The most interesting thing in GSElevator’s new book

The most interesting thing in GSElevator’s new book

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John Lefevre, the former banker behind the GSElevator Twitter account, has written a book and it has some pretty fascinating tidbits about the business of selling bonds. Readers of my work (the three of you out there) will know that this is a favourite topic of mine and Lefevre’s experience as a fairly senior syndicate guy means he has some some authority here. Even Matt Levine, who isn’t generally a GSElevator fan, thinks so.

Here’s what I found most interesting after reading a preview.

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A short lesson in duration, from some long Petrobras bonds

A short lesson in duration, from some long Petrobras bonds

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Earlier this week, Petrobras, the scandal-ridden, junk-rated state-controlled Brazilian oil producer, sold $2.5 billion worth of 100-year bonds.

The idea of these century-long bonds sent some tongues wagging about so-called duration risk. This is one of the more esoteric topics in bondland, but can roughly be defined as the sensitivity of a bond’s price to changes in its yield. The greater a bond’s duration, the more sensitive its price is to changes in its yield. With investors putting their money in Petrobras bonds for 100 years, so the thinking goes, these bonds are heavily exposed to the movement of interest rates. But is this the case?

One way of measuring duration is to look at something called PV01 on your (handy!) Bloomberg terminal.

This tells you by how many cents would the bond price changes following a 1 basis point move in yield. For Petrobras’s new century bonds, it’s less than 10 cents.

How does that stack up against some other bonds? For comparison, Petrobras’s bonds due in 2044 have duration of roughly $1.16.

Now I don’t mean to say that the 100-year Petrobras bonds aren’t risky. Investors still have to consider interest rates. And they have to think about what the Brazilian economy and the Brazilian government and the global oil market and Petrobras, still in the midst of a massive corruption investigation, will look like over the course of a century.

But duration risk for these bonds is not as high as it might be given investors are being compensated with a relatively high coupon and yield. Where duration risk is a concern is with all those low-yielding government bonds where that might not be the case. As Mark Holman at TwentyFour Asset Management points out, the duration of those 100-year Petrobras bonds is roughly equivalent to the duration of the current 10-year German Bund which, at the time of writing, has a yield of just  0.66 percent and a coupon of 0.5 percent.

The lesson: maturity ≠ duration.

Also, duration risk can crop up in unexpected places.

Why does everyone want corporate bonds? One word: Alpha.

Why does everyone want corporate bonds? One word: Alpha.

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Why the intense scrum for new-issue corporate bonds? It’s not just the yield on offer from buying the new debt. It’s the fact that that yield, for a brief but important moment in time, exceeds the benchmark.

Here’s a little Bloomberg post based on research from Citigroup credit strategist Jason Shoup.

He estimates that investors can add 20 basis points of alpha just by purchasing new-issue bonds.

… Alpha has been scarce in recent years. More than half a decade of ultra-low interest rates and extraordinary monetary stimulus from the world’s central banks means that many assets are moving in tandem, making it more difficult for investment managers to find alpha-generating opportunities. If assets were racing they’d be neck and neck, so to speak.

However, one place where alpha can be generated is in the corporate bond market where big companies sell their debt. The reason is simple. When companies sell a new bond there is typically a lag between the bond being issued and when it’s included in benchmark fixed income indexes …

The simple reason why everyone wants new corporate bonds

One last (FT) look at the corporate bond market

One last (FT) look at the corporate bond market

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This is my last big story for the Financial Times, as I’m heading off to a brand new gig at Bloomberg. The piece seeks to bring together a lot of what I’ve written about bond market liquidity, the rampant search for yield and the growing power of big buyside investors into a single narrative. Do read the full thing if you can.

Dan McCrum at FT Alphaville also has an excellent summary.

I’ve left some key excerpts below:

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New column – The unbearable tightness of benchmarks

New column – The unbearable tightness of benchmarks

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Benchmarks.

Their importance in financial markets cannot be overstated. So here’s a look at how the makeup of one particular benchmark bond index is making life difficult for big investors and in some cases encouraging them to use derivatives to introduce artificial duration to their portfolios.

(Writing about duration is always a huge hassle, but it too is very important in financial markets, so I try)

Here’s an excerpt:

If there were a recipe for creating the Barclays US Aggregate Index — one of the most important benchmark bond indices in the world — it might go something like this: take some US Treasuries, add a smattering of corporate bonds and securitised debt, then fold in a large chunk of mortgage-backed securities. Mix it all together et voilà — you are ready to serve a heaping portion of fixed income exposure to hungry investors around the world.

Fund managers are like chefs, trying to follow this basic recipe and improve on the outcome where possible — baking the basic bond fund cake, but adding their own twist to beat the benchmark. (After all, if you are simply replicating the benchmark’s returns, you had better be chargingvery low fees.)

However, fund managers seeking to outperform the Barclays “Agg” face a unique problem in the market in the shape of a severe lack of ingredients, and there are lurking concerns as to just what exactly fund manager cooks are reaching for in the kitchen.

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Bond index mix creates ingredient shortage

Creating liquidity from illiquid stuff

Creating liquidity from illiquid stuff

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A quick take on a long-running theme in markets, especially fixed-income.

Investors are reaching for a toolkit of exchange traded funds, mutual funds and credit derivatives to make up for a dearth of liquidity in parts of the financial system, according to market participants and research from Barclays.

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Many have turned to ETFs, mutual funds and certain derivatives to make up for a lack of liquidity. ETFs use a network of banks and trading firms to give investors cheap and instant exposure to a wide variety of assets.

The trend is particularly pronounced in the fixed income market, where new rules aimed at increasing bank capital and reducing the risk of a run in the “repo market” — Ground Zero for the financial crisis — are said to have most hurt ease of trading.

Risks squeezed out of banks pop up elsewhere

 

Big data, finance and inequality

Big data, finance and inequality

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… Financial companies have the option of using data-guzzling technologies that make the observation of shopping habits look downright primitive. A plethora of information gathered from social media, digital data brokers and online trails can be used to mathematically determine the creditworthiness of individuals, or to market products specifically targeted to them.

The degree to which such algorithms are utilised by mainstream banks and credit card companies is unclear, as are their inputs, calculations and the resulting scores. While many types of data-driven algorithms have been criticised for opacity and intrusiveness, the use of digital scorecards in finance raises additional issues of fairness. Using such information to make predictions about borrowers can, critics say, become self-fulfilling, hardening the lines between the wealthy and poor by denying credit to those who are already associated with not having access to it.

“You can get in a death spiral simply by making one wrong move, when algorithms amplify a bad data point and cause cascading effects,” says Frank Pasquale, a professor of law at University of Maryland and author of a book on algorithms called The Black Box Society.

I’ve said before that I am incredibly proud of this Financial Times piece exploring the impact of big data on finance and equality. Researching this kind of topic is challenging because details on the use of big data remain murky – even more so when it comes to banks and financial companies. For that reason, much of the discussion remains theoretical, although it’s hard not to believe that this is the direction we are heading when you read that Google – a company notorious for using big data to personalise ads and search engine results in the name of advertising dollars- is now trialling money transfers. The British bank Barclays has reportedly also begun selling aggregated customer data to third-party companies.

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New column – All the young traders who’ve never experienced an interest rate hike

New column – All the young traders who’ve never experienced an interest rate hike

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It’s been ages since the Federal Reserve last raised interest rates. Who remembers how that works? (Certainly not me, I was a baby reporter covering airlines back then) Here are some excerpts:

At least at the junior end, Wall Street is now peppered with traders and investors who possess no first-hand professional experience of an interest rate rise. Even for finance veterans, the habit of measuring one’s profit and loss on a day-to-day basis leads to notoriously goldfish-like memory spans and it has been six years since rates were last above the zero bound.

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Years of ultra-low interest rates have become integrated into the very fabric of markets. Asset managers live and die by their interest rate bets. Hundreds of billions of dollars have poured into riskier asset classes as investors seek out higher returns with borrowed money, or leverage, used to amplify profits.

Markets display total recoil on Fed interest rate rises

New column – Asset managers, repo and derivatives. Oh my!

New column – Asset managers, repo and derivatives. Oh my!

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Chances are, when you think of the repo market you think of banks and broker-dealers and the craziness that went down in 2008. This column, based on an amazing research paper by Zoltan Pozsar, suggests that’s a mistake.

(Bonus: It calls out Pimco on window-dressing its balance sheet)

Here’s an excerpt:

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