11.22.2011

Sica Eschews Holding Overnight

11.22.2011
Terry Flanagan

New Jersey-based asset manager eliminates overnight positions on CDS fears.

Financial-market concerns seem to emerge ever more frequently, but none compare to the threat of the contagious financial deterioration—whether among countries, financial institutions, or most likely the combination—brought about by the expanding use of credit default swaps (CDS).

That notion has prompted Jeff Sica, president and chief investment officer of Morristown, N.J.-headquartered SICA Wealth Management, which manages more than $1 billion in assets for institutions and family offices, to stop holding securities positions overnight.

“We were occasionally holding positions overnight, but that’s been eliminated almost entirely over the last six weeks,” Sica said. “You have to have a very compelling argument for me to take that overnight risk.”

Sica had already trimmed the firm’s longer-term stock holdings to about 15% of its portfolio by May, and following the Federal Reserve Board’s meeting that month those holdings were reduced to rare occasions by August. Now, even that’s gone. “Our average trade is a three and a half minute hold, if we do trade something,” Sica said, adding the only truly defensive positions are cash and short-term Treasuries.

The notional volume of CDS, as reported by the Bank for International Settlements, rested at $32.4 trillion, significantly lower than before the 2008 financial crisis but creeping from the lows in 2010. However, the volume CDS contracts outstanding in European sovereign debt has doubled over the last three years.

Sica fears an MF Global-type bank run, only on a much bigger scale if a country defaulting on its debt results in a run on a much bigger institution and triggers the financial deterioration of the global banking sector as institutions discover CDS counterparties are unable to fulfill their interwoven obligations.

“My greatest concern is the complete implosion of the banking sector, resulting from deteriorating credit quality of these financial institutions,” Sica said. “The CDO market is very vulnerable. What makes it vulnerable is that now it involves sovereign debt.”

Sica cautions against owning stocks of financial institutions as well as the “temptation to bargain hunt” based on measures such as low price-to-earnings ratios, which he calls meaningless until the likelihood of a catastrophic event is significantly reduced. “Investors spend to much time looking at those measures, rather than the economic backdrop the stock trades in,” Sica said.

 

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