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Waddell & Reed Culprit of Market Collapse

It turns out that the $70B asset manager Waddell & Reed may have caused much of the market commotion on May 6th.  Within a 20 minute span during the spike downward, Waddell & Reed sold 75,000 e-mini futures contracts.  That equates to a short position of 75,000*50*1100 = ~ $4B.

Waddell & Reed issued a statement saying that it was part of the “normal operation of our flexible portfolio funds”.  I do not buy it.  To adjust the position of the $70B of assets managed by nearly 6% in a 20 minute time-window makes absolutely no sense.  First, the futures market cannot handle that kind of volume in such a short window and they should understand that liquidity issue.  Second, why would they place all of these trades in e-mini contract and not trade fewer large contracts which have a multiplier 5 times greater which would lead to far fewer commissions?  Third, even if Waddell & Reed was hedging all of their fee income for the year that would only equate to a 1.25%*$70B = $875M or less short position which would never be put on in one day much less in 20 minutes.  Fourth, if they are dumb enough to move a large portion of their funds to market neutral or short positions during a one-day market decline then they deserve to lose money.

I am not buying the story so here are my theories:

1) This was a fat-fingered trade being covered up, a break down in operational processes, or an incredibly stupid strategy.

2) If this was merely a “hedging strategy” then they should have lost quite a bit of money, most likely an amount much greater than $20M

3) If they made money on these trades then either the fat-fingered mistake worked out to their benefit in which the sold a large amount on accident and started covering at much lower levels or this was more of a manipulation of the market in which they sold heavily knowing that the market couldn’t take it and bought back as it went into freefall.

It will be interesting to see what their next announcement states.

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