Too Big to Succeed?

The financial crisis briefly spurred calls for the big banks to be broken apart, capitalizing on the popularized notion of “too big to fail” to argue that any institution too big to allow it to go bankrupt should be too big to exist. The moment passed, all we got was Dodd-Frank, and in the end the banks remain as big as ever. But today we stumbled on an interesting read from Scientific American (yes, even SciAm is writing finance articles now… is this like the magazine cover indicator?) which argues that the financial transactions of big investment banks have started to grow too huge – and too complex – for even them to manage. In other words, they’re too big to succeed:

Much has been written about banks being “too big to fail.” The equally important question is are they “too big to succeed?” Can anyone honestly risk manage $2 trillion in complex investments?

Managing these banks is no longer simple. Most assets now owned have risks that can no longer be defined by one or two simple numbers. They often require whole spreadsheets. Mathematically they are vectors or matrices rather than scalars.

In addition, markets are prone to feedback loops. A bank owning enough of an asset can itself change the nature of the asset. JP Morgan’s $6 billion loss was partly due to this effect. Once they had began to dismantle the trade the markets moved against them. Put another way, other    traders knew JP Morgan were in pain and proceeded to ‘shove it in their faces’.

The author contends that the old banking model, when the business was about capturing the spread between the interest it paid on savers’ deposits and the interest it collected on loans, it was relatively easy to measure and manage risk.  But as banks grow bigger and seek more attractive returns on their capital, they turn to exotic trades that are much more difficult to manage. When banks grow so large that they encompass a vast, interconnected web of complex derivatives, the effect of uncertainties can begin to multiply. If one item on a spreadsheet with an unknown risk is used as collateral for a bet on another complicated transaction… well, as we have seen – not even Citigroup or JP Morgan can stay in control. (Especially if they continue to use outdated and probably worthless risk metrics like VaR).

While there are no managed futures firms too big to fail, the article makes you wonder if there are some which are “too big to perform.” It has been documented that as programs grow bigger, it becomes more difficult to maintain the same levels of risk and return that they could with a smaller AUM, and in many cases we see a pattern of smaller gains and losses as a program grows. But for CTAs, that path isn’t always predictable. There are giants like Winton that still perform, just on a smaller scale with smaller (by percentage) wins and losses. And there are programs which see more volatility when they get bigger – like John W. Henry – leading to a messy demise.

Fortunately, not even the behemoths of the managed futures world (as John W Henry was in its heyday) are big enough to cause systemic concern when they falter and fall. But the big banks? Well, we saw what their stumbles can do in 2008. So the refrain of “too big to fail” wasn’t enough to bring about a breakup of the banks, but maybe “too big to succeed” will be more effective. At any rate, we aren’t likely to see the call to break up the big banks disappear any time soon, and articles like this may be just the thing to keep the crusade running strong.

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

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