“The Initial Mystery that attends any journey is: how did the traveler reach his starting point in the first place?” – Louise Bogan, poet and author
After 40 years, the Securities and Exchange Commission (SEC) announced on July 10, 2020 that it had proposed to amend Form 13F to update the reporting threshold for institutional investment managers and make other targeted changes. The proposal would “raise the reporting threshold to $3.5 billion, reflecting proportionally the same market value of U.S. equities that the current threshold – $100 million – represented in 1975, the time of the statutory directive.” Furthermore, the new threshold is expected to “retain disclosure of over 90% of the dollar value of the holdings data currently reported while eliminating the Form 13F filing requirement and its attendant costs for the nearly 90% of filers that are smaller managers.”
Now, those of you who have been following Alphacution’s work know that we have leveraged 13F data in ways that no one else has ever replicated, and therefore, has become a very important dataset for us. While most observers of 13F reporting – like, for example, our friends as WhaleWisdom – tend to focus on showcasing the top positions of market luminaries like Warren Buffett or Stevie Cohen as if that information was itself a trading signal, Alphacution has leveraged the entire 13F report as a signal for a manager’s underlying strategy. From there, we have typically organized the entire history of a manager’s 13F reports into time series, like a signal for the evolution of that underlying strategy. And most recently, we have been able to leverage a library of 13F-supported models to compare notable managers and illuminate an expanding spectrum of their impacts on the trading and asset management ecosystem…
Though the initial spark of inspiration arrived accidently in the form of Wedbush’s 13F filings, Alphacution’s first Feed post based on 13F data was published on November 28, 2018 and was somewhat provocatively titled “Goldman Sach’s Book: Hiding in Plain Sight.” That post was the first to introduce the novel concept that trading and investment strategies have shapes:
Of course, like moths to a flame, many flocked to this story – and many of the Hiding in Plain Sight stories that followed – based on the title without having the faintest notion of what we were talking about. (Strategies have shapes?!)
Over a short period of time, the pictures became much more sophisticated and the insights ran deeper into the details; even close to where we had originally started:
Eventually, we could see where some of the most legendary asset managers in history were beginning to come face to face with the boundary conditions of their core strategies (as imposed on them by the capacity constraints of the market itself):
We have even gotten to the point where we can look further and further into the evolutionary construction of option books by some of its most sophisticated practitioners:
And yet, one amazing aspect of all this free data lying around in plain sight is that we have still just begun to harvest insights from what has been organized so far. There is so much more on deck for us to extract from this uniquely assembled dataset…
So, with these thoughts and pictures as preamble, you might guess that we would be violently opposed to a substantial reduction in the transparency provided by the current 13F disclosure rules.
First, SEC Commissioner Allison Herren Lee has done a better job than we will ever do in mounting a case in opposition to this proposal. To summarize, she says that 1) this proposal would “eliminate access to information about discretionary accounts managed by more than 4,500 institutional investment managers representing approximately $2.3 trillion in assets, 2) the projected cost savings from this proposal – and I paraphrase – is a crock of sh*t, and 3) the Commission doesn’t possess the statutory authority to make the proposal in the first place…
That’s a tough act to follow. However, in addition to that gem, here’s a little extra:
Let’s pretend that an adjustment to 13F disclosure rules is the best use of the SEC’s time in the current environment. (And, while we’re at it, let’s pretend that the notional value of a $7 trillion Fed balance sheet hasn’t had any impact on the capitalization of US equity markets. )
In the highly unlikely event that that were the case, it might make sense to revisit the core objective of 13F reporting altogether, given that so much more than just the valuation of equity markets has changed since 1975. (Hint: The entire technology revolution!)
In additional to “monitoring the holdings of (larger) investment managers,” 13F disclosure thresholds should also be set to capture a comprehensive roster of institutional investment managers that are impactful to the market ecosystem. In others words, given the growing body of evidence that the industrialized use of technology leads to “winner-take-all” dynamics in all types of markets, we need to make sure that new value-only thresholds are not set such that smaller, yet highly impactful, investment managers are filtered out with new 13F disclosure rules. (Translation: Let’s keep a close eye on the quants…)
A way to guard against this may be to set an additional threshold based on position count.
For example, based on data assembled by Bloomberg News in late 2019, Virtu Financial was the #2 wholesaler of US equity retail order flow (behind #1 Citadel Securities and ahead of #3 G1 Execution Services, a unit of Susquehanna International Group). Alphacution believes that Virtu still holds this #2 position, which is ~25% of US equity retail order flow.
If a new 13F reporting threshold were set at $3.5 billion, as proposed, Virtu – like nearly all other market makers and highest- turnover proprietary trading firms that are capturing so much of the theoretical capacity of alpha today – would likely no longer be subject to 13F disclosure rules (at a time when we know so little about these increasingly powerful players).
However, if an additional 13F disclosure threshold were imposed based on position count, it would capture many of the smaller firms (by value) that are punching well-above their weight class because they have harnessed technology and quantitative methods in a way that allows them to manage hundreds – and often, thousands – of positions with relatively small teams and comparatively small asset bases. The chart, below, represents the long side only position counts for Virtu’s US equity book for the 49 quarters beginning Q4 2007 and ending Q4 2019:
Now, truth be told, as the market ecosystem becomes more concentrated, Alphacution’s research suggests that many of these smaller investment managers – the 4,500 managers Commissioner Lee expects to be filtered out by the new 13F disclosure proposal – are going to struggle to remain competitive anyway. The asset levels necessary to generate the performance and/or fees to support the technical and human capital arsenal necessary to compete for declining capacity of outperformance in this environment continues to go up. Meaning: Fewer and fewer will make the cut…
So, on that basis, it may become overly costly to pay attention to these (uncompetitive) players relative to the dent – or, lack thereof – that they will ultimately leave behind in this market ecosystem. And, it may not matter necessarily how new value-based 13F disclosure thresholds are ultimately set.
However, if new position count-based 13F disclosure criteria could be added to the mix, thereby continuing to provide much needed transparency on a tech-savvy segment of institutional market participants, the SEC may preserve the possibility that they may one day – by dumb luck or otherwise – stumble over the exceptional unharvested value of this dataset.
I won’t be holding my breath – and I’m certainly not waiting around for someone else to do that harvesting…
Until next time…