The world is all in the same boat

It’s important I keep you all informed at times of stress like this. I know many of you will be worried. 33 years in this business has armed me with the kind of experience that will certainly help us all once we get through this volatile period.

I have said it would continue to be a rocky road, right up until the end of the month on 31st. Then I believe the markets will settle as the next quarter starts. I believed that there had to be many forced sellers in the market, now I’m starting to see the proof of that hunch.

hedge fund wipe out

We are all investors for the long term. We inhabit markets though with many gamblers. Institutions that borrow huge amounts, combine it with further huge amounts and then let it ride to the end of the quarter when they are forced to settle up. Winning often, but when events turn against them potentially losing everything. Here’s an excerpt from a note from a knowledgeable expert that I have followed for the last decade:

Guys,

I wanted to share for any input. I’ve been watching what is going on in markets and my conclusion was that Risk Parity has blown up and Citadel and Millennium are in deep trouble. I just received a call from an old GS friend who now runs a large part of a Japanese bank balance sheet in the US and he was highly agitated…

His observation is that Bridgewater has faced massive redemptions from Saudi and others and that is what is caused some of the more dramatic moves last week (gold, bonds, equities and FX). He thinks AQR and 2 Sigma are in the same boat. There is massive forced liquidation of risk parity. All of them run leverage in the strategy, sometimes significant. Sovereign wealth, he thinks, is running for the hills as are others.

To put that into layman’s terms; All the huge hedge funds have dumped everything they have held to cover huge withdrawals and significant bets that have gone wrong, some of the withdrawals are needed to finance the oil wars between Saudi, Russia, Iran and the US. Even safer assets which should rise in times of stress have been sold like precious metals and Government Bonds causing their values to fall. Many of the hedge funds which I have referred to as “pirates” over the years are looking like they have been wiped out. By comparison we are a cottage industry.

hold or fold?

The vast majority of my clients don’t take a significant level of withdrawals. Of those who do, again the majority hold significant levels of cash in their portfolios to service the withdrawals without becoming forced sellers. Enough in most cases for at least 6 months. Some clients however do take much higher levels of withdrawals. It is only for those few clients that I will have to sell some assets in a couple of months time. I do not need to sell anything for anybody right now. So we all hold.

could i sell if i needed to?

To answer this hypothetical question, I need to help you to understand the process. If all of our assets were in funds, we could instruct the fund manager to sell. If he doesn’t hold enough cash to meet the redemptions he could say no and suspend the fund. The first commercial property funds have just shut their doors to withdrawals again, with several more to follow soon I suspect. We don’t hold illiquid property funds.

Most of our assets are held in shares. If you have read previous blogs you will remember that every share sold needs a buyer and every share bought needs a seller. They don’t just hang around like a used car does on a forecourt until the next owner comes along. I instruct the platform to sell, they pass my instruction to the stockbroker who puts all orders together and approaches 37 market makers who are authorised to act as the middle men. They each come back with a bid and the stockbroker takes the best bid and completes the transaction. Most shares are so liquid (many buyers and sellers) that the overall cost for buying or selling is just pennies. But right now much of the volatility is caused by the number of bids available. A lower number of bids means the cost between buying and selling goes wider. We can see this where there is a big seller on one day who has to accept a low offer, sending the price down, followed by a big buyer on a day where there are only reluctant sellers so the price goes up. Causing the same company to fall 10% one day only to rise 10% the following day. Currently if I sold it would not be for good value and if I bought it would not be at good value. Hence I’m remaining neither a seller or a buyer.

At times like this all systems come under extreme pressure, that’s why there are trip switches in the market to delay things whilst systems catch up. In the US a 15 minute trip has occurred on 3 days recently.

what comes next?

Worse I’m afraid. The middlemen have been instructed to work from home, but they cannot. Global regulations prevent that from happening. There is no office oversight in traders homes. The rules were brought in after Nick Leeson collapsed Barings in 1995. As Covid-19 spreads, traders will be forced to self isolate. I can still instruct the platform, the orders can go to the stockbroker but without the traders still operating from offices then no bids will be made.

Either regulations will need to be paused or stock markets will need to close for short periods. Already many counties have outlawed betting on shares falling like they last did in 2008.

don’t just do something, sit there

It may appear that we are currently sat on our hands but we are watching and waiting. The FTSE 100 has fallen 33% from it’s peak, much of it based on panic. However it seems to have already started to hover at around 5000 points and has been steadier over the last few trading sessions. Sell at any price has come to an end I hope, even earlier than the end of the month that I had suspected.

In times like this, shares move from weak hands to strong hands. We do not have weak hands because we are not forced to do anything. Shortly we can use that strength to start to pick up the babies that have been thrown out with the bathwater.

It’s natural to worry. If I’ve heard anything repeatedly since this crisis started it is clients telling me that they are glad they are not me! I’m glad I’m me. 33 years has primed me to see this through and put us all on the road to recovery. Who else would I trust with my life savings?