What are the takeaways for shareholders?
Since the SEC and the Commodity Futures Trading Commission, or CFTC, issued their Oct. 1 postmortem on the May 6 flash crash, a lot has been written about Waddell & Reed, which is the subadvisor to Ivy Asset Strategy
He Said, SEC Said
For those unfamiliar with the back story, the SEC's report was designed to assess the causes of the flash crash. The report lays much of the blame on the fund's May 6 selling of $4.1 billion in futures contracts linked to the S&P 500 Index, the now infamous E-Mini contract. The fund sold the E-Minis in order to hedge some of its equity exposure, which it does frequently given its somewhat defensive, absolute-return approach.
The problem, according to the SEC, was poor trade execution. The report claims that the trades were initiated by a computer algorithm and were sold into a falling market without regard to time or price. Rather than scaling back its orders in response to that day's volatility, the algorithm accelerated its trading. While selling 75,000 E-Minis would normally take five hours, these contracts were dumped in just 20 minutes. There weren't sufficient bids for the contracts, and the heavy selling ultimately spilled over into the equity markets. At least that's the SEC's take.
There is hardly consensus on the SEC's magic-bullet theory. Many market observers believe that the SEC assigned far too much blame to Waddell & Reed and not enough to high-frequency traders, the specialized hedge funds, and market makers who largely abandoned the equity market during the sell-off. It was their rapid trading of the E-Minis that afternoon which may have led Waddell & Reed to believe that the market was more liquid than was actually the case.
Regardless of where blame truly lies, the market's structural defects that led to the debacle remain. Such an event could certainly happen again. But where does this leave Ivy Asset Strategy's shareholders? What should be their take-aways?
Is This the Best Way to Control Volatility?
From a shareholder's standpoint, Ivy Asset Strategy's role in the flash crash is something of a red herring. As we have noted in the past, the fund did not perform that much worse than the overall market on May 6, losing just 60 basis points (0.60%) more than the S&P 500 Index. Its underperformance that day, moreover, owed more to extensive holdings in China and other markets in emerging Asia than E-Mini misadventures.
Ultimately, our concerns about the fund stem from its at-times reactionary approach to risk management and the rationale behind its hedging strategy. The fund's activity leading up to and including the flash crash reinforce those concerns.
Starting with the crash itself, the management team, led by Michael Avery and Ryan Caldwell, has said on several occasions that it placed these hedges on May 6 due to concerns about the European banking system. The Greek debt crisis was coming to a head at that time, and the team worried about the fate of French, British, and German banks, which owned a large chunk of Greece's debt.