Stories from the Institutional past #3

Nothing is Free

Welcome to another edition of my stories, memories from bygone years in the saddle. I hope you enjoyed the previous two instalments.

Thank you for your kind words and encouragement to continue writing them. There are two aspects as to why I am sharing those. One being a hopefully entertaining recollection of my experiences and the other to note down some lessons learned.

This new article goes about the notion of getting things for “free”. I mean, you do get things for free in monetary terms, but there is always, usually, a price attached to it somewhere. That’s especially true in finance, where virtually nothing is free.

Money for nothing and lunch for free

When I started my career, there were no such things as a centralised trading desk. We all traded our things individually. These days, due to increased regulation, there are centralised trading desks in place where you have to send your trades to. A bit annoying and sometimes inefficient, but rules are rules.

The good thing when directly trading with your counterparties is that you get to talk to the person on the other side of the phone. Typically, you’d be chatting with the salesperson and very rarely with the traders themselves. You’d be having direct lines on your “Turrets”, as shown below.

While I am at it, the best thing was the phone (see picture below), which had a switch on top (I think they still do) that muted/unmuted your telephone. They had to be sturdy as hell, as they got most of the bashing. I used to have two of them.

Anyway, back in the day, salespeople invited and offered you perks in order to entice you to do more trades with them. More trades, more commissions for them. Before the GFC and before local regulations clamped down on entertainment (these days, you have to declare anything above 25 £ with larger perks being forbidden), I’d get invited to concerts, lavish lunches and dinners, sports events and skiing trips, of course. I didn’t overly enjoy the “piss-ups”, etc., but I certainly liked to be invited to sports or music events. Times were good, and there were no limits on expenses, as far as I could tell.

A particularly crazy story was involving a friend of mine who was obsessed with football. This was in 2004 during the European championships in Portugal. She was invited to the France vs England group-stage game, which was held on a Sunday evening (France won 2-1 btw.). Unfortunately, she was also at a wedding the day before, which was held in Norway. The problem was there were no flights to Portugal from Norway that day for whatever reason, so the banking geniuses organised a speedboat to get her to the UK overnight so that she can make the private jet to Lisbon in time. Not a small journey (see the pink line on the map below).

These were the crazy days, and in hindsight, I should have possibly made more out of it. But those perks were not really for free. It was an untold understanding that in exchange for their invites and entertainment, there had to be something in exchange which was obviously linked to offering them more business. So it became natural that pretty much everybody built their favourite banker network with whom they would be transacting most of their trading volumes.

It has to be said that this did not happen (at least not with me) to the detriment of the end client. My favourite brokers would be included in obtaining a quote (usually min. 3 quotes for normal trades, one or two for larger tickets), and if they didn’t offer the best price, they wouldn’t get the trade. If they were offering the same exact price, yes, you would typically give it to your favourites.

You might not be surprised why regulators have clamped down so drastically on entertainment. Where there is money and incentives, there will always be people who will try to manipulate and game the system to their advantage. I haven’t personally seen it myself, but there are enough stories out there that should certainly make for good movies.

As for financial markets, which are highly competitive and complex systems, numerous market participants like private investors, institutional investors, hedge funds, sovereign reserve managers and algorithmic trading systems actively seek profit maximization every single second of the day. The never-ending pursuit for alpha (aka alfa) drives intense competition to exploit any smaller inefficiency in markets. You can find one that works over time but rarely will it work for a longer period.

I remember when I discovered one such profitable streak back in 2020 amidst the Fed buying bonds (QE operations). There was an exploitable anomaly where lond-dated Treasuries would underperform during the day in the local hours (EST) of lunchtime. My assumption was that the New York Fed dealers who are transacting QE on behalf of the Federal Reserve were simply having lunch and, as such, off their job buying bonds. The simple strategy worked for about 3 weeks, pretty much every day, until it seized to exist. A free lunch while others are at lunch, so to speak.

Knowing who you are up against is very important. I remember this trader at Bluecrest who was famous for fleecing drunk US-based players on online poker forums on Sunday mornings (UK time). His strategy and idea were simple: Weakened competition due to intoxicated counterparts offers opportunities as they’re prone to make mistakes.

The idea of effortlessly reaping substantial gains in financial markets is a tempting proposition, and many claim to hold the holy grail of such a pursuit. It is, however, extremely difficult to run this over long stretches. This should not hinder you, however, from starting investing or trading but should offer you a strong hint that consistently banking alfa is a very, very hard thing to accomplish.

Hope you enjoyed this!