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May 25, 2010 Tuesday 15:57 PM EST
SECTION: NEWS & ANALYSIS; Commentary
LENGTH: 690 words
HEADLINE: Abacus vs. ‘The Ultras’
BYLINE: Eric Oberg, RealMoney Contributor.At the time of publication, Oberg was long Goldman Sachs.Eric Oberg worked in fixed income, currencies and commodities for Goldman Sachs for 17 years before retiring as a managing director.
This post appeared yesterday on RealMoney. Click here for a free trial, and enjoy incisive commentary all day, every day.Just for giggles, let’s compare and contrast “Abacus” and “the Ultras.”Abacus, of course, is the transaction at the center of the SEC’s civil complaint with Goldman Sachs (GS:NYSE); “Ultras” is the catchall phrase associated with all of the double-levered, triple-levered and short-side ETFs.Both Abacus and Ultras are derivative products, and both utilize swaps. Abacus was privately marketed solely to sophisticated and qualified institutional investors, who themselves acted as fiduciaries and made their living analyzing, modeling, managing and investing in structured products. Ultras are advertised in the papers, they’re available to the general retail public, and you don’t need a margin account (a selling point highlighted in their advertising) or special suitability documentation to buy Ultras.Abacus referenced asset-backed securities and delivered the returns based on the performance of the underlying mortgage pools — the purchasers understood, and could analyze, the risk they were getting, and they got the risk they sought. Ultras reference stocks and baskets of stocks, yet their performance does not match the performance of those baskets per se — it is a path-dependent performance and may very well have large tracking errors if used for longer than a one-session holding period (despite the fact that most people do not associate ETFs and mutual funds as intraday holdings). Many Ultra investors have ended up with a much different risk profile than they sought.In Abacus, the “winner” was a neophyte to the structured products market, the “losers” were dedicated structured products professionals who sat on panels at securitization conferences as experts in their field. In Ultras, the “winners” are those who understand the quirks, the “losers” are those who lack the sophistication to understand those quirks. In fact, there is a built-in “greater fool” premise to the Ultras’ very existence — if used as directed, the companies would have no assets under management.In Abacus, although the impact was severe for the professional participants, the existence of the deal did not affect the individual mortgagors in the underlying pools — reflexivity was impossible. In Ultras, the underlying securities and their respective holders are indeed affected by the side bet — there is reflexivity given their existence (particularly in narrower sector funds).In Abacus, the purveyor sought to match up two sides, in a trade both sides fully understood, and took out a $15 million fee, a little over 1% of the transaction size; for this fee, the participants got exactly the risk they sought. In Ultras, by segmenting liquidity between longs and shorts, the purveyors have ensured they take out 95 basis points on every dollar wagered long or short … and there are 25 billion to 30 billion of these things outstanding, equating to $250 million to $300 million in annual revenues. Whether those paying the fees get the risk they seek is subject to question.In Abacus, there is concern over disclosure and debate over whether the economic interests of the participants is material. Abacus was a private placement based on the performance of a portfolio of asset-backed securities that was fully disclosed; this was a synthetic transaction which required — by definition — the necessity for there to be a short side. Ultras are publicly offered securities, and there is concern over whether all the risks (negative compounding, short volatility position, hedging reflexivity, etc.) were/are adequately disclosed in order for a buyer to reach an informed investment decision and truly understand what they were/are getting.The SEC has sought to prosecute for fraud the purveyors of Abacus, while there is no inkling the institutional investors in the transaction ever intended to do so. At the same time, the self-proclaimed “Investor’s Advocate” has approved myriad Ultras, yet there are several class-action lawsuits being brought by retail investors who feel aggrieved by these products.Hmmm…
LOAD-DATE: May 26, 2010