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A year ago, the world seemed oblivious to signs that a novel virus outbreak in China was a serious, global threat. But one of Wall Street’s biggest but most secretive money machines saw the debacle coming and battened down the hatches.
Jane Street may be little known outside its community — and even there mostly famous for its cultish dedication to a recondite programming language called OCaml. But the company has become one of the world’s largest market-makers, trading more than $17tn worth of securities in 2020.
Its forte is lubricating trading in exchange traded funds, which manage nearly $8tn of assets according to data provider ETFGI. Jane Street is especially dominant in the niche but rapidly growing world of bond ETFs. That prowess has allowed it to reach a beachhead in corporate bond trading, where it is now going toe-to-toe with some of Wall Street’s most pedigreed businesses.
“Jane Street is this big, important and growing player that no one’s really heard of,” says Steve Zamsky, previously head of corporate credit trading at Morgan Stanley and now a fund manager at Smith Capital. “They’re sophisticated, quirky and not typical of Wall Street traders.”
Culturally, Jane Street has also always been a little paranoid, with executives constantly fretting about the risks of improbable but catastrophic crashes. Even beyond every trading desk’s routine hedging of positions, Jane Street at a company level spends $50m-$75m a year on put options — derivatives that pay out if markets slump. In early February, the firm aggressively ramped this up to ensure it could still confidently keep trading even if turmoil hits the markets.
“Our basic service, standing ready to buy and sell ETFs, options and bonds, is even more critical in times of stress,” says Josh Kulkin, one of its top traders. “Because we bought all that extra protection we didn’t have to worry about the extreme moves, and were prepared to provide liquidity in an outsized way.”
That extra confidence paid off handsomely when markets were thrown into a tailspin last March, and bond ETFs emerged as a major faultline. Some sceptics argue that only the Federal Reserve’s extraordinary stimulus prevented a disaster for fixed income ETFs, and remain convinced that they could still prove fragile.
Nonetheless, a smattering of studies in the wake of the tumult have guardedly concluded that bond ETFs proved resilient and may even have helped investors manage the coronavirus shock. In fact, investor interest has been whetted by how fixed income ETFs kept trading even as corners of the bond market gummed up, with inflows hitting a record in 2020.
Even Charles Schwab, the founder of his eponymous brokerage and once a sceptic of the new breed of higher-speed, modern market-makers like Jane Street, has grown more appreciative of the role they play. “They provide an essential service to the marketplace,” Mr Schwab says. “They provide liquidity by both buying and selling, which is crucially important. You could see the results when markets took a deep dive in March of last year.”
“We think of ourselves as mainly built for crises,” says Rob Granieri, one of the company’s founders. Nonetheless, Mr Granieri insists there is little triumphalism at Jane Street. “I still walk in every day thinking that we’re still struggling to survive,” he admits.
Myriad signs of financial distress were visible when the global economy went into lockdown last March, but one of the most alarming were huge differences that opened up between the tumbling price of many bond ETFs and the value of the securities they held.
Some analysts warned of a potential “liquidity doom loop”, arguing that massive ETF selling was hammering the underlying bond market, which could have culminated in market meltdowns had not the Fed intervened so aggressively. Some critics even say the US central bank’s decision to start buying corporate bonds for the first time — including through ETF purchases — was akin to a bailout for the industry.
These issues go to the heart of how ETFs function. Their shares trade like stocks on an exchange, but shares are also separately constantly created or redeemed to handle inflows and outflows and ensure that they track their index. When there is a demand imbalance, specialised market-makers that have the right to create or redeem ETF shares step in. These “authorised participants” — like Jane Street — are the under-appreciated cogs of the industry’s machinery.
If an ETF trades above the value of its assets, APs buy the underlying securities that match the ETF and use them to create new shares to sell to investors. When ETFs fall below the value of their assets, they instead redeem shares for a proportional slice of the underlying portfolio and then sell them. Mostly this continuous arbitrage doesn’t actually require the ETF itself to buy or sell anything and keeps it trading in line with its index.
However, a fire sale by investors desperate to raise cash hit bond trading in March. That meant APs struggled to narrow the widening dislocations between the fast-sliding prices of bond ETFs and the lagging value of their assets, simply because they had trouble selling the underlying bonds.
“This wasn’t an ETF liquidity story,” says Matt Berger, head of bond trading at Jane Street. “It was liquidity drying up in the underlying fixed income markets.”
In contrast, while the creation-redemption process clogged up, trading volumes for bond ETF shares spiked violently as firms like Jane Street continued to match buyers and sellers despite the turmoil. March saw an average of $33.5bn traded a day, more than three times the 2019 daily average, according to BlackRock.
In practice, many bond ETFs traded almost like traditional closed-end funds, the Bank of Canada concluded in a postmortem published in December.
“These results suggest that market liquidity conditions were resilient in the fixed income ETF market throughout the crisis. Moreover, the results suggest that fixed income ETF prices continued to provide a real-time view of the value of the underlying bonds during the crisis,” BoC said. “In contrast, the net asset value of fixed income ETFs with less liquid holdings provided only a lagged indication of their ‘true’ value due to poor bond trading activity.”
Investors certainly appear reassured. Inflows accelerated to more than $240bn last year, nearly twice the inflows of all other bond funds, according to data provider EPFR. That has taken the size of the overall fixed income ETF industry to north of $1tn.
“It was a really acute period of time when it was very difficult to trade bonds, even Treasuries,” says Samara Cohen, co-head of BlackRock’s iShares markets and investments unit. “That created a real groundswell of institutional adoption for fixed income ETFs.”
For a firm like Jane Street — which estimates that it accounts for almost a third of all primary and secondary trading in US bond ETFs — it was nirvana. In the first six months of 2020, Jane Street made $6.3bn in adjusted profits, up more than 1,000 per cent from the same period in 2019, and its first-half net trading revenues were $8.4bn, according to financial data shared with some of its lenders last year.
While almost every trading desk enjoyed a trading bonanza in 2020, Jane Street’s first-half revenues were equivalent to one-seventh of the combined fixed income, commodities and currency trading revenues of all the world’s biggest banks over the same period, according to research group Coalition. It was more than twice the reported earnings of Citadel Securities, the formidable market-maker owned by hedge fund magnate Ken Griffin.
Things calmed down in the second half, with Jane Street’s net trading revenues in the third quarter of last year falling to a more sedate $1.5bn, according to people familiar with the matter.
Jane Street executives are wary of discussing any financial details and are keener to highlight the implicit endorsement of the Fed: in September the central bank added Jane Street to its list of companies through which it would implement its corporate bond purchases, alongside the likes of JPMorgan, Morgan Stanley and Citi.
Jane Street in numbers
The firm’s trading volume in exchange traded funds in 2020
Its equity trading volume in 2020. Bond trading volume was worth $1.4tn
ETFs in which it is the authorised participant. It is lead market-maker on 506 ETFs
The reason Jane Street has been able to seize such a big role in bond ETF trading is that it straddles the approach of high-speed, algorithm-powered trading firms like Virtu or Jump Trading and the human bond traders that still dominate Wall Street trading desks.
Jane Street’s trading capital is about $15bn, a size closer to that of a Wall Street bank’s trading desk, and unlike many classic high-frequency trading firms it will hang on to positions for hours, even days or sometimes weeks, which is essential for ETFs that track less-traded markets. On any given day, Jane Street will be holding about $50bn of securities, much more than many of its fleeter-footed rivals.
“They obviously have a lot of smart technologists, but in their DNA they are really traders,” says a one-time rival. “Many market-makers are very technology-driven, but Jane Street is a trader-driven firm. Jane’s niche is that they will price less liquid ETFs better than anyone.”
For an industry that often cultivates cinematic genesis stories, the opacity around Jane Street’s birth, ownership and even management is unusual.
Sometime in early 2000, a trio of traders from Susquehanna — another big market-maker — and former IBM developer Marc Gerstein set up what would become Jane Street, initially trading mainly options and American Depositary Receipts, US-traded stocks of overseas-listed companies, on the old American Stock Exchange, or Amex.
Tim Reynolds, Michael Jenkins, Mr Granieri and Mr Gerstein were soon joined by a medley of traders and coders, such as Yaron Minsky, who convinced the firm to adopt OCaml as its sole programming language. Today, Jane Street’s source code is 25m lines long, about half as much as the Large Hadron Collider uses.
“Building trading systems is on some levels terrifying,” Mr Minsky admits. “So a lot of our decisions have been organised around safety, and OCaml has lots of features that make it easier to write code that does what you intended it to do.”
Jane Street’s unorthodoxy goes well beyond its programming language. Mr Granieri is the only remaining founder still at the company, but there is no chief executive, hierarchy or even a clear management committee. Instead, Jane Street almost resembles an anarchist commune, informally led by a group of 30 or 40 senior executives. A smattering of titles have been reluctantly adopted in recent years, but internally they are little used and people rotate around the firm to keep things fresh. Few leave.
The move into ETFs was also coincidental, rather than grand strategy. Amex was later acquired by the New York Stock Exchange but had been instrumental in developing ETFs in the 1990s. They were still in their infancy when Jane Street was founded, but similarities to ADRs meant that moving early into ETFs represented only a modest leap.
“We focus on natural progressions of our business that are close to things that we are already doing,” says Jeff Nanney, who leads Jane Street’s Asian operations. “There was no masterplan about moving into ETFs, we typically just don’t make quantum leaps like that.”
What now for Wall Street’s least-known trading tycoons? Jane Street made a move into trading directly with investment groups in 2014 — territory historically dominated by big banks. It is now expanding its business in Asia and planning to push more aggressively into equity market options.
Nonetheless, the events of 2020 highlight just how big and influential the growing bond ETF universe is, and how vitally important firms like Jane Street are to their functioning. And that has some downsides.
Equity ETFs are often supported by a plethora of market-makers and APs, but bond ETFs are more specialised, with a narrower club dominating activity. Some analysts and investors have long fretted what would happen if an accident were to befall one of the bigger players. “If you think the fixed income ETF market is systemically important, then Jane Street is systemically important,” says the one-time rival.
Jane Street’s executives say they are well aware of the implications. “We know we are an important part of the efficiency of many of these markets, and that’s something that we feel a huge responsibility for and take very seriously,” Mr Berger says.
The first three charts wrongly identified the iShares MBB mortgage-backed securities ETF as the iShares municipal bond ETF, which is known as MUB. They were corrected on February 15
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