Credit Suisse is being absorbed into UBS ostensibly to prevent it from being completely vaporized. The debt is now worthless, I saw PIMCO and Invesco are/were large holders. But what about the exchange traded notes, ETNs? CS has a few out there and apparently they'll be ok. ETNs look a lot like ETFs except they are actually unsecured notes of the issuer.
When you buy an ETN you are adding the layer of potential complexity that a bankruptcy could wipe out the ETNs. To quote Mark Yusko, risk happens fast. That I could be out in front of a bankruptcy is not a bet I would want to make in the context of owning an ETN for whatever exposure and also knowing the bank well enough to know it was going to fail. CS stock has been in a verrrrrrrry long trend downward, it has been in trouble for a long time. Why couldn't something like it failing have happened a couple of years ago or a couple of years from now?
Understanding the risk associated with ETNs is pretty simple and it takes almost no due diligence to grasp that they can be wiped out in the face of a bankruptcy. There are risks associated with other strategies that come in fund form, really all funds have some sort of risk ranging from the very simple possibility that an index fund goes down a lot in value not because the fund breaks but because the index it tracks goes down a lot. Some random actively managed fund that goes up 80% in an up 10% world could easily go down that much in a down 10% world, we saw a variation of that with Cathie Woods' funds.
Merger arb funds which we write about all the time can be vulnerable to some sort of weird macro situation that could cause deals to fail, for just a bit it looked like the Credit Suisse debacle might be a problem for convertible bonds and maybe by extension convertible arbitrage. Last week I mentioned that most managed futures funds got whipsawed by the extreme volatility in the front end of the treasury curve. Certain VIX products have blown up by 5 or 6 sigma events. Any strategy fund could have something bad happen for a reason you might be able to piece together or some reason that no one could reasonably piece together.
We've been seeing a small wave of multi-asset funds that use leverage coming to market lately. They don't hide that they are using leverage but they are positioned with the terms capital efficiency and return stacking. It's not that leverage on its face must be bad but at the heart of many capital market calamities has been the misuse of leverage.
The WisdomTree Efficient Core ETF (NTSX) was early to the capital efficient space. It is 90% equities and 60 bonds. The way the math works, a 67% allocation to NTSX (Portfolio 2 with 33% in the T-bill ETF) equals 100% in Vanguard Balanced Index Fund (VBAIX) which is a proxy for 60/40 and Portfolio 3. Portfolio 1 is 100% in NTSX which in 2022 was down 25.84% versus down 16.85% for Portfolio 2 and 16.87% for Portfolio 3. That's not a deathblow misuse of leverage but is illustrative.
There's one fund our there with 90% in equities and 90% in gold and another with 100% in bonds and 100% in managed futures. Too much exposure to the 90/90 when both stocks and gold go down would be a problem. Too much in 100/100 would be a problem when both bonds and managed futures both go down. Sizing the 90/90, how much do you want in gold? A 5% weighting to that fund would be get you 4.5% in gold. You'd also be picking up 4.5% toward the total you want in equities. A 10% allocation to the 100/100 would get you 10% in managed futures if you wanted that much (I don't) and 10% toward your bond allocation. For purposes of the example, there is the presumption that you'd even want equity exposure the way 90/90 accesses it and that you'd want the bond exposure the way the 100/100 accesses it but in the real world you may not.
Capital efficiency has also made its way into multi-asset funds, meaning 5 or 6 asset classes. That sort of leverage relies on correlations that are typically low or negative always being low or negative. Have you have heard the phrase that in crises all correlations go to one? That is a simplification of course but something to be aware of in a fund that kitchen sinks 6 different assets together with leverage.
I have no interest or intention of using any of the funds mentioned personally or for clients.
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