Lucius Cassius Longinus was consul of the Roman Republic in 107 BC. His most famous friend was Gaius Marius who eventually ended up serving seven terms as consul of Rome. Lucius is most famous for one of the greatest defeats in the history of Rome. While serving in Gaul (Germany/France today), he was killed in an ambush which was eventually named the Battle of Burdigala. His entire legion of 10,000 legionnaires and all of their followers were killed. The rest of the army was eventually forced to capitulate—give up half of all of their goods—and return to Rome in shame. This famous painting by Marc-Charles Gabriel Gleyre shows the Roman troops passing under the yoke while the Gauls (and their children) openly mock them.
So, that is his most famous achievement.
Not great.
His second most famous achievement was coming up with
the maxim "Cui Bono."
Cui Bono is used to imply that the person who initiates
an action is usually the one that stands to benefit from the action. It
basically translates as "who benefits?"
So, can this possibly have anything to do with
investing? You know I will say, "Of course!"
We should consider the test of Cui Bono every time we
make a financial decision. Consider with me for a moment the recent bond that a
leading investment bank made. It should be noted that shortly after they issued
this high-optioned security, another leading investment bank followed suit with
virtually the same structure in an effort to bolster their balance sheet.
Can we agree that these issuers are neither financially stupid, nor altruistic?
- Issuer: GS Finance Corp (A2/BBB+/A)
- Structure: 10Yr NC 1Yr Callable "Steepener"
- Coupon: Year 1: 4.00%
- Years 2-10: 3.00% * (CMS30Yr-CMS5Yr), Cap = 7.00% & Floor = 1.00%
- Settle: 3/10
- CUSIP: 40057FQ72
- Price: $100
Now, I know that not every reader is a bond geek, so
let me give you a layman's description. This bond's coupon will start at 4% and
then float quarterly at a rate of three times the amount of the difference between a proprietary swap index's rates at two
tenors (or maturities): 30 years and 5 years. The bond was marketed as a steepener
because if the yield curve steepens, the coupon will go up. Of course, the
coupon also can also go down if the curve flattens. Additionally, it has an
imbedded call option after one year. Remember my own maxim, don't sell cheap
options? This call option allows the leading investment bank to take the bond
back at par if it becomes worth more than par, that is, if the yield curve
steepens. Remember, the benefit the fancy steepener coupon formula was supposed
to give you? Interestingly, even though they were able to unload this debt onto
the marketplace on March 8th at a price of $100, it quickly traded
down to $94.55 and then was resold at $95.23, all on March 8th,
2021.
Cui Bono?
Seriously…let us consider who benefited from this issuance.
- The investment firm? Yes
- Brokers? Yes
- Investors? No
Now, admittedly, this is an extreme example of hubris.
However, if one looks closely, we can see similar maneuvers every day in the
capital markets. Think back six short months ago, when 5-7-year callable bonds
with coupons way below 1% were being issued at $100. Today, many of those bonds
have already decreased in price by 5-6%.
Today, we see a renewed surge in the issuance of
callable step-ups, the general term for bonds like the bond we've been
discussing. If the slope in the yield curve continues to increase, we will
probably see even more of these being pushed. Here is a recap of callable
step-up issuance over the past 10 days:
Cui Bono?
To be fair, all bond prices have fallen due to a
general rate rise of 50-60 bps in the mid portion of the yield curve, but you
can be sure that Fannie Mae, FHLB, and others who issued this kind of debt are
thrilled.
Brokers, by their very nature, have some similar characteristics. They are usually very socially gifted and able to make interesting and entertaining conversation. They are generally fairly aggressive and driven to get things done. Many, maybe most, of my friends are brokers of one sort or another, and I consider the vast majority of them to be really great people, but we, as investors, must remember at the end of the day they need to sell securities to make a living. It's just that simple. There is nothing wrong with that. We just need to keep in the back of our minds, Cui Bono?
We, as investors, must remember at the end of the day they need to sell securities to make a living. It's just that simple. There is nothing wrong with that. We just need to keep in the back of our minds, Cui Bono?
This does not
mean that they are not going to bring you great ideas and great securities.
Sometimes the issuer will benefit, sometimes the broker, and sometimes the
investor. In a perfect world, all three parties would benefit, but we are not
in a perfect world, as evidenced by the issuance above.
At the end of the day, you are the one making the decision. That decision needs to be the best possible one for your institution and your portfolio. It doesn't really matter how nice or engaging a person is on the other end of the line. Your job is to try your best to ensure that when it comes to your investing decisions, the answer to the question Cui Bono includes your organization.
At the end of the day, you are the one making the decision. That decision needs to be the best possible one for your institution and your portfolio. It doesn't really matter how nice or engaging a person is on the other end of the line. Your job is to try your best to ensure that when it comes to your investing decisions, the answer to the question Cui Bono includes your organization.
To make sure that you are the one that is benefitting,
maintaining a disciplined approach is essential. Every security must be
scrutinized through the lenses on time and money across a variety of interest
rate scenarios.
Remember, as I discussed in my last post, some of the best
decisions you can make are what not to buy.
Final, final thought: Really good fish tacos are tough
to beat. Please share your best recipes with me.
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