Hayne Leland

Hayne Leland is an economist and professor emeritus at the University of California, Berkeley. Prior to becoming emeritus, he was the Arno Rayner Professor of Finance at the Haas School of Business. Before joining Berkeley, Leland was an assistant professor in economics at Stanford University, and he has held visiting professorships at the University of California, Los Angeles and the University of Cambridge. He received his A.B. from Harvard College, followed by an M.Sc.(Econ) at the London School of Economics and a Ph.D. in economics from Harvard. He received an honorary doctorate degree from the University of Paris (Dauphine) in 2007.

His research in capital markets and corporate finance has received several awards, including the inaugural $100,000 Stephen A. Ross Prize in Financial Economics in 2008. In 2016, he was named "Financial Engineer of the Year" by the International Association of Quantitative Finance. Leland served as President of the American Finance Association in 1997, and has served on numerous scientific advisory boards, including those of Goldman Sachs, Wells Capital Management, the Chicago Mercantile Exchange, and the Swiss National Science Foundation. He was an independent trustee of the mutual funds group of Barclays Global Investors (BGI), prior to BGI's acquisition by BlackRock.

Much of Leland's theoretical work has found direct applications in asset management and corporate financial structure.^[1][2][3] This includes portfolio insurance, option pricing with transactions costs, and valuation of risky corporate debt. More recently, he has worked on introducing equity-sharing contracts in financing home purchase, and structuring retirement funds to provide assured income over retirement years.

Portfolio Insurance and the 1987 Crash.^[4]

In 1979, Leland realized that then-recent work on option pricing could be applied to dynamically hedge a portfolio, resulting in a financial product termed "portfolio insurance". In conjunction with Mark Rubinstein, a Berkeley colleague and options expert, and John O'Brien, a financial industry professional, he co-founded Leland O'Brien Rubinstein Associates (LOR) in 1980 to provide portfolio protection strategies.^[5] LOR's protected asset base grew rapidly, reaching $50b by mid-1987 (the equivalent of almost $500b when adjusted to the S&P 500 level in mid-2017). In 1987, Leland and his partners Rubinstein and O'Brien were co-named "Businessmen of the Year" by Fortune magazine.

The portfolio insurance strategy required that clients sell (to hedge) stocks or stock index futures as the market declined. During the crash of October 19, 1987, the drop in stock prices required LOR to sell large amounts of stock index futures, creating further downward pressure on stock prices. While portfolio insurance was not the initial cause of the crash, the Brady Commission Report examining trading that day concluded that insurance selling, roughly 15% of total stock and futures sold that day, was contributory to the magnitude of the crash.^[6] Market mechanism failures, including the failure of the SuperDot system, were also held responsible in the Brady Report.^[7]

The SuperTrust: The first U.S. ETF.^[8]

Looking for a means to provide portfolio protection without dynamic trading, LOR then developed a fund structure to allow fully collateralized portfolio protection and basket trading.^[9] LOR's SuperTrust consisted of two funds, known as SuperUnits, whose assets were S&P 500 stocks and short-term Treasury securities, respectively. To provide a basket product, shares of the SuperUnits required continuous trading when markets were open, similar to the trading of exchange-listed closed-end fund shares. But for the funds' market value to closely track the underlying portfolio value—a problem with closed-end funds whose shares often fell to discounts—fund shares also needed to be redeemable daily for cash or for underlying assets at net asset value (NAV). The SuperTrust's SuperUnits allowed smaller redemptions in cash, with larger redemptions in stock bundles.^[10] The Investment Company Act of 1940 disallows such a fund structure, i.e., with simultaneous closed-end and open-end fund properties, but it does allow the SEC to provide exemptions to the regulations when they're deemed to be in the public interest.^[11]

LOR applied for exemptive relief from the U.S. Securities and Exchange Commission (SEC) in April 1989. Arguments justifying LOR's request for exemption are available at http://www.40act.com/community/etf-supertrust-history-files/. While these arguments are now widely accepted and relief has been granted to hundreds of ETFs, the request was controversial at the time and required five amended applications and a hearing before the full Commission prior to final approval in October 1990.^[12][13] After some initial funding delays, LOR launched the SuperTrust with $1 billion in assets in November, 1992, with the SuperUnit shares trading on the American Stock Exchange (Amex).^[14] The SuperTrust's SuperUnits were the first U.S. exchange-traded funds that allowed daily redemption of shares at NAV. The SuperTrust's Index SuperUnit was the first S&P 500 based ETF.

The Amex initially had cooperated with LOR to develop a basket product, but subsequently decided to follow their own path with the Standard and Poor's Depository Receipt (SPDR), also based on the S&P 500. Their request for exemptive relief from the SEC was filed over a year after LOR's, and approval was received two years after LOR's.^[15] Their proposal was somewhat different in structure (e.g., redemption in large stock bundles only, and no sub-shares) but cited The SuperTrust exemptive order as precedent, using many of the same arguments made previously in application by LOR.^[16]

The SPDR was launched in 1993, three months after SuperUnit shares began trading, with initial asset value just over $6 million. However, with the Amex's marketing blitz (e.g., "spiders" descending from the ceiling onto the trading floor) and campaign, the SPDR ultimately became the basket product that gained liquidity and for many years was the largest ETF. The SuperTrust, which had an initial term of 3 years, failed to gain competitive liquidity and was not rolled over after its initial term.

References

1. "Replicating Options with Positions in Stock and Cash," (with Mark Rubinstein), Financial Analysts Journal, July–August 1981
2. “Option Pricing and Replication with Transactions Costs,” Journal of Finance 40 (1985), 1283-1301
3. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance 49, (1994), 1213-1252.
4. An extensive account is available in Diana Henriques, A First-Rate Catastrophe: The Road to Black Monday, the Worst Day in Wall Street History. Henry Holt and Co., 2017. ISBN 9781627791649.
5. Peter Bernstein, “The Ultimate Invention,” Capital Ideas: The Improbable Origins of Modern Wall Street. Free Press, 1992. Paperback edition, Wiley, 2005.
6. "Brady Report": The Presidential Task Force on Market Mechanisms (1988): Report of the Presidential Task Force on Market Mechanisms. Nicholas F. Brady (Chairman), U.S. Government Printing Office.
7. "Computer trading: leverage, forced asset sales, and market stability". GOV.UK. Retrieved 2023-08-24.
8. A history of the SuperTrust and ETF history files is at http://www.40act.com/community/etf-supertrust-history-files/
9. "Leland O'Brien Rubinstein Associates, Inc.: SuperTrust ^ 294050". HBR Store. Retrieved 2023-08-24.
10. An additional feature of LOR’s fund shares was their optional divisibility into sub-shares termed SuperShares, one of which provided protection of the S&P 500 Index value over a three-year term that was fully collateralized by US Treasury securities. A more complete description is provided in P. Tufano and B. Kyrillos, op.cit., and the short video (1990) referenced at http://www.40act.com/community/etf-supertrust-history-files/
11. In particular, exemption from Rule 22(d) was needed. Rule 22(d) required open-end fund shares to trade only at NAV, which was typically calculated only after the market close. See J.Heffernan and J. Jorden, “Section 22(d) of the Investment Company Act of 1940—its Original Purpose and Present Function,” Duke Law Journal Volume 1973: 975- 1008.
12. In the Matter of the SuperTrust Trust for Capital Market Fund, Inc., (“SuperTrust”), Investment Company Rel. Nos. 17613 (Jul. 25, 1990) (notice) and 17809 (Oct. 19, 1990) (the “SuperTrust Order”), granting exemptions under Section 6(c) from Sections 4(2), 22(c) and Rule 22c-1 thereunder, and 22(d) of the Act and an order under Sections 11(a) and 11(c) of the Act. SEC News Digest, Issue 90-204, October 22, 1990, available at http://www.40act.com/community/etf-supertrust-history-files/.
13. A fuller history of the difficulty in achieving the requested exemptions is provided in P. Tufano and B. Kyrillos, op.cit.
14. Due to earlier licensing arrangements between Standard and Poor’s (S&P) and the Chicago Board Options Exchange (CBOE), S&P insisted that the sub-shares be traded on the CBOE rather than their more natural home on the Amex.
15. The sequence of SuperTrust and SPDR filings is documented in https://www.sec.gov/comments/s7-11-15/s71115-12.pdf.
16. SPDR Trust, Series I, et al., Notice of Application, File No. 812-7545, Investment Company Act of !940 Rel. No. 18959 (Sept. 17, 1992), See "Applicants' Legal Analysis," paragraph 4.