1scsdccd by 11blabmagg42

Volume 25 / Issue 4

Rise of the Buy Side

The Seven-Year Short

Alpha Insights, Revealed

Game Your Gray Matter

All hail the mighty bond lords, who suddenly seem stronger than ever p 82

China’s yuan has defied hedge fund manager Mark Hart. Will he prevail? p 90

Portfolio analysis uncovers what propelled a “Dogs of the Dow” strategy p 58

Train your brain for trading! Neuroscience informs a new function p 48

“I will never declare victory” Tidjane Thiam on the total makeover of Credit Suisse p 74

September / October 2016

research

“Bank of America Merrill Lynch” is the marketing name for the global banking and global markets businesses of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., Member FDIC. Securities, strategic advisory, and other investment banking activities are performed globally by investment banking affiliates of Bank of America Corporation (“Investment Banking Affiliates”), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional

counts Deliver insights that clients value, and everyone wins.

Voted Top Global Research Firm 2011-2015 Institutional Investor TYPE BAM <GO>

The power of global connections™ Clearing Corp., both of which are registered broker-dealers and Members of SIPC, and, in other jurisdictions, by locally registered entities. Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp. are registered as futures commission merchants with the CFTC and are members of the NFA. Investment products offered by Investment Banking Affiliates: Are Not FDIC Insured • May Lose Value • Are Not Bank Guaranteed. THE POWER OF GLOBAL CONNECTIONS is a trademark of Bank of America Corporation, registered in the U.S. Patent and Trademark Office. ©2016 Bank of America Corporation

Helping Investors Get Out of Their Own Way Financial advisors (FAs) need to understand how to help their clients overcome the psychological roadblocks almost all of us face when it comes to retirement savings, according to Vicki Bogan, a Professor of Finance at Cornell University. She also serves as director of its Institute for Behavioral and Household Finance and LV D +DUWIRUG )XQGV Ã&#x20AC; QDQFLDO UHODWLRQVKLS H[SHUW

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,Q SK\VLFV LQHUWLD PHDQV WKDW DQ REMHFW DW UHVW ZLOO UHPDLQ DW UHVW XQOHVV DFWHG XSRQ E\ DQ XQEDODQFHG IRUFH ,Q SHUVRQDO Ã&#x20AC; QDQFH \RX VWDUW \RXU ZRUNLQJ OLIH ZLWK QR UHWLUHPHQW VDYLQJV VR \RX VWDUW DW UHVW 7KH )$ QHHGV WR EH WKDW XQEDODQFHG IRUFH that pushes clients into motion. ,I \RX ZDQW VRPHRQH WR VDYH IRU UHWLUHPHQW DQG \RX NQRZ WKHLU QDWXUDO WHQGHQF\ LV WR EH VWLOO WKHQ \RX FDQ VHW XS ZKDW HFRQRPLVWV FDOO Â´FRPPLWPHQW GHYLFHVÎ¼ WKDW KHOS WKHP WDNH action. You can help them set up automatic contributions to their N RU \RX FDQ JR EH\RQG WKDW VR WKDW WKH\ KDYH DXWRPDWLF increases in their contributions when they receive raises. They FDQ GHYRWH WKDW SHUFHQW VDODU\ LQFUHDVH WR D SHUFHQW LQFUHDVH in their 401(k) contribution. , ZRXOG DOVR HQFRXUDJH )$V WR KDYH DXWRPDWLF checkpoints to revisit issues. Itâ&#x20AC;&#x2122;s easy to set things XS LQ DQ DXWRPDWLF IDVKLRQ DQG WKHQ QHYHU WRXFK them again. Thatâ&#x20AC;&#x2122;s also a problem with inertia; LWÂ·V MXVW UROOLQJ DORQJ DQG \RXÂ·UH QRW JRLQJ WR GR DQ\WKLQJ EHFDXVH LWÂ·V LQ PRWLRQ %XW \RX QHHG WR KDYH \RXU FOLHQWV ORRN SHULRGLFDOO\ DW ZKHUH WKHLU money is going. All investments are subject to risk, including the possible loss of principal.

7R OHDUQ PRUH DERXW LQYHVWRU SV\FKRORJ\ DQG KRZ )$V FDQ EHWWHU FRPPXQLFDWH with their clients, go to the Hartford Fundsâ&#x20AC;&#x2122; HumanCentricInvesting.com

Human-centric investing means understanding the behaviors, motivations and eccentricities of your clients, not just the market.

Î&#x2013;QWURGXFLQJ WKH +DUWIRUG )XQGV QHWZRUN RI QDQFLDO UHODWLRQVKLS H[SHUWV At Hartford Funds, we believe in something we call human-centric investing, an approach that seeks a deeper understanding of LQYHVWRUV DQG KRZ HPRWLRQV H[SHULHQFHV OLIH VWDJH DQG SV\FKRORJ\ D HFW WKHLU YLHZV RI LQYHVWLQJ DQG QDQFLDO DGYLVRUV b :LWK WKDW LQ PLQG ZHČ&#x2021;UH SURXG WR DQQRXQFH WKH HVWDEOLVKPHQW RI D QHZ DQG XQLTXH QHWZRUN RI H[SHUWVČ?QRW VLPSO\ RQ QDQFH EXW RQ KXPDQ SV\FKRORJ\ DV LW UHODWHV WR PRQH\ DQG UHODWLRQVKLSV Î&#x2013;Q WKH FRPLQJ PRQWKV WKLV JURXS RI KLJKO\ UHVSHFWHG WKRXJKW OHDGHUV ZLOO EH R HULQJ XS WKHLU XQGHUVWDQGLQJ DQG LQVLJKWV DORQJ ZLWK WKHLU WKLQNLQJ RQ KRZ QDQFLDO DGYLVRUV FDQ XVH WKLV NQRZOHGJH WR FUHDWH VWURQJHU DQG ORQJHU ODVWLQJ UHODWLRQVKLSV ZLWK WKHLU FOLHQWVČ?EURXJKW WR \RX E\ +DUWIRUG )XQGV 7R UHDG ZKDW WKH\ KDYH WR VD\ JR WR humancentricinvesting.com

Dr. Barbara Nusbaum

Dr. Kristy Archuleta

Dr. Vicki Bogan

Tim Sanders

Clinical Psychologist, 3K ' H[SHUW DQG VSHDNHU specializing in the intersection of money, psychology and life

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Professor and Director of the Institute for Behavioral and Household Finance (IBHF) at &RUQHOO 8QLYHUVLW\

Author and expert on motivation, emotional talent and sales innovation

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Bloomberg Markets

Volume 25 / Issue 4

74 Q&A With Tidjane Thiam: “I Will Never Declare Victory” The CEO of Credit Suisse on the bank’s total makeover By Francine Lacqua

Contents

The Rise of the Buy Side

Virtu Never Loses*

The business of bond trading has been turned on its head. And a once-lowly player has emerged as the lord of fixed income By Alastair Marsh and Sridhar Natarajan

A few bucks at a time. Millions of times a day. That’s how this company became the most successful in the history of electronic trading *Actually it did lose … once By Matthew Leising

The Waiting Game

Industry Focus: ESG

Mark Hart has been betting for seven years that China’s currency will collapse. He’s not about to give up now By Saijel Kishan

Investors championing causes such as environmental practices and gender diversity are helping to change corporate priorities like never before By Bloomberg Intelligence

P H O T O G R A P H B Y F E L I C I T Y M c C A B E / C O V E R A R T W O R K B Y A L E X A N D R A C O M PA I N - T I S S I E R

Surveillance

Train Your Brain for Trading (No, Really!)

What matters most to people in markets as they look ahead

Contents

25 Forward Guidance

It Was a Union for the Ages, Until Suddenly It Wasn’t. Is Europe Lost?

Neuroscience shows the way

Brexit makes the unthinkable thinkable

Here’s an Algo That Can Help You Beat a Benchmark

Tradebook’s PAIR makes it easy to implement relative-value strategies

<GO>

Hello, Shortcut An LNG tanker goes through the expanded Panama Canal

30 A New Trade Route for Natural Gas Emerges

54 Digging Into China’s Growing Mountain of Debt Can mainland leverage prompt a global crisis?

No one is happier than the U.S. shale industry

How a “Dogs of the Dow” strategy came out on top

Alpha Insights How to Value Government Bonds as Yields Continue to Fall Fair-value curves can help you identify opportunities

38 This Basically Anonymous Fund Manager Oversees $800 Billion Gerry O’Reilly runs the world’s biggest mutual fund

44 Europe’s New Market Abuse Rules Require a Lot of Disclosure The workflow of salespeople making recommendations is changing. Here’s a tool to help

60 The Rules of Fixed Income Are Anything But Fixed for Michael Hasenstab The star bond-fund manager looks to make massive bets pay off again

102 Cheat Sheet The 17 most important functions you should know about right now

104 A Function I Love

Editor Joel Weber Art Director Josef Reyes Features Editor Stryker McGuire

Contributors

<GO> Editor Jon Asmundsson Graphics Editor Mark Glassman Photo Editor Donna Cohen

Hong Kong-based Jing Sun (“Digging Into China’s Growing Mountain of Debt,” page 54) specializes in equities in the Greater China region. Before joining Bloomberg last year, he managed stock portfolios at firms including TIAA-CREF. Sun says Bloomberg Intelligence estimates of China’s borrowing and other data on {BI CHIN <GO>} can help you gain insight into the contentious topic of the country’s economy. “When it comes to China and its growing debt, there have never been so many agreeing on so little,” he says.

Saijel Kishan (“The Waiting Game,” page 90) reports on hedge funds for Bloomberg News in New York. Her profile of Fort Worth-based Mark Hart chronicles the hedge fund manager’s seven-year wager against China’s currency. “He’s under the radar,” she says, “even though he identified the two biggest economic crises in the past decade.”

Based in London for Bloomberg Television, Francine Lacqua co-hosts The Pulse and Bloomberg Surveillance and also anchors Leaders With Lacqua, a half-hour program of conversations with chief executives and other luminaries. She interviewed Credit Suisse Chief Executive Officer Tidjane Thiam for Bloomberg Markets over the course of two sessions in the British capital (“I Will Never Declare Victory,” page 74). Lacqua is multilingual (Italian, French, English), as is Thiam (German, French, English); for this occasion they settled on English.

Bloomberg Markets utilizes the resources of Bloomberg News, Bloomberg TV, Bloomberg Businessweek, Bloomberg Intelligence, and Bloomberg LP.

Editor-in-Chief John Micklethwait Deputy Editor-in-Chief Reto Gregori Advisory Board Tracy Alloway, Robert Burgess, David Gillen, Christine Harper, Paul Smith, Joe Weisenthal Creative Director Robert Vargas Photo Director Clinton Cargill Managing Editor Kristin Powers Copy Chief Lourdes Valeriano Copy Editors David Purcell, Wendy Marcus Production Manager Susan Fingerhut Map Manager Ilse Walton Production Associate Loly Chan Head of Bloomberg Markets Rebecca Miesch / 212 617-7539 U.S. Sales Ted Dolan / 212 617-2182 Head of U.S. Financial Sales Michael Dukmejian / 212 617-2653 EMEA Sales Rob Huckin / 44 20 3525-9217 APAC Sales Patrick Brownlow / 65 6231-3486

Matthew Leising, who came to Bloomberg News more than a decade ago, covers market structure from New York. His article on Virtu Financial (“Virtu Never Loses*,” page 96) is the first major look inside the firm, which made a name for itself by losing money on only one day from 2009 to 2013. “There aren’t many Wall Street firms founded by a former soldier of the 101st Airborne,” Leising says, referring to Vincent Viola. “This one is, and it shows.” Virtu’s carefully regimented strategy is to make small gains—$10, for instance—millions of times every day. 14

Global Chief Revenue Officer Keith A. Grossman / 212 617-3192 Head of EMEA Sales Viktoria Degtar / 44 20 3525-4026 Head of APAC Sales Mark Froude / 65 6499-2818 Production/Operations Melvin Arriaza, James Delahanty, Debra Foley, Steven J. McCarthy, Mariya Rosier, Bernie Schraml comments@bloombergmarkets.com

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W H AT M AT T ERS M O S T TO P EO P L E I N M A R K E T S A S T H E Y LO O K A H E A D

“Emerging markets are punching above their macroeconomic merit.”

Surveillance

Mauro Ratto D IR ECTO R FO R PO RT FO LI O MA NAGE ME NT AT PIO N E E R INVEST ME NT MA NAGE ME NT

Volume 25 / Issue 4

“In a world of interest rates approaching zero, a scarcity of sales growth, and an abundance of macro risks, we find it surprising that health care—the sector with the fastest revenue and dividend growth and one of the lowest leverage ratios—is trading at a discount to the market.”

“The distinctions that we often have in the investing landscape are somewhat artificial. For instance, we spend a lot of time arguing about active vs. passive. I would argue that you really don’t care if it’s active or passive. What you care about is your risk-adjusted return.”

Dan Suzuki

Shundrawn Thomas

I N V ES T M E N T S T R AT EG I S T, B A N K O F A M E R I C A M E R R I L L LY N C H

H E A D O F F U N D S A N D M A N AG E D AC C O U N T S , NORTHERN TRUST

“Whether it’s Trump or Clinton, the reality is that there are great outcomes either way for the markets. The markets just want clarity.” Alan McKnight C H I E F I N V ES T M E N T O F F I C E R O F W E A LT H M A N AG E M E N T, R EG I O N S F I N A N C I A L

“Most advisers and investors forget that the capital markets were not created to provide them returns. The capital markets were created to give money to businesses and entrepreneurs to drive the economy and to offload risk onto investors. And it does a wonderful job of that.”

“We’re overweight Russia. It’s still cheap by conventional evaluation measures. Plus, we’re bullish on oil, which will underpin earnings in the energy sector—by far the biggest sector there. The central bank has also done a really fine job and is now on course to lower interest rates as inflation continues to fall.”

Paul Bouchey

Geoff Dennis

C H I E F I N V ES T M E N T O F F I C E R , PA R A M E T R I C P O R T F O L I O A S S O C I AT ES

H E A D O F G LO B A L E M E R G I N G M A R K E T S T R AT EGY, U B S S EC U R I T I ES

Bloomberg Markets

“The market has been disciplined on the new-issue side. Typically when you have a significant amount of inflows, you see stupid stuff happen.” Ray Kennedy P O R T F O L I O M A N AG E R , HOTCHKIS & WILEY

“We think the dollar is nearing its peak, so we’re buying more foreign currencies. And in the bond world, we think there’s an interesting opportunity in India. It’s got 7 percent yields; it’s triple-B rated, so investment grade; and it has a central bank likely to cut interest rates a little bit more.”

“The big elephant in the room is the longer-run impact with the rise of populism. A stagflationary outcome—low growth, higher inflation—may be something to start preparing for. And in that environment, very few assets will do well, inflation-linked bonds and gold among them.”

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Volume 25 / Issue 4

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Forward Guidance

It Was a Union for The Ages, Until Suddenly It Wasn’t. Is Europe Lost? By CLIVE CROOK I L L U S T R AT I O N B Y M AT T C H A S E

to quit the European Union is the enterprise’s worst setback since it was conceived in the 1950s. Until now, the EU has always grown in scale and ambition. For the first time, Brexit shows that Europe’s manifest destiny—ever closer union—may not be destiny after all. Merely knowing that European integration can be reversed is a threat: It makes the unthinkable thinkable. But this isn’t the only danger. The union is increasingly unpopular not only in the U.K. but also in other European countries. Its political capital is depleted. Working through the mechanics of Brexit may deepen divisions, severely testing the union’s ability to adapt. Brexit could conceivably spur support for the union. But this will demand consensus, flexibility, and farsighted calculation, none of which can be taken for granted. If governments can’t rise to this challenge, Brexit may be the beginning of the end of the European dream.

THE U.K.’S VOTE

today’s discontent is nothing new. There has often been a gap between the grandest designs of Europe’s leaders and the readiness of the continent’s citizens to go along. The EU’s

IN ONE WAY,

remarkable achievements in securing peace and prosperity in the postwar era required brave, visionary leadership, and voters were rarely up to speed. For years, that was fine. The model was top-down institution-building, followed by good results, then popular backing—in that order. It all worked beautifully. Europe’s postwar political and economic reconstruction was a modern miracle. But now the model is failing. The Brits aren’t the proof. They’ve always been uncomfortable in the EU, late to the party and a nuisance throughout; their vote to quit was a shock, but probably shouldn’t have been. Lately, though, the disenchantment has spread far more widely. According to one recent poll, the EU is less popular in France—France!—than in the U.K. So what went wrong? The EU’s deep structural flaws arise from the tradition of overreach. During the 1990s, after the collapse of communism, the EU had to choose whether to broaden the union to include new (and much poorer) entrants from Eastern Europe, or to deepen it with additional commitments to political and economic integration among its existing, and more similar, members. Its main architects were divided: Germany wanted to broaden; France, to deepen. Their fateful choice was to do both at once. The EU would bring in new members and take further strides toward full economic and political union, notably by creating the single currency—the boldest innovation yet. As things turned out, too bold. Even at the design stage, many economists said the euro’s political underpinnings were too weak. Monetary union, they argued, demanded a commitment to a form of fiscal union. (If currency devaluation with respect to other 26

EU currencies was going to be ruled out, fiscal transfers would be needed to help cushion economies from downturns.) This would require a widely shared sense of common purpose—in effect, a more fully developed European identity. Without it, member states would balk at collective fiscal action. And balk they did: Fiscal union, with the need for fiscal transfers across the union’s internal borders, wasn’t part of the plan. If that couldn’t be done, the alternative was to let governments use their own national fiscal policies more forcefully. But the new system said no to that, too: As well as ruling out fiscal union, it set strict national limits on public borrowing. With fiscal policy shut down and monetary policy moved to the European Central Bank, macroeconomic policy at the sub-EU level was therefore all but forbidden. As a result, the crash of 2008 hit parts of the EU exceptionally hard. In many countries unemployment remains high, especially among the young. Surges of migration within the union have worsened economic insecurity, especially in Britain and France, and added to the feeling that national governments are no longer attending to voters’ concerns. Europe’s problem is essentially a crisis of confidence arising from this mismatch between ends (the commitment to ever closer union) and means (popular support for EU-wide institutions). The question is whether Brexit can bring the two into better alignment—first, to secure a successful, mutually advantageous post-EU settlement for the U.K.; and second, to quell the secessionist momentum that’s building in some of the remaining 27 member states. The Leave vote shows that neither will be easy. Bloomberg Markets

In the months before the referendum, Prime Minister David Cameron sought new terms for British membership. Discussion centered on the EU’s so-called fourth freedom—free movement of workers within the union (in addition to free trade in goods, services, and capital). Cameron needed the EU to modify its commitment to free movement. Europe’s other governments said no: The four freedoms, enshrined in the EU’s treaties, are “indivisible.” At home, Cameron’s renegotiation was widely seen as a failure. The Leave campaign won the vote, and Britain and Europe were thrown into turmoil. Free movement of workers will be a major source of disagreement in Britain’s exit negotiations. Cameron’s successor, Theresa May, has said she’ll seek the closest possible economic integration with the EU, but she’ll insist on restoring control over immigration. This will be hard. Membership in the European Economic Area would grant full access to the EU’s single market, including so-called passporting privileges that allow British financial-services firms unrestricted access, but this model also imposes free movement of workers. Any plausible alternative would require unanimity among the EU’s 27 members in allowing a degree of flexibility on a core issue of principle, something Europe’s governments have refused to do so far. If no agreement can be reached—the worst case for Britain—exit would impose standard World Trade Organization rules on U.K.-EU exports and imports, without special provision for services. Britain could pursue free-trade agreements with other countries, but the price for regaining control over immigration would be steep. The focus on Brexit, while

OPINION ON THE EUROPEAN UNION Share of Pew survey respondents with a favorable view of the EU Italy

80%

France 70%

Germany

60%

U.K. 50%

2016

2004

40%

Source: Pew Research Center

understandable, has obscured the pressing need for reform among the EU-27, especially the 19 countries in the euro region. Voters in many countries—Austria, France, Germany, the Netherlands, and others—are increasingly aggrieved about immigration. Many euro area economies are uncompetitive and also afflicted with fragile banks, high public debt, sluggish growth, and high unemployment. The structural flaws in the single currency’s design continue to take their toll. IDEALLY, EUROPE would go back to the drawing board, correcting the error it made in simultaneously broadening and deepening the union. A core group would press on with closer integration, including free movement, some form of fiscal union, and the pooling of political sovereignty those would require; a broader

group, which once could have accommodated the U.K. (and still might), would choose less integration but remain members of the wider single market. Ends and means would be aligned by moving to a two-speed Europe. Sadly, the clock can’t be turned back. A complete remodeling risks a collapse of the entire enterprise and seems out of the question. What’s worse, a partial remodeling will be almost as hard. Even modest incremental reforms to allow flexibility where national politics demands it (as with free movement of workers) or new institutions where economics demands it (fiscal union) are likely to require treaty changes. Treaty changes require unanimous approval by member states and, in many cases, parliamentary ratification and/or—perish the thought—referendums. The current mood of Volume 25 / Issue 4

discontent therefore makes Europe’s leaders shy away from changing the treaties, a move that would expose the EU to greater popular scrutiny. It’s a characteristically European dilemma: The less popular the union, and by the same token the stronger the case for change, the more reluctant governments are to attempt serious reform. Overreach meets institutionalized paralysis. In the short term, the rot can probably be stopped at Brexit. The U.K.’s experience is sure to be challenging, and that will discourage copycats. Even so, Europe’s future seems certain to be heavy on discontent and chronic economic disappointment, and light on dreams come true.

Crook is a Bloomberg View columnist and member of the editorial board based in Washington.

<GO>

I N S I DE T H E T E RMI N A L

Hello, Shortcut WHEN THE SUN rose over the Caribbean Sea on July 25, the Maran Gas Apollonia was churning toward the new Panama Canal with a shipment of U.S. liquefied natural gas that it had loaded at Cheniere Energy’s Sabine Pass terminal in Louisiana. Tugs guided the 90,434-ton tanker into the first of the Panama Canal’s new Agua Clara Locks. The gates closed, and water filled the first chamber. That night the vessel passed through Gatun Lake and the new Cocoli Locks and entered the Pacific Ocean, becoming the first LNG tanker to transit the expanded shipping lane that opened in June. Built in 2014, the Royal Dutch Shell-chartered tanker is about 13 meters (43 feet) wider than the largest ships the old locks could handle. The expansion opens the Panama Canal to about 90 percent of the world’s LNG fleet, up from less than 10 percent. To learn more about the new trade route’s potential impact on the natural gas market, turn the page— and you can also run {COSY <GO>} to view sample commodities studies, including charts that let you track Sabine Pass flows and the drop in pricing since the canal’s expansion. —Jon Asmundsson

P H OTO G R A P H BY TO B I AS H U T Z L E R

Energy

A New Trade Route for Natural Gas Opens in Panama By ALEX NUSSBAUM and NAUREEN S. MALIK

Panama Canal’s expanded locks slid open in late June, perhaps no one was happier than executives in the U.S. shale industry. With the goal of making the U.S. a global powerhouse for natural gas exports, these frackers have their sights on Asia. Now they have a more direct route that could significantly benefit their bottom line. Nine years of construction work at a cost of more than $5 billion have equipped the canal with a third set of locks and deeper navigation channels, crucial improvements that doubled the isthmus’s capacity for ferrying goods between the Atlantic and Pacific oceans. Within a week of opening, officials said they had more than 170 reservations for transits this year, mostly for so-called New Panamax cargo carriers that couldn’t fit through the old canal. For natural gas suppliers, the expansion comes at a pivotal moment. It coincides with a big increase in U.S. shale production and the construction of several Gulf Coast export terminals designed to help American gas muscle its way onto the world market. The canal’s deeper channels can accommodate the kind of football field-size tankers that transport

WHEN THE

liquefied natural gas (LNG), shaving 11 days and one-third the cost of the typical round trip to Asia. In July the U.S. Department of Energy predicted 550 tankers could be crossing each year by 2021. “We can send gas ships that couldn’t fit through the canal before,” says Bill Diehl, president of the Greater Houston Port Bureau, a maritime industry trade group. “Asia looks like a good market for us now. The shipping costs look like a fair fight.” A week after the locks opened, the Panama Canal Authority announced its first booking for an LNG carrier. Then in July the authority said Royal Dutch Shell had made a reservation that jumped ahead of the previous booking. Departing from the U.S. Gulf Coast, the 289-meter (948-foot) Maran Gas Apollonia on July 25 became the first LNG tanker to carry the fuel, used for heating and power plants, through the expanded canal. Although a slump in oil and gas prices and slow growth in Asia have kept a lid on exports, the volume is expected to grow by the end of the decade, says Jason Schenker, president of financial market researcher Prestige Economics in Austin.

<GO> Inside the Terminal

To track LNG tankers, run {BMAP NEW <GO>} for the Commodity Maps function.

GAS PRODUCERS won’t be the only ones affected. Markets from Chile to China are now more accessible for oil drillers across the Americas, and millions of tons of container shipments originating from Asia could start bypassing western U.S. ports and opt to dock instead along the Gulf Coast or the Eastern Seaboard. The anticipated growth has triggered a multibilliondollar dredging and building binge at ports in the U.S., Caribbean, and South America, all seeking a share of the traffic boom. “There are going to be a lot of feeder services that develop around it,” says Moses Kopmar, an analyst with Moody’s Investors Service in New York. “What it will do is basically unlock a huge amount of the global fleet in terms of being able to transit the canal.” The 102-year-old shipping route risked losing relevance if it didn’t expand to handle the increasingly large vessels favored nowadays, industry experts say. The new locks—a set of chambers sealed by 3,200ton doors used to raise and lower water levels— provide access to a wider lane for vessels: 180 feet across, compared with 109 feet in the original locks. (Many cargo ships squeezed through the old canal with only a couple of feet of clearance on each side.) In the middle of the isthmus, the authority also dredged deeper, wider lanes through Gatun Lake, where ships spend much of the interoceanic voyage. For gas companies reeling from the recent collapse in prices, which in March reached the lowest level since 1998, the drop in time and shipping costs will provide a much-needed lift. The new canal can accept almost 90 percent of the world fleet, the

authority says. That will cut the round trip from the U.S. Gulf to Asia to about 20 days, compared with 31 days through the Suez Canal or 34 days around Africa’s Cape of Good Hope. Sailing from Louisiana to Tokyo via Panama would be about 35 percent cheaper than through the Suez, says Jason Feer, head of business intelligence at Poten & Partners, a ship broker in Houston. “It certainly gives U.S. LNG producers options,” he says. “It is a significant percentage of the reason that Asian buyers have been willing to sign contracts with U.S. producers.” American LNG exports began in February, when Cheniere Energy opened its Sabine Pass terminal in Louisiana. By 2020, U.S. export capacity is expected to expand to 9.2 billion cubic feet a day, a fifteenfold increase, with the country becoming the world’s third-biggest LNG producer, behind Australia and Qatar, the U.S. Energy Information Administration says. Panama itself is trying to become a destination for some of that fuel. It has tentative plans for a gas import terminal in the canal zone to supply the rest of the region. A U.S.-funded feasibility study is under way. “There is a lot of activity, there are a lot of emotions, so we’d like just to stay calm,” says Oscar Bazán, the canal authority’s executive vice president for planning and business development. “But it’s clear LNG is going to be a big market for us.” Nussbaum and Malik cover energy for Bloomberg News in New York.

<GO> Inside the Terminal

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How to Value Government Bonds As Yields Continue to Fall

Rates

By ROBERT GEE

Run {GOVY US <GO>} and select Spline Spread Exponential to view spreads of individual securities to the model-generated fair-value curve.

The new 10-year Treasury trades richer to fair value than the old. Click here to graph how a bondâ&#x20AC;&#x2122;s liquidity premium has changed over time.

have rallied this year because of the outlook for slow growth around the world and central banksâ&#x20AC;&#x2122; extraordinary monetary policies. A Bloomberg index that tracks developed-country sovereign bonds was up almost 12 percent in the first half. As bonds rise in premium above par, evaluating their true value becomes more important when making investment decisions. In government bond markets, differences in valuations along the yield curve are linked to the liquidity of individual securities. Bonds that are more liquid tend to trade at a premium to the curve, whereas those that are less liquid trade at a discount. To measure those premiums or concessions,

GOVERNMENT BONDS

Bloomberg has built fair-value curves for the major sovereign markets. The curves are constructed from universes of bonds that use a set of rules to filter out securities with distinctive liquidity characteristics. The rules differ by country, but in the U.S., for example, recently issued bonds, typically trading at a liquidity premium, would be excluded. Once the universe is defined, a fair-value curve is fitted through those bonds. As part of your relative-value workflow, you can use such curves in a number of ways. is to identify relative-value opportunities by measuring the spreads of individual bonds to the curve. To see these fitted spreads for

ONE APPROACH

<GO> Inside the Terminal

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CME Group is a trademark of CME Group Inc. The Globe logo is a trademark of Chicago Mercantile Exchange Inc. All other trademarks are the property of their respective owners. Copyright © 2016 CME Group. All rights reserved.

TYPE CME <GO>

To compare German and Spanish par yields, run {GC RV2 RV8 <GO>}.

Click here to see how the spread between the curves for the two countries has changed over time.

U.S. Treasuries, run {GOVY US <GO>} and set the Spread to Spline Spread Exponential or to Spline Spread Cubic. (For more on the spline methodologies, press <Help> and click on the White Papers link.) Click on the Actives subtab. The Spread column in GOVY shows a spread for each bond, which is calculated using the discount factors from the fairvalue curves. GOVY prices the cash flows of individual bonds and derives a price that’s used to calculate a model yield. The spread, the difference between the model yield and the market yield, is driven by liquidity. For example, you can compare the spread of the active 10-year note with that of the old 10-year. In the Security section of the screen, the active bond is denoted “10Y” in white, and the old bond is “O10Y.” The current 10Y is more liquid and so trades about 1.5 basis points richer to fair value than does the old. You can also use spreads to fair value when targeting a certain part of the yield curve. Click on the subtab for that part of the curve—7- to 10-year, for example. Next, click on the Z-Score column to sort the bonds by Z-Score, which measures how many standard deviations the bond is trading away from the mean of its history. A positive (green) number means the bond is cheap on a Z-Score basis. A negative (red) number means it’s rich. The metric is important: Some bonds may systematically trade above or below fair value. You can analyze the fair-value curves in the Graph Curves function. Run {GC RV1 <GO>} to load the U.S. curve. The points on the curve represent constant maturity par yields and can be used to 36

analyze the principal components of the yield curve. By comparing par yields instead of market yields, you can capture relative value between sovereigns on a like-for-like basis. That’s especially the case in the current low-yield environment, where aged bonds with higher coupons trade significantly above par. In an upward-sloping yield-curve environment, market yields on high-coupon bonds will be lower than the par yields—even if all bonds were to trade at fair value to the spline. So comparing market yield is an inadequate measure of fair value. For example, the market-yield spread of a high-coupon Spanish bond trading above par to a recently issued German bond trading at par would favor the German bond over the higher-coupon Spanish bond to potential buyers. To compare the par yields of these countries, run {GC RV2 RV8 <GO>}, and select “Spread Chart” in the top right of the screen. You can also use the par yields to monitor the shape of the yield curve—to track the curve’s slope, as shown in the spreads between two tenors,or to gauge convexity, as shown in the so-called butterfly spread among the 2-year, 5-year, and 10-year notes. To see that, run {HSA <GO>}. Select Government Curve as the mode and choose a country. The Curve Id buttons in the upper right of the screen let you select fair-value curves for your analysis. Select RV1 for the U.S. market to analyze curve spreads while filtering out the effects of the benchmark liquidity premium or auction rolls. Gee is a fixed-income market specialist at Bloomberg in New York.

<GO> Inside the Terminal

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Insurance products and services are offered through non-bank affiliates of Wells Fargo & Company including Wells Fargo Insurance Inc. and Wells Fargo Insurance Services USA, Inc.

Wells Fargo Securities is the trade name for the capital markets and investment banking services of Wells Fargo & Company and its subsidiaries, including but not limited to Wells Fargo Securities, LLC, a member of NYSE, FINRA, NFA, and SIPC, Wells Fargo Prime Services, LLC, a member of FINRA, NFA and SIPC, and Wells Fargo Bank, N.A. Wells Fargo Securities, LLC and Wells Fargo Prime Services, LLC are distinct entities from affiliated banks and thrifts.

Investing

This Basically Anonymous Fund Manager Oversees $800 Billion By BEN STEVERMAN

wasn’t fazed by Brexit. On the Friday morning after the U.K. voted to leave the European Union, the manager of the world’s biggest mutual fund was on the trading floor in Malvern, Pa., watching numbers flickering on the four screens in front of him. Stocks were down 8 percent in Europe and 3 percent in the U.S. O’Reilly didn’t appear stressed. “For what we do, it’s not a huge deal,” he says. That’s because O’Reilly’s job at Vanguard Group is to embrace the market, not avoid volatility. Every trading day, he makes sure the $450 billion Vanguard Total Stock Market Index Fund matches the performance of its 3,600-stock benchmark. That means owning stocks whether they’re plunging, surging, or unchanged. O’Reilly manages a lot of money. In addition to running the biggest mutual fund, he oversees the third-largest exchange-traded fund and 16 other funds. Total assets for which he’s responsible: $800 billion. Investors, driven by evidence that even the best active managers have trouble beating the market, have flocked to index funds like O’Reilly’s. As a result, Vanguard, the index investing pioneer, is now the world’s largest mutual fund manager, with more than $3 trillion in assets. GERRY O’REILLY

often called “passive investments,” yet there’s nothing particularly passive about what O’Reilly and his Vanguard colleagues do all day. Joe Brennan, the head of the firm’s equity index group, likens managing an index fund to a game of darts—one in which both the player and the target are

INDEX FUNDS ARE

constantly moving. Money rolls into Vanguard’s funds almost every day, and that cash has to be put to work. The funds must match hundreds of small shifts in their underlying indexes, caused by corporate actions such as acquisitions and share issuances. “We have to deliver perfection every day,” Brennan says. “Sometimes you have to deliver perfection-plus.” In theory, the best an index fund can do is the return of the benchmark minus the fund’s fees. In reality, a fund faces additional costs from trading and transactions that can widen the gap between the returns of a fund and those of its benchmark. Success or failure is measured in tiny increments. “A basis point to us is a huge deal,” O’Reilly says. The best index fund managers find small ways to wring out additional gains while tracking a benchmark. For the past five years, the Vanguard Total Stock Market fund has lagged its index by an annual average of only 1 basis point, or 0.01 percent, even as it charges an expense ratio of 0.04 percent in its institutional share class. How does the fund pick up the extra return? It makes some money by lending shares to short sellers. Last year it made about $95 million, or 2 basis points, from that. The rest comes from smart trading. Vanguard’s traders continually walk a tightrope. On the one hand, they want to match their indexes as closely as possible. On the other, they want to buy and sell at the best prices while not letting other market participants take advantage of their need to stay fully invested. And even as it tries to be smart about where and when it trades, Vanguard’s equity team doesn’t

<GO> Inside the Terminal

The Vanguard Total Stock Market Index Fund has returned more than 7 percent a year for the past decade. Run {TRA <GO>} to calculate the total return for a selected fund.

Click here to select a time period, such as 10 years.

want to get too smart. “We don’t want to take arbitrary risk,” says Ryan Ludt, co-head of U.S. equity trading. “My job is not to try to time the market to outperform.” Vanguard has invested heavily in technology. Algorithms help managers figure out where to buy and sell while minimizing market impact. Risk software makes sure the portfolio stays close to the index. Because of these technologies, Brennan says, “we probably have the most assets per head of any asset manager in the world.” (The key determinant of staffing, he says, is the number of portfolios, not the assets in them.) But you can automate only so much, and the tough decisions still fall to the portfolio managers. When is the best time to buy an illiquid stock that trades only once or twice a day? How do you handle a corporate deal structured in an unusual way or the issuing of a new class of stock? “People think a computer could run index funds—and they’re so wrong,” says Brian Bruce, a former index fund manager who’s now chief executive officer of Hillcrest Asset Management in Plano, Texas, and editor-in-chief of the Journal of Index Investing. The skills of an index fund’s human managers are underappreciated, Bruce says. While the top active fund managers are often treated like rock stars, index fund managers are basically anonymous. 40

O’REILLY, 52, was a bit of a star himself as a young man. A native of Ireland who retains a subtle accent, he came to the U.S. in 1983 to attend Villanova University on a track scholarship. As a junior, he ran the mile in less than four minutes—a feat he repeated six times. He led Villanova to a conference championship and represented Ireland at the 1988 Summer Olympics in Seoul. A few years later, O’Reilly joined Vanguard. He started managing the Vanguard Total Stock Market fund in 1994, when it had less than $1 billion in assets. For a guy who oversees the better part of a trillion dollars, O’Reilly doesn’t put on many airs. He doesn’t have his own office. Instead, he works at a standing desk on Vanguard’s equity trading floor, which was renovated earlier this year in a somewhat utilitarian style. Vanguard doesn’t spend a lot of money on art or frills. “We don’t need fancy couches or stuff like that,” Brennan says. “We’re here to work.” Working next to O’Reilly is Michael Buek, who’s managed the Vanguard S&P 500 Index Fund since 1991. Buek’s S&P fund now has $240 billion in assets. O’Reilly’s Total Stock Market fund, which is increasingly used in 401(k) plan target-date funds, passed Buek’s in size seven years ago. O’Reilly likes to needle Buek by reminding him of that.

<GO> Inside the Terminal

The Fund Screening function, {FSRC <GO>}, lets you find funds that meet criteria you specify, which allows you to compare the tracking errors of index funds or other investment vehicles, for example.

Enter “tracking error” here and click on the metric you want in the list of matches.

a minor event for O’Reilly and his colleagues, they were furiously busy a week earlier during the quarterly rebalancing of the Total Stock Market fund’s benchmark and other U.S. indexes. When stocks undergo significant changes— such as when a company is purchased—that gets reflected in the index at the end of a trading day. Minor changes, however, are bundled up and implemented once a quarter. At Vanguard, the quarterly rebalancing is an all-hands-on-deck affair, requiring the buying and selling of hundreds, sometimes thousands, of stocks. On June 17 a team of 18 traders worked Vanguard’s U.S. portfolio. Pizza was served so staffers could stay at their desks as 4 p.m. approached. In index investing, the daily closing price is the crucial metric. For the most liquid stocks, such as those in the S&P 500, Vanguard buys and sells as close to 4 p.m. as possible to minimize tracking errors. Near the closing bell is also when volume is highest and Vanguard’s trades are least likely to move the market. For smaller, less liquid stocks—some of which trade only a couple of times a day—the firm has to take care to avoid influencing their prices. It often buys these stocks earlier in the day, whenever traders see the best opportunity. “We don’t just blindly send” an order, O’Reilly says. “We screen to make sure our order

ALTHOUGH BREXIT WAS

won’t make too much of an impact on the price.” Unlike other firms, Vanguard doesn’t separate the jobs of portfolio manager and trader. A portfolio manager must know not just what to buy and sell but where to do so. “They have a much tougher job than they used to,” Bruce says, given the increased complexity of the stock market. There are a dozen stock exchanges and more than 40 pools of liquidity in which trades can be executed. family back in Ireland don’t really understand what he does. Even on Vanguard’s campus, 28 miles outside Philadelphia, he barely attracts attention. He can visit the Galley—the cafeteria whose name, like everything else on the campus, reflects the firm’s nautical theme—without being recognized as the manager of Vanguard’s largest fund. “That’s a good thing,” O’Reilly says. Even though his name is on the fund paperwork, he says, managing an index fund is a team effort. “There’s a great camaraderie on the desk,” he says. “If you have any kind of an ego, it’s going to get cut down pretty quickly,” he says. “If I come in with a bad haircut, I’m going to hear about it.”

O’REILLY’S FRIENDS AND

Steverman covers personal finance at Bloomberg News in New York.

<GO> Inside the Terminal

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© S&P Dow Jones Indices LLC, a division of S&P Global 2016. All rights reserved. S&P and Indexology are registered trademarks of Standard & Poor’s Financial Services LLC. ® Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. It is not possible to invest directly in an index. S&P Dow Jones Indices receives compensation for licensing its indices to third parties. S&P Dow Jones Indices LLC does not make investment recommendations and does not endorse, sponsor, promote or sell any investment product or fund.

Europe’s New Market Abuse Rules Require a Lot of Disclosure. Here’s a Tool to Help

Regulation

By FLORENCIA AHUMADA SEGURA

the European Union introduced new rules that change the way salespeople and traders can communicate with clients when making investment recommendations. Aimed at fostering market integrity and protecting investors, the Market Abuse Regulation, or MAR, has raised many questions among people who need to comply with it. The new rules took effect on July 3. Overseen by the European Securities and Markets Authority (ESMA), MAR is the successor to Europe’s Market Abuse Directive, or MAD, which was introduced in 2003. The new version was created to address a number of shortcomings in the previous regime. Among other things, the previous EU-wide framework covered a comparatively narrow slice of products and trading venues that had quickly appeared out of date as new platforms started and markets became increasingly global. What’s more, MAD did not specifically address the issue of benchmark rigging. Scandals such as the manipulation of the London interbank offered rate, or Libor, were a call to European authorities to update the framework. MAR thus has a broader reach than MAD. The new framework seeks to protect investors by bringing into its scope new markets, platforms, and behaviors. In addition, it aims to harmonize the regime across the EU.

WITHOUT MUCH FANFARE,

One of the main implications of MAR is a change to the workflow of salespeople. The rules now require that recommendations provided to clients be accompanied by a high level of disclosures. That’s a big change from what had been a light-touch framework. Under MAR, people producing or disseminating investment recommendations must ensure that the information is objectively presented and must disclose any conflict of interest. A lack of clarity about the requirements has fueled different interpretations across the industry. Banks thus face several challenges: How should they capture recommendations covered by the regulation? In particular, how do the requirements apply to recommendations involving over-the-counter derivatives? How should they provide the required disclosures? How should they track recommendations within a firm and aggregate all the data? All of these trigger operational issues about how to track the recommendations. In addition, implications for crossborder clients are still unclear. at an example of how compliance with MAR can work: A salesperson recommends buying Company A in a chat—a recommendation that differs from the firm’s research view. Among the set of disclosures MAR requires: a 12-month history of LET’S TAKE A LOOK

<GO> Inside the Terminal

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© MMXVI Sotheby’s International Realty Affiliates LLC. a Realogy Company. All Rights Reserved. View of Auvers, used with permission. Sotheby’s International Realty® is a registered trademark licensed to Sotheby’s International Realty Affiliates LLC. An Equal Opportunity Company. Equal Housing Opportunity. Each Office is Independently Owned and Operated.

TYPE SIRA <GO>

To create and maintain a list of recommendations you can send to clients, run {RECO <GO>}.

Recipients hover over or click on the “pill” for more info about the recommendation.

In IB, click here and select Recommendations to add a disclosure from RECO to your chat.

recommendations, disclosure of whether the sender owns more than a certain percentage of the security, and any other relevant disclosure. The requirement applies across communication channels: e-mail, trade idea systems, chats, and voice. the necessary disclosures, you can use the new Recommendation Disclosures function by running {RECO <GO>}. When providing a recommendation, RECO lets you build the history, disclose any potential conflicts of interest, and provide any additional disclosures. The function integrates with IB chat and enables you to attach the disclosure to a chat in the form of a so-called pill. The recipient can then click on the pill to see the disclosures. Many in the industry say that complying with the disclosure requirements will impact the “timeliness” of

TO PREPARE

a recommendation—and thus liquidity. On one hand, the disclosures appear to be designed to provide recipients of recommendations with additional information to enable them to make better-informed investment decisions. On the other hand, capturing and aggregating a 12-month history of every sales communication across asset classes might have a negative impact on the very essence of the broker’s role as a broadcaster of information. It could even lead to an end of that activity. Lastly, while RECO is a promising start, the financial industry is still waiting for the ESMA to shed light on some of MAR’s remaining gray areas. As it does, more solutions will no doubt follow. Ahumada Segura is a trade ideas and research market specialist at Bloomberg in London.

<GO> Inside the Terminal

Neuroscience

Train Your Brain for Trading (No, Really!) By JON ASMUNDSSON

about to veer to the right, so you step to the left. It’s also what enables some traders to look at the tape, she says, and see that “someone’s slamming the bid.” experiment, detailed in “Exploring the Nature of ‘Trader Intuition,’ ” a paper published in the Journal of Finance in 2010, researchers set up a stylized market. They had participants trade two “stocks” in a series of sessions. The payoff from the two stocks together was fixed at 50¢, but the portion of the payout that would come from each stock was revealed only after the session ended. One might pay 49¢ and the other would pay 1¢, for example.

IN THE CALTECH

The Caltech study found activation in a theory-of-mindrelated region called the paracingulate cortex, which is located about here.

ILLUSTRATION BY BROWN BIRD DESIGN

is ticking up and down on a screen in front of you. Do you rationally evaluate the probabilities that the price will rise before you pull the trigger on a trade? Or do you go with your gut? You may prefer to think superior ability—that mysterious X-factor some traders appear to have— is rooted in the former scenario. But a few years ago, researchers at the California Institute of Technology went to the trouble of taking pictures of people’s brains while they were evaluating trades. Surprise: As rational as you are, you probably opt for that gut feeling a lot. Using fMRI scans, neuroscientists can identify which brain structures are associated with particular activities. To do so, they might put a subject in a machine and have him solve a math problem so they can watch the fireworks go off. Those math-related structures aren’t what lit up in the Caltech experiment. Instead, the activation occurred in parts of the brain associated with something psychologists call “theory of mind.” That’s essentially the ability to read other people. “It’s a viewpoint on what another person is thinking and feeling and what they’re likely to do,” says Denise Shull, founder of the ReThink Group, a New York research and consulting firm that coaches financial professionals and athletes. You unconsciously use theory of mind all the time to process experiences in the world, says Shull. It’s what helps you navigate a busy Manhattan sidewalk: You can tell that the guy in front of you is

A STOCK’S PRICE

The tension is palpable. Check out the Bloomberg Tradebook Trader Exercise, {TBX <GO>}, to find out what happens next.

For more information on the nature of the trader intuition that underlies the exercise, click here.

In some of the sessions, none of the participants had any additional information about the payoffs. In other sessions, some participants were given a hint about what the payoffs would be. Based on that hint, those participants might bid up one of the stocks. The trading during those sessions took place electronically and was videotaped. Later, a different group of subjects watched replays. After a while, a researcher would stop the video and ask the subjects to predict what the next price would be. In the sessions where some traders were acting on hints about the payoff, the observers could infer information about how stocks would move just from watching the prices and flow of orders. The explanation: The fMRI scans showed the observers had engaged the theory-of-mind-related parts of their brains. Also, the observers who were better at predicting prices did better on separate tests of theory-of-mind abilities. The Caltech study has some interesting implications. Among them: Theory of mind may explain how uninformed traders infer new information and act on it in such a way that prices quickly come to fully reflect it—as is posited by the efficient markets hypothesis, a cornerstone of finance theory. Peter Bossaerts, an author of the Caltech study who’s now a professor of experimental finance and decision neuroscience at the University of Melbourne, says subsequent research also supports the idea that

theory of mind may explain how information flows through markets. “We have more evidence for it,” he said in an e-mail, citing papers that show connections between theory of mind and market bubbles. THE MYSTERIOUS X-FACTOR isn’t such a mystery after all, according to ReThink’s Shull. “I would describe the X-factor of risk judgment as part of a suite of emotional competencies that extends from knowledge to recognition to understanding,” she says. One part is emotional self-awareness—knowing not to make a decision when you’re agitated, for example. Another is the ability to predict prices and read people. So, can you sharpen your skills for that? Yes, says Shull. “It’s trainable.” Although theory of mind is unconscious, Shull says there’s a conscious version of the same type of processing, which she calls cognitive empathy. “Cognitive empathy is thinking about it and trying to do it intentionally, and that’s where you can train yourself,” she says. The new Bloomberg Tradebook Trader Exercise—go to {TBX <GO>}—lets you test your abilities and practice to improve them. Developed by Shull’s ReThink Group in conjunction with Tradebook, Bloomberg’s agency brokerage, the activity uses various animated shapes to challenge your gray matter. Keep an eye on that pentagon! Asmundsson is <GO> editor of Bloomberg Markets.

<GO> Inside the Terminal

Here’s an Algo That Can Help You Beat A Benchmark

Trading

By MICHAEL BARADAS

A chart shows trading in Microsoft shares and the S&P 500 on June 17.

A simple relative-value strategy would be to buy Microsoft shares when they underperform the benchmark during the day.

TO GENERATE ALPHA, many fund managers and traders use advanced-execution algorithms. Such automated trading can enable you to capture gains from the relative pricing of securities—whether that’s a pair of stocks that usually trade in sync, a mergerarbitrage situation, or a complex relationship of multiple assets denominated in different currencies. To take a look at a simple relative-value trade and how you can execute it algorithmically, let’s start with a wide-angle view. You can track how a selected security has performed relative to a benchmark using the Compare feature in GP charts. For example, to

chart shares of software giant Microsoft, run {MSFT US Equity GP <GO>}. Click on the Compare button on the red tool bar, and you can specify a benchmark, sector, or peer stock you want to measure against. For Microsoft, let’s use the S&P 500. Check the box to the left of “Normalize these series … .” Then use the drop-down menu to select SPX Index—Last Price. Now click on Update and then 5Y to see performance of Microsoft relative to the benchmark. In some periods the stock trailed the S&P 500, while in others it outperformed. Zoom down to an intraday scale, and you can

<GO> Inside the Terminal

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The PAIR function in Bloomberg Tradebook lets you implement a strategy such as buying Microsoft shares when they trade at a 40-basis-point spread to the S&P 500.

likewise construct a trading strategy based on the performance of a stock relative to a benchmark. For example, you might decide to buy Microsoft stock while it’s underperforming the S&P 500 during the day. Generally, the expectation in such a strategy is that the stock will revert to its historical relationship, tracking or outperforming the benchmark in the future. On June 17, Microsoft traded at $49.97, down 0.83 percent, or 83 basis points. The S&P 500, meanwhile, was down 43 basis points. That meant the stock was underperforming the index by 40 basis points. You might decide to buy, say, 10,000 shares at that relative level. To easily implement such a strategy, Bloomberg Tradebook clients can use Tradebook’s PAIR MultiAsset Benchmark algorithm. (Tradebook is Bloomberg’s global agency brokerage business. For more information, go to {TBH <GO>}.) The PAIR platform lets you algorithmically execute trades based on a user-defined relationship formula, such as a spread or ratio, among two or more securities. In the Relative Benchmark algorithm, only one security will be executed by the algo, at price levels relative to a benchmark, as you define them. The benchmark doesn’t need to be a tradable 52

security, which lets you choose from a broad range of tickers for such strategies. To execute a trade based on how Microsoft is trading in relation to the index, run {PAIR <GO>}. Click on Launch Ticket and select the Relative Benchmark ticket. In the Pair Strategy ticket, Select ChgOnDay as the Price Convention. For the Leg 1 security, select Buy as the Side. For Ticker, enter MSFT US Equity. For the Leg 2 Benchmark, enter SPX Index in the Ticker field. For Leg 1 Shares, enter 10,000. To buy Microsoft while it’s underperforming the S&P 500, enter 40 basis points in Spread (bps). The algorithm will dynamically adjust your Microsoft working price limit. Select Strategy Bsmart with Aggressive Level NORM and then Activate to start executing your strategy. Many fund managers and traders execute their trades relative to a benchmark. With the right tools, you can automate the process with a relative-value algorithm as we’ve done here. Doing so may help you generate the alpha you’re looking for. Baradas is a product manager for cross-asset trading at Bloomberg Tradebook.

<GO> Inside the Terminal

INTECH U.S. MANAGED VOLATILITY FUND (JRSIX)

Do you know when to shift from offense to defense?

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INTECH INTERNATIONAL MANAGED VOLATILITY FUND (JMIIX)

3 YEAR MORNINGSTAR RATINGTM OUT OF 720 FOREIGN LARGE BLEND FUNDS AS OF 6/30/16

INTECH GLOBAL INCOME MANAGED VOLATILITY FUND (JGDIX)

3 YEAR MORNINGSTAR RATINGTM OUT OF 940 WORLD STOCK FUNDS AS OF 6/30/16

To learn more, visit Janus.com/advisor Please consider the charges, risks, expenses and investment objectives carefully before investing. For a prospectus or, if available, a summary prospectus containing this and other information, please call Janus at 1.800.525.3713 or download the ﬁle from janus.com/ reports. Read if carefully before you invest or send money. Past performance is no guarantee of future results. There is no assurance the stated objectives will be met. INTECH U.S. Managed Volatility Fund. Class I Shares ratings as of 6/30/16: 4 stars out of 1,392 funds, 5 stars out of 1,392 funds, 5 stars out of 1,206 funds and 3 stars out of 895 funds for the Overall, 3-, 5- and 10-year periods, respectively in the Large Blend category. INTECH International Managed Volatility Fund. Class I Shares ratings as of 6/30/16: 5 stars out of 720 funds, 5 stars out of 720 funds and 5 stars out of 631 funds for the Overall, 3- and 5-year periods, respectively in the Foreign Large Blend category. INTECH GLOBAL Income Managed Volatility Fund. Class I Shares ratings as of 6/30/16: 5 stars out of 940 funds and 5 stars out of 940 funds for the Overall and 3-year period in the World Stock category. INTECH’s focus on managed volatility may keep the Fund from achieving excess returns over its index. The strategy may underperform during certain periods of up markets, and may not achieve the desired level of protection in down markets.

Investing involves risk, including the possible loss of principal and fluctuation of value. For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating™ based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of the funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. (Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages.) The Morningstar Rating™ may differ among share classes of a mutual fund as a result of different sales loads and/or expense structures. The Overall Morningstar RatingTM for a fund is derived from a weighted average of the performance figures associated with its three-, five- and ten-year (if applicable) Morningstar RatingTM metrics. Ratings and/or rankings may be based, in part, on the performance of a predecessor fund or share class and are calculated by Morningstar using a performance calculation methodology that differs from that used by Janus. Differences in the methodologies may lead to variances in calculating total performance returns, in some cases this variance may be significant, thereby potentially affecting the rating/ranking of the Fund(s). The rating/rankings are displayed for informational purposes only and should not be relied upon when making investment decisions. © 2016 Morningstar, Inc. All Rights Reserved. Janus and INTECH are registered trademarks of Janus International Holding LLC. © Janus International Holding LLC. Janus Distributors LLC. C-0716-3492 10-15-16

466-41-43196 07-16

Digging Into China’s Growing Mountain of Debt

Capital Allocation

By JING SUN

are worried about China’s debt. George Soros sees an “eerie resemblance” between conditions in China now and those in the U.S. leading up to the financial crisis in 2008. “It’s similarly fueled by credit growth and an eventually unsustainable extension of credit,” Soros told the Asia Society in New York in April. BlackRock Chief Executive Officer Laurence Fink was asked about China’s mounting debt on Bloomberg TV in May. “We all have to be worried about it,” Fink said, adding that he remains bullish on China’s economy in the long run. And in June a Goldman Sachs report warned that the country’s large and unaccounted-for shadowbanking activities raised concern “about China’s underlying credit problems and sustainability risk.” Indeed, many segments of the Chinese economy have taken on considerable debt, especially since the global financial crisis. Over the past decade, total debt grew 465 percent. Debt rose to 247 percent of gross domestic product in 2015, from 160 percent in 2005. Bloomberg Intelligence breaks China’s total debt into four components: bank, corporate, government, and household. For tickers, run {CHBGDCOP Index DES <GO>}. Bank debt has decreased slightly in relation to the size of the country’s economy over the past 10 years, to 19 percent of GDP in 2015. Corporate debt, meanwhile, jumped to 165 percent of GDP from 105 percent. Government debt rose to 22 percent of GDP. Household debt has increased to more than 40 percent of GDP, a rise of 23 percentage points.

SOME PROMINENT INVESTORS

Despite that rapid growth, household debt in China is far below levels in the U.S. before the subprime crisis. At its 2007 peak in the U.S., household debt reached almost 100 percent of GDP. What’s more, in China household savings are twice as large as debt. Deposits were about 55 trillion yuan ($8.4 trillion) at the end of 2015, while debt was 27.4 trillion yuan. Another big difference between China today and the U.S. during the subprime bubble is that Chinese residential properties are typically purchased with significant down payments. According to the China Household Finance Survey, the average household debt in urban areas amounted to only 11 percent of home value in 2012. Mortgage debt remains comparatively rare. That showed up in the survey data: The median household debt was zero percent. The same survey also found that if housing prices were to decline 50 percent, less than 14 percent of mortgages would exceed the value of the properties. Given China’s high savings rate and low leverage, it seems unlikely that households would cause a financial crisis. If overwhelming debt does trigger a crisis in China, it’s more likely the spark would come from corporations and their main creditors, the banks. China’s bond market has shown signs of growing stress, including 17 defaults through June 30, almost triple the number in 2015. That and a series of delayed payments prompted rising credit spreads and cancellations of new issues. Leverage problems aren’t evenly spread across Chinese corporate sectors. Energy and materials companies have the lowest ability to service debt.

<GO> Inside the Terminal

When interest rates rise, MNI subscribers are prepared To stay informed in this ďŹ nancial climate you need to get as close to the source of market intelligence and insights as possible and no one gets you closer than MNI. Our essential macroeconomic and market intelligence comes from our global team of experts who provide you with highly relevant, real-time intelligence and analysis around the clock. We ensure you are conďŹ dent in making prompt, informed, investment decisions. Discover MNI on Bloomberg MNII<GO>, Reuters F9<MNMenu> www.mni-news.com

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CHINESE DEBT AS A PERCENTAGE OF GDP Corporate

Household

Government

Bank 250%

200%

150%

100%

50%

2004

2015

Sources: {CHBGDCOP Index HP <GO>}, {CHBGDHOP Index HP <GO>}, {CHBGDGOP Index HP <GO>}, {CHBGDBAP Index HP <GO>}

Among Chinese energy companies in 2015, the median earnings before interest and taxes was less than one times total interest expense, according to Bloomberg Intelligence. At materials companies, the median EBIT was twice the interest expense. By contrast, Chinese health-care companies have median earnings of more than nine times interest expense. Information technology and telecommunications-services companies generate earnings that are more than five times interest expenses. While certain industries and enterprises have a lot of debt, Chinese companies’ average leverage isn’t high, according to a recent International Monetary Fund working paper. Since 2006, listed companies that aren’t state-owned have reduced median liabilities to 55 percent of common equity. At state-owned enterprises, however, median leverage has been unchanged at about 110 percent. Leverage has increased at the tail end of the distribution, driven by rising debt at companies in construction, mining, real estate, and utilities. An increasing share of debt is attributed to a few companies with high leverage ratios. China is different from other markets in an important way. Many large corporations and nearly all the major banks are state-owned. In other words, the debtors and creditors are ultimately owned by the same entity. That means the country could address debt problems in some unusual ways. One scenario is the state could take from the prosperous—coastal regions or high tech, for example—and give to the struggling. Another is that the government could simply cover 56

debt. Some unprofitable state-owned enterprises are supported by lending from their banks essentially to keep employment at acceptable levels. Such debts could eventually be absorbed by the state as part of its social welfare expenditures. As China gradually opens up its stock and bond markets, more capital could become available to deal with the country’s obligations. The potential inclusion of Chinese stocks and bonds in the global indexes over the next few years would help facilitate that. This isn’t to say that China doesn’t have some serious problems. Growth is slowing and the economy needs major restructuring. There will be winners and losers and turmoil in the market. Shadow-banking activities add another risk. It isn’t certain that the government will handle the challenges in the next decade as deftly as it has in the past. The country’s economy is far larger and more complex. Fortunately for the rest of the world, China has a high savings rate. Capital controls aren’t fully lifted, making capital flight difficult. The government has almost complete control of the banking industry. In addition, China’s listed banks get about 70 percent of their funds from deposits. In comparison, U.S. investment banks in 2008 relied heavily on short-term money-market funding. Such circumstances make it unlikely that China’s debt will spark a global crisis in the near future. Sun is an equity market specialist at Bloomberg in Hong Kong.

<GO> Inside the Terminal

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How a ‘Dogs of the Dow’ Strategy Came Out on Top

Alpha Insights

By BRANDON KOCHKODIN

Run {PORT <GO>} to analyze a selected fund or portfolio.

The SunAmerica Focused Dividend Strategy was beating the S&P 500 by more than 6 percentage points. How much is true alpha?

alpha, less can be more. Take the approach of the SunAmerica Focused Dividend Strategy Portfolio: It picks 30 stocks once a year and hangs on to them. That seemingly simple buy-and-hold strategy made it the best-performing U.S. large-cap value fund over the past 10 years. The fund returned an average of 10.6 percent annually through July 13, topping all of its 261 peers, according to data compiled by Bloomberg. The $12 billion fund, managed by Timothy Pettee in Jersey City, uses a quantitative model to select stocks. “Our strategy is based on a two-part process combining the ‘Dogs of the Dow’—a strategy of buying

IN THE HUNT FOR

the 10 highest-yielding stocks in the Dow Jones Industrial Average—with a rules-based model which screens the Russell 1000 Index for yield, profitability, and valuation,” Pettee says. “Over the long term, our alpha is generated by stock selection in general.” This year through July 13, the SunAmerica fund had a return of 13 percent. That put it 6.4 percentage points ahead of the S&P 500 index. Does this year’s outperformance come from true alpha or factor contributions? Use {PORT <GO>} to find out. Kochkodin covers executive compensation at Bloomberg News in New York.

<GO> Inside the Terminal

PORT’s model shows that factor exposure drove the fund’s outperformance this year. The remaining idiosyncratic return that can’t be attributed to factors, also known as selection effect or alpha, was actually a -1.47 drag on performance.

As the fund invests in U.S. stocks, you can use the U.S. Equity Fundamental model to analyze it.

Style factors contributed most to performance. Click here to drill down and see the individual factors that made the biggest contributions.

Factor-Based Attribution In PORT

The biggest single factor contribution came from exposure to the U.S. Dividend Yield factor.

To analyze a selected portfolio or fund using factor-based attribution, run {PORT PA <GO>}. Click on the Settings button on the red toolbar, and then on Calculation Defaults. Select Factor Based as the Attribution Model. Click Save. Running an attribution analysis on the SunAmerica fund shows that the main catalyst for success this year was its exposure to dividend-yielding stocks. The second-biggest single factor contribution was the fund’s underweight of momentum stocks. Alpha, which is shown in PORT in the Selection Effect column, was significant—though negative. The fund’s holding of Kohl’s took the biggest bite out of returns. Is Pettee and his team’s long-term success similarly dependent upon a historically low interest rate environment and the ensuing starvation for yield? In the past five calendar years, with interest rates at the zero bound, Pettee’s stock selection has produced positive alpha three times.

Click here to see the individual stocks that drove alpha.

The fund’s holding of Kohl’s stock, which dropped 19 percent this year through July 13, was the biggest driver of selection effect.

<GO> Inside the Terminal

Bonds

The Rules of Fixed Income Are Anything But Fixed for Michael Hasenstab By YE XIE and BORIS KORBY

PHOTOGRAPH BY MATHEW SCOT T FOR BLOOMBERG MARKETS

“IF I DON’T GET to the top,” Michael Hasenstab was telling himself, “I have to rename our fund.” Franklin Templeton’s star bond-fund manager found himself somewhere around 24,000 feet on Mount Everest when he became intimately familiar with the effects of oxygen deprivation. An avid mountaineer who’d spent the preceding five years bagging peaks to train for the world’s tallest, Hasenstab knew to expect pain on the Lhotse Face. It was 40 degrees below zero, the numbing wind ripped across the mountain, and misery accompanied every step on the blue-ice slope. Yet he was still hours away from Camp Three, where he’d begin breathing bottled oxygen, and he found his mind was fixating on a flag stashed inside his pack, one emblazoned with the logo of his three-year-old hedge fund, Global Summits. “If I don’t get to the top, I have to rename our fund.” He found the thought funny, and it motivated him to keep going. “I am not changing the name,” he told himself. “It’s printed on the flag.” “I needed to put it on the top,” the curly-haired Ph.D. says three years later. Everest wasn’t the only peak he scaled in 2013. By then Hasenstab was one of the world’s top investors, with his flagship Templeton Global Bond Fund ranking No. 4 in returns among 113 U.S.-based fixed-income funds tracked by Bloomberg for the previous 10 years. Assets under management across all his funds had swollen to $190 billion— equivalent to the annual economic output of Portugal— from less than $2 billion in 2001, when he started managing the Global Bond Fund. Unlike mainstream global bond investors, Hasenstab had excelled at making huge one-way bets on the higher-yielding debt and currencies of developing nations. Once the contrarian saw a path to recovery, he’d make signature trades that sniffed out opportunities in situations with big upsides. “The goal is not to be a contrarian,” he says. “The goal is to be research-driven and be comfortable being a contrarian.” When the European debt crisis drove away investors in 2011, for instance, he loaded up on Irish bonds in an €8 billion wager that returned 70 percent. A similar bet on out-of-favor Hungarian bonds the same year also netted billions. Since 2013, however, assets managed by Hasenstab’s team have declined by about $60 billion, or 32 percent, as clients have withdrawn funds. After riding the boom in emerging markets over the past decade, the fund manager is now confronting a radically new financial landscape—one in which growth is slower, potential returns are lower, volatility is higher, and pitfalls are plentiful. By far his biggest bruise came when a high-profile multibillion-dollar bet on Ukraine soured with Russia’s 2014 invasion of Crimea. After loading up on 40 percent of the country’s bonds, Hasenstab saw a major chunk of his

investment wiped out as the conflict with pro-Russian rebels deepened an economic recession that drained the country’s reserves. The Ukraine experience hasn’t stopped Hasenstab from going big, including a massive wager on rising interest rates after 30 years of declines. So far that gamble has been a flop: The U.S. economy struggles to gain traction, inflation remains below target, and Treasury yields are still near record lows. A $19 billion bet on the dollar against the yen is also losing money, in the face of a more-dovish-thananticipated Federal Reserve and a less-dovish-thanexpected Bank of Japan. Through Aug. 2 the $47 billion Templeton Global Bond Fund is down 1.1 percent this year. That’s after a loss of 4.3 percent in 2015—its worst year since 1999—when the emerging-market selloff caught Hasenstab off guard. His ill-timed trades aren’t necessarily disastrous; they could eventually turn in his favor. Indeed, last year Hasenstab managed to salvage his Ukraine investment with a better-than-expected debt restructuring that ranked alongside those in Argentina and Greece among the largest ever. And his doubling-down in countries such as Brazil late last year was prescient and largely offset his losing trades. “He deserves praise on how well he did through this varying, treacherous environment,” says Dan Fuss, 82, vice chairman of Loomis Sayles, whose main bond fund beat 89 percent of its competitors over the past 15 years. Yet the rare miscalculations for Franklin Templeton’s 30-year-old fund are beginning to taint a previously impeccable record. Over the past three years, it barely made money and lagged 91 percent of its peers, according to Morningstar. Hasenstab’s go-big, go-early, and go-against-the-herd approach faces a crucial test: Can it still work when powerful, unconventional central-bank policies have changed the way markets function? “I am comfortable being out of consensus,” the spectacled Hasenstab, 43, tells Bloomberg Markets from his corner office at Franklin Templeton in San Mateo, Calif. It’s June 24, the first trading day after the U.K. voted to exit the European Union. He says the losses, the outflows, and even Brexit haven’t shaken his conviction in his fundamental outlook on the global economy and the bets he’s staked his reputation on. To Hasenstab, the future looks clear: Treasuries will fall as inflation picks up, the dollar will rally, and a handful of emerging markets—including Mexico, Brazil, and Indonesia—represent once-in-ageneration opportunities. “We are in that period needing patience and vigilance,” he says. “The philosophy hasn’t changed.” If Bill Gross, the former Pimco bond king now at

<GO> Inside the Terminal

Janus Capital, and Jeffrey Gundlach, the DoubleLine Capital founder, are the public faces of modern bond investing, with egos as big as their assets, the babyfaced Hasenstab is every bit the opposite. Sitting behind a desk stacked with research papers, he comes across more like a bookish professor— especially when he drops terms such as “the Lewis Turning Point” in a quiet voice befitting a library. Yet Hasenstab lives for adventure. He spent part of his senior year of high school in China, traveling alone across the country. He once swam from Alcatraz to the San Francisco shore, and he’s run several marathons in Death Valley. For their honeymoon, he and his wife climbed Mount Kilimanjaro. It’s this combination of studious academic and ambitious risk-taker that’s done so well for the firm built by the late Sir John Templeton. A pioneer of global investing who had a knack for finding undervalued companies, Templeton borrowed money as World War II broke out to buy every stock listed on the major U.S. exchanges selling for $1 or less, an investment that minted him a fortune. Hasenstab and his team of 20 have carried the founder’s vision into bond investing. They comb the world for mispriced assets, often disregarding benchmarks and ignoring the opinions of ratings companies. Hasenstab himself spends at least three months a year crisscrossing continents, meeting prime ministers, economists, even local business owners. “A lot of the research that I do on the ground is the opposite of glamorous,” he says. “You’re talking about going around the back alleys of Jakarta sweating through your suits in 100-degree weather to meet people.” Speaking with academics during his travels excites him most, he says. In the early 2000s, for instance, a lunch with a Chinese professor helped him realize that the country’s one-child policy would lead to a labor shortage and force the government to shift its growth model to consumption from exports. That very transformation—mostly just a provocative idea at the time—has unfolded in recent years and reshaped the global economy. For years, Hasenstab’s funds have been the largest investors in countries such as Ghana, Sri Lanka, and Uruguay, as well as in larger markets such as South Korea and Indonesia. At the end of June, Mexico, Brazil, Indonesia, Ukraine, and Malaysia accounted for about half of his Global Bond Fund’s total holdings, compared with a weighting of about 1 percent in the Citigroup World Government Bond Index. In a bold move for Hasenstab, he’s accumulated short positions in the yen and the euro that now account for about 20 percent of the Templeton Global Bond Fund’s value at risk. The duration of its U.S. interest rate swaps, a measure of sensitivity to changing 62

TEMPLETON GLOBAL BOND FUND Total assets $80b

$40b

1/31/2006

6/30/2016

One-year return 20%

10%

0 2006

2016* *2016 return as of June 30; Source: {TPINX US Equity DES <GO>}

interest rates, amounted to minus 2.6 years, lowering the average duration of the fund to 0.2 years, a massive contrast to the benchmark’s 7.7 years. That means for each 1 percentage-point increase in bond yields, the valuation of his holdings will rise 2.6 percent. Many bond investors, including Gross and Gundlach, see the three-decade bull market in Treasuries coming to an end. With 10-year yields at about 1.5 percent, they say there’s little room for price appreciation. The U.S. economy, while far from booming, continues to expand at a moderate pace. The unemployment rate is at a nine-year low, bolstering the case that inflation will creep up and prompt the Federal Reserve to raise rates. In Japan the chorus grows ever louder for more monetary and fiscal stimulus, moves that may reverse the yen’s 19 percent appreciation this year against the dollar. With inflation falling and the economy on the brink of contraction, a steady appreciation in the yen is the last thing the country needs. Yet there’s always a risk that the payoff never comes. Betting against Treasuries has been the wrong wager since the recession ended in 2009. Some investors are already calling it the next “widowmaker,” a term used in Japan to describe the perpetually losing trade of shorting government debt. Buckling under aging populations and falling productivity, growth in almost every major economy outside the U.S. is faltering. The outlook is even dimmer post-Brexit, increasing the demand for safe-haven government debt. And with more than $10 trillion of

<GO> Inside the Terminal

COMPOSITION OF TEMPLETON GLOBAL BOND FUND As of June 30, 2016

Other 4.7% Poland 3.6% India 4.8% Malaysia 4.8% Ukraine 5.3%

Cash 24.4%

Indonesia 9.5%

Mexico 15.8%

Brazil 15.1%

South Korea 12%

Source: Franklin Templeton

bonds in Europe and Japan offering yields below zero, the case to buy Treasuries is increasingly appealing. “Sometimes you have to stick to your guns, to what is going to be good long-term value, and let them go out of favor temporarily,” says Gilbert Armour, a San Diego-based financial adviser at SagePoint Financial who’s invested in the Templeton Global Bond Fund for more than a decade. Armour says Hasenstab is “certainly not afraid to do that” and calls him “a brilliant guy.” Hasenstab’s strategies have also begun to court controversy. Critics say few global bond investors ever amass positions as large as Templeton’s in certain markets. And once the firm decides to exit a position, it exposes the country to unnecessary volatility. Critics also maintain that Hasenstab’s investments can give governments, sometimes authoritarian ones, an easy pass to carry out policies that erode democratic values. Viktor Szabo, a money manager at Aberdeen Asset Management, says he finds Hasenstab’s strategy most troubling in Hungary. After coming to power in 2010, Prime Minister Viktor Orbán has embarked on one of the most extensive centralizations of power since the end of communism. He’s installed party loyalists to key oversight posts, including the Constitutional Court, while seizing control of private pensions worth $11 billion. “By buying up the bonds, [Hasenstab and Templeton] allow the government to go on with all these crazy, unorthodox policies,” Szabo says. “That could all happen without

[Hasenstab], but it would be much more difficult should the market provide decent enough feedback that the policies are not right.” Hasenstab brushes aside these concerns. His investments help countries build schools and bridges and fund social programs, he says, while making a profit for his investors. “If the country does well, our investors do well,” he says. “We absolutely have every incentive for a country to succeed.” If the big, contrarian trades worked out well for him in Ireland and Hungary, his investment in Ukraine underscores the risk. To make himself whole, Hasenstab had to enter an unfamiliar role as the lead negotiator of a sovereign-debt restructuring deal that took center stage during a global power struggle. The breakthrough finally came in August 2015. With Hasenstab facing the very real prospect of a default without any restructuring agreement in place, Ukrainian Finance Minister Natalie Jaresko flew 6,000 miles to meet him for breakfast at the Hyatt Regency in downtown San Francisco. Their ensuing deal exceeded the markets’ expectations, sending benchmark bonds up as much as 16¢ on the dollar the day after it was announced. In the space of days, Hasenstab had recouped his losses, while Ukraine got the debt relief and access to multilateral aid it needed. “It was a deal in which both sides gave things up and both sides got something,” says Charles Blitzer, a former International Monetary Fund official with experience advising on sovereign-debt restructurings. Hasenstab ranks the restructuring as his single biggest professional achievement. “We were not just managing a simple restructuring exercise,” he says. “We were managing our role in this geopolitical situation. It was beyond just getting the economics right.” In all his triumphs, including Ukraine, Hasenstab says he succeeded by having the patience to weather turbulence other fixed-income money managers couldn’t stomach. His strategy remains the same. And while he admits he mistimed his wagers on Treasuries and the yen, he remains undeterred. “I’m comfortable going through periods of pain, sweat, and tears, knowing there’s a reward at the end,” he says, referring to both investing and climbing. “It’s not a quick reward.” Neither was planting his Global Summits flag atop Everest. It was a bluebird day when he summited, and as the sun rose, he could see the mountain’s shadow all the way to the horizon. “The achievement of getting onto the top is rewarding,” Hasenstab says. “To me, though, it’s the process of climbing that I enjoy more.” Xie covers emerging markets for Bloomberg News. Korby is the team leader for U.S. bonds and FX coverage in New York.

<GO> Inside the Terminal

Nikeâ&#x20AC;&#x2122;s recently expanded European Logistics Campus, located outside Antwerp, sources all its energy from renewable resources. For more ESG insights about the company, go to {NKE US EQUITY ESG <GO>}.

Bloomberg Markets

Industry Focus ESG

JUST DOING IT

+64%

Change in Nike’s annual revenue from fiscal 2008-15

-19%

Change in carbon emissions per unit over the same period

In recent years, pension funds, activist shareholders, and even casual investors have been paying closer attention to the financial cost of environmental, social, and governance (ESG) issues. It’s getting easier for them to do that, because companies are doing a better job of disclosing data. Applying a sustainability lens to ESG costs can run the gamut from looking at energy efficiency to employee diversity. In the pages ahead, Bloomberg Intelligence— our research platform providing analysis and data sets on industries and companies at {BI <GO>}—helps you focus that lens.

Unilever sells everything including Axe deodorants, Dove soap, Hellmann’s mayonnaise, and Lipton tea. Slinging millions of products through dozens of brands has also made the London-based company the world’s second-largest advertiser.

using sexist stereotypes, a strategy that may help improve sales to women, its primary buyer, and demonstrate the advantages of gender diversity. Unilever has also asked its industry peers to join its campaign to end gender stereotyping in advertising.

THE COMPANY:

The company credits its “sustainable living plan,” introduced in 2010, with adding to sales growth and cash flow while also increasing margins. Unilever has duly rewarded its chief executive officer, Paul Polman; it increased his annual bonus 40 percent in 2015 for accomplishments, including on its Sustainable Living Plan goals and gender diversity. During Polman’s tenure, the company has seen a 36 percent reduction in carbon emissions.

THE PLAN:

A recent company analysis of 1,000 ads found that half of them portrayed women in a stereotypical way and that 40 percent of women don’t identify with how they’re depicted, its chief marketing officer said in June. Unilever says it plans to stop

THE PLEDGE:

THE FEMALE PRESENCE: The company achieved gender balance in its boardroom at the end of 2015, with half its directors female, slightly ahead of Procter & Gamble and L’Oréal, BI data show. The number of female executives lagged, however, at only 15 percent.

According to comments Polman made last year, showering had declined 15 percent in Brazil because of droughts, prompting growth in Unilever’s more expensive dry shampoos. Water scarcity could continue to boost sales of the company’s so-called sustainable living brands, which are expanding twice as fast as its other products and are more profitable. Learn more at {BI ESG<GO>}. —Gregory Elders, BI ESG analyst

THE ENVIRONMENT:

GENDER BALANCE AT HOUSEHOLD PRODUCTS COMPANIES Share of board positions held by women in 2015

Avon Products 58.3%

Unilever 50.0%

L’Oréal 40.0%

Oriflame 33.3%

Revlon 30.8%

IFF 30.0%

Colgate-Palmolive 27.3%

Beiersdorf 25.0%

Symrise 25.0%

Henkel 37.5%

J& J 33.3%

Svenska Cellulosa Reckitt Benckiser 30.0% 28.6%

Church & Dwight 22.2%

Givaudan 22.2%

Where Women Aren’t

In Europe, government quotas are helping push companies to quickly narrow the gender gap in their boardrooms. Europe Stoxx 600 companies have doubled the proportion of female directors, to a median 25 percent, since 2011. Yet appointing women to boards has proven relatively easy compared with changing corporate cultures and creating opportunities to promote women to executive leadership. Only 20 percent of companies on the Stoxx 600 have two or more female executives; more than half have none. In the U.S., where government-imposed diversity is less palatable, more than threequarters of S&P 500 companies have at least one female executive. —G.E.

There’s a Tool for That

Use {ESG<GO>}, Bloomberg’s new environmental, social, and governance analysis tool to gauge how a company is behaving based on its reported data. The function works with an equity or corporate ticker to load industry metrics of a company and its peers. The top section of the screen displays grades of Better, Worse, or Neutral in the ESG categories. A company is compared with itself five years ago and with its peers. —Lee O’Dwyer, Bloomberg equity market specialist

PREVIOUS SPREAD: COURTESY NIKE

Why Unilever Is Such an ESG Darling— and What’s Coming Next

The Latest Developments in Activist Investing A B LOO M B E RG I NT E LLI G E N C E PRI M E R

Tech and consumer discretionary companies have accounted for 40 percent of campaigns in the last five years and one-quarter this year through July.

COMPANIES TARGETED BY ACTIVIST INVESTORS SINCE 2010 10 targets By sector

By year

Consumer discretionary

Financials

Industrials

Health care

Energy

Consumer staples

Materials

Communications

29 5

Utilities

Once known for a corporate-raiding, slash-and-burn approach, activist investors are increasingly working constructively with struggling companies. They’ve also seen mixed performance of late as the field has become crowded. This year has been slow. Through July the 35 largest activists tracked by Bloomberg introduced 35 campaigns, the fewest since 2012. Only five companies with a market value of more than

ILLUSTRATIONS: LA TIGRE

110

117

Technology

101

’10

’16*

$2 billion have been targeted in 2016, indicating a preference for smaller game. Activists may be spending more time on research. Through the first half of 2016, the targets earned a median 4.4 percentage points more than their peers. A new campaign is generally met with a positive shareholder response: An announcement brings a median one-day share return of 1.8 percent.

Activists have the best performance when they achieve quick victories and exit within nine months. (Median excess returns are 739 basis points.) Longer than that and returns drop to 173 basis points— and -342 basis points when ongoing campaigns are included. Activists seek to boost share returns quickly, which may be negative for long-term reinvesting and for bondholders. Share buybacks and higher dividends are a fast way to increase returns, but they may come at the expense of research and development spending and higher debt leverage. Rather than endure public sparring, three-quarters of targeted companies enter constructive dialogue with activists and acquiesce to demands for board seats, M&A, higher returns, or other changes. —G.E.

How to Binge-Watch Icahn’s Campaigns

Track the latest activist company targets and performance using the new database, {BI ESG ACTIVISM <GO>}. For instance, to see Carl Icahn’s major investments since May 2010, click the drop-down arrow to the right of the box labeled “Any Activist” and select “Icahn Associates” from the pop-up list of more than 30. Click the “Return” heading at the upper right to sort from biggest to smallest. Note that Netflix’s stock returned more than 363 percent during Icahn’s period as a major investor. —Michael Thieme, Bloomberg global data analyst 67

At Total, a Total Rethink

Of all the global oil majors, Total has emerged with the most aggressive strategy for renewable energy. To move to a lower-carbon business model, France’s largest oil company expects to have 20 percent of assets in renewables by 2035 (up from 3 percent now), with natural gas overtaking oil in its production mix. Total leads peers that are spending more than $8 billion on clean energy deals and financing since 2011, including acquiring majority control of SunPower and a planned acquisition of battery maker Saft. Renewables appear to be less of a priority at Chevron and Exxon. —G.E.

The Rise of Renewables

VALUE OF OIL COMPANIES’ CLEAN ENERGY EQUITY AND DEBT DEALS Cumulative value since 2000 $10b Total BP Statoil Shell Chevron ExxonMobil

$8b

$6b

$4b

$2b

2000

2016*

Hydroelectric production has dropped 80 percent at Southern California Edison since 2011 because of California’s drought, highlighting the risk of operating in regions where water is scarce. Almost all of Edison International’s SCE conventional plants are located in extremely high baseline water-stressed regions, the highest exposure among the largest electric utilities measured by market value. By contrast, peers Southern Co. and PPL have no exposure to regions with such stress. —G.E. 68

Spills and Bills

Oil companies with higher worker accident rates often have higher oil spill rates, which may shed light on a company’s safety culture. (It makes sense the two would go hand in hand, but they also may provide insight into relative operational risks.) Husky Energy, which struggled to contain a spill in Saskatchewan in July, has the highest three-year average oil spill rate per barrel of oil equivalent produced. Small spills, not only the catastrophic ones, can hurt earnings and productivity. —G.E.

OIL SPILL RATES Spills per million barrels of oil equivalent produced 6 4 2 Statoil

Chevron

Exxon

Eni

Total

Shell

Galp

Husky

ILLUSTRATION: LA TIGRE

Water Woes

Wind and solar may account for 61 percent of new U.S. electric capacity in 2016, eclipsing natural gas at 32 percent, according to U.S. Energy Information Administration data on planned projects through May. Congress’s extension of wind and solar tax credits may push some late-2016 projects into 2017, but its five-year federal tax-credit extensions offer policy stability and will likely increase construction through at least early in the next decade. Leading U.S. wind and solar equipment suppliers include Gamesa, Vestas, SolarCity, and Canadian Solar. —Cheryl Wilson and James Evans, BI energy analysts

Advice you can trust from one of North America’s leading brokerdealers.*

BMO Capital Markets has the sales, trading, and research capabilities you need to navigate the world’s markets. Type BMOC 3 <GO> to learn more about our full-service offerings. bmocm.com *Institutional Investor, 2015 BMO Capital Markets is a trade name used by BMO Financial Group for the wholesale banking businesses of Bank of Montreal, BMO Harris Bank N.A. (member FDIC), Bank of Montreal Ireland p.l.c, and Bank of Montreal (China) Co. Ltd and the institutional broker dealer businesses of BMO Capital Markets Corp. (Member SIPC) in the U.S., BMO Nesbitt Burns Inc. (Member Canadian Investor Protection Fund) in Canada and Asia and BMO Capital Markets Limited (authorised and regulated by the Financial Conduct Authority) in Europe and Australia. “Nesbitt Burns” is a registered trademark of BMO Nesbitt Burns Inc., used under license. “BMO Capital Markets” is a trademark of Bank of Montreal, used under license. “BMO (M-Bar roundel symbol)” is a registered trademark of Bank of Montreal, used under license. ® Registered trademark of Bank of Montreal in the United States, Canada and elsewhere. ™Trademark of Bank of Montreal in the United States and Canada.

Sustainable Investing BY MELISSA MITTELMAN

Companies traditionally have been held accountable for one bottom line: profit. A growing number of so-called sustainable investors want two more measures: social and environmental impact. The Situation Sustainable investing goes by many names and encompasses several overlapping trends. Assets managed using a broad definition of the approach reached $21.4 trillion at the start of 2014, a 61 percent increase from two years earlier, according to a report funded by a group of financial companies, including Bloomberg LP. Some of these investors expect companies to be agents of social change, for example, through the promotion of diversity. Some stress robust corporate governance on issues such as executive compensation; of rising interest are environmental concerns. Some 92 percent of the world’s largest 250 companies reported in some way on their social and environmental impact in 2015, one survey shows.

The Johannesburg Stock Exchange was the first to require companies to include such factors in their financial reporting, and the EU issued a similar rule, due to start in 2017. The Background In recent decades, civic-minded investors have gone beyond screening out companies to choosing those that support their values. Many believe companies with social and environmental objectives minimize certain vulnerabilities, such as the risk of lawsuits from employees or toxic spills; they look for these goals as predictors of performance. The U.S. Department of Labor in 2015 revised its guidelines to allow pension funds to consider social impact in their investments. Companies have increasingly adopted sustainability agendas in response to shareholder and consumer demands.

executives spend company money on a social agenda, the cost is passed on to stockholders, consumers, and employees. In effect, he argued, corporations are taxing these individuals and deciding how to spend the proceeds, which is what elected government is for. Advocates of sustainable agendas dispute the premise that there must be a cost. They cite studies in which companies with such goals financially outperformed companies without them, though researchers face a challenge proving that socially conscious strategies created the better results. The Sustainability Accounting Standards Board, chaired by Michael Bloomberg, founder and majority owner of Bloomberg LP, has published metrics for 79 industries. Metrics for airlines, for example, include “total fuel consumed, percentage renewable.”

The Argument Free-market guru Milton Friedman wrote in a 1970 essay that when

Find more QuickTakes at {QUICK <GO>}

ASSETS MANAGED USING A SUSTAINABLE APPROACH 2012 Canada $0.6t

Europe $8.8t

U.S. $3.7t

Asia, Australia and New Zealand $0.2t

2014 Canada $0.9t

Europe $13.6t

U.S. $6.6t

Asia, Australia and New Zealand $0.2t

In July, Berkshire Hathaway’s Warren Buffett joined other influential U.S. financial leaders in releasing a letter and report detailing “common sense” recommendations for public companies to improve governance. Yet Buffett’s own failure to meet several of the principles outlined in the report shows the ease with which companies carve exceptions and the risk of so doing. Berkshire fails to meet recommendations to have an independent lead director if a company has a combined chair and CEO and to avoid dual-class share structures. —G.E.

Paid to Be Good

Almost half of the energy companies in the S&P Global 1200 index linked their executive compensation to environmental, social, or corporate governance goals in the latest fiscal year, Bloomberg data show. At the other end of the spectrum is the financial sector, in which only 7 percent of companies in the index have ESG-linked pay. On average, 16 percent of these companies consider these issues when it comes to compensation at the top levels.

ILLUSTRATION: LA TIGRE

QuickTake

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The Markets Q&A

Tidjane Thiam: “I Will Never Declare Victory”

By FRANCINE LACQUA P H OTO G R A P H Y BY F E L I C I T Y M c CA B E

environment today, particularly chief executives of European institutions—as Tidjane Thiam of Credit Suisse has learned firsthand. Since Thiam took the reins as CEO in July 2015, the 160-year-old bank has lost more than half its market value. Critics have scrutinized him from the start for a lack of banking experience, and the Swiss media has repeatedly speculated about a possible replacement. ¶ Born in the Ivory Coast, Thiam studied engineering at École Nationale Supérieure des Mines de Paris, one of France’s most prestigious universities, before working as a consultant at McKinsey, then rising in his native country’s government to become a cabinet member, and eventually taking over as CEO of insurer Prudential. Months after Thiam’s start at Credit Suisse— a bank steeped in history but mired in controversy—Thiam announced his strategy: expand wealth management and reduce dependence on trading. He raised capital and pushed ahead with cost cuts. An abysmal first quarter was followed by an unexpected second-quarter profit. Supporters say Thiam’s turnaround is already working: Operating expenses recently fell to the lowest level in more than two years, and the lender’s core capital ratio increased. ¶ Over two interviews in July, Thiam explained why sports is a blueprint for running a bank; divulged what type of criticism wounds him most; and discussed the bank’s strategy, progress, and many challenges. “Luck is not a strategy,” he says. BANKERS FACE A DAUNTING

FRANCINE LACQUA: You’ve been in charge at Credit Suisse for a little more than a year now. It’s been rocky at times. What have you learned? TIDJANE THIAM: It’s been a very interesting, busy year. We’ve defined a new strategy for Credit Suisse, which is really leveraging the brand of the bank. It’s very old and strong, one of the reference brands in the world of banking. There was a lot of heavy lifting at the beginning, because we had to strengthen our capital balance sheet and change the nature of our market activities—to consume less capital and to also have less volatile earnings. When you describe all of that, it’s sensible. The real challenge has been to do that in very challenging markets. The last 12 months have not been very bank-friendly. FL: Your second-quarter results were better than expected. Are you starting to win? TT: Oh God, I will never declare victory. I played a lot of sports, and you never declare victory until the final whistle. But it’s a good start. I’m pleased for our people, who’ve worked really hard. What is nice in life is to succeed together. It’s why I’ve always liked team sports. FL: Were those results a signal to the market that you don’t need to raise capital? TT: I’m a cautious man, so I will never say words like “We don’t need to raise capital.” I will caveat that with, in most foreseeable scenarios, we do not need to raise capital. Being in control of our own destiny, I think that’s ultimately what management is about. Now we can focus on what the business is supposed to do, which is serve the clients. You always have to go back to the clients and start from there. FL: How is that guiding you? TT: A business has to have a purpose, and the purpose of what we do is to create value for our clients. It’s the raison d’être. We are nothing without our clients. If you listen to your clients, then the rest is relatively easy. It becomes: We understand what they want; we’re going to support them. FL: Are you going to update the strategy at all? TT: When you design a strategy, you have to make it flexible. As the world moves from Brexit to other things, there will always be unexpected events that we need to take into account. But overall, in its key features, the strategy should last. I believe in the strategy we’ve defined. I’ll tell it to you in one sentence: to be a leading private bank wealth manager with strong investment banking capabilities. FL: You’ve been under scrutiny because of the share price. How much of that scrutiny is fair? TT: The share price, frankly, has dropped a lot. There are many reasons why. Overall I’m very pleased with the progress made, because you have to think about what we’ve been trying to achieve, which has been to fundamentally de-risk the business. If you go back to

the third quarter of 2015, we had the VAR [value at risk] at about $60 million. The average European bank had $34 million. So we were running about twice the trading risk of the average European bank. And our CET1 ratio [Tier 1 capital] was about 10.3 percent; the average European bank had about 11.7 percent. The way the business was organized meant that we were taking quite a bit of risk with not a lot of capital. The journey we’ve been on is to change those terms. FL: How’s morale? Can you put it on a scale of 1 to 10? TT: I cannot quantify it, but it’s improving—it’s even palpable. People inside the company comment that it’s an improving trend. [Directs attention to a 10-year chart of Credit Suisse’s share price and then pinpoints his July 2015 arrival.] This is me. The narrative in the media is “An evil person clearly came and destroyed this great bank, look!” Sorry, that didn’t happen. Maybe we’ve gone down by 50 percent since I started, but it was divided by 5 first—and that’s over 10 years. I’m here, and if I’m going to be crucified for that, so be it. But the facts are the facts, and the facts are stubborn. FL: Are you unlucky? TT: No, it’s not a question of being unlucky; it’s just the way it is. I can do many things, but I have not created problems of that scale in 9 or 12 months. We are dealing with a situation that developed over a period of 10 years. At least now the problems are visible, and we have a strategy to tackle them. They were there before and not visible. So we have given the markets transparency. Sometimes the truth is not very pleasant, but that’s what it is. At least now there’s a chance that it’s going to be addressed. FL: How much time do you have to correct the share price? TT: Look, ultimately the share price is the single most important thing. Am I happy with where the share price is? No. I feel sorry for our shareholders that we are at this price level—and remember I am a shareholder, too. We are working hard to correct this situation. I firmly believe that it will be corrected, because the share price absolutely does not reflect the value of the company. We have a lot of work to do to convince the market that we have a new model. I believe it’s the right model, but we need to build a track record. We’re also not the only bank in this position. FL: How long does it take to build a track record? TT: I cannot make a forecast. All I know is that, in my previous experience as CEO, it took quite a few quarters—which is fair. And you have to demonstrate results quarter after quarter. FL: What do your biggest shareholders say? TT: They really want us to drive the strategy forward, to execute and not get distracted. It’s very simple: Control the elements, control the risk. One shareholder told me, “Thank you. You are reducing risk. For many

Bloomberg Markets

“We need to create a better track record. … Unless you have credibility, your share price will be under pressure”

years I’ve been told we were reducing risk. Now I believe it’s being reduced. I can see it.” The fact that we have de-risked allows us to focus on serving our clients, rather than worrying about balance sheets, and winning in the marketplace. FL: What have your critics gotten wrong about you, and what have they gotten right? TT: The kinds of changes I’ve described, that we are implementing, cannot happen without disruption. That disruption is painful. I don’t minimize it. I recognize it. It’s very difficult for a lot of people. And of course it generates a lot of noise and discomfort. But we believe we can develop this together. FL: This economic environment presents more than a few challenges. What’s the path forward? TT: If you look at the sector today, ultimately the real challenge is a lack of belief in our ability to grow sustainably and profitably. At the end of the day, the evaluation of a company is about growth. The only answer is to cut costs. That becomes the only way to grow earnings if there’s never any top-line growth. That’s necessary in certain parts of any business. But ultimately you also need to be able to grow. FL: When will you feel as if you’ve cut enough costs? TT: When we don’t have to cut them anymore. My real philosophy about cost is productivity gain. I am, for all my faults and sins, an engineer. I come from a culture of automation technology. I believe in productivity improvements. An organization should improve productivity by 2 or 3 percent every year. And I always prefer to talk about productivity more than cost. It’s a much better word, because that’s what’s relevant. We’re promoting a culture of continuous improvement, and the restructuring and reengineering is very deep. It’s about changing the structure of processes and redesigning them in a more efficient way. Our global markets division has done a pilot of that, and their solution was a front-to-back, but also backto-front, reengineering in eight weeks. They’re really excited about the opportunities, where we can serve our clients better, cheaper, and faster. But for that you need to break the silos, you need to get people around the table and say, “How can we work better?”

So how do you build a team? It’s a very important thing. Maybe that’s all we do in business—because, at the end of the day, that’s the only way we can impact reality and change things. You have to be inclusive. I hear all the criticism, but if you look at the five divisions we have, they’re each run by someone from within. I didn’t bring one person from the outside to run the businesses. I could have, but I didn’t. So it was a form of a compliment to the organization. I really have nothing but respect for the people inside. And then it’s really getting the team to work together. There’s no substitute for spending time together. It’s the only way humans get to know each other, the central point of which is that we can reliably predict what we’re going to do. And with that you can control the outcomes. Often the problems come from the uncertainty and not knowing how we’re going to react. Also, having gone through a fire together generates trust. That’s human nature. And trust is the glue with which you move forward. FL: Do you have the support of your investment bankers? TT: The proof of the pudding is in the eating. I wrote a memo to congratulate everyone for Brexit, because it took a lot of coordination to manage that well. We had worked for weeks. Two weeks before, I got uncomfortable. I could see the bookies were saying there was a 22 percent chance of Brexit, which was too high. It was a bit like a Russian roulette probability. We had to set a maximum loss, and then we took that number down. We went into the referendum in a safe place, and our execution was excellent because it was across units, across markets, across divisions. It was a robust, real-life stress test, and I’m thrilled how well the organization performed. Everybody pulled together. FL: Why do shareholders have so many questions about Credit Suisse? TT: I’m not sure that they have more fundamental questions. I think it’s really as I described. We’re doing the heavy lifting, de-risking, restructuring, in markets that are completely unsupportive. So if you think about what we did between the end of the year and the end of the first quarter, we cut the VAR by FL:

TT:

Volume 25 / Issue 4

one-third. We reduced the risk by one-third. That’s a massive de-risking—one of the most massive ever conducted in the industry, and we conducted it very quickly and at a reasonable cost. FL: Less than four months into the job, you unveiled a whole new strategy for Credit Suisse. Should you have waited? TT: No, because we really needed the capital. I won’t elaborate on what would have happened if we had hit the fourth quarter without the capital. FL: But it would have been ugly? TT: I will leave the choice of words to you. It would have been at least uncomfortable. Extremely uncomfortable. My view on risk is that you never know when things are going to go wrong, so you always need to be in a position where you can withstand any shock. Luck is not a strategy. FL: Was there a communication problem when you unveiled the strategy? Shareholders said they didn’t get enough details, which led some to question it. TT: The key thing is to learn some lessons from every situation. As we all know, one cannot change the past. What happened, happened. And it’s really “What do we do going forward?” FL: It’s been said you look at risk as a consultant does, which you once were.

TT: I’ve been working for 30 years. I was a consultant for 10 of them. I left McKinsey in 1994. That’s a long time ago. Kids who were born then are in college now, like my son. So no, my focus on risk is because financial services is all about risk. It has little to do with my consulting background. It’s about taking risks and making sure you’re appropriately rewarded for them. I think the fear when you focus on risk is that you’re not a risk taker, but I don’t think there’s a lot of evidence of that in my life and my career. FL: How has your view of risk changed? TT: Risk is at the heart of capitalism. Without risk, there isn’t capitalism, and I’m a great believer in the capitalist system. But the risk appetite of investors has changed. Post-crisis, regulations have changed, the interest rate environment has changed, and the macroeconomic environment has changed. Tolerance for a certain level of volatility of earnings in regulated companies has gone down. People have no appetite. So companies have to take that into account. And when I say we have to profoundly rethink how we run a bank, that’s part of the debate. My absolute No. 1 priority was to shore up the capital. From there, it’s a chance to survive. The single most important thing in life is not to die. First, you stay alive. Then you can think about the future and evaluate risk. We didn’t

have that luxury, not with the lowest CET1 in the industry and carrying twice the risk. FL: If you could change one thing about Credit Suisse straightaway, what would you do? TT: You mean other than the share price? [Laughs.] FL: Is that what you would change? TT: No. See the thing with change is that the process is often as important as the outcome. You grow, and you develop, and you learn by achieving difficult things. That has enormous value. A magic change would almost not be worth having, because you wouldn’t learn anything and you might end up repeating the same mistake. I’m tempted to say nothing, because it’s good to learn things. There’s a lot that an organization and its people can learn from that process. FL: When you took charge of Credit Suisse, you were seen as an outsider. Are you still an outsider looking in, or are you an insider? TT: In my head, I’m an insider. It was a big decision for me to take this job. It’s an unusually important job. I’m really excited about it. I think the power of this franchise will show over time. The central point in all this is that we’ve really given a lot of thought to what a bank should look like in the new, post-crisis world. We’ve come up with a model that addresses those questions, and every indication we have in terms of numbers shows it’s working. We’re dealing with a lot of issues that aren’t resolved, but we’re convinced that these are the right issues to deal with. FL: So if you had to build a bank from scratch, what would it look like? TT: Client-focused. Client, client, client. To me, we should only engage in activities that mean something for a client somewhere. That’s a question I ask: “What is this going to do and for whom?” That has to drive the whole business, so it’s a bank that’s really client-focused and is trying to understand its clients and accompany them in what they do. It’s also having really, really good people. I pay credit here to Credit Suisse and the culture of this bank. We have a long tradition of great people who are really creative and willing to change things—which we’re doing now. Finally, and maybe this is a more personal thing, I like doing meaningful things in the societal sense of the word. I see us as a force for good in the world economy. FL: You’ve made ultra-high-net-worth individuals a big part of your strategy. How do you win their business? TT: It’s a people business, a relationship business, which is something I like. It gives a huge premium to the human aspect of it. There’s an alignment and a closeness between our people and the clients that’s great to see. There’s a lot of wealth accumulating in emerging markets, where we’ve built a strong presence. All that wealth, all that GDP, is driven by entrepreneurs. We see opportunities everywhere.

We have $150 billion of assets in Asia; there’s plenty of room for growth there. We see opportunities in Europe, in the U.S. There’s about 460 billionaires in the U.S.; our investment bank serves about 100 of them. How do you develop those relationships? By doing things for them. FL: What sort of things? TT: Either from a business perspective—buy a company, bring ideas—or what I talk about in Asia, the monetization of illiquid wealth. This is really a central concept in our emerging-markets strategy. For these billionaires, much of their wealth is in physical assets. What you do as a banker is monetize those assets. Moving them out of that position takes a lot of investment banking skill. We can only be successful in the long term if we are best in class at investment banking. These clients don’t want to deal with the second best or third best. FL: What do you wish someone would have told you when you were considering this job? TT: I think I went into it with my eyes open. I knew it would be very difficult. A lot of issues weren’t hidden. No, it was—and is—a big executional challenge, which is something where we as a bank haven’t excelled. Delivering what we’ve said on the cost, the capital, the development of the businesses. And that’s why I focus so much on our execution. FL: Where is there the most room for improvement? TT: We need to create a better track record. If you look at the last 25 quarters, we’ve only met or beaten expectations six times, which means we’ve missed them 75 percent of the time. Our peers have a positive statistic: They’ve missed 20 percent of the time and hit the other 80. Unless you have credibility, your share price will be under pressure. FL: When do you think you’ll have less scrutiny? TT: I don’t know. One hundred percent of my energy is focused on driving the company. It’s hard enough doing what’s right for the company. It’s not the first time I’ve submitted to scrutiny, so I just have to live with it. Look, how do I feel about my life? I get up in the morning, and I try to do my best. And I do that every day, one day at a time—from when I get up to when I go to bed. And that’s what I focus on, because that’s what I control. The level of scrutiny I cannot control. FL: How often do you feel you’re misrepresented? TT: It’s my fault. I must misspeak too much. FL: There aren’t many black CEOs in Europe. Do you see yourself as a champion of diversity? TT: Oh, that’s a simple issue: I happen to be black, I say. I’m black, and I’m right-handed. When I get up in the morning, I think about neither. I wasn’t given a choice. I could have been left-handed, but I’m righthanded. I don’t spend a lot of time wondering what life would have been like if I’d been left-handed.

Volume 25 / Issue 4

FL: Let’s talk about your cultural influences. You have many. Do you feel European? Swiss? Do you feel like a Londoner? Do you feel Ivorian? TT: I’m all of those things, fortunately or unfortunately. First of all, I speak in French, which is my mother tongue—and not by choice. It’s the fruit of history, because France colonized my country a long time ago. I’m a great believer that language shapes and structures your way of thinking. I’m European, if only by language. My home was steeped in French culture, French literature. I read a lot. Then I discovered, progressively, the English-speaking world—England, the U.S.—I loved that, too. I’ve also got very strong African roots. In my family, when we went home, we always took off our Western clothes and wore African clothes. Once a week we sat down and ate from the common bowl on the floor. My mother generally wore African clothes at a time, in the 1960s, when it wasn’t really popular to do so. And so I’m all of that. I also happen to have spent a good part of my childhood in Morocco, so I have a good understanding of the Arab world. FL: Tell me something else that people don’t know about you, or that they get wrong. TT: That would be a very long list. FL: There must be something that bugs you. TT: I’m revealing a vulnerability here, but any accusation of arrogance. That really wounds me very deeply. Because that’s just—I’m completely happy to admit to many faults. I can be impatient, for instance. But arrogance? I have such respect for other human beings, it’s such a central part of who I am. That’s something that I find extremely unfair. FL: And you’ve always been like that? TT: Yes, absolutely. I come from a very humanistic culture, one that’s focused on the person. I was raised deeply like that by my parents. Both my parents, they passionately believed in justice. The first day my father was in the Ivory Coast in 1947, he got arrested for not stepping off the curb when he met a white person, because that’s the way it was. And so my parents just really believed in fairness and equality. They never asked for any advantages. Also, there was a big emphasis on education, a strong belief in some kind of meritocracy. Those values were very important. FL: How was your relationship with your siblings? TT: I’m the seventh of seven, with four brothers. There was a lot of competition, but healthy competition. They really wanted me to achieve the most I could. FL: How rough were they? TT: I had a double fracture in my leg from one of my brothers tackling me. So it was real. But there was a lot of love, too. FL: You have two sons. What would you like to instill in them?

Hmm, what do I tell them the most? I think I’ve always felt that your real capital in life is your self-esteem. I have always thought of parenthood as a huge responsibility, because you have to take a human being to adulthood with the maximum amount of self-esteem. I tell them not to compromise that. Self-esteem, dignity, it’s all you have. If that’s taken away, it will kill you as surely as a bullet. All the rest—possessions, et cetera—can be taken away. FL: Is that something you learned from your parents? TT: Yes, although my mother would put it differently. But it’s very important. In the end, that’s the core of your personality and your ability to do things. And if it’s damaged, it leads to a lot of dysfunctional behaviors. FL: How did your mother put it? TT: I’ll keep that for myself. I don’t have her approval to quote her, and she’s been gone a long time. FL: Who else have you learned from? TT: I learn from everybody, really. I always recruit people to work for me who are much better than I am at many things. And I watch them and try to learn from them, because I really think everybody is good at something—at least one thing, if not more. And if you look every once in a while, you think, “Wow, that person is really interesting.” FL: Whom do you admire? TT: I’m not going to tell you. Then everyone else will be annoyed. No, there are many people I admire. FL: You heard from Roger Federer when you became CEO of Credit Suisse. TT: I was very touched. He sent a video message saying, “Welcome to Switzerland. We hope you have a good time here.” I have immense admiration for athletes. In some ways they exemplify the best features of the human spirit. The level of excellence they achieve, the apparent ease, the grace. Roger is a model of a human being. He always behaves with dignity, he’s a great champion, he’s always gracious to his opponents whether he wins or loses, and he’s a Credit Suisse client. [Laughs.] FL: Who else? TT: Well, I have a fascinating life. On my last trip to China, I counted 20 billionaires—in dollars— individually in an hour. Well, three hours, because it was a dinner. And each of them is exceptional. I went to China for the first time in 1984, so often I ask, “What were you doing in 1984?” And the answer, generally, is “All I owned was a bicycle.” And then you go through how they got to where they are. They’re exceptional people. I love spending time with them, and I learn a lot. FL: How does your business in Asia differ from elsewhere? TT: On the state of wealth in Asia, 65 percent is in TT:

Bloomberg Markets

“I’m black, and I’m right-handed. When I get up in the morning, I think about neither”

the hands of the first generation—so the people who actually made the money. In Europe, most of the money—more than half—is in the hands of the fourth or fifth generation. The kind of wealth management you do in those two universes is very different. FL: Do you see consolidation among European banks? TT: I think that would be very difficult in this new environment. One of the biggest headlines in the media remains “too big to fail.” If that’s the motto, how do you make institutions bigger? By definition, if you put two institutions together, you create a bigger institution. FL: If you were to buy one bank? TT: As I’ve said, the whole mood is not supportive of that. We have plenty of organic growth available. Plenty. We don’t need to do a transaction. FL: Credit Suisse itself is the product of consolidation. Does the First Boston legacy hinder or help? TT: Look, you can’t separate things. We’re the product of several traditions, and each is a core part of our identity. This is like asking someone if their parents hinder or help. You’ve got what you’ve got: You have a mother, you have a father. That’s our genetic heritage. And there are many great things about First Boston. It’s precious to have in our DNA, because it was always able to punch above its weight. I like the kind of grit and go-getter attitude there. FL: Which do you prefer, winning or competing? TT: Oh, that’s a philosophical question. I think both are very enjoyable. I enjoy competition. But fair competition, with rules, transparent competition where everybody has a chance. Winning is nice, if it’s done the right way without breaking the rules, and if you can win, in many championships, there’s a fair play title. If you can both get the fair play prize and win, then that’s great. FL: And in business? TT: It depends on how you define winning. To me, winning is serving your clients, having their loyalty, because ultimately that’s what business is, that’s what keeps you going. And then lasting. Prudential, where I was CEO previously, was created in 1848. Credit Suisse was created in 1856. So I’ve had the privilege of serving relatively old companies, and that’s always present in

my mind. I have to pass the baton. I have to keep it going because, God, it’s been going a long time. FL: What’s a better business, insurance or banking? TT: [Laughs.] They are both vital for the world economy and play a very important social role. FL: You more than doubled the share value at Prudential. Do you want to be the CEO who saved Prudential or the one who saves Credit Suisse? TT: I just aspire to leave the company in a better state than I found it. And that can continue. FL: Would you ever go back to politics? TT: No. That’s the easiest question you’ve asked me. FL: Why not? TT: There’s a time for everything. I don’t regret doing it. I learned an enormous amount about how the government operates, the complexities and the challenges. Which gives me a better understanding vis-à-vis public sector employees. They have a difficult job. Having tried to drive an economy, that’s a humbling experience. Driving a company is hard enough. FL: You love your job? TT: [Laughs.] I love the people, because they are worth it. This is why accusations hurt. When people say I am distant. If you come to a town hall with me or the trading floor, it’s the people who are interesting. And there is nothing more exciting than when you can get people to do something they think they’re not able to do. That’s very, very gratifying. FL: If you were to lose your job tomorrow, what would be your biggest regret? TT: That’s a fantastic question. Not being part of the collective journey anymore, that it’s going to go on without me when I think I can make a positive contribution. FL: How hungry are you for this job compared with when you started? TT: Hungrier. I see more opportunities now. I saw some from the outside, but now I can really see the scale and range of the opportunities, and they are vast. Of course, you also understand the problems and the challenges, but luckily you get both. Lacqua is an anchor on Bloomberg Television in London.

Volume 25 / Issue 4

Financial rewards for trading are down. Incentives for making markets are gone. The business of bond trading has been turned on its head. And one player looks stronger than ever IT’S NOT WALL STREET, where the biggest names in banking stalk the canyons of Manhattan. And it’s not the City of London, where grand financial institutions new and ancient grace the shores of the slate-gray Thames. No, this is Columbus, Ohio, and John McClain, a portfolio manager at Diamond Hill Capital Management, surveys a panorama unlike the traditional citadels of capitalism. From his desk, McClain gazes out at a Tim Hortons fast-food joint and the arena where the NHL’s Blue Jackets play. Sure, McClain’s office setting is a departure from our accustomed, sepia-toned image of the world of high finance. But so is the way he does business. Take this anecdote from November. McClain spotted a seller wanting to part with a chunk of company bonds, which happened to include $2.2 million of notes issued by Rent-A-Center, a company that deals in rent-to-own furniture and electronics. Having spent hours crunching the numbers of the company, based in Plano, Texas, he knew Rent-A-Center was a name he liked; he also knew its bonds didn’t change hands often. Yet here they were, in an odd-size offering packaged with the bonds of a bunch of other companies and being sold by a “transition manager,” which indicated to McClain that the counterparty wanted to move fast. Before the global financial crisis, a trader at a bank wouldn’t have blinked twice before taking the Rent-A-Center paper on his balance sheet to parcel out as he found buyers. Such a play is as good as dead now, says McClain, 34. If the trader doesn’t have the

The Rise of The Buy Side

By ALASTAIR MARSH and SRIDHAR NATARAJAN I L L U S T R AT I O N S B Y M A R T I N A PA U KO VA

other side of the deal lined up, the bank isn’t going to stick its neck out. Indeed, a day after the opportunity presented itself, the Rent-A-Center bonds were still up for grabs. McClain saw just one viable dealer quote, and it proposed buying only a portion of the bonds at their market price. If the seller wanted out completely, McClain reasoned, he could buy them at a discount. So he made his move, bidding for them about 2¢ lower than their trading level—but with the promise to buy all of the Rent-A-Center notes. His offer was accepted on an electronic-trading platform. That sort of transaction would have been “unthinkable 10 years ago,” says McClain, who succeeded in resetting the price on the notes without interacting with a single Wall Street trader. If he had gone the traditional route through a sell-side dealer, he might have coughed up $50,000 or more on that one trade alone, he estimates. “Now it’s more of a level playing field, as dealers have been pulling their balance sheet and simply crossing trades,” he says. “We have stepped in to provide liquidity.” Having stepped in when someone was discarding the bonds in distress, McClain would have been able to sell them in late July after recording gains in excess of 10 percent. McClain’s Rent-A-Center play is a stark illustration of an irrevocable shift in the balance of power in the global bond market since the financial crisis: the rise of the buy side. “Before the crisis, it was like everyone was onstage but only the sell side

had speaking roles,” says Richard Prager, the New York-based head of trading, liquidity, and investments at BlackRock, the world’s biggest money manager. “Now everyone is speaking up.” Even in Columbus. THE BOND DEALERS and investment banks that make up the sell side were once the lords of fixed-income markets. They would have snapped up that Rent-A-Center paper before McClain had spotted it. Prior to 2008 they maintained large warehouses of bonds and were the first port of call for investors looking to add or offload securities. They also took debt onto their own balance sheets, made bets with their own money, and spearheaded developments in trading and technology. Today, post-crisis regulations intended to make banks safer and discourage risk-taking are eroding their profits and forcing dealers to rethink their business model. Banks are pulling back from market-making and shedding assets, business units, and employees. The dealer has essentially been demoted from maitre d’—deciding where everyone sits and recommending dishes—to a waiter taking orders. These changes have created a vacuum in the bond market and made trading much trickier. They’ve also paved the way for the buy side— from asset managers to hedge funds—to exert more influence than ever on the market. Those on the sell side once employed armies of analysts to come up with the smartest trade ideas to make money for themselves and their clients. Not any longer. An ongoing brain drain has left some dealers overstretched, underresourced, and less able to compete with the buy side. “The banks have fewer resources and less capacity, so the buy side has to be more self-reliant,” says Lior Jassur, who works for the $425 billion investment management firm MFS in London. A case in point: Just before Christmas last year, Carson Block, a short seller who made his name alleging fraud at Chinese companies, targeted French retailer Casino Guichard-Perrachon and its biggest shareholder, Rallye. In a typically scathing report by his firm, Muddy Waters Research, Block said Casino was using “financial engineering” to mask a “sharply deteriorating core business.” Block’s accusations, which Casino denied, sent both companies’ bonds and stocks tumbling. Across Europe, banks rushed out commentary and trading ideas. Within hours of Block’s move, Jassur was staring at reams of the stuff. At his desk in the City, which has a view of the U.K.’s tallest building, the Shard, Jassur stayed calm. There was a time, before the financial crisis, when the banks’ credit analysts were imparting gold-plated information. Now banks simply

don’t have the analytical firepower they once had. Jassur, 49, wasn’t surprised to see most analysts following Block’s lead. None recommended buying. And their recommendations didn’t change—even as the bonds lost 13 percent of their value over the next month. Jassur and a colleague did their own analysis. They pored over data, talked to Casino’s staff, and reached their own very different conclusion: Block’s strike had created a buying opportunity. They were proved right. Casino’s 2026 bonds, which had raised €900 million ($1 billion) for the company when they were sold in 2014, fell to a low of 76.3¢ on the euro in mid-January from 87.7¢ on the day Block launched his attack in December. But the bonds recovered that loss by March as Casino sold off assets to improve its finances. By late July they reached a one-year high of 108¢. (Jassur, citing company policy, declined to comment on any trades MFS may have made in Casino’s bonds.) because the $100 trillion global bond market is an essential part of the machinery that keeps the world’s economies ticking. It provides a place for governments and companies to borrow money and for investors, including pension funds and hedge funds, to buy securities. Today the business has been turned on its head, according to interviews Bloomberg Markets conducted with a dozen buy-side, fixed-income traders at firms that manage a combined $8.5 trillion of assets. Put simply, the buy side rules—and it’s no longer looking to dealers to set the tone of the market or determine its structure. In the pre-crisis bond market, a money manager with a position to sell would typically ask a handful of dealers for a bid and accept the most competitive one, thus being a price taker. No more, says Brett Chappell, who works in Copenhagen as head of fixed-income trading at Nordea Asset Management, which oversees about €190 billion. Today, says Chappell, who began his career trading interest rate swaps in Paris in 1990, buy-side traders need to become price makers, especially on less liquid trades, communicating to dealers a specific, take-itor-leave-it price. Bond investors should also be able to determine how much they pay to trade with dealers, says Cathy Gibson, head of fixed-income trading for Deutsche Asset Management’s U.K. operations in London. Gibson’s unit has €719 billion of assets under management. Before the crisis, it was the norm for banks to take bonds onto their balance sheets for months at a time before selling them back into the market. Today banks act much more like brokers: seeking to match buyers with sellers without assuming any of the credit risk.

ALL OF THIS MATTERS

Gibson says that as the business model has changed, so too should the pricing. Banks can’t expect to be paid pre-crisis fees for post-crisis business. She gives this example: In a trade where a bank is taking a high-grade corporate bond onto its books, she might be willing to pay a premium of 15 basis points above the bid-ask spread. If the dealer is simply looking to pass on the notes, Gibson says she wouldn’t be willing to pay extra. technology-fueled data analysis improves trading relationships. The Frenchman got his first job in finance in 1995 working for a stockbrokerage in Casablanca, where he learned computer programming and database management. Orève is now in Brussels as the global head of trading at Candriam, an investment management firm that oversees about €97 billion in assets, and his experience shows just how advances in technology are changing the way buy- and sell-side firms interact. From electronic-trading platforms to services allowing investors to identify who owns the securities they may wish to trade, the bond market is undergoing a transformation. For the past year, Orève has been collecting data on all of Candriam’s fixed-income trades. The firm crunches the numbers and sends its dealers in London a monthly report detailing how they rank against their peers in terms of volume of business done with the firm across bond sectors. “Both ourselves and our counterparties can exploit the wealth of information in the table to create new business opportunities,” Orève says. Running the numbers also helps Orève spot quirks in the market. At certain times, dealers are less willing to trade, potentially leaving investors stranded in a trade they wish to exit. Orève noticed, for instance, that every three months, as banks approached their quarterly earnings announcements, they became more reluctant to take on new positions and would widen their average bid-ask spreads to make buying and selling less financially rewarding for investors. “They know we know,” he says—and that can make for improved relationships during those quiet trading periods. The increasing electronification of the bond market, where many trades are still conducted over the phone, has given investors greater access to information and cut some trading costs. Money managers can now conduct their own analysis of market prices and investor positioning for certain bonds. That, in turn, can help them be better informed when dealing with sell-side players. These advances, together with developing strong relationships in the market, can help buy-side firms become price makers, says Nordea’s Chappell.

FOR FABIEN OREVE,

Today, from London to New York to Singapore, more than 100 electronic platforms offer fixed-income trading. And venues are cropping up to fill the gap left as banks retreat from the market, making it harder to buy and sell debt. Some, such as Liquidnet Holdings, connect buy-side firms directly with one another, cutting out the dealers altogether. (Bloomberg LP, the parent company of Bloomberg Markets, competes with Liquidnet in providing a venue for electronic trading of corporate debt.) THE BANKS’ GLOBAL fixed-income businesses, once among the most lucrative in finance, have been torpedoed by rules imposed after the financial crisis to make banks take on more capital and less risk. Tougher regulations for dealers—including Basel III and the Dodd-Frank financial reform law—have eroded the financial rewards of trading and removed incentives for making markets. Declining revenue has also prompted dealers such as Barclays and Deutsche Bank to cut costs by downsizing and repositioning their businesses. In the past 12 months, banks, including Credit Suisse, Morgan Stanley, and Nomura, have cut jobs and stopped trading certain products, such as mortgagebacked bonds and distressed debt. Most dealers’ bond desks have been hollowed out; they’re turning over less volume with fewer staff for lower rewards. Revenue from trading in fixed income, currencies, and commodities fell to $70 billion last year at the 12 largest global investment banks, the lowest level since 2008, according to data compiled by Coalition, a financial research firm. Meanwhile, the number of traders and salespeople at those firms declined by about a third from 2010 to 2015, with 9,000 jobs lost, according to Coalition. The pain is far from over. With higher regulatory costs and record-low interest rates suppressing returns, banks will look to reduce their balance sheets by about an additional 10 percent in the next two years, according to a joint white paper produced by the management consulting firm Oliver Wyman and Morgan Stanley. The sell side’s retreat from market-making and its shrinking inventory of bonds have coincided with a deluge of bond sales from companies taking advantage of the extremely low borrowing costs to raise funds cheaply. The result has been a rapid expansion of buy-side bond holdings, which has given certain firms greater ability to wrest more influence. Yet with greater power comes greater scrutiny. As the buy side’s asset pile and prominence burgeon, according to the Oliver Wyman-Morgan Stanley report, asset managers could face the kind of stress tests that banks have endured in the wake of the

financial crisis, as well as additional examinations of liquidity risk and financial conduct. While the buy side has been hurt by the deteriorating trading conditions in the debt markets, caused by market makers’ retrenchment, it has the potential to see a liquidity crisis of its own making. Mutual funds that invest in bonds and allow investors to withdraw their money on a daily basis more than doubled their holdings of U.S. credit in the past decade. Policymakers have warned that the mismatch between debt that can take weeks to sell and funds that offer daily liquidity creates instability and could be dangerous in a market rout. That’s not the only area of buy-side business that regulators are looking at. The Financial Stability Board, whose members include the U.S. Federal Reserve and the Bank of England, said in June that exchange-traded, mutual, and other funds should have extra oversight to ensure they can sell assets to meet investors’ demands to pull out their money during volatile markets. The FSB also said it may designate certain assetmanagement companies as systemically important and in need of stricter supervision. BlackRock, with $4.9 trillion in client assets, has lobbied regulators and published reports stating that concerns over funds triggering the next financial crisis are overblown. Although the equilibrium of the bond market has shifted greatly since the financial crisis, the sell side and the buy side still, to varying degrees, need each other. Investment firms may profit from the demise of the dealers by buying their bonds and hiring their employees, yet for the most part they’re not looking to replace them entirely. “You’ll never do away with the banks, nor will we just wait for them to come up with solutions for problems in the market,” says Deutsche Asset Management’s Gibson. The buy side will continue to trade with dealers, yet it will also look to exert its influence on the way bonds are transacted, she says. Most money managers aren’t seeking to take on traditional dealer roles, such as becoming market makers, for that runs counter to their primary goal of generating returns for their investors, says BlackRock’s Prager. Even so, they’re becoming more assertive in saying at what price they want to buy and sell a security, rather than being a price taker, he says. “Being a good fiduciary,” Prager says, “means you don’t just sit back and let the market do whatever it does.” Whether in Columbus or London, toiling away across from a Tim Hortons or in the shadow of the leadclad dome of St. Paul’s Cathedral, the buy-siders are not sitting back. They’re the bond lords these days. For Bloomberg News, Marsh covers corporate finance in London, and Natarajan covers corporate finance in New York.

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TYPE VETF <GO>

For seven years, hedge fund manager Mark Hart has been betting that China’s currency will collapse. He’s not about to give up now

The Waiting Game By SAIJEL KISHAN P H OTO G R A P H BY B R A N D O N THIBODEAUX

after Mark Hart and his wife have put their kids to bed, he’ll duck into his bedroom closet and close the door behind him. Then, by pixellight, he goes to work. Hart, a hedge fund manager in Fort Worth, has a single fixation: the Chinese yuan. And at 9 p.m. Texas time, China’s financial markets are in full-throated roar 13 time zones away. Surrounded by shirts and pants—the closet is more convenient than his basement office—Hart, 44, talks to Hong Kong, parsing the latest numbers and the scuttlebutt from Beijing and Shanghai. In the seven years since this all started, he might as well have learned Mandarin. (All three of his children speak the language now, unlike their old man.) Doggedness has cost him millions—not to mention investors, employees, and, at times, damn near his sanity. But he won’t, or maybe can’t, let go now. Hart says China is headed for a fall. Sure, others in finance think so, too—now. But Hart, who’s little known outside a small hedge fund clique despite making a fortune on the U.S. housing bust and predicting the euro zone debt crisis, got in early on the China bear trade with currency options and held on. And on. And on. To some, he’s ahead of the curve. To others, he’s so far behind it he seems to have lost his way. The world of finance can reward the bold, but it can also devour those whose conviction bends toward obsession. On one level, Hart’s story is a familiar tale of one man’s attempt to navigate those shoals. On another, it’s much more than that—an up-close-andpersonal account illustrating one of the most important economic stories of our time: the ongoing tug of war between the free hand of the global marketplace and the Communist Party of China, which has sought to harness the power of capitalism without quite submitting to its will. In both stories, the ending remains unwritten. “Mark is certainly a trend-setter,” says Harlan ON ANY GIVEN EVENING,

Korenvaes, the 65-year-old founder of $21 billion Dallas hedge fund HBK Capital Management, who now manages his own wealth. “But staying on these highreturn, high-volatility trades could be to his detriment.” Hart’s case, in a nutshell, is this: China’s currency is wildly overvalued. By some accounts, the yuan’s real effective exchange rate vs. the dollar is twice as high as it was two decades ago and almost 40 percent higher than it was in 2008. Hart foresees a one-off devaluation of at least 30 percent, maybe more, with consequences worse than those of the global financial crisis. Otherwise, he says, Beijing will just burn through foreign exchange reserves trying to fight a losing battle. “You have to go through the valley to the other side,” Hart says of China. “It’s not necessarily going to be pain-free. But it’s good.” Hart might as well be talking about himself: He’s trudged through the valleys, felt the pains. Before he started betting against the yuan, his hedge fund, Corriente Advisors, managed $1.9 billion. He started the Fort Worth outfit, named after a breed of cattle used mainly for rodeo events such as bulldogging, in 2001, at 29. Employing a top-down approach to investing, he analyzed economic trends, studied price charts, and spoke with people to gauge sentiment. He did pretty well for himself, too, posting an annualized return of 30 percent through 2006 on rising markets. Then he and his friend Kyle Bass, another, more famous Dallas-area hedge fund manager, cleaned up in the subprime mortgage bust. They bet against the market and sextupled their money in little more than a year. In 2007, Hart turned his gaze across the Atlantic and bet—correctly again—that European government bonds were headed for trouble. Some investors saw their money double. In short order, he’d made billions for clients. Then he set his sights on China. It seems so long ago now. Even shutting his main hedge fund in 2012 and giving investors their money

CHINESE YUAN-U.S. DOLLAR EXCHANGE RATE Weekly

January 2015 Hart says devaluation is imminent

September 2015 Hart starts another China fund

$0.16

December 2009 Hart starts betting the yuan will fall June 2015 Hart’s China fund expires

9/7/2008

$0.17

August 2015 China devalues the yuan

$0.15

7/17/2016

$0.14

Source: {CNYUSD Curncy GP <GO>}

TO UNDERSTAND HOW he got here, you have to go back to November 2008. That was when China first caught his attention. Lehman Brothers had just collapsed. Markets everywhere were reeling—except in Shanghai. Over there, the stock market started rallying. Why? Hart was puzzled, especially when

everybody from George Soros to Marc Faber started talking China up in early 2009. Hart sniffed an opportunity, the kind of market divergence he often seeks. As with all his trades, he dug deep, reading constantly, carrying stacks of books and charts around with him, and poring over everything from China’s consumer savings patterns to nonperforming loans at the nation’s banks. His research led him to Jim Walker, the Hong Kong-based economist who predicted the market turmoil that swept East Asia in the late 1990s; Dr. Gloom, as he’s known, was also skeptical of China. Hart began building an informal brain trust, talking to other longtime China hands such as Logan Wright, now at Rhodium Group, and Victor Shih, a professor at the University of California at Irvine, who was warning about a credit bubble. “I drive people crazy,” Hart says. “I’m constantly prying.” By December 2009, all that prying had helped him formulate his strategy. Hart’s big play: currency options that would pay off if the yuan fell sharply. About $225 million from investors poured into his China fund, a “special purpose vehicle” with a set mandate and time period. He used the money to buy contracts as far out as two years. It was, in the scheme of things, a relatively safe bet: If he was right, the payoff would be huge. If he was wrong, the options— bought for a few basis points—would expire worthless. Hart couldn’t blow up; he could only bleed to death. With the yuan trading at about 6.8 to the dollar, he figured he’d give his trade five or so years to work out. With that, all those restless nights began. At first, Hart woke up every half-hour to monitor the markets and call brokers in Hong Kong. He was still invested in Europe, too. It was all markets, all the time. “I had $25 billion of notional exposure!” he says of his yuan bet, leaning in close. “I wouldn’t say it was an obsession. It’s a lot of hours, a lot of work. You have to be completely committed.”

CHINESE FOREIGN EXCHANGE RESERVES

VALUE OF CHINESE EXPORTS IN U.S. DOLLARS

back after losses seems ages ago. Hart’s contrarian ideas previously had gotten him laughed out of meetings with investors and bankers, but “he was laughed out the hardest on the China trade,” says Adam Rodman, who worked as an analyst at Corriente until 2012 and now runs a hedge fund his former boss has backed. For a time, as the markets moved against him, Hart almost couldn’t bring himself to watch. Yet on this warm May afternoon, he’s relaxed, walking barefoot around his office in a converted warehouse he owns on the outskirts of downtown. Hart is Texas born and bred, a product of the University of Texas at Austin, but his vibe is more Brooklyn hipster than Texas oilman. A lean 6-foot-2, he gives off a chill surfer-dude air. Here, in the 24,000-square-foot space far from the canyons of Wall Street, he has a gym, a rec room, and an art gallery. A chalk-on-blackboard copy of The Raft of the Medusa, that icon of 19th century French Romanticism, dominates one wall of his lair. Joel Sternfeld photographs hang on the others. The bric-a-brac runs from vinyl records (the White Stripes are a favorite) to a teapot in the shape of Ronald Reagan with a green Mao hat sitting on top. A couple of slacklines are installed. Next door, in a second warehouse, he’s got a half-pipe for skateboarding. Hart pretty much has the run of the place. Corriente has only five employees, down from 25 in 2008. He’s not bitter, at least not anymore. After all, he had a hell of a run. And if this trade pans out, he says, he may make a full comeback to the hedge fund industry.

Monthly

Monthly year-over-year change $4t

60%

$3t 30% $2t 0 $1t

9/2008

6/2016

9/2008

6/2016

-30%

Sources: {CNGFOREX Index GP <GO>}, {CNFREXPY Index GP <GO>}

If he was right, the payoff would be huge. If he was wrong, the options would expire worthless. Hart couldn’t blow up; he could only bleed to death

To some, Hart treads on dangerous turf. China’s central bank has warded off speculators by making it costly to bet against the yuan, says Frank Zhang, head of foreign exchange trading in Shanghai at China Merchants Bank. “It’s not wise to battle against the People’s Bank of China, because you’re not going to win,” he says. “Even if there are pressures for the yuan to weaken, the PBOC will likely manage market sentiment and let the currency fall very gradually.” Hart takes exception to being known as a Chinabasher and clarifies that he’s not betting against the country’s central bank, with its $3.2 trillion currency hoard. In fact, he says, he shares the same position as the PBOC: long dollar, short yuan. Hart talks with intensity about his trade, spanning topics from Premier Xi Jinping’s grip on power to the implied volatility of options. He says China experienced an unsustainable economic boom that attracted substantial foreign capital inflows and fueled excessive credit growth. The resulting imbalances—overinvestment, asset-price bubbles—leave it vulnerable to a massive correction. You might assume he developed these ideas on the ground, but he’s actually never set foot on the mainland. “You’re just subjecting yourself to hearing what they want you to hear,” says Hart, who’s opted to send his analysts instead. The closest he’s come is Hong Kong—an “adult Disneyland,” he quips. The Texan concedes his trading style isn’t for everyone—and sometimes, it turns out, it isn’t even for him. After starting to bet on the yuan’s fall in 2009, Hart watched as the currency moved in the opposite direction. A year passed. Then two. Then three. Then four. He was accustomed to making clients billions, yet here he was watching hundreds of millions of dollars’ worth of yuan options sink down the plughole. “Sometimes, to our detriment, we looked at these investment ideas not just as work, but as life’s work,” says Rodman, his former analyst.

Making matters worse, Hart was losing money on his European trade. His temper began to fray. His employees became demoralized, and he was barely spending time with his family. His father, also named Mark, was battling Parkinson’s disease. Hart was overwhelmed. “I felt like I was under siege,” he recalls. “I was working harder and not having any results.” He stands up, stretches his arms and legs, and sits down. “I’ve certainly broken a few phones.” By late 2012 the yuan was still moving against him, strengthening almost 10 percent against the dollar since he started his wager. With stress taking its toll, Hart took a break to clear his mind. He kept a journal. He read Hemingway. Finally he concluded he couldn’t keep juggling every ball. After 11 years, Hart shut his main hedge fund and gave investors their money back. His European fund then expired, after losses. “I blame myself. I’m the one who f---ed it up,” he says, raising his voice and shifting in his chair. “One big mistake that I made was that I believed China would recognize that it would be in their best interest to stop defending their currency once it became apparent that the days of foreign exchange inflows were over. “It was insane,” Hart continues. “For a long time I’d let these trades dominate my life. I was too dogmatic.” He loses the thread for a moment and then says, half to himself: “I was so convinced I was right.” Closing his main fund was one of the best decisions he’s ever made, Hart says: “It was incredibly liberating.” He pulled himself together, using Brazilian jiujitsu as an outlet. He went as close to vegetarian as a Texan can, barely touched alcohol, and made breakfast a regular ordeal: a few forkfuls of sauerkraut (fuel for a healthy gut); sardines and eggs (paleo staples); a vegetable drink; and a protein shake. Then, in early 2014, the yuan began weakening. Hart held his breath, hoping to see the epic devaluation he’d long expected. He didn’t have much time left; the

Bloomberg Markets

China fund, all he had left, was nearing its end. In January 2015, he went so far as to tell clients that a devaluation was imminent. He hoped to raise more money, but there was little uptake. “Mark Hart fatigue,” he says. The fund expired in June 2015 without turning a profit. He hung his head and took the summer off. in August, China devalued the yuan by more than it had since it ended a dualcurrency system in 1994. Shock waves rippled across global markets as the currency weakened 1.8 percent on Aug. 11. That might seem minuscule, but even hardened China watchers were stunned, with Khoon Goh, head of Asia research at Australia & New Zealand Banking Group, saying he initially assumed financial news wires had published the wrong exchange rate. Hart had just returned from a family vacation in Austin and was busy getting his kids ready for the school year. He almost didn’t notice: With no skin in the game, he hadn’t been paying attention. Even if he’d still had his wager in place, “it’s not like it would have really made me money,” Hart says. It would have on a mark-to-market basis for a while, but ultimately it wasn’t the big one-off devaluation he was waiting for. Nonetheless, the congratulatory e-mails began pouring in. “It was really satisfying,” he recalls. “It seemed as though my thesis was proving itself.” That thesis happens to remain in play. Last September, Hart decided to take another stab at shorting the yuan and opened another China fund, raising about $50 million. Since then, others have taken aim at the currency—including David Tepper, Bill Ackman, and Bass, who’s started his own China fund. Bill Gross, the former star of Pimco now at Janus Capital Group, likened the pressure on the yuan to the 1992 attack on the British pound that turned Soros into the man who broke the Bank of England. Shorting the currency became such a crowded trade, in fact, that

TWO MONTHS LATER,

early this year China’s central bank went on the offensive to drive out speculators. Hart hadn’t put all of his money to work when the PBOC tightened capital controls, intervened in currency markets, and waged a verbal campaign to support the exchange rate. Hedge funds run by Dan Loeb and Paul Singer were among those posting losses on the trade, which Hart says he avoided. And he’s since slowly added to his wager, buying yuan options a month or two into the future. “My mindset has been much better on China,” he says. “I’ve been a lot more willing to accept government action.” The currency has continued to weaken, hitting its lowest in more than five years on July 18. Even so, things may be turning around in China, with data from gross domestic product to retail sales fueling optimism that economic growth will steady. Foreign exchange strategists tracked by Bloomberg say the yuan will drop just 1 percent vs. the dollar by yearend, while the central bank has pledged stability against a basket of currencies. Just how it will end is anyone’s guess, though Hart’s latest fund is scheduled to expire in December. He says that once the yuan weakens dramatically— and he insists it will—he’ll invest in an exchangetraded fund that tracks the nation’s biggest companies. “Even if he doesn’t win on this China trade,” Dallas investor Korenvaes says, “he’s one of the first guys that spotted it, and others came aboard.” Outside, the temperature in Fort Worth is approaching 90F. Hart hasn’t touched the water bottle in front of him. Later, in the gym, he grapples with his jiujitsu instructor. He employs a body lock, making his instructor tap out before releasing him. “He let me win,” Hart says, laughing. Will China? —With Tian Chen Kishan covers hedge funds for Bloomberg News in New York.

Volume 25 / Issue 4

A few bucks at a time. Millions of times a day. In the history of electronic trading, no company has been as successful as this paradigm-changing market maker, which operates in more venues than it has employees. Yeah, go ahead and do the math By MATTHEW LEISING P H O T O G R A P H B Y J U S T I N FA N T L

Virtu Never * Loses *Actually, it did lose ... once

rang out on Virtu Financial’s New York trading floor one Friday morning in late May: “Something’s wrong.” This was the Watcher, an automated program the electronic market-making company created to alert risk managers when any of the millions of orders it places on a given day go awry. In this case, Virtu had entered into a $1 million currency contract but then decided to cancel the order. While it took only 700 microseconds to get confirmation that the trade was on, the cancellation hadn’t been acknowledged by the exchange within five seconds, triggering the Watcher’s Stephen Hawking-like voice. That morning, the Watcher had already flagged another issue on an order at an African stock exchange. A bit later it directed risk managers to investigate two trades on a European energy market. Virtu often trades as many as 5 million times a day. Amid that ocean, it’s built its risk-management systems to catch even these few errant drops of water. If this precision feels militaristic, that’s because it is. Vincent Viola, who founded Virtu in 2008, graduated from West Point and came of age jumping out of airplanes for the U.S. Army’s 101st Airborne Division, also known as the Screaming Eagles. He named the company Virtu for the Latin word “virtus,” peppers his speech with terms such as duty and mission, and instills in his employees the type of devotion more common on a battlefield than in a boardroom. And like anybody

A COMPUTERIZED VOICE

VIRTU’S AVERAGE DAILY ADJUSTED NET TRADING INCOME Equities Options and fixed income

Commodities Unallocated

Currencies

$1.2m

$0.9m

$0.6m

$0.3m

1Q’14

1Q’16 Source: {VIRT US Equity CF <GO>}

who flings himself from the back of a C-130, Viola values two traits above all: trust and efficiency. “I’ve tried to re-create that in my Wall Street experience,” he says during a rare interview at a Manhattan cafe in June. Viola’s principles have not only transformed how markets operate in an increasingly computerized era, they’ve also made his company—with its market value of $2.4 billion—part of Wall Street’s new guard, one that’s risen as power and profit have shifted away from traditional gatekeepers such as JPMorgan Chase and Goldman Sachs since the financial crisis. Virtu and other relative newcomers, including Jump Trading, DRW Holdings, and Citadel Securities, as well as smaller, nimbler enterprises, are filling voids created by new regulations and technologies. Virtu’s combination of microscopic electronic surveillance, lightning-fast algorithms, and rigorous risk management also explains why this relatively small company has become the most consistently profitable market maker in the history of electronic trading. “The discipline they apply to the wholesale market-making game is different than other firms,” says Rich Repetto, an analyst at Sandler O’Neill & Partners. The consistency with which Virtu earns a profit is almost beyond belief. From 2009 to 2014 it lost money on only one day. (The aberration happened when it missed a special dividend payment for a stock, throwing off its model and causing a seven-figure loss.) In 2014, the last year it disclosed its daily win-loss ratio, Virtu was in the black every day, generating revenue of $723.1 million and net income of $190.1 million. Rather than go for big trades that could blow up and lose a lot of money, Virtu prides itself on making small amounts—as in $10—millions of times a day. Between the Watcher’s sporadic warnings on that Friday in May, the company was making markets in gold exchange-traded funds and futures. Over a series of 23 transactions in Chicago and New York, it earned all of $36. “They’re consistently profitable in an area that’s not known for that,” Repetto says. Profitability, however, hasn’t prevented the company’s share price from slumping since its initial public offering in 2015. What the company wants to do over and over is to sell to buyers and buy from sellers, not take positions of its own, and either hedge its risks at the end of the day or go home with no risk at all. It does this with stocks, currencies, futures, and fixed-income securities. All told, Virtu makes markets in more than 12,000 financial assets. The ruthless efficiency at its core is most evident when you consider that it trades on more markets (230-plus venues in 35 countries around the world) than it has employees (148 at the end of 2015). cotton pants and a black Dockers shirt, hardly a uniform that would make fellow

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cafe-goers on the Upper East Side notice that in their midst is a man worth $2.3 billion, according to the Bloomberg Billionaires Index. At 60, the former soldier is fit with short, cropped hair and dark brown eyes. The Medium Is the Massage, the 1967 book by Marshall McLuhan and Quentin Fiore, changed his life. “I started to understand that the power of information and the way it was presented was almost as important as what was being said,” says Viola, who’s focused and intense and prone to touching you on the arm to emphasize a point. Raised in Brooklyn, N.Y., by a truck driver and a homemaker, Viola never set foot inside a business class. Yet he proved a natural fit on the floor of the New York Mercantile Exchange, where he jostled and shouted out orders in the crowded oil futures pit in the early 1980s. He eventually became a board member of the exchange and its chairman from 2001 to 2004. Two events during his Nymex years convinced him that electronic trading was the future. In 1989 a deal he, as a director, was negotiating for a stake in the Chicago Mercantile Exchange’s electronic trading system fell through. Nonetheless, Viola was put in charge of Nymex’s newly created electronic trading committee. There he learned that a few years earlier, in 1984, Nasdaq had introduced an electronic trading method that automatically matched small orders against the best quotes in the market. In other words, Nasdaq had opened part of its market to be accessible from multiple locations, unlike the closed-system exchanges where traders had to be physically present on a floor. Viola may have been a bit late in picking up on Nasdaq’s innovation, a huge change in markets, but he realized its importance. “That was my ‘Aha!’ moment—when I realized these markets were destined to be electronified,” he says. carried out his revolution on his own. Doug Cifu, Virtu’s chief executive officer, has been at his side since Day One. A private equity lawyer prior to Virtu, Cifu met Viola through Bill Ford, now the CEO of General Atlantic, which in 2006 had bought a stake in Nymex. Three years ago, Cifu and Viola purchased the NHL’s Florida Panthers—which fills Cifu’s Twitter feed, unless he’s telling the world his son pitched a no-hitter and batted 4 for 4 in a Little League game. Cifu, 51, points to probability theory and the millions of times Virtu trades every day to explain its winning ways. The law of large numbers dictates that the company, seeking only to earn the spread on each transaction and not bet on the direction of markets, will make money close to 50 percent of the time. (It loses a lot, too—on the whole its strategies just happen to win slightly more than they lose.) “This firm is about making a tick,” Cifu says. “We don’t hold on to positions.” The former lawyer is brash and prone to cussing,

VIOLA BY NO MEANS

100

which has helped make him well-liked on Wall Street. From 2012 to 2014 he and Viola more than doubled Virtu’s net income. Then, just as they prepared to take the company public, Michael Lewis published Flash Boys, about a team of former Royal Bank of Canada traders trying to launch an exchange, IEX. In the fallout, high-frequency trading companies came under fire for allegedly rigging the U.S. stock market. Virtu has never considered itself an HFT company, Cifu says, because it never holds on to the assets it buys and sells. Still, the business got caught in the media firestorm that followed Lewis’s book and shelved its IPO plans for a year. That Virtu only makes markets and isn’t an HFT company “fell on deaf ears,” according to Mehmet Kinak, head of global equity market structure and electronic trading for T. Rowe Price. The circumstances also made Cifu adopt the role of corrector-in-chief. “There are some people who don’t appreciate the role of a market maker,” he says. “Natural buyers and sellers will never meet.” Then he adds a zinger: “Michael Lewis might not understand that.” (When asked for comment, Lewis responded: “The book did not make the unsubstantiated claim that the stock market was rigged. It described the extremely careful and persuasive tests run by RBC traders that showed how it was rigged.”) Virtu is built to benefit from more electronic trading, Cifu says. The company doesn’t make money from inefficient markets, he clarifies—just the opposite. “The secret of Virtu is the scale and the efficiency we brought to the market,” he says. “The biggest misconception of this firm is we’re some nefarious quantitative firm with a secret algorithm.” Viola says being cast as a villain was “the most bizarre period of my life.” Yet he rallied the troops at Virtu—as he did while chairman at Nymex after the terrorist attacks of Sept. 11—gathering everyone on the New York trading floor to tell them, “We know we’re good actors.” Virtu saw the moment as an opportunity to engage with the broader market and show how the company operated. Cifu played a star role in setting the record straight, according to Kinak; after Flash Boys, the CEO bared all to prove how his firm does its thing. As a result, Virtu ended up creating a service in late 2014 to execute trades for T. Rowe Price and broker-dealer Themis Trading. Kinak is a fan. The so-called agency business is “helping our cost of execution,” he says. Virtu’s technology and the way it sends orders into the market are superior to what T. Rowe was using before. And then in early August, Virtu released a bombshell. It agreed to provide its order routing and execution services to JPMorgan, Wall Street’s largest fixed-income shop, for use in the $13.4 trillion U.S. Treasury market. Without naming the bank, Cifu had hinted at this development back in May. “I see more of these kinds of arrangements in the future,” he says.

Bloomberg Markets

to generate profits aside, investors have so far been unimpressed. As of Aug. 1, Virtu shares had fallen 21 percent since its April 2015 IPO. “Despite a decent environment, it seems like they haven’t lived up to expectations,” says Alex Kramm, an analyst at UBS. That may be because the company is a bit of a black box, he says; investors are unsure of Virtu’s ability to sustainably expand its business and not lose market share to competitors such as KCG Holdings, Citadel Securities, and Global Trading Systems. A promising development is the agency business: Kramm expects the strategy to be a big part of Virtu’s future, helping to increase revenue as much as 15 percent in the next two years. According to Kramm, one disadvantage of the company’s business model is that amid all the assets Virtu trades, it’s difficult to get a view into what’s driving the bottom line. Take foreign exchange. “FX has been a challenging area for them in terms of not growing as fast or being down in some quarters,” he says. He also notes the rich irony that, for a company buying or selling just about any financial asset under the sun, it’s difficult to get Virtu shares on the open market, because so few are available. “It’s a hard stock to buy and sell,” he says. Cifu says analysts and investors need more time to understand “the push-pull of our business.” And being a bit opaque is intentional so as not to “create a road map” for competitors. Still, he acknowledges having to balance that with convincing investors that the company can increase its profitability. Another challenge Virtu may face, especially as it steps into markets that have traditionally been the domain of the JPMorgan Chase crowd, is that the tiny

PHOTOGRAPH BY BENEDICT EVANS FOR BLOOMBERG MARKETS

VIRTU’S CONSISTENT ABILITY

Cifu, Virtu Financial’s CEO, stands by a painting of Nymex’s pit-trading heyday

company will open itself up to stricter regulation. After 2008, regulators have demanded more safety and accountability from all segments of market infrastructure. Viola remains undeterred. “I don’t fear regulation. I embrace regulation,” he says. “We have a duty to make people understand what, to the average person, is complex and frightening.” He also embraces penny-pinching. When Virtu moved into its new office a few years back, the space had been occupied by a hedge fund that vacated in such a hurry it left behind all its office furniture and a gym with treadmills, stationary bikes, and free weights. Viola and his executives decided to keep everything. “Every penny spent impacts the bid and offer we make,” Viola says. “Every penny.” That same tight cost control seems to apply even outside Virtu’s walls. Matthew Andresen, a market structure pioneer who’s the co-CEO of Headlands Technologies, has known Viola and Cifu for years. On a trip to Miami, Andresen and his wife—a huge hockey fan—decided to catch a Panthers game. Andresen called Cifu and Viola to score seats that would impress her. They hooked him up—and later sent him the bill. “God bless these guys,” Andresen says with a laugh. “They run a tight ship.” man and machine is nowhere more evident than on its trading floor. There are no stars here—or, as Cifu puts it, “no Ferraris, no yelling, no bowls of guacamole on the trading floor.” (He did give in and provide fruit plates after complaints the snacks were unhealthy.) On the May day when the Watcher was flagging issues, Cifu stood among his traders. The wayward currency order had been confirmed as canceled after seven seconds. “You have to understand this on a microsecond-by-microsecond level,” he said. One of the risk managers sat nearby. Asked what he was monitoring on the 20 windows spread across three huge screens in front of him, he replied, “The world.” (Executives requested that his name not be used, to adhere to Virtu’s no-stars policy.) “We can shut off Japan from here, which we have done,” Cifu said, referring to the company’s operations. Then he boasted that Virtu’s risk-management systems—all of which were built from scratch—are so good, the company is often the one to alert a market to its own issue. Cifu said, “We’ll call an exchange and say, ‘Hey, are you having problems?’ And they’ll say, ‘Umm, we don’t know.’ And we’ll say, ‘Go f---ing check.’ ” Odds are, Virtu was halfway through another profitable day. To that, the Watcher had no retort.

VIRTU’S MELDING OF

Leising covers market structure for Bloomberg News in New York.

101

Cheat Sheet A Compendium of Noteworthy Functions FEATURED IN THIS ISSUE COSY

NEW ENHANCEMENTS TO TRY RIGHT NOW

Lets you view a library of ready-made commodities studies.

BMAP Tracks the movement of vessels such as LNG tankers.

GOVY Monitors the spreads of individual bonds to a model-generated fair-value curve.

Graphs fair-value curves and compares, say, German and Spanish par yields.

Analyzes the total return of an investment in a selected fund.

Screens for funds that match criteria you specify and compares them on metrics such as tracking error.

Lets you prepare and save disclosures required under Europe’s Market Abuse Regulation (MAR).

Provides direct communication in real-time text conversations with colleagues and clients.

TBX

Exercises your trading brain.

PAIR

Algorithmically trades based on relationships between two or more securities.

TRA FSRC

RECO

CHBGDCOP INDEX DES Provides tickers for Bloomberg Intelligence estimates of components of China’s debt. PORT

ESG

Shows how a selected company is leading or lagging in critical environmental, social, and governance indicators, enabling you to track how the company performs on specific ESG metrics over time and vs. its peers. 64

The Document Search function, which you can use to drill into crucial information in millions of transcripts, research reports, filings, company presentations, and news items, has been enhanced to let you expand a search using suggested keywords. The function also enables you to analyze filings with a redline view and to find insider filings by major executives.

NEWS Lets you search for news right from the command line using natural language. Try typing NEWS ON BREXIT, NEWS ABOUT TRUMP, or NEWS FROM NYT, for example: The system will map your query to the right topic, person, wire, or company code. GP

BIO 54

Enables you, among other things, to use factor-based attribution to analyze the drivers of a return for a selected portfolio or fund. 58

The Line Chart and related graphing functions have been enhanced to make it easy to compare a selected stock relative to its market sector and to specify benchmarks for relativeperformance analysis.

The People Profiles function now enables you to stay up to date by setting alerts that will notify you of breaking news related to a person. You can also now get deeper insight into companies via BIO, use SPDL IDs to find profiles, and quickly add a person to your Salesperson Dashboard (DASH).

Faster, better answers—24/7. <Help><Help> for Bloomberg Analytics

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BUILT BY INVESTORS, FOR INVESTORS

FlexShares TIPS ETFs are like you: they’re in it for the duration. ®

A successful portfolio is prepared for anything – including inflation. TIPS have helped protect portfolios from the corrosive effects of inflation since 1997. But FlexShares TIPS ETFs are among the only ones on the market that target duration, to seek even more stability against fluctuating interest rates and changing economic cycles. Making sure you and your clients aren’t just informed, but ready. For more information, visit FETF <GO>

CAPITAL APPRECIATION

RISK MANAGEMENT

TDTT

INCOME GENERATION

LIQUIDITY MANAGEMENT

TDTF

Before investing carefully consider the FlexShares investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by visiting www.flexshares.com. Read the prospectus carefully before you invest. Foreside Fund Services, LLC, distributor. An investment in FlexShares iBoxx 3-Year and 5-Year Target Duration TIPS Index Funds is subject to investment risk, including possible loss of principal amount invested. Funds’ returns may not match those of their respective indexes. The Funds may be subject to the following risks: asset class; derivatives; fluctuation of yield; income; inflation protected security; interest rate/maturity; management; market; non-diversification; passive investment; and tracking. For a complete description of risks associated with each Fund please refer to the prospectus. Duration is a measure of the sensitivity of the price (principal value) of a fixed income investment to a change in interest rates, expressed in number of years. In addition, FlexShares iBoxx 3-Year and 5-Year Target Duration TIPS Index Funds may invest MANAGED BY in derivative instruments. Changes in the value of the derivative may not correlate with the underlying asset, rate or index and the Funds could lose more than the principal amount invested. The Funds are non-diversified meaning their performance may depend on the performance of a small number of issuers because the Funds may invest a large percentage of assets in securities issued by or representing a small number of issuers.

As the World Turns By JOE WEISENTHAL

A Function I Love

GMM <GO> ON THE MORNING of June 24, we witnessed one of the most extraordinary market events in years. As soon as it became clear that U.K. voters supported leaving the European Union, markets around the world hit an air pocket: Sterling tumbled, U.S. futures plunged, interest rates on government bonds collapsed, and the yen surged. The incident was the latest to show just how correlated global markets have become. Throughout the turmoil, my eyes were glued to the Global Macro Movers function, {GMM <GO>}, which has become a fixture on my Bloomberg Launchpad.

At any given moment, you get an instant snapshot of what’s moving in global stock markets, currencies, sovereign bonds, and commodities. Not only can you easily spot which markets are surging and tumbling according to their Z-scores—as I’m writing this, I’m watching a huge rally in Indonesian assets, Japanese stocks, and the price of cotton and coffee—but you can also easily discern outliers, as well as those making highly unusual moves, with the help of the function’s colorcoordinated security tiles. Shrink or expand the universe of markets from G-10 countries to a comprehensive

world view via the drop-down menu, and then do what I do and adjust the function’s slider to the right to filter down to the biggest movers over the time period you’ve selected. When you see a major mover you want to know more about, just click into the module to get related headlines. On this day, for instance, Indonesia seems to be catching a nice bid thanks to a general move in emerging markets and improving trade data. I also see that coffee is rallying because of tight supply data in Brazil. It’s impossible to follow markets these days and not take a global view, and this function enhances my outlook.

Weisenthal co-hosts What’d You Miss? on Bloomberg TV and is the managing editor of bloomberg.com/markets.

104

Bloomberg Markets

Enter OTCQ <GO>

Follow the OTCQX International Index (.OTCQXINT) to track the world class companies that trade on our market in U.S. dollars

DISCOVER

Unlock access to RealTime Quotes across the OTCQX, OTCQB and Pink Markets.

GLOBAL COMPANIES YOU WON’T FIND ON A U.S. EXCHANGE www.otcmarkets.com

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WHY BUY A SINGLE STOCK WHEN YOU CAN INVEST IN THE ENTIRE SECTOR? Technology Sector SPDR ETF Top Ten Holdings*

XLK - TECHNOLOGY Company Name

Symbol

Weight

Apple

AAPL

12.68%

Microsoft

MSFT

9.74%

AT&T

6.44%

Facebook A

6.40%

Alphabet A

GOOGL

5.00%

Alphabet C

GOOG

4.95%

Verizon Communications

4.56%

Intel

INTC

3.77%

Cisco Systems

CSCO

3.51%

3.44%

10 Visa A

* Components and weightings as of 6/30/16. Please see website for daily updates. Holdings subject to change.

Potential beneﬁts of adding Sector SPDR ETFs Time For A Stock Alternative

to your portfolio include: • S&P 500 Components • The all-day tradability of stocks • The diversiﬁcation of mutual funds • Liquidity • Total transparency • Expenses – 0.14%*

TECHNOLOGY - XLK

Visit www.sectorspdrs.com or call 1-866-SECTOR-ETF

An investor should consider investment objectives, risks, charges and expenses carefully before investing. To obtain a prospectus, which contains this and other information, call 1-866-SECTOR-ETF or visit www.sectorspdrs.com. Read the prospectus carefully before investing. The S&P 500, SPDRs®, and Select Sector SPDRs® are registered trademarks of Standard & Poor’s Financial Services LLC. and have been licensed for use. The stocks included in each Select Sector Index were selected by the compilation agent. Their composition and weighting can be expected to differ to that in any similar indexes that are published by S&P. The S&P 500 Index is an unmanaged index of 500 common stocks that is generally considered representative of the U.S. stock market. The index is heavily weighted toward stocks with large market capitalizations and represents approximately two-thirds of the total market value of all domestic common stocks. Investors cannot invest directly in an index. The S&P 500 Index figures do not reflect any fees, expenses or taxes. Ordinary brokerage commissions apply. ETFs are considered transparent because their portfolio holdings are disclosed daily. Liquidity is characterized by a high level of trading activity. Select Sector SPDRs are subject to risks similar to those of stocks, including those regarding short-selling and margin account maintenance. All ETFs are subject to risk, including possible loss of principal. Funds focusing on a single sector generally experience greater volatility. Diversification does not eliminate the risk of experiencing investment losses. * Gross & Net Expenses are the same – 0.14%. ALPS Portfolio Solutions Distributor, Inc., a registered broker-dealer, is distributor for the Select Sector SPDR Trust.