear the bank might be insolvent, they crowd the bank and demand their deposits in physical cash. The bank quickly runs out of physical cash and closes its doors, further fueling a panic.

The federal government began insuring deposits after the Great Depression triggered the collapse of hundreds of banks, and that guarantee limited bank runs, as depositors no longer needed to fear a bank closing would mean their money on deposit was lost.

But since people could conceivably sense a disturbance in the Financial Force and decide to turn digital cash into physical cash as a precaution, eliminating physical cash also eliminates the possibility of bank runs, as there will be no form of cash that isn’t controlled by banks.

So, when the dust has settled who ultimately benefits by this war on cash - government and the central banks, pure and simple.

Which explains why Norway's biggest bank, DNB, has called for the country to stop using cash which is just the latest move in a country that has been leading the global charge toward electronic money in recent years, with several banks already not offering cash in their branch offices and some industries seeking to cut back on paper currency.

DNB's proposal suggests eliminating the use of cash would cut down on black market sales and crimes such as money laundering.

“Today, there is approximately 50 billion kroner in circulation and [the country’s central bank] Norges Bank can only account for 40 percent of its use. That means that 60 percent of money usage is outside of any control. We believe that is due to under-the-table money and laundering,” Trond Bentestuen, a DNB executive, told Norwegian website VG, the Local reported.

“There are so many dangers and disadvantages associated with cash, we have concluded that it should be phased out,” he added.

The country has already moved in this direction. Bentestuen estimated that only about 6 percent of Norwegians use cash on a daily basis, with the numbers higher among elderly people.

Norway’s Ministry of Finance is opposed to the proposal, however, and other critics have raised concerns about privacy issues as well as how the change would affect tourists. Privacy advocates in Norway have expressed worries for years that, without cash, there would be no way for an individual to purchase something without being tracked.

In 2014, Finans Norge, a financial industry organization in Norway, said the country was on pace to be a cashless society by 2020, Ice News reported. While DNB said its proposal will take time to complete, executives suggested the country start phasing out cash by discontinuing the 1,000 kroner note so it could focus on updating its banking system.

“Eighty-five percent of our customers say that they never or only very rarely go to the bank. Therefore we think it is a mistake to maintain a very old structure with local branch offices. It is better to follow the customers and improve the offers where the customers are: digital,” Bentestuen said.

In the meantime, DNB and Norway’s second largest bank, Nordea, have already stopped using cash in their branch offices. And the movement toward a goal of no cash has been going on for a while. The Norwegian Hospitality Association pushed to eliminate consumers’ right to pay cash at all stores and restaurants in 2013, The Local reported.

Other countries including Denmark and Sweden have made similar pushes as their populations also rely largely on electronic money.

If allowed to continue, state wealth control will exist.

And thus, as we concluded previously, if you can’t withdraw your money as cash, you have two choices: You can deal with negative interest rates...or you can spend your money. Ultimately, that’s what our Keynesian central planners want. They are using negative interest rates and the War on Cash to force you to spend and “stimulate” the economy.

If you ask us, these radical and insane measures are a sign of desperation.

The War on Cash and negative interest rates are huge threats to your financial security. Central planners are playing with fire and inviting a currency catastrophe.

http://www.zerohedge.com/news/2016-01-23/norways-biggest-bank-demands-cash-ban 

Stackelberg competition

The Stackelberg leadership model is a strategic game in economics in which the leader firm moves first and then the follower firms move sequentially. It is named after the German economist Heinrich Freiherr von Stackelberg who published Market Structure and Equilibrium (Marktform und Gleichgewicht) in 1934 which described the model.

In game theory terms, the players of this game are a leader and a follower and they compete on quantity. The Stackelberg leader is sometimes referred to as the Market Leader.

There are some further constraints upon the sustaining of a Stackelberg equilibrium. The leader must know ex ante that the follower observes its action. The follower must have no means of committing to a future non-Stackelberg follower action and the leader must know this. Indeed, if the 'follower' could commit to a Stackelberg leader action and the 'leader' knew this, the leader's best response would be to play a Stackelberg follower action.

Firms may engage in Stackelberg competition if one has some sort of advantage enabling it to move first. More generally, the leader must have commitment power. Moving observably first is the most obvious means of commitment: once the leader has made its move, it cannot undo it - it is committed to that action. Moving first may be possible if the leader was the incumbent monopoly of the industry and the follower is a new entrant. Holding excess capacity is another means of commitment.

https://en.wikipedia.org/wiki/Stackelberg_competition