Image Credit: Liu Bolin
“The problems are solved, not by giving new information, but by arranging what we have known since long.” – Ludwig Wittgenstein
Launching ourselves right into a new year with a continuation of our curiosity with all the delicious clues lying around in plain sight, we give you a morsel of Flow Traders’ book. Perhaps not the precise bromide for your hangover, but one that may end up tickling your intellect and soothing a need for a creative distraction at the same time…
In the chart below, we present the shape of Flow’s long portfolio value for the 28 quarterly snapshots beginning 12/31/2011. (For a little background on why we present this chart without the numbers, see our recent example on Citadel.) As of now, Alphacution interprets an upward sloping long portfolio value as a sign of success from either position count scaling and/or average position size scaling.
Now, since I’ve already had the debate with a few of the high-speed, market-making types (on the potential illusions of 13F reports), I’d like to preempt the question straight away: Yes, a market-making or high-speed firm like Flow would much prefer to capture its spreads (and/or other arbitrages) and go home flat each day. But, in order to grow, you either need to lengthen your trade list or tolerate going home with some deltas.
This is similar to the concept of “same-store sales.” In order to grow, you need to expand the profitability of each “store” – er, trade – and then expand the things you trade… Increasing portfolio value implies (at least to us) increasing scale somewhere in the portfolio, and therefore, ongoing success in scaling the entire book (even though we can only see a fragment of it).
Speaking of fragments, what if we do as we did with Citadel and provide a reference point for Flow’s portfolio shape above. In the chart below, please find the relative long portfolio values for Flow and Virtu for the 28 quarters beginning 12/31/2011:
This is fascinating stuff. Didn’t we showcase just a couple months ago (way back in October 2018) how Virtu and Flow Traders were very similar companies? For a refresher on that, check Adventures in Speed: Virtu Financial, Flow Traders plus the relevant chart below:
Anyway, at some point it may be fun to peel the onion back another layer and perform a position level comparison. For now, let’s simply look at a comparison of position counts.
In the chart below, we present the full sample of 28 quarterly snapshots of total long position counts for Flow Traders. Here we can see that the reported total position count has not changed all that much over the 7-year period. This is fascinating by itself – and begs the question whether this is an intentional boundary. Second, it tips the hand that the increase in portfolio scale mentioned at the outset is more probably due to increasing average position size.
However, in addition to these two observations is the spike in position count in late 2016. Our initial read of the cause of this is strategy experimentation; perhaps bolting something new onto the core strategy. In any case, whatever the experimentation was, it appears to have been shut off by mid-2017. (Again, a position level analysis might shed more light on this.)
It is this spike in position count that creates the illusion that the overall portfolio value is increasing over time. Without this, both reported long position count and long portfolio value would appear to be more flat over the 7-year period.
One more visual to share for now since we have been using Virtu as a reference point: In the chart below, Alphacution presents a comparison of the long position counts for both Flow Traders and Virtu. Of course, here we find a lot of similarities – and each with their own spikes of some kind of strategy experimentation – up until the point that Virtu adds KCG to the mix in Q3 2017 when clear divergence occurs. (As a bit of foreshadowing, this is largely due to the KCG’s option book, which involves a story for another day…)
CORRECTION 1/4/2018: Spike in Virtu’s position count is due to the legacy Knight Capital customer business, a vast majority of which is stock (not options) positions. From 3/31/2011 to 12/31/2015, Knight’s average 13F option position count was 1,169. It was around this time that Knight’s option market making business was sold. Prior to the KCG acquisition, Virtu’s average 13F stock position reporting for the stand-alone period 12/31/2009 to 6/30/2017 was 280. As an additional point of reference, GETCO’s average 13F stock position count for their pre-Knight stand-alone period 12/31/2008 to 6/30/2013 was 130. Clearly, these are similar levels to Flow’s current average position counts.
Reminder: In case anyone has lost the plot here, we are speaking of 13F reported positions only. These are temporal fragments of what are likely much bigger portfolios. All of these firms are making markets in and otherwise trading around a (much) broader spectrum of securities, many of which do not qualify for 13F reporting and/or do not hold positions in relevant 13F securities on the dates that the reporting is due.
Final thought: I have quite a bit more to say about the level of intelligence that this type of analysis yields (about players and strategies in this neck of the trading ecosystem), however it’s not something that I want to do in the context of a few hundred words of spit-balling. That exercise is something that needs to be done a bit more methodically and with a few more words of explanation. Eventually, I will get around to that presentation. In the meantime, I look forward to sharing selective snippets and insights.
Don’t be shy about sending questions or other firms you’d like to see showcased.
Thanks for your attention – and wishing you and yours a healthy and prosperous 2019!
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