Alberto Gallo, CFA

Genuine question for fellow QT nerds / financial plumbing experts. The BoE MPC voted to keep the pace of Quantitative Tightening unchanged at £100bn for the next 12 months, c. 90% of which will come through a passive run-off of existing holdings, and c. 10% from active sales. Bank reserves are currently upwards of £700bn, well above the BoE’s own estimate of even the £490bn upper bound of the Preferred Minimum Range of Reserves (which should delineate between what central bankers have started calling “abundant” and “ample” reserves). In other words, by the Bank’s own reckoning, it should have lots of room to shrink its balance sheet before bank reserves start to become scarce. Fine. However, this is happening against the backdrop of exponentially growth in banks drawing on the Bank’s Short Term Repo (STR) facility – not something you would expect in an environment where every bank has “abundant” reserves. If you were sitting on the MPC, would this give you pause? Are there any risks associated with moving out of "abundant" territory too quickly, or are gilt-backed reserves just going to seamlessly get replaced with repo-backed reserves?

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My thanks to Citywire and Baroness Ros Altmann for the below article, which Baroness Altmann has written in response to Henry Cobbe, CFA’s article earlier this week. See below. Two key points are as follows: 1) everyone is calling for transparency and full correct disclosure. Investment trusts (or listed closed ended investment companies - LCICs) disclose all expenses via their reports & accounts, as they always have done. 2) LCICs share characteristics with OEICs but they do not have “ongoing charges”. Ongoing charges are deductions from investor capital that occur annually. For LCICs, there are recurring operating expenses (part of which is analagous to ongoing charges of OEICs), but these are known in advance and impact the NAV not the share price. The share price discounts (encapsulates) theses expenses. The value of the investment with a LCIC is the share price not the NAV. In a lively and good-natured comments section to my LinkedIn post earlier this week, Mr Cobbe called for a consultation. But first we need to wait for the results of the extensive consultation on HMT’s Statutory Instrument taking the UK out of the PRIIPs regime and into the new UK-only Consumer Composite Investment (CCI) regime. 329 signatories (the most significant response to a HMT consultation ever apparently) signed the LSEG (London Stock Exchange Group) response calling for LCICs to be excluded. LCICs are not “CCIs” (or even PRIIPs). Investors have no contractual right to receive a share of NAV at a time of their choosing (as they have with OEICs). Prospectuses are usually clear on this point. The value of the investment in a LCIC is the share price. If HMT decide to keep LCICs in scope of CCI, the FCA will surely consult on the disclosure regime. Incidentally, our arguments apply to ALL LCICs, even those investing in vanilla equities. I have long characterised LCICs has inhabiting a spectrum from ordinary listed operating companies to OEICs. Some are closer to either end, but none are at either end. We need a disclosure regime that is bespoke for LCICs and we mustn’t crowbar them into either category. Our campaign group has come up with a “Statement of Operating Expenses” that we suggest all LCICs could disclose. This surfaces expenses correctly and in a way that will aid comparison between LCICs & OEICs. Finally, our campaign group share some of the aims of the The Association of Investment Companies (AIC) but we do not agree with their back up proposals. We believe ongoing charges of OEICs, ETFs should be aggregated in the OCFs of fund of funds. These are deductions from capital. LCIC expenses should not be aggregated for the reasons outlined above: they simply do not have ongoing charges. Thanks again to Baroness Ros Altmann and Henry Cobbe, CFA for shining a light on this wonderful sector. https://lnkd.in/eB96qPrG

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Closet Benchmarking Among UK Equity Funds? In the ever-evolving landscape of UK equity funds, it’s important to identify which funds are truly active versus those more aligned with the benchmark. Our latest research, visualized in the scatter chart below, sheds light on where funds fall on this spectrum, with the X-axis showing stock active share and the Y-axis displaying a blend of country and industry-level active share, compared to the FTSE All Share index. We observe a wide spread of results, showing the diversity in fund strategies, from highly independent stock-pickers to those with a more benchmark-aligned approach. We highlight 4 funds with the greatest independence from the benchmark: • Lindsell Train UK Equity • Finsbury Growth & Income Trust • Aviva UK Listed Equity • Castlebay UK Equity What do they have in common? Low to zero allocations to sectors like Energy, Health Care, and Materials - proving their differentiated approach from the FTSE All Share index. However, it's crucial to note that while 'closet benchmarking' can suggest a lack of transparency, that might not be the case here. Many of the funds with lower active shares fall into specific categories, such as ‘tilt,’ ‘enhanced index,’ or ‘beta plus’. These approaches are deliberate and part of a well-defined fund strategy to remain aligned to benchmark indices. In terms of performance, the inset chart shows that high active share funds have outperformed their lower active share peers over time. Since April 2012, high active share funds have returned 164% on average, compared to 131.6% for low active share, 126.2% for medium active share, and 134.5% for the benchmark FTSE All Share ETF. What do you think about active investing with benchmark constraints? Is true independence from the benchmark the key to success, or do defined strategies with low active share still have a place in the market? #UKEquity #ActiveManagement #FundResearch #Investing #PortfolioManagement #assetmanagement #stocks

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ECB CUTS RATES? WILL IT DO MORE? One cut doesn’t necessarily make for a starting gun. While the ECB became the second G7 central bank to cut rates, it is by no means certain that it will follow through with more than one cuts this year. A rate cut cycle faces two headwinds.   For one, inflation ticked up in the Eurozone last month. While prices of goods have been lower, services inflation remains sticky. We are at a point where China is deliberately lowering export prices to capture market share. One way or another, this practice has a time limit. If services inflation hasn’t come down by then, Europe could find itself having to raise rates again. Second, even if prices continue to come down, the ECB still depends on the Fed. If Christine Lagarde lowers rates before the Fed has kicked off, she risks significant capital flight towards higher yielding savings accounts in Dollars, not to mention importing inflation from goods and commodities priced in Dollars. #ECB #Interestrates #economy #europe

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Key Takeaways from Fitch Ratings' ABS sector rating revision to Neutral: - Default rates holding up really well especially driven by better-than-expected non-prime sector - There has only been a mild deterioration in delinquency rates especially in German Auto - Significant performance worsening seems unlikely - UK credit card sector default rates have been revised down along with European Auto - Expect softening in the labor market both in the UK and Germany (less so in France, Italy and Spain) but assume a broadly flat unemployment rate in Europe - Expect further interest rate cuts across the board - Main topics going into 2025: a) Residual value for used cars has been declining across Europe (UK down 15% from peak April 2023) but still above historical norms b) improving recovery rates are not expect to continue c) battery electric vehicles residual values have been declined more rapidly than conventional vehicles as the primary market is fueled by tax incentives but the consumer secondary market is not deep enough yet d) non-prime borrowers performance has seen limited decline thanks to AI and more sophisticated underwriting models driven by Open Banking and leading to better default rate predictability; many of those borrowers are being pushed out towards BNPL #finance #lending #consumerlending #abs #bnpl #europe #rating

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Had a great conversation with Magdalena Torfadóttir at Icelandic daily Morgunblaðið this week about global macro and markets. A few takeaways: -Inflation has mostly been brought under control without severe output losses and we’re likely to see a slow but synchronised monetary easing cycle starting in H2 following the ECB’s lead in June. -After firefighting for 4 years straight, policymakers will need to reckon with the deeper long-term challenges facing economies, chief among them elevated debt-levels and bloated deficits against the backdrop of higher interest spending, increased defence outlays and aging populations. -Revamping growth and productivity will be key to addressing these challenges, but I’m worried the rise of neo-mercantilist policies along with increasing fragmentation in the global order will weigh on both. -Nevertheless, European growth is set to recover, as real wages are finally recovering and rate cuts support consumption. Meanwhile, the US economy is starting to gradually slow down as pent-up savings and fiscal stimulus fade. I would expect growth rates in the US and Europe to start converging in 2025 and 2026. -I‘m increasingly worried about how narrow the tape in the US market is becoming. Ten companies constitute well over a third of the S&P 500. Some of these are being traded at valuations which leave no room for disappointment in upcoming earnings seasons. This makes me uncomfortable and heightens the risk of relative broadening taking place in a down market (I’m less nervous about valuations in Europe and UK, which trade at increasingly deep discounts to the US). -I love Nvidia and it’s combination of advanced GPU chips, network capabilities and CUDA software platform make it uniquely placed to benefit from the AI boom for years to come. However, no company is so incredible you can’t overpay for it. Current valuation of 40x EV/Sales feels… rich. Think about what it means: Its revenue could quadruple, and it would still take you 10 years to break even on the investment if the company passed every single buck it made on to investors with no costs, capex or taxes. -However, I also admitted I would have said the exact same thing 6 months ago and the index has returned 17% since then and Nvidia 170%, so you would’ve lost out massively holding cash. Having concerns about valuations and profitably trading them are two very different things. -We’re starting to see less dramatic shifts in bond markets as investors are finally settling on a monetary policy story which anchors the curve (notwithstanding political turmoil ahead…). Curves are still distorted by large central bank holdings of longer-term bonds, which have squeezed term premia out of the biggest bond markets in the last 10 years. As central bank balance sheets are gradually normalised, I would expect to see steepening, generally favouring shorter-term paper for now.

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For the first time in years, rising yields have made bonds a much more powerful part of the asset allocator’s toolkit. How should asset allocators be thinking about the role of fixed income in portfolios? Download the report → https://bit.ly/3yddQc3

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For the first time in years, rising yields have made bonds a much more powerful part of the asset allocator’s toolkit. How should asset allocators be thinking about the role of fixed income in portfolios? Download the report → https://bit.ly/3yddQc3

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Does it not strike anyone else as concerning that the “Magnificent 7” have a cumulative market cap of $2T more than the entire MSCI Europe equity market index? Looking at the years covered in this chart below, this happened both recently and very aggressively - note the blue line has quite recently gone almost fully vertical. Unfortunately this is anything but a traditional hallmark to a long-term sustainable bull market. Bloomberg #Research #Economy #Markets #Macro #Equities

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We've written a case study on how the addition of equities combined with cost-efficient option-based downside protection ('Protected Equities') can add particularly large value to pension portfolios, especially in the pre-retirement and decumulation phases. This case study is applied to the U.K. DC market. Enjoy reading!

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French Bond Yields jumped on President Macron's decision to call a snap election. In the chart below you can see the yield on French ten year bonds minus the yield on German 10 year bonds. Both countries use the euro, but yields on French bonds (OATs) have tended to be higher than on German Bonds (Bunds) due to the fact that Germany is precieved to be financially more sound and stable. The soaring yield differential of 0.64% is nothing to write home about (yet). In 2011, the differential reached 1.5% for a brief period.

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our paper on stochastic volatility is on #ssrn we have tried to apply irregular jumps to cater some shortcomings of #heston #slv and other models such as #variancegamma

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Snapshot taken from the back of a taxi earlier today 🇫🇷🗼🤩 ** Heightened political uncertainties last week contributed to raised capital markets volatility (V2X was at around 20, up +7points over last week); ** French government bonds witnessed their widest spreads relative to German bunds since 2012 (10 years French government bonds widening last week from +45 to +80 basis points); ** Wider selling concessions observed on last week’s sizeable corporate bond issuances; and ** The CAC-40 stock market index correcting down 6.2% last week, leading the Eurostoxx down 4.2%. All these are very punctual, ephemeral, data points. France’s many great strengths, entrepreneurial spirit, resilience, flair and charm however are just eternal 👏🏼🇫🇷. And an excellent football team too ⚽️. Find this helpful? [ 𝗿𝗲𝗽𝗼𝘀𝘁 ] “Nice post, Luigi” [ 𝗹𝗶𝗸𝗲 ] Want to see more [ 𝗳𝗼𝗹𝗹𝗼𝘄 ] #corporatefinance #mergersandacquisitions #investmentbanking #financeeducation #mba #masterinfinance #columbiabusinessschool #columbiauniversity #imperialcollegebusinessschool #imperialmeansbusiness #imperialcollegelondon

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How solid are the ratings of the publicly-rated bank portfolio in the US, Europe and Hong Kong in the face of mounting CRE workouts? Excellent work from Monsur Hussain and Konstantin Yakimovich looked at a severe CRE stress, applied as an instantaneous shock to bank financial statements and CRE collateral data. All CRE exposures with loan-to-values (LTVs) at or above 80% were assumed to default, with LTVs restated to 100%. Of the CRE exposures with LTVs below 80%, a fifth of US office CRE, Hong Kong and China CRE loans were assumed to default, with LTVs restated to 85%. Lastly, 10% of other office CRE exposures were assumed to default, with LTVs restated to 75%. When calculating loss given default, we applied a further 30% discount to collateral recoveries, and did not factor in any equity injections from sponsors or borrowers. You can see their conclusions in this free-to-air summary at https://lnkd.in/eGTVp-zw The full report is available to subscribers at https://lnkd.in/eYn4bUQK #fitchoncredit #commercialrealestate #bankcapital #property #creditratings #usbanks #hongkongproperty

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The recent gyrations of financial conditions in the US are an excellent case study for the Maradona theory of monetary economics. We've seen some fairly large moves in financial conditions in the US this year; first a loosening as yields rallied and stocks rose after Powell's pivot in December, which arguably overstimulated the economy in Q1 and prompted the subsequent tightening we've been seeing since the start of April. The remarkable thing is that all of this has happened without the Fed having to lift a finger - rates have been completely flat since July last year. At our Macro Breakfast this week, my colleagues and I talked about how this is an example of what Mervyn King called the Maradona theory of central banking: One of the marvels of inflation targeting regimes (despite their faults) is how expectations do the heavy lifting for policymakers once a credible target has been established. From Lord King's 2005 speech (full speech here: https://lnkd.in/eh5ggstY.) --- "Maradona’s first “hand of God” goal was an exercise of the old “mystery and mystique” approach to central banking. His action was unexpected, time-inconsistent and against the rules. He was lucky to get away with it. His second goal, however, was an example of the power of expectations in the modern theory of interest rates. Maradona ran 60 yards from inside his own half beating five players before placing the ball in the English goal. The truly remarkable thing, however, is that, Maradona ran virtually in a straight line. How can you beat five players by running in a straight line? The answer is that the English defenders reacted to what they expected Maradona to do. Because they expected Maradona to move either left or right, he was able to go straight on. Monetary policy works in a similar way. Market interest rates react to what the central bank is expected to do. In recent years the Bank of England and other central banks have experienced periods in which they have been able to influence the path of the economy without making large moves in official interest rates. They headed in a straight line for their goals. How was that possible? Because financial markets did not expect interest rates to remain constant. They expected that rates would move either up or down. Those expectations were sufficient – at times – to stabilise private spending while official interest rates in fact moved very little. That pattern is sometimes described as “the market doing the work for us”. I prefer a different description. It is the framework of monetary policy doing the work for us." --- ...and how could I not end this post with the Goal of the Century 😉 https://lnkd.in/ekPAsrTF

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Fund flows are the lifeblood of markets as they drive share prices and enable investors to support fundraisings and IPOs of growth companies. The negative flows are core to the undervaluation of UK smaller companies and drives susceptibility to takeover activity. This chart shows the monthly fund outflows from UK smaller company funds over the last 2 years (data in $ from EPFR). This is precisely why we need to encourage investment in UK businesses through pension fund reform, a UK ISA and other tax incentives.

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Peter Cotton wonders why doesn't Modern Portfolio Theory have "almost no impact on portfolio theory" ? (At the opposite of the Option Theory for example) A beginning of answer is Portfolio Management is at the same time a question of : - Financial Analysis of each quoted company you are interested in ; - Microeconomics of the market / Economic sector of these companies ; - Macroeconomics of the economies and monetary zones these companies are involved into ; - following and guessing Central Banks behaviors. After these analysis, you may have guesses the returns and variances needed for the computation of your optimum but at this stage, either you are fool (by randomness ? 😉 ), or you have already understood the question is much more complicated than the current state of the "Modern Portfolio Theory". A reliable portfolio theory must integrate all the preceding points as well as a mathematically fine and efficient modelling framework.

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Spreads narrowed significantly in recent weeks, and USD spreads tightened notably further in the days following the US election. USD investment-grade (IG) and USD high-yield (HY) spreads are around levels last seen pre-global financial crisis. However, spreads appear more attractive in European corporates and securitised credit. While not mentioned in the below, Australian credit offers a bright spot in the credit landscape with attractive spreads and higher quality than other markets. Explore the latest monthly analysis from our global team: https://okt.to/JVn0q7 #Schroders #Investing #FixedIncome #Credit #Bonds

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Interesting Pic for the Day : Bond Yield Spread Analysis The first graph shows the spread between Greek and French 10-year government bond yields from 2004 to 2024. The spread experienced dramatic spikes, most notably during the European debt crisis around 2011-2012, reaching approximately 30-35 percentage points. After this peak, the spread has gradually declined, with a smaller surge around 2015, and has since stabilized at much lower levels.French Budget Balance The second graph depicts France's budget balance as a percentage of GDP from 2000 to 2025E. The country has consistently maintained a budget deficit, as indicated by the negative values. Notable observations include: The deficit significantly worsened during the 2009-2010 period, reaching approximately -7.2% of GDP A gradual improvement occurred between 2010-2019 . A sharp deterioration to -8.9% occurred around 2020 Projections for 2024E and 2025E show expected deficits of -5.0% and -6.1% respectively Source : Jefferies #Yield #Opportunities

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