On Recent Market Turmoil and the Safety of Your Assets
The market volatility over the last two weeks has occurred across a broad section of financial markets with varying levels of severity. And this dynamic is likely to remain present for some time as Fed policy remains tight and market confidence unsteady.
In times of market stress and financial instability it’s helpful to hear from you regarding questions and concerns you have. We appreciate those who have reached out to us directly. And we thank everyone for the continued confidence you place in our team. We have great confidence in our clearing firm partner Pershing (see information at the bottom of the piece), which is owned by the Bank of New York Mellon, a G-SIB.
There are many features of capital markets and the investment landscape. The weaknesses and fragility of some become exposed during periods of turmoil; prior to recent events many believed bank runs were thought to be a thing of the past. The last two weeks reminded me financial instability is cyclically inherent to markets and human nature.
Over the past week, I reread several market commentaries we penned many years ago during periods of market turmoil. Here are a few excerpts we believe still apply today and, if in place, protect portfolios and mitigate investor angst related to current events:
Should the economy weaken, credit health is spotlighted
This was published a year after Meredith Whitney’s notorious call for “hundreds of billions of dollars-worth of defaults” within the municipal sector. We touched on our Three Pillars of municipal credit research we use to evaluate the safety of single securities:
- Underlying credit quality
- Deal purpose
- Deal structure
The proverbial quip “return of principal versus on principal” is our aim when examining the credit health of a bond. And we believe focusing on the above allows us to understand an issuer’s ability and willingness to fund their obligations. This leads to a robust portfolio as it pertains to credit health.
We noted: We have always believed that complicated, leveraged, and opaque assets are less liquid. These features do not make for bad investments necessarily, only less liquid investments… The financial crisis has reinforced in our minds the significant advantage enjoyed by investors who use a SEPARATELY MANAGED, NON-LEVERAGED bond portfolio strategy.
As safe as a portfolio may be credit-wise, it must be mechanically sturdy as well. In this case, we believe a non-levered, separate account structure composed of fixed rate securities accomplishes this. Our always-touted “ladder” maturity structure has several benefits to protect against duration risk, as well.
We believe a municipal bond portfolio with the above attributes will provide a reliable income flow while offering reduced portfolio volatility and greater portfolio liquidity than many other available options.
SVB’s Failure and the Strong Hands of Pershing
The current crisis was precipitated by a bank run on Silicon Valley Bank (SVB) that threatens to become systemic. The run on SVB resulted from its overconcentrated deposit base, mismatch with its funding base (short term deposits and the high duration/long maturity nature of its investment portfolio), realized investment losses on its portfolio, and poor communication from management.
Pershing LLC which serves as account custodian for many of our investor clients is not a bank. It is a broker-dealer so your assets within the account are yours and yours alone: assets cannot be used by Pershing to make loans or buy other securities.
Pershing is owned by the Bank of New York Mellon, a Global Systemically Important Bank (G-SIB). We believe it is exceptionally well positioned to weather market storms with a stable asset base, strong ownership, and various additional levels of protection/insurance in place.
From recent Pershing disclosure:
SEGREGATION AND CONTROL OF ASSETS |Clients’ fully paid-for assets are segregated from our own, with quarterly vault inspections conducted. In addition, we segregate cash and/or qualifying securities in special reserve bank accounts for the exclusive benefit of clients, to protect clients’ funds in the unlikely event of Pershing’s failure and liquidation.
Pershing protects client assets through rigorous internal control measures. An annual audit by a major independent audit firm and the audit team at our parent company, BNY Mellon, helps to monitor controls that are in place. In addition, a Service Organizations Control report conducted by an independent audit firm provides additional evaluation of the design and operating effectiveness of Pershing’s internal controls.
Please review the links below which help underpin our confidence in its platform:
- Pershing: Strength & Stability
- BNY Mellon provides public disclosure of its Liquidity Coverage Ratio (“LCR”) as required by US regulators.
Do not hesitate to call your Bernardi Investment Specialist, Portfolio Manager, or me directly with any questions you have about the safety of your assets, your portfolio, or general market conditions.
Thank you for your confidence in our team.
Sincerely,
Ronald P. Bernardi
President & CEO
March 20, 2023