Pull Your Cash While You Can

It’s earnings season, bulls. The bulge bracket is wrapping up their Q3 earnings announcements this week. Time to dive into the biggest losers, minor winners and what their playbooks suggest for the market environment ahead.

Bottom Line Up Front

Contribute something new to the news you’ll coffee chat over

• Kanye West has agreed to buy Parler, a social media platform that has been embraced by conservatives who departed Twitter over allegations of political censorship.

• U.K. Prime Minister’s Trussonomics lasted shorter than a Boris Johnson hair styling, as Incoming Chancellor of the Exchequer Jeremy Hunt put his predecessor Kwarteng’s tax cuts to the sword.

• A US recession is effectively certain in the next 12 months in new Bloomberg Economics model projections.

But first, a quick note from The BAD Investment Company.

Tired of ESG Bullsh*t? Fortunately, there's a money manager that decided that B-A-D might be the better acronym for investors.The BAD ETF (NYSE: BAD) launched last December and is taking a different stance in this green washed world focusing on 3 industries for which the ticker represents – B-A-D.

• Betting – Casinos, gaming, and online gaming operations – 33%

• Alcohol – Alcoholic beverage manufacturing and distribution – 23%

• Drugs – Pharmaceutical and biotechnology product development and manufacturing – 33%Cannabis cultivators & distributors - 10% 

The case for these BAD industries remains strong for a simple yet important reason – they have historically offered attractive risk-adjusted returns. In addition to these industries overcoming government scrutiny, these industries have shown resilience during economic downturns because people tend to indulge in their vices, or what some call hobbies.

As a result, we believe these asset classes are typically underappreciated and therefore under-valued but the reality is that people will continue to consume alcohol, gamble, and need medicine in good times, and in BAD.

In regards to the betting and cannabis aspects, as these industries become more widely accepted socially and legally, they may offer investors additional growth as more states look to legalize those industries for additional tax revenues.

Learn more about the BAD ETF fund details and sign up for our mailing list to get the latest fund insights and information.

Deep Dive: Cash out, bro down.

Earnings season kicked off last week with 15 S&P 500 companies reporting. Banks and financial companies dominated the total.

The S&P 500 fell by over 1.5% for the week, but bank earnings provided some offset. Bank shares were almost 1% and regional banks over 3.5% higher last week.

Bank and financial earnings dominated the first week of the earnings season. Headline earnings from the banks were uniformly better than expected. PNC, U.S. Bancorp, JPMorgan, Wells Fargo, First Republic, Morgan Stanley, and Citigroup beat earnings estimates. As previewed last week, core earnings were bound to be boosted by lending benefiting from rising interest rates.

Net interest margin, the spread a bank earns in interest on loans compared to the amount it pays in interest on deposits, improved across the banks. Loan balances were also higher for the group. When combined, these two factors drove better net interest income. That being said, signs started showing that banks are preparing for future possible loan losses by increasing reserves.

And while reserves are increasing, banks ranks’ are decreasing and merging. Mergers across desks and groups are happening across banks heading into a recession, quietly slashing less “commercial” (read: underperforming) teams or dissolving them with others. Big-name executives have begun to “retire” from their firms the past couple months, or lose their prestigious titles for more “team player” ones. Let’s dive into some key banks’ departures, and what that means for their balance sheets.

Lock-Ups 

Analysts project that U.S. banks are well-capitalized and should be able to withstand any loan losses from a recession. But who manages what gets done with that capital is where banks across the street now need to keep a close eye on. Enter: lock-up provisions.

“Lock-up provisions” do not just pertain to how long key individuals need to hold their stock in a newly-public company (i.e. post-IPO). The lock-up period also refers to an individual investor’s ability to pull their money from a fund. These periods are vital to the liquidity of the fund. Fund managers pursue “sticky money,” or capital providers who remain in the fund over the long-term. In order to protect themselves from investors going in and out of the fund, fund managers will often set lock-ups.

In general, there tend to be two reasons why investors “redeem,” or pull their money. Either the fund’s returns were not as strong as the investor expected, or the investor themselves is facing redemptions and needs to sell their hedge fund holdings. If a hedge fund manager performs well, there are not typically worries or demands for a lock-up, given most investors would not want to pull their money from an out-performing fund.

The approach to lock-ups differs between the U.S. and Europe. More, there are also differences between hard lock-ups and “soft” lock-ups, wherein the former enforces redemption penalties. The average lock-up period for equity funds managed or advised by U.S.-based managers is 7 months, with a median of 12 months. For European-based managers, the average for their equity funds is 2 months, with a median of 0.

Thus, lock-ups tend to be a more accepted practice in the U.S. than in Europe. Any time a manager needs to spend time on fund structural issues, time is being taken away from talking about the main selling point. In other words, American funds will use lock-ups to protect their day jobs and profit generators, rather than fund maintenance.

Shaking Up Banks’ Lock-Ups:

Back in the prime of 2004, the SEC enhanced its rule of what portfolio managers were, at minimum, required to report. One of those required inclusions became “material departures.” All fund managers now had to include when a key individual had left the firm or switched roles in their recurring materials.

If a material individual does depart from the firm, clients may have access to previously-locked up cash. In other words, if your manager leaves, so does your money. This is where it gets interesting. If you’re a fund or bank that is re-aligning and re-assigning executives, their title may suggest they’re a material individual when realistically they have little to no involvement in the fund. This is about to become especially problematic for a certain bank with a current pension for realignment.

Goldman Sachs is shaking up its core of executives for the third time in four years. As CEO, David Solomon will be the one burning down some of the signature moves he made as recently as 2020. Most notably, Kathryn Koch, previously CIO of Goldman’s asset management business (“GSAM”), departed the firm last month to become president and CEO of TCW Group. Koch was in her role as CIO less than a year, only being appointed in Q1 2022. She was previously co-head of all of GSAM alongside Julian Salisbury, who has now also lost his “head” title as GSAM constricts. In short, the heads – or who the SEC would consider “material” managers – of all of Goldman’s asset management division have either departed or been demoted.

Across the Street, Credit Suisse Group AG is considering a sale of its US asset management business. According to reports, the Swiss bank recently began a sales process for its US asset management operations (“CSAM”). Executives pushing the matter hope the unit, which includes a platform for investing in collateralized loan obligations, will draw interest from private equity firms. The unit is one of two large businesses that the bank is looking to sell.

A final decision hasn’t been made on pursuing a sale and Credit Suisse could opt to hold onto the unit, insiders have claimed. Globally, Credit Suisse’s asset management business managed 427 billion Swiss francs ($429 billion) of assets as of the end of the second quarter. The potential sale comes as Credit Suisse prepares to unveil a turnaround to investors next week, as the bank looks to simplify and pare down following scandals and losses.

Goldman and Credit Suisse are merely two examples, if not the first major players, to transition earnings season into downsizing season. These moves, like Solomon’s now-fourth try at a campaign, may be enough to calm banks’ boards in the short-term. But whether major clients will be calm enough to not pull their cash, especially heading into a recession, will be the story to follow.

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