Derivatives Research House of the Year - Citi


It has not been an easy year for research houses. Following a surge in US subprime mortgage delinquencies, a sharp rise in volatility and correlation, and a squeeze in liquidity, the task of analysing, understanding and predicting a future path of events has become much more difficult than in previous years. Yet, more than ever, this is precisely the time at which good research is invaluable.

Citi has provided its clients with a string of products ranging from educational reports designed to increase the understanding of the credit crunch, to regular, actionable and, most importantly, money-making trade ideas. The team offers both multi-strategy publications and specific credit and equity derivatives reports for Asia, Europe and the US on a daily, weekly and monthly basis.

"Citi's guys seem to think two steps ahead of the rest of the market. They look at the current situation and have a long-term prognosis that is absolutely spot on," says one London-based hedge fund manager.

This market insight stems from a combination of experience, proximity to the trading desk, as well as a distinct approach to conducting research, says Leon Gross, head of multi-strategy at Citi in New York: "The main question we ask ourselves every morning is 'If I were a trader what would I do today?' and the main criteria is 'Would I do this trade with my own money if I could?'. This approach is different from more academic approaches or more sales-orientated strategies that some other research houses prefer."

It is a strategy that works. Clients praise Citi's research for its relevance and timeliness, as well as for suggesting practical trading strategies. "Compared with some of the other research providers, Citi has a good view of what's happening on the trading desks, which increases the relevance and practicality of their research and recommendations," says one New York-based investment manager.

The team is also highly flexible in the types of ideas and recommendations it can put forward. "We will consider all factors affecting a situation, from risk arbitrage or correlation perspectives to fundamental, statistical and macroeconomic perspectives, and are flexible in the types of ideas we can generate," explains Gross.

A prime example is a piece of research published on November 8, which assessed the size of subprime super-senior positions retained by banks, and estimated how much would need to be written down. "When Merrill Lynch came out with its third-quarter earnings, everyone seemed to start getting very scared about the magnitude of write-downs at different houses across the street. Yet it was actually pretty straightforward to look at who had issued what, calculate how much of that was super-senior and then estimate how much would need to be written down," explains Matt King, head of credit products strategy at Citi in London.

The team also made a call in March to short senior tranches of collateralised debt obligations of asset-backed securities (CDOs of ABSs) and go long the junior tranches, on the basis that widespread downgrades would, on a relative basis, be far worse for senior tranches than for junior parts of the capital structure. "Our call to short AA-rated tranches and buy BBBs was a typical case of looking at market pricing, rather than starting from a fundamental view. Now, of course, people almost take it for granted that the two levels of securitisation make the senior tranches especially vulnerable, but people weren't talking about CDOs of ABSs in this way back then," says King.

A correlation skew trade, put forward by Citi's equity team in May, worked along similar lines. The trade aimed to take advantage of a supply and demand disparity in index and single-stock options - there was strong demand for call options on merger and acquisition targets and also for puts on equity indexes for protection, causing anomalies in the relationship between stock and index volatility skews. The group recommended selling index skew and buying stock skew.

"With the correlation skew trade, we had been keeping our eye on pricing levels and when the market pulled back and pricing levels hit a point where we thought it was a reasonable strategy, we worked with our equity strategists to identify good fundamental reasons for reversion, recommended and traded it," says Gerry Fowler, head of trade floor multi-strategy at Citi in London.

A popular aspect of Citi's offering is its client consulting service, whereby its analysts visit hundreds of investors around the world to explain market developments and trade recommendations. The team also puts a lot of emphasis on educational advice. "Citi's research team has as good understanding of the market and provides clear analyses that draw together complex themes in a comprehensible way," remarks David Wall, senior manager in the markets area at the Bank of England, which uses Citi's research to help inform its assessment of financial stability.

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