“You can have all the transfer orders that you want, but you have to ask me nicely.” – Col. Nathan R. Jessup, “A Few Good Men”
On December 11, 2019, Bloomberg News editor Tom Maloney publishes an unusually illuminating article on Citadel Securities, “Ken Griffin Has Another Money Machine to Rival Hedge Fund,” citing specifically that the market maker earned $3.5 billion of revenue in 2018 and “handles more than 1 of 5 shares traded in the US each year.” Of note, the article includes two charts, the first of which ranking net trading revenue in 2018 for a selection of bank and non-bank market makers; and the second of which showcasing the shifting market shares of US retail equity wholesalers.
Given that Alphacution has followed this and other firms in this space as closely or moreso than any others – for example, we are not aware of any other research and advisory group publishing a comprehensive case study on Citadel Securities – I wanted to add a few thoughts that we will bucket into Code Reds and Pulled Punches.
It is unclear where the $3.5 billion revenue figure for 2018 comes from other than the disclosed sources, Bloomberg Intelligence, a research arm, and Bloomberg News. The chart below, from the article, shows how (Bloomberg calculates that) Citadel Securities ranks against two non-bank and five bank-owned market making groups.
Now, there are a few things that are puzzling about the fact that this number – $3.5 billion – is out in the open that are worth considering (separate from any errors). Notice that the list of sources does not include “company data.” So, it appears that this figure is not published anywhere (even though the article does seem to intimate that certain detailed disclosures may have been made in conjunction with at least one of a series of bond offerings).
Meaning: This figure may have been telegraphed to Bloomberg (and, it looks like, no others) – and, more importantly, given the high level of discipline consistently demonstrated by this group, Alphacution’s hypothesis is that there is little possibility that such a figure was able to see the light of day without being directly sanctioned by Ken Griffin himself; much in the same vein as the “code red” could only have been ordered by Col. Jessup in the movie, “A Few Good Men.” With that, and begging your pardon for the dramatic comparison, the next questions are: Why? Why now?
Hold that thought…
Secondly, the figures and rankings of the non-bank players (from the chart above) are foggy. According to Alphacution’s modeling, the Flow Trader revenue figure is accurate (at $453 million) but the Virtu figure (at $1.9 billion) is not. Virtu’s net trading revenue for 2018 was $1.3 billion – the difference represented by net interest, net dividend and commission revenue plus a one-time bump from the proceeds of BondPoint ($338 million), which was part of the KCG acquisition in 2017.
Furthermore, we know that 2018 was a strong year for leading equity market makers, like those listed, in notable part due to the violent spike in volatility that occurred in January (and, to a less surprising extent, November) of that year. The charts below, related to Virtu and Flow Traders, illustrate just how unique the impact of these spikes were on players in this space. And, pending additional analysis and modeling of the bank-owned market makers – and given its modeling of numerous other proprietary trading firms – Alphacution’s working hypothesis is that the relationship between volatility and the profitability of hyperactive market making (and related) strategies are similar. (For a bit more on this, see “Virtu Financial: More Acquisitions on the Way, If…” where Alphacution compares the sensitivity to volatility between the Virtu and original GETCO strategies.)
Lastly, the prior point throws into question whether Citadel Securities’ $3.5 billion revenue figure for 2018 is actually net or gross. We may never know. However, in the Feed post, “Citadel Securities: Estimated 2018 Revenue,” Alphacution makes a case for a 2018 revenue estimate of $1.5 – $2.0 billion based, in notable part, on growth in member’s capital. Of course, we could be wrong…
Here’s one more thing to consider: The chart below from the Bloomberg article presents a vivid picture of US retail equity wholesaler market share for the 169-month period August 2006 to August 2019. This is the part of the story that translates into Citadel Securities handling more than 1 out of every 5 US equity shares traded per period. Of course, paying closer attention to the numbers than the words, the picture below shows something closer to 2 out of every 5 shares, but hey, maybe we’re splitting hairs here.
Anyway, if you will tolerate a bit of shortcutting here, Alphacution made an argument (with lots of data and pictures) in its aforementioned case study that Citadel Securities is now trading pretty much everything it possibly could trade in the US equity and equity-linked markets – across stocks, ETFs and options – and therefore, may be maxed out in terms of US equity-linked inventory.
When we overlay this argument with what is implied in the chart above (related to a dominant market share position) and what Alphacution knows about the dominance of Citadel’s – as in, the entire Citadel platform’s – technical and intellectual approach to alpha extraction relative to the banks and non-banks listed above (along with other leading prop firms), one could go so far as to make the improbable argument that Citadel is now pulling its punches.
Meaning: It could continue to grow its share of these markets (and bleed others into weaker positions), however, to do so would be to increase the risk of destabilizing markets whose concentration, in Alphacution’s opinion, is already too high. In other words, and though it seems a little nuts to say out loud, Citadel is voluntarily stopping itself from running over the remaining competition in these markets.
As such, we see strong diversification into other asset and product classes – mainly, fixed income – and other regions. For example, in the charts below, Alphacution presents the growth in net trading income of the European unit – Citadel Securities (Europe) Limited – from 2006 to 2018 along with the segmentation of gross portfolio exposures by product class and side over the same period.
Notice the 250% spike in net trading income for 2014 that continues thereafter.
Now, notice the corresponding diversification of the portfolio into interest rate derivatives (and the broader FICC products) around the same time. Coincidence?
Final thought and summary of hypotheses (for now):
If you believe that the “code red” can only be ordered by one guy, then maybe the strategic “leak” (?) of the $3.5 billion revenue figure (which, btw, is likely to have been stronger than the expected 2019 number purely based on comparative vol levels) and the timing of the strategic leak (?) of the Blackstone story (discussed in our recent Feed post, “Citadel Punks Blackstone“) are both related, then this may be a broader effort of posturing to propel the non-equity and non-US piece of the business at a time when the US equity side may be at or near capacity.
Or, am I reading too much into a firm whose executive headshots are each meticulously coiffed down to their perfectly dimpled cravats?
As Al Pacino said in Any Given Sunday, “…the inches we need are all around us.”
And, in case any of you youngins have forgotten, as Dennis Miller used to say, “Of course, that’s just my opinion, I could be wrong…”
Until next time…