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That Monday morning just after Lehman had collapsed, the head of treasury department at CaixaBI, following market development on Bloomberg screens, was trying to figure out exactly what were the implications for its unit. A good chunk of the business was about managing a bond portfolio that profited from cheap and available funding. One thing was clear, that business could no longer be carried out. He hadn’t received any guidelines concerning funding restriction in the subsequent days but he knew that one day, the mother company, whom was providing 100% of the funding, would pose restrictions on the availability and on the price of the funding.

Understanding this was one issue, restructuring the activity at the business unit (BU) was another. In order to achieve the change, to reformulate the business model, team members had to “own” the change. A forced change was not likely to succeed. So, brain storming meetings were organized to discuss market developments and to position the BU for the new environment. The participation had to be as wide as possible. Not only to achieve consensus but also to grab as many ideas as possible.

Portfolio Management
Portfolio Management

After several lively discussions, where the wildest ideas were brought about, the end result was exactly what was expected: the team came up with a new approach to trading to minimize funding and capital usage. Furthermore, since the bank had targets for financial margin, the new approach was set allowing for achievement of those targets, with flexibility and minimal capital.

Concerning stable asset holdings the focus was given to short term assets with low capital requirements.

On the fixed income trading side, the focus was on the most liquid assets or on the ability of the bank to liquidize any trading position. Positions on Portuguese corporate bonds had an important role on this positioning, since the bank could benefit from an outstanding franchise. The sales Business Unit gave a particular boast in this respect allowing for a substantial turnover increase.

In addition, the BU supported a company initiative to provide electronic trading to institutional investors. This has been a useful tool to increase bond trading without holding position for long periods as was the case in the past. Now traders understand better institutional investor clients’ needs. Portfolio holdings are adjusted accordingly: issuer, size and maturity wise. As a consequence volumes and financial operations have been increasing steadily in the last couple of years with a much lower exposures and use of capital resources.

To compensate for the reduction of the size of the managed fixed income portfolio, the team organized itself in a more integrated fashion to manage a multi-asset portfolio with emphasis in exchange traded derivatives. The freed resources used before to manage credit portfolio are now devoted to manage that multi-asset portfolio jointly with the rest of the team. This reallocation of resources was an important element of the new strategy.

To manage the multi-asset portfolio, in order to reduce team biases to market directions, the whole team agreed to develop different market strategies, based on market or economic information. The human input to these models is pretty much confined to the conceptualization, testing and validations phases. Basically, the team identifies variables, either market or economic variables, that can signal ex-ante a market direction. To confirm that the signal is relevant, models are back-tested and confirmed for a long and relevant period. If finally the back-testing results are strong, the team proposes to set it up and once it gets it approved, it starts trading the model. Ideally the signals and the instruments to be traded should be as diverse as possible so that the end result is a diversified low correlated portfolio with returns non-correlated with the market direction of any single instrument.

The BU has currently up and running 10 long/short strategies, 3 based on fixed income futures and 7 based on equity futures. Four years on since inception, the results are impressive, in absolute and relative terms, especially in what concerns return/risk measures.

Both activities, future trading and bond trading, have produced outstanding results particularly if measured against capital usage and risk taken. Although there is still room for improvement, overall statistics are improving steadily. In the last 12 months in only 75 days out of 261 has the P&L been negative. However, more importantly, the average positive daily P&L is 3,5 times as big as the average daily negative P&L. On a weekly basis that figure is 13,6x.

Markets live currently in an apparent calm, however one never knows what the future may bring. One thing is for sure, the treasury department at CaixaBI seems prepared to withstand market volatility in whatever market segment it re-emerges. Tail events can always happen therefore the head of unit keeps challenging his team regularly to rethink the business model. For now everything seems to be working just fine but who knows what might threaten the business model in the future.