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The Education of a Corporate Bond Manager, Part XII (The End)

Posted on 7 August 20108 August 2010 by David Merkel

Tonight I pick up on the odds and ends.? Going along with last night’s theme of making mistakes, we had a saying in our office, “Great minds think alike.? Fools seldom differ.”? It helped us stay humble about our culture.? If we agreed, it might be because we were all bright, or all dumb.

As an aside, one of the brighter associates at the main office pulled me aside to ask about the foolish behavior of the client.? Having worked for a much larger and more professional firm, he was shocked.? I simply said (regarding the client), “It may be a rusty tub, but its OUR rusty tub.”? He gave me the grim smile of understanding.

Timing Purchases and Sales

I developed my own view of technical analysis while trading corporates.? I wrote about it in this post, A Fundamental Approach to Technical Analysis.? Here is the most relevant excerpt:

But not every fundamental investor agrees on what the proper prices are for buying and selling. As the old saying goes, ?It takes two to make a market.? Sometimes, I will make it into the office and my trader will tell me that someone is aggressively selling a company that we own. I might ask him if our brokers have any feel for the size of the seller, and how desperate he is. The answer is usually ?no,? but if we do get an answer, that can help dictate our trading strategy. We would want to buy more as the big seller is closer to being done. In fact, we want to buy his last block of shares from him, if possible. Sometimes that can be arranged by talking to our broker; other times not.

As another aside, this is simpler to do in the bond market than the stock market. The large brokers generally know who is doing what. Be nice to your sales coverages, and you?d be amazed what they will tell you?. Here?s a stylized example.

Broker: ?You sure you want to buy that Washington Mutual bond??

Me: ?Yes, why??

Broker: ?Uh, there?s someone with size selling the name.?

Me: ?How much size??

Broker: ?Best indications are eight times your order size.?

Me: ?I can?t take that much down. Keep me in mind, and when he gets down to about double the size of my order, call me, and I?ll take the tail [everything that?s left].?

Broker: ?You got it.?

There were other rules that helped me. Keeping the VIX on my screen helped me accelerate or slow down purchases and sales in a given day. Yield spreads lag behind option volatility even though the two should be closely related. Momentum of spreads also helped — falling and rising spreads tended to persist, so be more aggressive when the market was hot, and not when it is not. Beyond that, there were credit default swap [CDS] spreads, which were just becoming a factor then. I came to the conclusion that credit spreads moved a lot slower than CDS, so I developed a rule that said, “Don’t buy if CDS is above the credit spread. Wait for the CDS to fall below, then buy.” Worked well, and kept me out of deteriorating situations.

These rules also left me more calm and capable when the market was falling apart.? I also tended to build up a cash buffer when things were going awry, waiting for the eventual turn in the market.

Time Horizons

If I had to summarize it, it boils down to managing three time horizons:

Daily — watch daily momentum and deal flow.
Weekly-Monthly — how is the momentum going?? Gauge the speculative nature of the market.
Credit cycle — where is the credit cycle in heading to the next peak or through?? How long till we get there, and what will it feel like as we near the peak or trough?

Thinking of it this way aids daily trading, and allows for clever trading in bear market rallies, and bull market pullbacks, while still watching the overall macroeconomic credit cycle.? You can’t get all three horizons in full; they fight each other at times.? Doing this means you can more intelligently weigh the costs of action and inaction, because the client needs income, and it helps you determine how long can you delay in providing income in order to avoid capital losses.

The client was growing like a weed.? That made my job easier and harder.? Easier because I could snap up every mispriced bond that was money good.? Harder, because during sharp rallies, I could not let cash build up too much.? I took the opportunity to buy AAA & AA bonds rather than A & BBB bonds, which gave up yield, but it was better than cash.

Scaling

One concept that aided me in trading was realizing that I did not have to be a big trader.? Moving in and out of positions slowly, as market conditions warranted was useful.? If the liquidity was available, and you were facilitating someone else’s bold move, that is another thing.? But the cardinal rule was, “Never demand liquidity unless it is an emergency, and you meet the strenuous test that you know something everyone else does not.? But, make others pay up for liquidity where possible.? You are doing them a service.”

Those ideas affect me today in my equity investing.? Most of the time I do small trades around core positions, and adjust my companies at a slow pace.? I make money while I wait.

Income Replacement

I was the risk manager as well as a corporate bond manager.? I understood that the policies written by the client had implied hurdle rates attached to them.? Selling a bond that was a good buy two years ago would realize a great capital gain, but would lead to a reduction in income most likely upon reinvestment of the proceeds.

The question was, and always will be, how to maximize the long-term well-being of the client.? Short-term gains matter little.? How can you build up a sustainable interest margin is the key.? Thus in my trading I looked at income replacement, adjusted for quality, maturity, liquidity, optionality, premium/discount, and a wide number of lesser variables.? Given that the client foolishly wanted me to trade aggressively, I did so, but matched off interest-rate related gains and losses, while building interest margins.

The End

No good deed goes unpunished.? The neophyte corporate bond manager that excelled was eventually told by his boss in early 2003 that they were losing manager searches because he was not in the home office (far away), and that fund management consultants told them that multi-city firms did not work.? (Those who can’t do, consult.)

I was offered a move to the main office, or be severed.? Hearing this, I went and called my wife, using my cell phone in an out-of-the-way place.? Little did I know that there was a betting line in the main office favoring that I would come by 3-1.? My gift to those who knew me in the main office was that little win, because in early 2003, investment jobs were hard to find, and would I just give my job up?

Well, yes.? I had enough confidence in my abilities (under God/Jesus), that I looked to the needs of my family first.? We had friends that we did not want to give up in our congregation for the first time, and I gave my family the benefit of the doubt, saying that I would try other possibilities in the area for a year or so.

Informally, I let my colleagues in my office know in advance; they were friends.? So on the last day for my decision, I announced that I would take severance.? Then something weird happened.? They left me with trading authority for the next two weeks.? Ordinarily that is cancelled, because the unscrupulous use that to reward friends at the expense of the client.? Rather than do that, I used the opportunity to sell down positions that I was comfortable with, but were too large forthose that would inherit the portfolio I built.? I managed to get all positions but one down to a reasonable level, leaving a clean portfolio for my successor.

Parties

My colleagues in my office took me out for lunch; they gave me a great time.? The analysts came and thanked me because I genuinely listened to them, and never blamed them.? They even told me that I was the only portfolio manager they knew who could be a credit analyst.

A few days before that, Legg Mason took me out to dinner with a few of my colleagues.? I was mystified as to why.? Yes, I had traded with them a lot, but they had given me good value on my trading.? In the middle of the dinner, I said, “This is really nice, guys, but why so much for me?”? They looked at my sales coverage and said, “Didn’t you tell him?”? They picked up and said, “What you don’t know is that your willingness to trade with us allowed us to build up our corporates coverage; without you we would not have a business today.? Also, you were honest with us and kept us from mistakes when we were out of the market context.”

I was floored.? Really?? I did that much for you?? They said, “Whatever we can do for you, just ask.”? I asked for an interview with Bill Miller.? That probably exceeded their notional credit line, because that never happened.

As it was, I landed a job with a wonderful hedge fund, Hovde Capital, in two months, and was very grateful to them for hiring me.

Postscript

There is one story that I left out from the beginning, which still needs to be told.? When our little money management firm was being acquired by an arm of Old Mutual, the CEO of that firm balked at paying our credit analysts the salaries they were receiving, and was really annoyed at the bonus structure.? He said to me and the high yield manager, “Look, the only people I need are the two of you, and we can hire other analysts.”? The two of us knew that our analysts/friends were golden — analysts that would be hard to replace.

The prospective buyer of our little firm called the two of us to a phone conference.? Somehow it leaked to the analysts what was being proposed and when.? As we headed off to the meeting, one analyst who was Jewish, called out to me, “David, don’t forget you are a Christian!”? Surprised, I turned and said, “I won’t.”? What determination I had doubled.

The high yield manager and I went into the teleconference and held our ground.? Then the counterproposal came, “If you want to protect your analysts, are you willing to put your bonuses on the line?”? We looked at each other.? I nodded; he nodded.? I said, “If we don’t meet your expectations as a group, you hit our bonuses first.”

As it was, we did well, and we all got our bonuses.? But it was never lost on the analysts that we put them first, both as colleagues and friends.? It was one big reason why we continued to do great business together.

Though I was only a corporate bond manager for two very special years, where I did well against a tough market, the way I did business helped us to do well, by being ethical above all else.? In a bad environment, that can really help.? Even Wall Street differentiates between who keeps their word and who does not.

I would have loved to continue in that business.? It was a lot of fun, but jobs like that are not handed out willy-nilly.? All that said, I went out knowing that I had done my best, and was ready to do more for my next employer.

The Education of a Corporate Bond Manager, Part XI

Posted on 7 August 2010 by David Merkel

I appreciate my readers.? That doesn’t mean that I am the fastest to respond to e-mails, but I appreciate what they write, even when I don’t agree.? But here is an e-mail very relevant to tonight’s piece:

Great series, David.

If you have more posts planned, it would be interesting to know what the biggest mistake you’ve made that you learned from the most.

In my short tenure as a corporate bond manager, I had a very good run in the midst of a bad environment.? Sometimes I think my lack of formal training was a plus for analyzing a situation where little was going well.

But I did make my mistakes. One was Enron — don’t get me wrong, I urged the sale of Enron bonds, but was countermanded.? Could I have argued the cause better?

Fast-growing company in a slow-growing industry.
Management that could not take criticism.
Growing profits, shrinking cash flow.
We had a peek inside the veil, because we had financed some of their private deals.? The complexity was astounding.
Opaque balance sheet.

I made all of those points and still lost; my new bosses were not deep when it came to corporate credit; they were skilled in other areas of the bond market.? I eventually ended up selling the Enron bonds at an unfavorable price.? Would that I had sold on the date of the default, rather than a month later.

Then there was the Teleglobe situation, where I erred in many ways.? BCE, Incorporated had a unregulated subsidiary called Teleglobe.? Think of Global Crossing, and other marginal telecom ideas.? BCE was a sound company, and they offered verbal support for their subsidiary, but would not put it into writing, and formally guarantee their debt.

I did not know the company well, and I had no stock price to give me aid.? Stock prices are more sensitive than bond prices, and can give warnings before bond prices move dramatically.? My analyst went off to a telecom/technology conference, where the S&P analyst disclosed over dinner that she was likely to downgrade Teleglobe because of the lack of explicit support from the parent company.

Now given the broader picture, this should have been obvious.? There were too many situations where implicit support did not translate into real support, and Teleglobe, most than most, needed support.

My analyst called me after the comment from the S&P analyst, and I asked, “Should I sell?”? He said I should wait; he wanted to gather a little more data.? We had our opportunity to sell at $90, and waiting missed that.? By the time he returned, the S&P analyst indicated that a downgrade was likely, and the pseudo-price fell to $70.? But, we were now determined to sell.

So I called my favorite broker, who was at the only firm making a market in Teleglobe bonds.

DM: “What’s the market in Teleglobe bonds?”

FB: “$68/$72.”

DM: “Very good.? I sell you $XX Milllion of Teleglobe bonds at $68.”

FB: “I’m sorry, that’s not a real market, that is an indicative market.”

DM: “So where is the real market?”

FB: “We’ll take an order from you.”

DM: “You mean there is no real market?? You brought this deal to market, you have to maintain a market.”

FB: “We’ll take an order from you.”

DM: (Pause) You have an order for $XX million Teleglobe bonds at $65.

FB: “We will do our best for you.”

To this day, I have no doubt that she was serious with me.? Teleglobe bonds after that point traded in the $50s, but never at the main broker.? As I learned later, they had 10+ times more Teleglobe bonds than I did, and were trying to minimize their own exposure.? They lost a lot more than I did.

When BCE sent Teleglobe into bankruptcy several weeks later, we sold the bonds at $20.? The eventually went out as a zonk.? No value.

Lesson learned: bonds are asymmetric.? You are paid to be cautious regarding failure.? When in doubt, sell.? Also, don’t take your broker at face value always.

The fallout from the Teleglobe failure was twofold.? 1) the client accused us of incompetence, because we had missed on Enron, KMart, and Teleglobe. 2) My boss asked me how I could have missed it, and I said, “I was following it and did the best I could.? But I am following over 500 credits.”

Sadly, he made the wrong decision, and hired another corporate bond manager, and we split the portfolio.? It led to poorer portfolio management.

Another error: I am not politics-sensitive.? I am more interested in doing what is right for clients, than what looks best.? So when the client proposed value destroying ideas that would benefit them directly, I argued against them.? The asset manager took me out of direct client contact, aside from actuarial risk management, but asked me to tell them what was up, because the client asked for weird things.? The same applied inside the asset manager, where my willingness to take or avoid risk was in sync with opportunity, but out of sync with the firm.

I had learned to avoid undue pessimism from the high yield manager who sat next to me, and that often made me more optimistic amid gloom than others in the firm.? I was not a pea in the pod, and perhaps that made those that had acquired my firm wonder about me.? I never did anything more than make my opinions known, but that is enough for some to take umbrage.

Maybe the point is this: you can be right in the long run, but wrong in the short run.? What eventually happened to the client?? Well, I mentioned all of the dismissals before, but as God would have it, the client was sold yesterday to hedge-fund manager Phil Falcone.? The new CEO of Old Mutual said:

But just to remind you of the background of the transaction, we bought US Life in 2001 with the aim of building a Life business in the United States. This has proved to be a poor acquisition for the Group, and we acknowledge it, largely due to taking excessive credit risk, the impacts of which came to a head in the 2008 global financial crisis. So we said in March we intended to explore the sale of the business.

Old Mutual pumped in hundreds of millions in capital, in addition to what they paid for it.? They lost badly.? But they did not list the real reason why they lost, which gives me little confidence that they will do better in the future.? They lost because their US life division sold policies at levels that did not cover the cost of capital.? In order to avoid the inevitable losses from selling policies too cheaply, they pushed those who invested for them to try to make it up by taking much more risk.? The risk didn’t come first; what came first was a bad management culture that pushed sales growth at the expense of everything else.

Hopefully, Mr. Falcone will see that and realize that sales aren’t everything, and dial back investment risk.? But who can tell?

My main errors came from mis-estimating people.? I was not strong enough to change the culture, and I should have realized that, and tried to be more incremental.? As it was, I was right, but frozen out from being able to effect change.

Final episode tomorrow, most likely…

The Education of a Corporate Bond Manager, Part X

Posted on 6 August 20106 August 2010 by David Merkel

“We’re doing a CDO.”? So said the head of investments.? A few days later, the staff of an investment bank crashed the branch office where I worked, and told us what they would like us to do.? We would buy a lot of their distressed inventory of utility bonds and financial bonds, add in some bonds of our own design, and sell a CDO.

I thought the idea stunk.? I also thought we should do it.? Why?? Get your foot in the door.? You can only do deal #2 if you have done deal #1.? Investment banks were not banging on our door to help us create a CDO, and the collateral wasn’t horrible.? It wasn’t what I would have chosen if I had discretion, but it wasn’t horrible.? Besides, we would own the equity, so who would take the first losses?

Unfortunately, the deal meant a trip to Wall Street, or at least midtown Manhattan. Now, some find that a lot of fun, and I do as well, because I like meeting bright people, and exploring new ideas.? Often my brokers wanted to introduce me to some of their “thought leaders.”? I found that to be a lot of fun.

But much as I like wine and good food, I sometimes found the schmoozing to be a burden.? I try to be an ethical guy.? I’m out to serve my client within the scope of the law, and within extra-legal ethical codes (I am an actuary and I hold the Financial Analysts’ Charter.)? I’m also a “cheap date.”? I don’t have to have an expensive steak… a good burger will do.

We had a practice in my office, that we would take visiting brokers from Wall Street to Victor’s Cafe, which was a 3 minute walk from our office.? Not very expensive, and good food.? We could get back to work quickly.? The brokers would look at the bill and say, “How am I going to explain this cheap tab to my boss?”? I told them that it was our way; we enjoy people, not spending.

On that two-day trip to Wall Street to talk with brokers and cement the CDO deal, the meal on the second night would be at a certain five-star restaurant.? One problem: no reservations were made.? So, at the beginning of the second day, a competitor broker (the piece of work featured in part nine) asked what we were doing that evening, and we mentioned the other broker, the restaurant, and that we did not have a reservation.? He said, “I am close friends, with the manager of [that restaurant].? If you want I can get you reservations this evening.? The only thing I ask is that your coverage at [the competitor] send me a thank-you note.”? We said sure.? He called them up, and BAM! Reservations for twelve on the spot.

The guy was a piece of work, but he could get things done.? The evening was great; I made the bright move of ordering a Russian beer, which was so bitter that I drank little.? The food was rich, for the nth time on this trip, and as I went home on Amtrak, I said to myself, “You can’t do this to your body — too much rich food over two days.”? I felt horrible.

And, as God would have it, the CDO deal blew up within a week.? Management did not want to do a deal that they did not shape.? As for me, I could go either way.? Deal one for shops that don’t have a big name is typically a compromise.

But, I learned from my times visiting in Manhattan, enjoy it, but not too much.? The best parts were learning how the brokers worked.? In the times that I visited the trading floors, Wall Street completed moving the cash guys next to the derivative guys, to share information effectively.

I also learned that we were up against organizations that were so much more clever than those that they served (us!), that we were better off cooperating with them than competing against them.? It was fascinating to watch the flow of information ripple across the trading floor.

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Making Money

Merger arbitrage was an area I was surprised to find had value as a manager of bonds.? I trust my analysts; if they said a deal will go through, it will go through.? I would analyze the downside, and see if it was not acceptable.? In that era, the incremental yield on swapping acquirer bonds for target bonds was 40% annualized.? Woo-hoo!? Given all of the credit losses in 2002, I was able to make up for it all and more with some of these trades.

There was one big deal where my analyst said that the deal was a lock, and so I traded all of my shorter bonds, and bonds in the acquirer, for 30-year non-deal-protected bonds, and went up to my credit risk limit.? To my surprise, I got a call from the chief investment officer.

“Hey.”

DM: “What’s up?”

“What are you doing?”

DM: “Making money, and you?”

“Not funny.? You are messing with all of our credit risk limits here.? What if the deal doesn’t go through?”

DM: “It will go through.? The target will not survive well without it, though the bonds are money good, and the acquirer has its reputation on the line.”

“No more trading in this name, got it?”

DM: “Got it.” (I was done anyway.)

That ended up being our largest single capital gain for the year.? A close competitor was when I began buying the junior debts of banks in late 2002, particularly of the floating rate variety, which offered more upside.? After putting 2% of the client’s assets into the floating-rate trust preferreds, I got the call.

“Hey.”

DM: “What’s up?”

“What are you doing?”

DM: “Making money, and you?”

“Not funny.? You are messing with all of our credit risk limits here.? What if the banks don’t do so well?”

DM: “These are major, solid banks, where there is little risk of insolvency.? You’ve bought some outright preferred stock of some of these banks for portfolios, and this is safer.”

“Forget that. This trade is done, no more, got it?”

DM: “Got it.”? Again, the trade was done, and spreads had begun to collapse in, rapidly.? One broker who dominated the sub-market, but who I had done few trades through, told me that there was a buyer in the market, and so spreads were falling fast.? I wonder who that buyer was? 😉

Anyway, the smallest capital gain they cleared on that trade was 10%, and in bond terms, those were home runs.

I had other notable trades, such as credits tainted with Brazil exposure, where the company would be fine even if the Brazil exposure defaulted in entire — we loaded the boat, and sold after Lula was elected.? (Remember how worried people worried about Lula?? Another reason to remember that stability usually triumphs over discontinuity.)

If you give your bond managers enough rope, they may work wonders for you, or they might hang themselves.? We had our share of losses and gains in what was a horrible period 2001-2003.? On the whole, it was well above average, but our client was tough, and we got little appreciation for what we did.

If you work for money, you will be disappointed.? If you work for praise, the same.? If you work for excellence, you can only disappoint yourself.? I was happy with what I achieved for the client, even though the client didn’t like me much. More in the next piece.

PS — the broker did not send the thank-you note, and “the piece of work” got after him until he did.? What an episode!

The Education of a Corporate Bond Manager, Part IX

Posted on 5 August 2010 by David Merkel

You aren’t supposed to act like a market-maker as a bond manager.? That is the role of a broker-dealer, and should they know that you aspire to making the risk-free profits that they do, they may use their power to harm you, notably:

Give you lower allocations on new deals.
Be tougher with you on haggling.

There are exceptions, though, and both tales are instructive.? One time, I received an offer that had a lot of spread on a bank bond that I had never heard of (given my memory, that was rare).? It was from a third-tier dealer that I rarely traded with.? I called over my new banking analyst (NOTE: She is a stupendous corporate bond analyst for banks, and is looking for a job now… if you need such an analyst e-mail me.? You won’t be sorry.) and asked her about the company.? She commented, “Solid franchise, boring.? Credit metrics are fine.? Go ahead.”? So I bought the bonds.? Remember, I trust my analysts, but if the trade works out badly, it is my fault.? The buck stops here.

On that day, the new corporate bond manager, with whom I would divide the portfolio (because it had gotten so big) was there for the first time.? We met and chatted for a while, but while we met, I got a phone call from a different third-tier dealer who wanted the exact same bonds that I had just bought.? He asked be where I would sell them, and I named a spread level 50 basis points tighter than where I had bought them minutes ago.? To my surprise, he bought the bonds at the level.? The new portfolio manager asked where I had bought them, and when he heard that I had cleared $3 per $100 on a 15 minute trade, he gave me a big “high five” and told me that I was the best.

Now, for those that know me well, in person, I get embarrassed with too much attention.? Writing, that’s another thing because it is somewhat anonymous to sit in front of a screen and write to people that you don’t know personally, like now.? I was surprised at his reaction, and it proved to be an indicator of what he was like as a trader.? He liked to take advantage of the Street where he could, and he had a bit of a greedy reputation, as some of my brokers told me later.

Most corporate bonds I traded had three basis points between the bid and the ask.? I would try to shrink that to two, or even one where I could, without being rude.? This was common after the new guy was hired:

DM: “Could I get the bonds one basis point wider?”

Broker: “Let me talk to the trader.”? (Fainter: “could he have them a basis point wider?”)? Pause, indecipherable.

Broker: “Let me try again.” (Fainter: “It’s XXX.” naming my firm)? Pause, indecipherable.

Broker: “Let me try again.” (Fainter: “It’s Merkel.”)? Pause, indecipherable.

Broker: “You are done at your level.”

DM: “Thanks! You’re the best!”

Reputation matters.? There was another example where I crossed bonds where it was legitimate — if it was done to help a broker in distress.? One day, someone offered me a rare type of Capital One bonds at a normal level, and I asked whether the bonds in question were the ones that were in a major bond index, without saying that per se.? After figuring that out, I bought them at the level, and called a broker that was likely to be short the bonds to see if he wanted them.? He certainly did, and offered them at a three basis point concession to where I bought them, as opposed to ripping the eyeballs out (as the technical term went).

The whole set of two transactions took 15 minutes, and made $15,000 for my client.? What was funnier, was that my whole family came to visit me that day, my wife and at that time, seven kids.? They heard the two transactions, though I had to explain it to them later. To the second broker, I had each of the kids say “Hi,” ending with the then three-year old girl who squeaked “Hi.”? He said something to the effect of, “I knew you had a large family, but it only really struck me now.”

Underwriting Your Brokers

Just as I said in an earlier part about underwriting your credit analysts, the same was true of brokers.? It paid to analyze what they would say, and what they would do, and compare them.? Over time, I gravitated secondary trading business to those the “walked the walk.”? So, one day, one of the brokers of a big firm who did not “walk the walk” called me and asked, “Of all of your brokers, where am I in your ranking of getting trades done?”? I told him that I didn’t know, but asked him to call back tomorrow.? With my computer expertise, I ran a few analyses, and got the answer.? When he called back the next day, I told him that he was number eight.

“EIGHT! I am number three at worst with the rest of my clients, and you are my smallest client! Who is ahead of me with you?”

DM: “Salomon, B of A, Chase, Wachovia…”

“What!”

DM: “Hey, he covers me like a glove; you don’t often call. Lehman, Goldman Sachs…”

“No one does corporate business with Goldman!”

DM: “I do corporate business with Goldman, and I get a lot done because my coverage is earnest and looks out for me.? Merrill, Legg Mason…”

“LEGG MASON!!!? You’re &*^*&^ kidding me, they are nobodies!”

DM: “but they talk to me daily, and the broker I deal with there is honest, and we get trades done.? They may be nobodies, but I deal with those who will deal with me, and we care about the fixed income community of the city we are in.? You are next, do you want to hear who is after you?”

“NO! You are a TOTAL EMBARRASSMENT to me.? I don’t need to have you as a client.? You are my smallest client, and I have other clients who treat me with the respect the I deserve.”

DM: “Do what you want.? Other brokers send me ideas every day, but you don’t.? If you want to be a big broker with me; I am open to that, but you have to spend time on me.”

The conversation ended soon after that, but there were two results: I began to get more trade ideas from him, and he handed me off to a junior broker who worked for him who spent more time on me.? Business went up.

I have described some people I have worked with to my kids, but he was the first that I described as “a piece of work.”

There was a time that I had lunch with him in Midtown, with my old boss there as well, where he described the travails of his wife with two nannies, for his two kids.? My boss got angry on my behalf: my wife dealt with seven, home schooling, with no help, and he talked of the troubles of his wife.? Me?? I give people room.? What is hard for one is tough for others.

But what this touches on is the schmoozing that goes on with clients, and how that affects business decisions.? More on that in the next part.

The Education of a Corporate Bond Manager, Part VIII

Posted on 4 August 20105 August 2010 by David Merkel

“Price discovery is the toughest part of managing bonds,” one of my brokers told me early on.? Right he was.? There may be 7000 or so stocks that trade with some regularity in the US, but there might be one million different bonds.? The last trade on a given bond that you might consider might be weeks or months ago, if you could find it at all.? I was managing pre-TRACE, where reporting got standardized.

I dealt in more illiquid bonds than most managers would.? Part of that was inexperience, another part was knowing that I had a balance sheet behind me that could handle it, and the last part was knowing that my credit analysts were usually right, so if I could find bonds that were off the beaten track and could be held to maturity, we could make some extra money.? Pay us with a good yield, and I will eat the illiquidity risk on behalf of my client.

One of the dirty secrets of bond management is that after adjusting for default risk, the #1 predictor of the return you will get is the yield on the portfolio.? If you do default risk right, that’s almost a tautology — default risks should be lowered after the bust phase of the credit cycle, and raised as the credit cycle gets long in the tooth.? The tighter spreads get, the more you should raise your default loss estimates.

But how to come to the right price/yield/spread?? I had a few trades, but they were dated.? I knew the spreads then, and used the spreads of more liquid similar credits to adjust it to a likely yield spread today.? I put in a fudge factor because illiquid bonds are higher beta, and then studied which of my brokers might have a bead on the bonds in question.? I would ask them their opinion, and if they were in my ballpark, I would back up my bid some, and bid for $1 or $2 million of the bonds.? The response would come back, and I would have a trade, or nothing, but maybe some color on where they would be willing to sell.? If a trade, I would back up my bid a little more, and offer to buy more.? If no trade, I would offer 50-70% of the distance between our bid/offer, and see what they would do.

I never thought I would be good at haggling.? I’m a quiet person for the most part, and I was surprised at how much I enjoyed being on the phone with my brokers most of the day, buying deals, setting up trades, discussing market color, etc.? But I was good at haggling, and I carried tools in my bag that many did not.

I decided to hold auctions and reverse auctions.? On the reverse auctions, I would solicit liquid bonds to be sold to me — maximum spread wins, subject to a reservation spread, or a minimum number of offerers.? On the auctions, I would offer liquid bonds, minimum spread wins, subject to a reservation spread, or a minimum number of offerers.? It worked well, until I read a fiction book that had auction theory as a subtext.? So I designed a new auction.

One of the problems with the auctions was that some investment bank would overbid, and win, and then the salesman would come back to me, confess the error, and say, “Can you show me some love here?”? I was taken aback by it the first time I heard this, but came back with a fairly rational solution, giving back one-third of the difference between the winning bid, and the second-place bid.

But I came up with a better way.? Here is a? Bloomberg post that I made to five of my brokers:

BWIC [Bid wanted in competition] — 1:30PM — 5 dealers only.? I am selling these just to raise cash.? This is a continuation of my experiment so bear with me.? In an effort to reduce buyers remorse (and thus get better bids) I am awarding the bond to the winning bid at the COVER level.? In case of a tie, I will award bonds pro-rata at the tie level.? If you don’t want to play, let me know.? Thanks, David. [Bond list follows]

Everything has meaning here:

5 dealers — limit the auction to the dealers who have the most interest, it makes them fell comfortable that they have a shot at getting bonds.? I never used more than 6 dealers in an auction.
Just raising cash — says that you don’t know anything they don’t know.? Makes them more willing to bid.
Cover level is the second place bid.
You can’t come back begging for love here.
Ties were particularly valuable, because there was no love and both brokers got half of the bonds, and typically lost money on resale, since they were competing against each other.
If I did not get enough bids on an auction, typically three, I could cancel it.

I reviewed my auction results and found that it erased the advantages of my brokers.? I ended up selling bonds near their ask levels, on average.? What was worse, many thanked me for being innovative in creating an auction method that “showed love” in advance of the auction.? When I explained this gambit to my wife as we were traveling to prayer meeting one evening, she gave me a hard hit on the shoulder, and said to me, “David Merkel, you are horrible!? Not only do you beat Wall Street at its games, but you get them to thank you for it!”? Oh well, guilty as charged.? She doesn’t want me to be proud, and she was right.

There are limits on when to haggle, though.? Occasionally you are invited into deals that you know are good; only a pig would ask for more then.? Those that do ask for more will get dropped from the list.? So be a gentleman; if you are getting an unreasonable deal already, smile, thank them, and move on.? Don’t ask for more.? It is more important to be invited back, than to make a little more today, even if that were possible.

In haggling, I would bid/offer fewer bonds than was wanted by the seller/buyer at the level, and ask for better terms at their size.? That would make them more willing to deal.

I had more tricks in my arsenal, but one was always paying my brokers.? If at the end of a trade, my broker said to me, “Well, your prices match so I will cross the bonds to you,” I would say, “No, I am raising my price (by 1/64th on $100) so that you can be paid.? My broker must always earn something on my trades.”? This made my brokers more loyal to me.? They knew that I cared for them, which meant something, particularly with the regional brokers.

In one sense, trading was just an amplified version of character.? Could you be trusted?? Do you play fair?? I tried to be fair everywhere I could while making money for my client.? That had a lot of payoffs for my client, even though if they were watching over my shoulder on individual trades they might have said, “Why are you not pursuing the maximum here?”

I have a saying that playing for the last nickel might cost ninety-five cents in the long run.? Intelligent managers do not look like pigs, or their opportunities get shut off.

I would simply say that you should play for long run advantage.? Better to make modest gains in many opportunities, than to make a killing once, and be shut out from opportunity thereafter.

I have more tales on this topic, but they will have to wait until a later episode… I have four left at maximum I think.

The Education of a Corporate Bond Manager, Part VII

Posted on 3 August 2010 by David Merkel

Credit analysts are a corporate bond manager’s best friends.? No portfolio manager can be entirely aware of the extent of credit risks in a broad portfolio.? They provide a necessary check on the ability of the portfolio manager to play “cowboy” (or “cowgirl”), and to mix the metaphors, be a yield hog.

The native tendency of almost all bond portfolio managers, unless they have discipline, is to seek extra yield, for two reasons:

In the short run, on average, a portfolio with more yield earns more.
Many managers will conclude that a higher yielding credit will rally, due to mean-reversion.

The second observation is true about half the time in my opinion, but the rewards are asymmetric.? Gains are small, and losses are large.? It does not pay to be a yield hog.

I listened closely to my analysts.? After all, if you have talented analysts, why shouldn’t you listen to them aside from a misbegotten pride?? I always did what my analysts told me to do, but I did it on my timing, and I explained that to them: “I will sell this bond, but right now, the market is running hot, and marginal bonds like this one are in hot demand.? If I wait a week or two, I will get a better price.”

Communication is the key, as it is in any relationship.? More communication make the analyst feel valued.? Letting them know why you like or don’t like an idea of theirs is useful to them.? Giving them pricing data helps them grasp what you are up to, and can lead them to provide real help, once they grasp the problem.

But ignoring them, except to blame them when they make bad calls, leads to a poisonous relationship, and does not lead to stellar performance.? Don’t get me wrong, I think portfolio managers should lead, and credit analysts guide them, but if there isn’t respect for the analysts, you may as well give up.? They are professionals as well as you.

Now, the intelligent portfolio manager underwrites his analysts.? All analysts have biases.? Some will say “Yes” to almost everything, some will say “No” to almost everything, and some are balanced.? There are ways to break them out of their biases, though.? Giving them a list of spreads for the companies that they cover, and asking them to rank the credits in their sector is a good start.

For Mr. Yes, ask him about risk factors.? Ask him how it would rank relative to major competitors.? For Ms. No, ask her what are the best names she would invest in.? Where is there opportunity?? Ask her to rank the company versus major competitors.? It’s a challenge, but if your analysts are bright people, you can retrain them to think past their biases, and give you good information that you can apply to making buy and sell decisions.

If I may, this is another area where being polite, reasonable, and (dare I say) loving, pays off.? Showing care for you colleagues pays large dividends.? I am not saying be a pushover, but the more you cultivate your colleagues, the better results become.

Monoculture

Every investment shop tends to create? a sort of monoculture, modeled off the guy at the top.? Now, if the boss has succeeded for a long time, it is because his unique views have punch.? All the same, situations will come up where the firm is long a name to nearly the maximum level, and the credit analyst is certain of his opinion, though the price keeps falling.

What to do?? Here are the steps:

Have other analysts analyze it.? It may not be their sector, but they are professionals, and will bring a fresh set of eyes to the problem.? If that fails, then…
Have the portfolio managers take the name home and analyze it.? Let them poke holes in the thesis.? But if no one can find a hole…
Look at Street research, to find the bears… circulate the opinion to all on the team.? If the opinion makes sense at present pricing, sell out.? If it makes no sense, waive the credit limits and buy more.? Look for reasons as to why others might be forced sellers.

The idea is to challenge the internal credit culture of the firm, and analyze the market dynamics that might be creating a lower price in the short run than might exist in the long run.

That’s all for now, more to come in part eight.? Wait, how many parts will there be in this series?? The present target is twelve.

The Education of a Corporate Bond Manager, Part VI

Posted on 30 July 2010 by David Merkel

After 9/11, and and before the merger was complete on 9/30/2001, our investment team got together and came to an unusual conclusion — 9/11 would have little independent impact on the credit markets, so be willing to take credit risk where it is not well-understood by the market.? We bought bonds in hotels, airplane EETCs (A-tranches), anything having to do with confidence in the system at that time.? I consciously downgraded our portfolio two full notches from September to November.

I went to a Chief Investment Officer’s conference for insurance investors in October 2001.? What I remember most is that we were the only company being so aggressive.? In a closed0-door meeting, the representative from Conseco told me I was irresponsible.? To hear that from a company near bankruptcy rang the bell.? I was convinced we were on the right track.

By mid-November, we had almost completed our purchases of yieldy assets, when I received a phone call from the chief actuary of our client expressing concern over the credit risks we were taking; the rating agencies were threatening a downgrade.

Well, what do you know?!? The company that did not understand the meaning of the word risk finally gets it , and happily, at the right time.? We were done with our trade.

We looked like doofuses for three months before the market began to turn, and I began a humongous “up in credit” trade as we began to make a lot of money.? By the time I was done in early June, I had upgraded the whole portfolio three full notches.? A great trade?? You bet, and more.? What’s worse, it was what the client wanted, but not what it should have wanted.

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What should my client have wanted?? Interest spread enhancement with loss mitigation.? That is the optimal strategy for life insurers.? We were ready to do that, but at a meeting in late September 2001, the client said, “The management of assets for this company has been lazy; there is not enough trading.? We want to see the highest returns possible; give us total returns!”

I tried to explain why that was not the best way to manage insurance assets.? After all, I had been doing this for ten-plus years, and knew the difference between current GAAP accounting and long term sustainable GAAP accounting.

The CEO told me that I knew nothing at all, and that portfolio management needed to be active.? Activity meant more profits.? I told him that he was wrong, and was rudely cut off.? I did not go back to that argument.

After we had a few inconsequential defaults, the client complained loudly.? This was an ignorant client that did not recognize reality.? Defaults are a fact of life; if you run with your capital base so thin that you can’t take a few modest defaults, you are running your insurance company wrong.

As it was, the emphasis on trading did generate capital gains initially, the portfolio began with unrealized capital gains.? But the company took the capital gains to be “free money,” used them as new capital, and began writing more underpriced aggressive insurance/annuity policies.

But then, as capital got tight, the chief actuary came to me saying that they needed to do a financial reinsurance treaty to raise capital for the firm.? I replied that we did not have many bonds with an above market yield.? We had the Prudential
“C” bonds that I mentioned earlier, and a few more, but not a lot more.? I scraped together what I could, culling the best bonds from the portfolio, realizing that the remainder would be decidedly subpar.? You could say that they hocked the “family silver.”

They did the reinsurance deal over my objections, which technically did not meet the stipulations of the state regulations, and gained more capital to write business against.? There was a cost, though.? We could not sell any of our best bonds, and the regulatory profits of the firm would now be flat to negative.

I did my best to aid their business goals, finding weaknesses in the risk-based capital formulas, and managing the interest rate posture of the company to near-perfection, all of which reduced capital needs.? But when you are running a company that is addicted to making sales, even if the sales are only marginally profitable, and not covering the cost of capital, that is the path that matters will take.

Would that they had listened to me, but they were arrogant.? What price did they pay for their arrogance?

The company CEO was encouraged to retire.
The CFO and Chief Actuary had to leave.
The parent company CEO was forced to resign for all of the money he had plowed into that loser of a subsidiary in the US.
The company was put up for sale, but given the dubious operating history, bidders were few and reluctant to spend much.

Any successful insurance enterprise needs bright managers on both sides of the balance sheet.? Bright managers of the assets, and issuers of policies that don’t give away the store.

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PS — I had one bond that was a high interest second-lien loan on one of the most valuable buildings in Baltimore.? At the time, the equity owner of the building called me, and made me a lowball estimate to pay off the loan, a few months before it would spring to first lien status.? I politely told him “No way,” and named a considerably higher price at which I would consider a buyout.? He told me that I was ridiculous, and I said “Fine, but I have read the agreements, and know our rights.”

He then called the client, and made the same offer.? They pestered me to deal with him, and I explained how he was wrong, and that the price should be much higher.? They agreed with me, and that was put to rest… until I left the firm, and the equity own got the deal done, paying up a little more, but by no means what he should have.

As I said many times regarding my client, “You can’t teach a Sneech.”? Sad but true for many who don’t understand investing.

The Education of a Corporate Bond Manager, Part V

Posted on 28 July 2010 by David Merkel

There has been a lot of talk lately about systemic risk, a concept that is not well-understood.? Let me simplify it for you.? Anytime debt grows in an area of the economy at a rapid pace, there is an unstable situation to be avoided.? If you are a portfolio manager at such a time, you must take the tough decision and underweight the area of the bond market that is growing the fastest.? That is not easy to do, particularly because that is where most of the new issues are coming from.

I wrote a piece called Fruits and Vegetables Versus Assets in Demand, where I said:

There is a way in which fruits and vegetables and financial products are opposites: when quantities are high for fruits and vegetables, quality is high, and prices are low. With financial products, when issuance is high, quality is low, and pricing is expensive, leading to poor future returns from lower yields, and higher future defaults. I offer this for what it is worth, but is there something more to it, than the seeming oppositeness?? Why are they opposites?

I had a follow-up piece here that answered the questions.? It takes time and effort to farm, but financial products can be whipped up easily in any season.

In the present environment, this would mean avoiding government debt.? If you believe in inflation coming you can buy the short end, and if deflation, the long end, but aside from that, the ability of the US Government to repay is not growing as rapidly as their debts are.

When I came on the scene in 2001 as a corporate bond manager, there were several areas of the bond market that had a lot of issuance: autos and telecommunications.? I began selling the weaker bonds in those areas; I sold all of my auto bonds (including GMAC and FMCC) except for $10 million of an illiquid issue of a Dutch Ford subsidiary, and limited my holdings in Telecom bonds to the Baby Bells.

That took effort.? Debt-based industry expansions rarely work out well.? If the idea was that promising, it could be funded with higher cost equity, rather than debt.

Now, what would this rule have meant 2004-2007?? Avoid financials, especially banks, S&Ls and mortgage companies.? Though financials are always a large part of issuance, they were even larger then.

I can hear some manager saying, “But I can’t vary that much against the index!? That’s an impossible strategy for big fixed income managers to follow.”? I understand, there are tradeoffs in investing.? If I am underweight, someone else must be overweight versus the index.? Someone has to absorb all of the paper of the hot sector; don’t let that be you.

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Credit analysts understand the creditworthiness of bonds.? What are portfolio managers good for?? Portfolio managers should grasp three things at least:

Portfolio composition versus the needs of the client.
The trading dynamics of the marketplace, and whether a bond might be temporarily mispriced.
The dirty details of a bond.? What are the covenants, terms, etc.

I will handle #1 at a later point in time.? As for #2, a good portfolio manager attempts to explain to his credit analyst why he is ignoring his opinion for a time, because the market for a given bond seems promising in the short run.? There is momentum in bond pricing, and it is better to sell a little late rather than early.

As for point #3, it is the responsibility of the portfolio manager to understand all the special features of a given bond, and why there are pricing differences across the bonds of a given main obligor (borrower), taking advantage of those differences when they get out of whack.

Having been a mortgage bond manger, where document review was a bigger part of what we did, in the minority of corporate bonds that need that review, there is a lot of value to be added.? Often I would review a complex prospectus to find out a big negative: amid all of the legalese, the bonds were as secure, or more so than the senior unsecured of the main obligor.

In a time of panic, those insights are golden, because other managers toss out illiquid bonds that they don’t fully understand.

Even understanding what a put bond is worth is valuable; after deducting yield because of the illiquidity of the smaller put bond issue.? The same is true of trust preferreds, preferred stock, premium bonds versus discount bonds, call features, etc.

The portfolio manager has to balance all of those factors off, along with client factors, in order to manage the assets properly.

I’ll talk more about client factors in a later post; those are always fun, or at least controversial.

The Education of a Corporate Bond Manager, Part IV

Posted on 27 July 2010 by David Merkel

When I started this series, I did not think that it would expand as much as it has.? Part of that is getting great questions, such as:

Hi David,

Great series!

You mention that reputation/size matters. Are there any ?poker? aspects of reputation that can be detrimental? For example, if you develop a reputation for consistently making good purchases do brokers catch on and markup prices with the idea that your interest in a bond is evidence of underpricing?

Josh

Mmm… poker; I use gambling analogies freely, but I don’t gamble.? You have a point, Josh.? If you do have skill as a manager, how do you deal with the Street if you think they will use your knowledge against you?

First, it helps if you are honest, keep your word on trades, and never try to weasel out of a trade once you have said “done.”? Your word is your bond, and the Street quickly learns who can’t be trusted.? Second, it also helps if you have a genuinely fair reputation; that you don’t try to pull fast ones on the broker community.? A few things that help in that regard: 1) most trades are “low information” trades — you need to raise some cash, and so you look down your list of bonds that your analysts have tagged as “please sell in the next few months” and select a few bonds on which to solicit bids.? When you talk to the brokers in question, tell them how many brokers you are talking to about this bond, and that you just need to raise some cash.? That sets them at ease, and does not reveal that your analyst has a negative opinion on the bond.

Third, that reputation for fairness should be reinforced by other actions.? a) When an investment bank is quoting a price/spread out of the market context, let them know what you know.? If they insist that they are right, then trade against them. b) If their risk control desk comes to you with a trade because they have to cover a short, and you own the bonds, help them out.? This is an “Androcles and the Lion” situation.? Make them pay up, but don’t “gouge their eyes out,” to use the technical term.? Just make them pay a little more than the ask.? If you do that, they will be grateful, and might offer you the long cross-hedge bond at a very nice price (happened to me twice).

Fourth, in general, have an “openness policy.”? Many bond managers conceal 80% of what they are thinking and reveal 20%.? I would reveal 80% and conceal 20% — the most critical 20%. (Imagine a poker game where you, and only you, get dealt all of your cards face down, and you get to choose which one card remains face down.)? Truth is, most investors and investment banks are not set up to copy everything their bright investors do; it would quickly become an overload.

But there is another reason why if you are a bright investor that you don’t have to worry so much.? Brokers make money off of trades.? They thrive off of differences in information.? They like nothing better than to facilitate the trades of bright investors at the expense of not-so-bright investors, because it gives them a reliable series of trades, where they clip a little for themselves.? They aren’t dumb; they don’t want to kill you on one trade if they know they can have a continued stream of trades.

Fifth, your broker at the investment bank is proud of his best clients.? He does not want to lose you if you are bright, or if you trade a lot, or run a big account.

Sixth, never tell your whole story to any broker.? The intelligent portfolio manager breaks up his business among many brokers, each of which is working on specific deals, with no overlap, unless the brokers have been so informed.

Seventh, it is very good to have a reputation for being bright, or at least, not being a pushover.? It restrains the brokers from taking advantage of you and your client.

So I look at being bright in the bond business another way.? It is an advantage that needs to be manager through proper communications.

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On the Trading Log

My first boss had a trading log, and when he left, I imitated him, and copied down my notes from when I was trading.? In the short-run, it avoided confusion; in the long run it encouraged consistency of thought.

But, it is one thing to keep a log, and another thing to remember prices and spreads.? I did my utmost to forget where I entered trades, and then focused on what was the best thing I could do with any given bond, even of I sold it at a loss; at least I avoided a bigger loss.

It is freeing to avoid thinking about whether any trade will generate a gain or a loss, and rather, as how the portfolio can be improved.? We can’t control market prices, but we can choose the companies in our portfolio.? And though humans might be bad at making choices when there are thousands of options, we can be very good at evaluating whether swapping one asset for another can be bright, dumb, or too close to call.

The Education of a Corporate Bond Manager, Part III

Posted on 22 July 2010 by David Merkel

A reader MorallyBankrupt, asked,

What I am wondering here is the following, how fast was the decision process? For those of us that have never worked in the new-issue market for corps, the timeline is not obvious. How did it all flow, from getting notice of the deal, to getting a feel for the demand for it, to knowing what the offering price was going to be? How long did you have before requesting allocation in the deal?

Good question.? I answered part of this in the last piece.? It would vary based on three things:

The complexity of the deal — more complexity, more time
The creditworthiness of the issuer — lower creditworthiness, more time
The speculative nature of the market — less speculative, more time

Most new issue corporates do not require explanation; they are just straight bond deals.? Senior unsecured, do the credit work, do you want into the deal or not?? But some deals require thought.? When Prudential (US) went public, they securitized the business associated with their oldest policies, and issued debt against it.? Thick prospectus.? Many scared away in the midst of the credit troubles in 2002.? I looked at it and said, “They are offering more yield than on their surplus notes, but with better protection.? Time to buy.”

So I called my broker at Goldman and expressed interest in the deal.? He sounded a little surprised, and said that few had offered orders yet.? I said that I was interested, and he said that the syndicate would be interested in pricing guidance.? I gave him a schedule where I would be willing to buy more as the pricing went higher in spread.

But after that, I asked for protection on my order.? Early orders deserve protection.? Protection means you will get everything that you asked for, while others get pro-rated if the deal is successful.? They protected my order, which was large for us, while the marketing of the deal continued.

As it was, in the midst of the chaos of 2002. there were few takers for the low risks in a complex deal like that of Prudential’s old business.? So as the deal came to pricing, the yield rose.? The eventual yield for the non-guaranteed bonds was 8.695%, yielding a price in the $98s.? The first trade was $104, and went up from there.? What could be better? for us?? I bought some more when my credit limit expanded at $108.? What a great misunderstood bond.

But that is the way things work when credit markets are slow.? When they are fast, deals close rapidly, and syndicates allocate bonds proportionately to where their estimate of buying power is.? There is no protection there, aside from any big investors who move very early.

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But now onto the times when markets go nuts.? Deals are closing in less than 10 minutes.? You have to get your order in rapidly, or you will get nothing.? My one minute drill helps, but is not perfect.? On a deal on Disney bonds, they had a great yield in a hot market.? I bid for $30 million in bonds, and found myself trapped with 30 million of Disney long bonds, after an allocation that went bad.? I flipped 10 million for a small gain, and another 10 million at par, leaving me with 10 million that I did not want to hold.? I waited, and took my losses later.

But more often, I would avoid the deals when they got hot, and let others buy them.? I had strong opinions on what would work and what would not.? I remember several large deals where the syndicates begged me to buy (GE Capital, and AT&TWireless) and I refused.? The speculative cycle was high, and it was fun to refuse Wall Street when it was trying to stuff accounts full of promises that were underpriced.? I did not play in those deals, and it was fun to see the deals fail, and prices fall considerably versus the original offer.

In order to keep the system honest, some deals had to fail, and not provide profits to those who would flip.? Otherwise, many managers would beg for more bonds than they could hold onto, just so they could flip them.? When the market runs hot, the odds rise that the syndicates will overprice a deal, to deliver losses to those that foolishly ask for overly large allocations.

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Once you had notice of a bond deal, you could act. You could put in for bonds if you wanted.? But when conditions were speculative you had to move rapidly, and ask for an allocation quickly, or risk getting nothing at all.? Once the books closed, that was it.? Also, if multiple dealers controlled the books, it paid to put in through all of them.? One might have influence that the others did not on very rare occasions.? You wanted all of the bookrunners fighting for you.

All of that said, on some deals you would end up with a lousy allocation, and get less than 10% of what you asked for.? At times like that, one would typically flip the bonds to the highest bidder, because it was not worth the bother to hang onto a small position.? On massively oversubscribed deals, the percentage profits on the flip were high, but they weren’t big in dollar terms.

As an aside, occasionally, shortlyafter the deal closed, if you had a sterling reputation, and could say to your brokers that you had been hindered from putting in for bonds but had wanted to, you could still squeeze in.? Reputation and size matters.

Some deals were highly subscribed by large sponsoring buyers before deals went public.? Those deals would open and close in a minute shutting everyone else out but the large buyers, and what few got some crumbs.? I remember getting crumbs on a few occasions.

One way you could get the syndicates to notice you, was that if you really liked a deal, you would buy on the break.? The break is where bonds become free to trade.? Now, truth, there is what is called the “grey market” where after bonds are allocated but before they are “free to trade,” you could deal them away, or, buy some more.? Dealing in the grey market has some taint, and you don’t want to be seen doing it, lest your allocations be reduced.? The opposite is true for those who buy through a syndicate dealer on the break.? It shows the syndicate that you are a real money buyer, as opposed to? a flipper.? Syndicates want to place bonds entirely with long term holders if they can; that is their goal, because it means they priced it right, leaving little money for mere speculators.

As for me, I employed one second tier broker who would buy lousy allocations from me on oversubscribed deals.? No reason to make the analyst write it up.? It wasn’t worth holding onto, and the yield after the break was not attractive enough to buy more.

More to come in part 4.