Waddell & Reed and the May 6 “Flash Crash”

An October 6th story in The Wall Street Journal “The Mutual Fund in the Flash Crash” points to Waddell & Reed’s $27 Billion Asset Strategy Fund as a potential cause of May 6 “flash crash.” We ran a quick analysis of the fund with the findings outlined below.

First, notable information from SEC filings (Q1 and Q2 2010)[1]: the fund is using equity futures and options to hedge. In addition, it is using currency options to make currency bets or hedge currency exposure. Also, it is invested in gold bullion.

In our dynamic returns-based style analysis in MPI Stylus Pro, we use daily fund NAVs and generic asset indices with gold represented by SPDR Gold Shares (GLD) intending to track the Gold bullion. The cash position (green) indicates the hedged portion of the portfolio in addition to the actual holdings of short-term instruments and bonds. The analysis confirms large exposure to emerging market stocks, gold and large to midcap US equities. One should view this result as a net exposure accounting for the hedge[2].

Thus, the fund behaves as if it was about 50% hedged during the first quarter of 2010 with the hedge/cash eliminated by the end of the quarter. The analysis also shows a notable spike in hedging activity occurred on May 6th-7th 2010 in the amount of about 20% of the portfolio market value confirming the $4.1B trade mentioned in the Journal article. However, as seen in this year-to-date analysis, active hedging doesn’t appear to be unusual for the fund. Note the similar swift change in fund behavior during January 2010 and June 2010.

As expected the fund’s daily NAVs provide unique transparency: in the same analysis, performed using fund NAVs only through June 1st one could have detected the fund’s activity in May without having access to the fund’s holdings information.

The Wall Street Journal noted: “The fund’s lead manager, Michael Avery, said it is the type of trade the fund has made a dozen times in the previous three years, and has made again after May 6.”
Our dynamic analysis seems to validate this statement. The dramatic effects of May 6th likely had more to do with market conditions than the actual size of the trade/hedge.

  1. We analyzed both Waddell & Reed Asset Strategy Fund (UNSAX) and the Ivy Asset Strategy A Fund (WASAX). Given that portfolios are almost identical, the results of analyses are indistinguishable. []
  2. The actual holdings may differ from the analysis of NAVs. []
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