Should Dimon Take a Cue from CTAs?

We’re out of the office today, celebrating Memorial Day in the U.S., but we couldn’t resist putting out one tiny post. An interesting op-ed came out last week, calling for the breakup of too-big-to-fail banks. A tired line? Maybe, but this time around, the author wasn’t arguing for regulators or Congress to take action. No, she wants the bank leaders themselves to drop the axe. From CNNMoney:

Yet instead of waiting for the government or shareholders to act, the leadership of these megabanks should take the lead in downsizing. The best way for Dimon to provide a better return to his investors is to recognize that his bank is worth more in smaller, easier-to-manage pieces. Let’s face it, making a competitive return on equity is going to become even harder for megabanks as their capital requirements go up, their trading and derivatives activities are reined in, and their cost of borrowing rises as bond investors recognize that too-big-too-fail is over. If, by downsizing, Dimon can achieve valuations comparable to the regional banks’, he will potentially release tens of billions of value to his shareholders. And rule the roost once again.

Do we really think Dimon and the rest of the crew are about to pull the plug on their trillion-dollar circus? No way. Should they? Maybe. We aren’t bank CEOs (and proud of it), but we’ve watched and worked with numerous CTAs who have done what seems so difficult for the Wall Street titans: admitted their limitations.

When a CTA develops a program, their goal is to provide the best return for a certain risk level to investors. Sometimes they succeed, and sometimes they don’t. However, when they do succeed, and they see their assets surging, they may find themselves facing so called “capacity issues” because of their size.  For example, risking a certain percent of each account they manage may result in the need to buy 10,000 contracts of some futures market, and the market only does 12,000 contracts a day, on average.  CTAs don’t want to become any meaningful percentage of a market’s daily volume, for fear of their orders creating adverse price movement. They want to be a fly on the back of the bull (or bear), not the cattle prod which makes the animal jump this way and that.

The best CTAs, well before facing such tensions, will make a determination regarding capacity. In other words, they sit back and ask, “How much can I handle in assets before performance is impacted?” Through testing and experience, they set a ceiling on the amount of assets the program can accumulate. After a certain amount of time watching the markets, the capacity number may change, but generally speaking, it’s about CTAs knowing themselves and their programs well enough to say enough is enough. When we read that JP Morgan is in a bet so big that they essentially ARE the market, we know that such delibertations aren’t going on at one of the biggest financial institutions in the world.

We know that managers shutting their doors can be frustrating, even if it is in the best interest of the investor. They see a program, they like it, and they want in. But look at the other side of the coin, where you are in a position so big that it will take weeks/months/years to get out, and your position is so big that everyone knows you want out and won’t let you out anywhere near a reasonable price. JP Morgan is far removed from the fly on the back of the bull – they are the bull rider, the clown, and the rodeo all rolled into one.

Speak Your Mind

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DISCLAIMER

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.

The entries on this blog are intended to further subscribers understanding, education, and – at times- enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex, and is not intended as investment advice, or an offer or solicitation for the purchase or sale of any financial instrument. Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts. Opinions expressed are that of the author.

*The mention of specific asset class performance (i.e. +3.2%, -4.6%) is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.), and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship and self reporting biases, and instant history.

The mention of general asset class performance (i.e. managed futures did well, stocks were down, bonds were up) is based on Attain’s direct experience in those asset classes, estimates of performance of dozens of CTAs followed by Attain, and averaging of various indices designed to track said asset classes.

It should be noted that past market performance is not indicative of future market movement.No market data or other information is warranted by Attain Capital Management as to completeness or accuracy, express or implied, and is subject to change without notice.

Managed Futures Disclaimer:

Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.