Alphacution’s Paul Rowady continues his examination of the equity market’s ‘structural alpha zone’ and asset management ecosystem with a look at the top bank-owned broker-dealers. And he uncovers a clue in explaining the demise of Deutsche Bank’s US equities business in the bank’s approach to trading.
“You can’t connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future.” –Steve Jobs
In a Feed post entitled, “Remembering Deutsche Bank: A Market Macro-Structure Canary?” Alphacution hinted that our modeling of Deutsche Bank Securities, Inc. (DBSI) was really a “first step towards quantifying the ongoing battle between and among bank and non-bank broker-dealers (BDs) and market makers.” Well, perhaps this post is the second step.
So, let’s briefly revisit why measuring and comparing various BDs at the center of the market ecosystem – otherwise known as the structural alpha zone – might be important. By now, many of you are familiar with Alphacution’s asset management ecosystem map and our core hypothesis that since the capacity of alpha is finite, dominant players that operate in closest proximity to sources of liquidity ultimately impact the capacity of residual alpha that is available to be harvested in neighboring sectors of the map, namely the active and passive management zones. The chart below is our latest visualization of this map and its three zones. (For those of you who are new to the Feed – or simply want to refresh – curl yourself up with What Does Citadel* Spend on Technology? and work your way to the present.)
Now, with the exception of the recent piece on DBSI, Alphacution has mainly been focused on modeling non-bank broker-dealers – i.e., buy-side market makers and proprietary trading firms – on the right side of the structural alpha zone carveout, below. However, with some of our latest modeling in place, Alphacution is starting to expand its analyses and rankings of the players on the left side of that chart (highlighted).
Referencing our focus on exchanges and bank-owned liquidity venues chart (below) – from our all-time most popular post to date, “Top 100 Players in US Listed Market Structure” – we arrive at a list of the dark (and lit) market operators from which we will gather the candidates for the next step in our analysis; namely, Goldman Sachs & Co. (GS) and Morgan Stanley & Co. (MS), along with DBSI, which are the broker-dealer entities within these banks.
In the next chart, below, Alphacution presents its latest bank broker-dealer comparison of total assets for GS, MS and DBSI over the 18-year period beginning 2001 and ending 2018. Here, it’s difficult to avoid noticing the similarity of trajectories – both pre-Global Financial Crisis (GFC) and post-GFC – for these three trading operations.
Now, recall that the catalyst for the initial DBSI post was the announcement that Deutsche Bank would exit its global equities business and so we thought to measure the US component of that business using data found in Form X-17A-5. Though all three trading operations – for GS, MS, and DBSI – reflect the common challenges to be found in the post-GFC risk-, regulatory- and fee-pressured landscape, DBSI has been in an increasingly clear decline since about 2013. Anyone who had had the foresight to assemble this data back in 2014 or 2015 would have found the odds of DB shuttering – or, at least, restructuring – its US equities operation increasing.
This picture becomes much more vivid when we focus in on the next two charts, Gross Cash Equities and Net Cash Equities. Here, we see that DBSI is approaching the US equities business is an entirely different manner than GS and MS.
Sure, DBSI is smaller than these two comparisons, but, more important, it has maintained much more neutral exposures, while GS and MS appear to be introducing strong market biases into their BD portfolio positioning.
Granted, this is our first pass at this analysis. It will become much more illuminating once we can add the other major sell-side players as well as look into the specific 13F holdings reports and conduct various earnings analyses and volatility comparisons for each of them. However, for now, these early findings are noteworthy.
This article originally was published on the Alphacution Feed.