Waddell & Reed and the flash crash hypocrisy

Halloween's only three weeks away and we have a brand new witch to hunt. By now, everyone has heard of Waddell & Reed and how the Kansas City mutual fund is reason du jour for the end of capitalism and further legalizing of market manipulation.

As the story goes, on the afternoon of May 6, 2010 an algorithm propelled sell-off of $4.1 billion of futures contracts linked to the S&P 500 sent the market reeling. As with all good witch hunts, Waddell hasn't officially been named, but via leakage that would make the BP oil spill seem tame in comparison, we have our new villain.

I can hear the sound of Blankfein's cheeks stretching into a grin. It sounds like press on nails on a chalkboard.

The fund's leading trader is named Michael Avery. Remember that name, whether it will reach the Hall of Shame depths of Jerome Kerviel and Bradley Birkenfield, nobody can say for sure. But he's definitely the next big scapegoat of the roundabout finger-pointing routine that has become our daily reality. Anybody seen Groundhog Day with Bill Murray, lately?

Good flick, reminds me of our financial news over the past year.

Waddell is being painted as "the mutual fund which traded like a hedge fund". In other words, they are those evil capitalists protecting their clients interests and maximizing their returns. The nerve of this slick Midwestern folk. Taking risk and then...hedging it!

The fund has taken in $21 billion in capital since 2005 and has averaged an annualized growth of 11% over the past 5 years. Now this is a bit of info which bares an interesting inference.

The words of Morningstar analyst Kevin McDevitt underscore a scary reality:

"Any time you are hedging you are cutting risk, but the way they do their hedging, the fact that they are putting hedges on and off quickly, means they are more tactical than most of these funds. It means they can get caught on the wrong side of the market. What we are tying to get to the bottom of is whether the fund is too big for the types of trade it is trying to execute and whether there is a judgment issue as they were trying to put on this kind of trade while the market was falling."

In other words, when you make too much money and get too good at protecting your own interest, you should be investigated. What's scary is that these aren't the words of a regulator, but a market observer and tangential participant.

I see nothing wrong with what Waddell & Reed did on May 6th. They traded. They saw movement in markets and reacted. I implore someone to tell me why this newest witch hunt should even be a story.

Let alone the one gathering all the headlines and attention.

Comments (9)

Oct 8, 2010

For those wanting to read the full story a copy/paste of the title into your search engine of choice should do the trick.

Oct 8, 2010

so as someone who works on a prop desk, i can tell you for sure that i think all of the W&R causing the crash indirectly is a bit shady... i can bring up a long list of names (if anyone really wants to i can grab the names) of preferred stocks that were slipping off WELL before the rest of the market slipped and tumbled extremely hard and i was long a ton of them... in the end made beaucoup dollas :D

Oct 8, 2010
shorttheworld:

so as someone who works on a prop desk, i can tell you for sure that i think all of the W&R causing the crash indirectly is a bit shady... i can bring up a long list of names (if anyone really wants to i can grab the names) of preferred stocks that were slipping off WELL before the rest of the market slipped and tumbled extremely hard and i was long a ton of them... in the end made beaucoup dollas :D

Dog eat dog world, keep going for the jugular. Just make sure you bury your bones deep.

Oct 8, 2010

Short,

That's more than a valid point. The W&R trade happened after the slippage first started. I'm blanking on names that went down, but I think PG was one of them.

Midas,

Futures and options markets are hedging and risk transfer markets. The report [The SEC references a series of bona fide hedging transactions, totaling 75,000 contracts, entered into by an institutional asset manager to hedge a portion of the risk in its $75 billion investment portfolio in response to global economic events and the fundamentally deteriorating market conditions that day. The 75,000 contracts represented 1.3% of the total E-Mini volume of 5.7 million contracts on May 6 and less than 9% of the volume during the time period in which the orders were executed. The prevailing market sentiment was evident well before these orders were placed, and the orders, as well as the manner in which they were entered, were both legitimate and consistent with market practices. These hedging orders were entered in relatively small quantities and in a manner designed to dynamically adapt to market liquidity by participating in a target percentage of 9% of the volume executed in the market. As a result of the significant volumes traded in the market, the hedge was completed in approximately twenty minutes, with more than half of the participant's volume executed as the market rallied - not as the market declined. Additionally, the aggregate size of this participant's orders was not known to other market participants.

Additionally, the most precipitous period of market decline in the E-Mini S&P 500 futures on May 6 occurred during the 31/2 minute period immediately preceding the market bottom that was established at 13:45:28. During that period, the participant hedging its portfolio represented less than 5% of the total volume of sales in the market.

First of all the CFTC came out and said outright that W&R did not cause this crash. Not only did W&R not cause this crash, their volume, both in the ES overall and the ES during the crash, were less than 1.5% and 9% of the total volume during the trading day and the flash crash respectively. These are within normal guidelines unlike what was implied in the SEC report. Additionally, of the shares traded during the crash, the bulk of the amount of shares traded during that time occurred after the ES drop hit its lowest point. This means that W&R was executed on the recovery, indicating that they were making fair trads dealth with market participants on both sides of the crash. W&R's trades were legal, fair and compliant. There was nothing wrong with the trades and when you look at what the governing body for futures trading said, one can believe and accept with a high degree of certainty that W&R did nothing to cause the crash.

Second, as Short pointed out, the ES mess was a result of slippage in equity markets due to issues I've mentioned in the past concerning liquidity provision, quote stuffing and HFT trading. W&R used a vanilla algo from Barclays according to the SEC report. Vanilla algos don't go apeshit and complete orders in 20 minutes without having some fundemental move in the markets trigger them to do so particularly at the rate of sale indicated by the SEC. Even if there was an issue with the algo used, W&R saw the majority of their execution on these 75,000 ES contracts on the recovery. If they were fully executed during the decline, that would be one thing and indicate that they or the algo they used caused the crash. That's not the case, meaning that their total trade volume was not dicted by one way participation, known in its entirety to the market and was fairly trade to unknown parties, which helps make these trades legitimate trades that were caught in the crossfire when they shouldn't have been.

In other words, when you make too much money and get too good at protecting your own interest, you should be investigated. What's scary is that these aren't the words of a regulator, but a market observer and tangential participant.

You said it best. If that's the case, I demand an investigation into John Paulson and PIMCO. Why won't they look into their activities since they are both good at protcing themselves and have made way too much dinero. This entire farce is part of the reason why Mary Shapiro needs to be removed as the head of the SEC and someone with no ties to the street needs to be brought in to file litigation against the shops causing this stuff to happen. It's a scary thing knowing that they wont or are too inept to do so.

Either way, have you made your peace with the markets yet?

Oh, and if you're really interested, read the NANEX report for some shocking tale of the tape that you don't get otherwise. This is more indicative than anything of W&R's lack of involvement in the flash crash. http://www.nanex.net/FlashCrashFinal/FlashCrashSum...

Oct 8, 2010
Frieds:

Either way, have you made your peace with the markets yet?

Oh, and if you're really interested, read the NANEX report for some shocking tale of the tape that you don't get otherwise. This is more indicative than anything of W&R's lack of involvement in the flash crash. http://www.nanex.net/FlashCrashFinal/FlashCrashSum...

Yes I have Frieds. You could say I am at the acceptance stage of the grieving process:D

That is some shocking info in that link. What's really shocking about it is that I am not the least bit surprised.

Oct 8, 2010

I'm right there with you. I accept the bullshit as much as I don't want to and have made peace with the failed markets.

Nanex, by the way, is phenominal. There is a reason why they are the best at Forsenic Market Research.

Oct 9, 2010

FTB/PRB, HBA/PRG, LNC/PRG, SFI/PRF PRA PRG PRI PRC, AGM/A, BAC/PRI, BCS/PRD, DRE/PRN, FPL/PRF, HPT/PRC, JPM/PRP, KEY/PRF, LNC/PRF, MET/PRB, NCC/PRA, RAS/PRC, RBS/PRF, RF/PRZ, SOV/PRB, STD/PRA, STD/PRC, RNR/PRD, USB/PRE, USB/PRK, WRB.PRA

Look at the chartso f any and all of these, I was personally buying them as they slid off prior to the market crash (although their moves were extended by the force of the market collapsing afterwards) and therefore shows that SOMETHING other than an e-mini order

i wouldnt be surprised if the whole HFT shop targeting is actually misdirection and nowhere near the cause -- my firm got semi 'pinned' to the HFT and may 6th crash as a result of something not related to either things at all. i bet the HFT shops are actually taking cash away from the big banks that pay into finra and the sec and thus theyre being targeted.

Oct 9, 2010
shorttheworld:

FTB/PRB, HBA/PRG, LNC/PRG, SFI/PRF PRA PRG PRI PRC, AGM/A, BAC/PRI, BCS/PRD, DRE/PRN, FPL/PRF, HPT/PRC, JPM/PRP, KEY/PRF, LNC/PRF, MET/PRB, NCC/PRA, RAS/PRC, RBS/PRF, RF/PRZ, SOV/PRB, STD/PRA, STD/PRC, RNR/PRD, USB/PRE, USB/PRK, WRB.PRA

Look at the chartso f any and all of these, I was personally buying them as they slid off prior to the market crash (although their moves were extended by the force of the market collapsing afterwards) and therefore shows that SOMETHING other than an e-mini order

i wouldnt be surprised if the whole HFT shop targeting is actually misdirection and nowhere near the cause -- my firm got semi 'pinned' to the HFT and may 6th crash as a result of something not related to either things at all. i bet the HFT shops are actually taking cash away from the big banks that pay into finra and the sec and thus theyre being targeted.

What's worse quoting myself or speaking in the 3rd person?

Oct 11, 2010
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