Despite early indications in this month’s TRADE poll that demand for risk pricing is on the rise, some US-based buy-side heads of trading suggest that a more cautious approach by chastened portfolio managers is restraining the appetite of large institutional investors.
Blanket confidence in rising stock values, unsurprisingly, has been replaced by selective optimism. In the words of one senior trader, “Use of risk pricing is dependent these days on the level of conviction behind the trade, at least as far as the fundamental-based finds are concerned.”
Accentuated by an extended bull run, it has long been the habit of many portfolio managers in the US and beyond to allow momentum to build behind a stock before having sufficient conviction to place an order with the trading desk. At this point, however, misgivings about making the wrong call are often overtaken by the fear of missing the boat. The portfolio manager becomes anxious that the order will not be executed until the majority of the upside has been realised and insists that the trader complete the transaction as soon as possible. This pressure to secure the stock immediately has frequently been a factor behind the trader’s decision to seek a risk price from a broker.
But in today’s uncertain economic climate, portfolio managers at a number of large US institutions appear even more reluctant to put their heads on the block. Momentum, to an extent, has given way to value. And patient investing is leading to patient trading.
“Today, on the fundamental-driven fund side, our portfolio positioning is more long-term and less event-driven than perhaps it might have been pre-Lehman,” one head of trading at a New York-based buy-side institution says. “As such, the PMs have less conviction on their trades: they no longer have to have a stock now, because more of them are looking at a longer-term alpha horizon. As such, we don’t need to go out in the market in such a rush.”
While the task of predicting which firms, sectors and countries will lead the global economy out of its sharp downturn is strewn with pitfalls, the financial markets have nevertheless grown in confidence over the past six months. Volumes have risen with values, particularly in the US, with the uptick in liquidity limiting some institutional investors’ need to use risk pricing to offset potential market impact costs. Yet supply of risk pricing has returned, albeit often from new sources.
“It’s not necessarily the usual players you saw pre-Lehman,” a market participant notes. “More likely it’s the second-tier, boutique or regional firms that have expanded and invested to take advantage of the troubles of the bulge bracket brokers.”
But if the financial markets’ cautious optimism has been overplayed, demand for risk pricing may still witness a resurgence among US institutional investors. The upcoming October quarterly earnings season is seen as a potential turning point. This is because it could give a definitive answer as to whether previous robust figures from US corporates, largely achieved through cost-cutting, can be sustained in the longer term, thereby supporting hopes of a quick and ongoing return to GDP growth.
“You never know what might happen with the earnings season coming up,” said one senior buy-side trader. “Last time round, earnings beat expectations, but that was not from top-line growth. There’s only so much fat you can cut. The risk is that falling earnings could trigger an avalanche of sells that could need capital commitment.”
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