8 December 2011

DELTA MALES AND GREEK ALPHA BETS

A trenchant recent observation by MBMG’s affiliated portfolio manager Scott Campbell of Miton Optimal followed on from UBS-gate, where a trader’s mistakes threatened to undermine one of Europe’s biggest banks:  

 ‘We have written in the past that not all Exchange Traded Funds (ETFs) are created equal and due diligence is just as important as with hedge funds or other collective investment vehicles. Well UBS shareholders discovered some of these risks when 31 year old trader Kweku  Adoboli lost US$2.4 bn of the banks money. He worked for Delta One and as one city analyst noted, most CEOs of investment banks could not explain what their Delta One team are actually doing!  

Well the ETF connection is that the not all ETFs are ETF’s. In fact, most are ETN’s which stands for Exchange Traded Notes which are not Funds at all. These are promissory notes from an investment bank giving specific performance of an index or asset or commodity to investors. The Delta One team is responsible for trading the banks’ money to ensure that they can meet this promissory note. Any excess profit (or loss) generated from managing the risk (or creating it) in a cost efficient manner, is kept by the bank. JP Morgan predicted last year that Delta One would be a prime future source of revenue for global investment banks. “What were they smoking?”  

When investing in an ETF you are buying an underlying basket of assets in a fund that happens to be listed. When you buy an ETN you are buying the promise of an index return by an investment bank. As many found in 2008 with the ETN’s backed by AIG, who nearly went bust, these promises can have very different volatility profiles. Given all the other eerie 2008 correlations going on, ensure you know your F’s from your N’s, as not all is equal. 

Source: MitonOptimal.com Global Weekly Comment – Week 39 – 30 Sep 2011