Hedge Funds Are Facing a US Criminal Probe Over Bond Valuations – Bloomberg
May 11, 2017 \ 5 Comments
Full Article: Bloomberg
By carrying securities on their books at artificially inflated prices, hedge funds can show better performance. They can collect more in management and performance fees — or hide poor performance for certain holdings.
This shouldn’t be a surprise as there are many bad apples in the fixed income markets who would do anything asked to ingratiate themselves with people for a variety of benefits/opportunities. But I do not think there are more bad apples in fixed income than in other markets or for that matter in other professions. I also do not believe this kind of behavior is rampant or normal. However, there are plenty of marking issues in FI that exist simply due to market illiquidity and the practice of using quotes to do EOD marks instead of using real market clearing… Read more »
Bond valuation corruption again? Yawn. Unfortunately, this article gives a false sense of just how wide the problem could be. This is not isolated to “illiquid securities” and this blatant inflation of valuations has not become more pronounced because investors are pulling out of hedge funds. This is an every day problem in a market that has no real method for figuring out current value…objectively. Under the hood of the bond market is a process where billions of dollars of bond positions are priced based on say-so. Do you think only hedge funds do this? Try again: http://www.etf.com/sections/blog/pimcos-20m-fine-highlights-bond-pricing-fiction What is… Read more »
If there are incentives to shade something in someone’s favor, they will always err on the side of shading it in their favor. If you add in difficulty in discerning “fair value” and limited negative consequences, then you’ve got a recipe for widespread abuse.
That said, this issue seems to be exacerbated by the (a) consolidation in the pricing space that has created a market oligopoly and (b) the lack of transparency and complex nature of bonds to evaluate bonds and (c) the archaic and non-standardized ways that buyside firms price portfolios.
All good points here. The worst thing for the markets will be if the press, incumbents, and regulators see something like this and trot out that exhausted bromide, “MORE ELECTRONIC TRADING WILL SOLVE THIS AND CREATE THE TRANSPARENCY!” FI markets, from structured up the ladder, need to start with the building block of execution, more organization around pretrade information.. Can games be played in inherently illiquid securities with few price points,, most definitely yes. Are there thoughtful ways of aggregating data to give a “better picture” without giving away the store and improving the ability to control gamers yes. Will… Read more »
There are two separate (hard) problems here: bad apples and bad prices. On bad apples: As several others have pointed out, if there’s a way to tip the scale, someone somewhere will do it. So make it impossible to tip the scale. Not trivial, but it can be done with some clever design. Minimizing direct human influence on the pricing models should help. See Libor as a great example of what NOT to do. Make the pricing model sufficiently complex that individuals find it hard to “crack the code”, take humans out of the process wherever possible, and give more… Read more »
Blackrock’s Richard Prager: The Liquidity Is Out There – Institutional InvestorMarch 18, 2016
Everyone is Worried About the Thing Markets Need Most, But They’re Not Asking the Right Questions – Business InsiderMarch 25, 2016
US Companies Overpaying for Bonds; Banks May Be to Blame – ReutersMarch 31, 2016