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Sunday 19 December 2010

Hedge Fund Performance Through Credit Crisis

Hedge Fund Performance Analysis:

> Time is circa 3 years since the onset of the US-housing led global recession. A timely look at hedge fund performance justifies with caution the new asset class.

> Using data from the leading hedge fund index provider and Fund Portfolio Management (FPM) analysis, the HFRI Fund Weighted Composite Index gained 5% versus the S&P 500 loss of 20%, over the three years ending November 2010.

> The best performing hedge fund strategy (as highlighted by FPM's many "Green for Go" in the above Perfomance table) are Macro hedge fund strategies: returning the best compound return of 15% against other hedge fund strategies and market benchmarks, over the said period. Notice that macro funds were the leading performance in terms of 10 of the 12 analytical metrics. FPM’s sub-sectoral analysis reveals that the “Macro: Systematic Diversified Index” returned 23%, contributing to overall macro strategy outperformance (sub-sectoral analysis not shown in table - available on request only).  

>FPM’s analysis highlights in yellow the worst performances per analytical metric in the considered set of investments. Indeed “Yellow Alerts” galore for the Market Index – S&P 500; including worst drawdown / loss of 17% in October 2008 (not visible in table), time of Lehman bankruptcy. The broader FPM Level II shows that “Emerging Markets: Russia/Eastern Europe Index” was the poorest performer with 6 out 12 lowest metrics of entire hedge fund indices and S&P 500.

> Careful conclusions drawn from the performance of the asset classes (i.e. between bellwether US equities and alternative asset hedge funds) shows that hedge funds overall preserved capital, which is one their raison d'etre. Additionally, that hedge fund’s premise of dynamic asset allocation is best exemplified by macro strategies over the long-term.

> Notable is the -9% loss in the fund of hedge funds (FoHFs) sector, as displayed by the Fund of Funds Composite Index. In context, this performance is still more than 50% better than being invested in long US equities. The FoHFs loss does raise concerns about the business model’s benefits (especially if considered in a parochial absolute performance context).

>  Some investors may find it a surprising that emerging markets strategies produced lower volatility than the developed market equity benchmark the S&P 500 (16% and 22% annualised standard deviation). FPM understands that the risk-focus of the hedge fund model contributes to this lower volatility. That said, the volatility metric of emerging markets is also the highest when compared just to other hedge funds. FPM believes volatility is indeed a characteristic of general emerging market investments.

> As highlighted by “Yellow Alerts” the emerging market index suffered the worst drawdown of all the strategies over the 3 years to end November 2010. Drawdown, which is defined as consecutive months of negative returns in the investment / index, was a dismal -45%. What is not visible on performance table (only FPM’s Excel-based comments shows the drawdown periods), is that this run of negative monthly returns from emerging market focused funds occurred between June 2008 and February 2009; a notably heightened period of systemic market stress, encompassing massive subprime related write-downs and Lehman’s demise.

> Only a few considerations of hedge fund analysis were observed using the above longer-term 3-year window of performance (December 2007 to end-November 2010). Hedge funds performance viewed over the last 2 years (as in performance table below) shows some differences, what a difference a year makes! as recessionary fear abates and the credit-led crisis works out.

> Notable that Relative Value index shows more “Green for Go” metrics: for example, with Sharpe ratio of 3.89 the sector demonstrates the best return per unit of risk (volatility / standard deviation). Macro strategies, which over 3-years looked like the best performing strategy, but over this 2-years window now looks relatively lacklustre, especially with 0.66 sharpe ratio. Suggesting volatility in all investments asset classes and difficulty in tactical asset allocation.

> FPM’s Excel comment (not visible in above 2-years performance table) indicates that Relative Value strategies had their peak performance over 16 month period (between January 2009 and April 2010), where consecutive positive index returns produced a staggering  28% outpacing the Macro index showing of just +4% over the same period.
Additionally, the best sub-sectoral strategy within the total relative value universe was asset-backed fixed income.

> Complexity of constructing a hedge fund portfolio is even more entangled if one looks at the last 12 month to end-November 2010 performance, as shown in table below. 

> In the past year of modest global economic recovery and debt work-out for the credit-weaned businesses and individuals, the relative value sector seems the best strategy for selection. The strategy includes credit-focused hedge funds in asset –backed securites and convertible bonds (Click HFRI Indices Classifications to see what comprises the Total Indices).

> Comparisons of FPM’s performance metrics using HFRI indices (or even individual hedge fund NAVs) facilitate tactical asset allocation through observations in quantitative terms of hedge funds. FPM’s author, has aimed to provide basic qualitative observations from the performance table.

> Hedge funds as an asset class has not widely been embraced by investors (compared to say ETFs). FPM believe hedge funds are here to stay and that they will eventually converge with mutual funds, with inevitable issues to be ironed out of infant industry in institutional stages.  Yet this crisis (as previously with the 2000 technology bubble), has shown that active management and investment technology combine well for riding out difficult markets ie ones without clear secular long-trend rallies.

FPM endeavours to educate and convey aspects of hedge fund investments.
Please contact FPM’s editor Kristian Siva (ksiva@talktalk.net) for further information.

Wednesday 28 July 2010

The Devil is in the Deed-Tail

Updated 21 December 2010: The tail end of June is half year mark and  brings in the tidings for the rest of the year, as does July with the 1H reporting season fully underway. Specifically “tidings’ about economics and investment markets outlook. As 'half-time' corporate and economic results are reconciled with earlier budgeted expectations, the rest-of-year's budgets can be forecast.

Taking a planned-for-event  headline: "BNY Mellon's Little joins Kedge Capital to build global multi-boutiques business", and interpreting this 2nd half strategic plan suggests decision-makers at the helm (mainly people who put their money where their mouth is!) consider that this is a good time in the business cycle to expand an existing business.
A little research into the headline suggests that multi-billionaire Ernesto Bertarelli (commercially-famed for the family biotech firm Serono and it's sale to Merck in 2007), is spearheading the venture to develop a global asset management business by buying “typically single-manager asset management business in both the long and alternative space”; Kedge Capital is the 100-personnel family office assigned with managing the wealth of the Bertarelli clan.

Professional acumen reading between the line suggests that either a) valuations of asset managers are expected to decline further, b) valuations are already near bottom or c) valuations beginning to rally. The latter observation is trader’s idea “buy on the up and sell on the down”.
[Post-publication edit: Indeed asset manager valuations are intended as a indicator of overall financial and economic health. The numerous demand and supply factors that affect valuations are both macro- and micro-issues in regard to the reference entity. If asset managers are to be acquired that signals expectations about financial asset performance and trends in money management. End-edit]

Since proverbially, the devil is in the detail: Jon Little is not expected start till later this year in November, after leaving BNY Mellon this Friday and gardening leave. Further, the headline value of this enterprise might be of greater impact than the actuality in the end (if plans do unfold at all).

So one may be able to see what this lack of immediacy on expansion plans augurs for the market and economic expectations. No great turn-around in economic upswing is in the offing; and in fact the much vaunted double-dip recession is still possible. How close were we from economic and capital markets tail-spin which was only averted / postponed after over 6 months of discussions to rescue Greece. Lehman, subprime, housing problems etc would seem insignificant to a sovereign default especially of an EU member country.

As discerning readers know, akin to taking the pulse rate, headlines augur bullish or bearish wishes / fulfillment depending on its public relations value and the confidence sentiment of the reader.

One can be led to believe that the economic and investment climate is one of the severest since the Great Depression, and even that we are emerging already from it, as has been analysed in this excellent "deduction-by-mechanism" presentation in Daniel Booth's "An overview of US monetary policy - the implications of quantitative easing Nov08".

The reality-and-rhetoric-check tells me policy makers have indeed pulled the rabbit-out-of-the-hat and confidence verges "recovery" not "depression", but on closer examination of macro and micro considerations (never mind 'black-swan' geopolitical risks such as wars, austerity , and weak-links), strongly indicates an uncertain path with pitfalls especially for financial markets. For example, examine the banking and automobiles industry half-year results FT Lex: HSBC and FT Lex: Global carmakers. The Devil is indeed in the Deed-Tail. [kks/27/07]

Tuesday 2 February 2010

Volker Rule Retraces & Enhances Glass-Steagall

The "Volker Rule" loaded with reforms to banking activities today was presented to the Senate Banking Committe (Volcker's Testimony to Senate Banking Committee) . It is of no great shakes!

If the rule passes and becomes enacted as legislature, as opposed to populist appeasment rhetoric, it will only wind-back and fine-tune the the Depression-era Glass-Steagall Act. This Act went a great way to dealing with systemic crisis of the day in the 1930s. This act was at the beginning of this Millennium repealed. The effect of which as we all know with great "Harry Hindsight" was to blur the lines between investment banking activity and commercial banking activity, or in the cant: the "Chinese Walls" were torn down.

The implication for fund managment firms is big: presumably they become the only game in town with legitimate proprietary trading books. Does that mean we pile into the listed active managers like Fortress, Blackstone, or UK versions like Ashmore and BlueBay at the expense of Goldmans? (Noticiable the intra-day plummet in the GS stock on the day of Volker's speech to the Senate Committee, also the daily closing price jump of $0.43 or 3.33% in Blackstone stock; GS closed up $3.81 or 2.49%). Not the worst relative value trade trading theme in the play-out of the "Volker Rule" jacanory, yours truly believes.

While GS and Morgan Stanley and few others of the US market find ways to circumvent potential loss of proprietary trading income, Volker did give with the other hand. A wind-fall opportunity for investment bank's corporate finance to underwrite and advise on mergers and divestitures of dark pool trading entities ie hedge funds and private equities. As a conseuence we can look for the next saga of this, I imagine a "too big to fail" hedge fund like LTCM or other will become prominent or come to the fore. The game just moves on, never eradicated.

Also, as sure as the "Volker Rule" in diluted-form will come to be enacted in the US, there will also need to be a global-wide initiative to shore up systemic-risk banking activities. (Recommendation: Buy listed fund managers and sell investment banks). KKSiva 2/2/2010

Tuesday 19 January 2010

The Calm Before the Storm

Instead of re-cycling what is predominantly out there as views on macro and micro developments I aim to emphasise my bearish view towards March 2010.

These two website analyses are from somewhat knowledgeable bears (aside of Wall St Journal / Bloomberg headlines or mainstream hacks: 1) pragcap.com hears Felix Zulauf of Zulauf Asset Management 2) SeekingAlpha.com's Double-Dip Recession View.

The patched-up economy is just that: real unemployment is still at depression-level highs, the housing-bubble has not been allowed to burst properly, while corporations have been quick to recognise and act upon the 'recision-period', have not seen revenues increase. Corporate revenues cannot develop in a climate of consumer fear about jobs: finding one or losing one; and corporate fear about interest rates ultimately rising, but maybe sooner, and if not sooner why not?

Well, it may be that prolonged recession plays out in the real economy (skin to Japan's lost decade or similar to the Great Depression), while the Street will certainly soon expect to consolidate after state-aided momentum / herd-rally since March 2009 lows.

I felt apt at using the weather analogy: the calm in the eye-of-the-storm because of Climate Change devastations like Haiti and Japan’s fourth largest bankruptcy of flag-carrier JAL having less than a ripple in the markets. Investors are presumably de-sensitised in the World of Calamity as the Noughties ends and we enter a new decade.
Those who chose to exercise longer-term memories will realise this “patch-up” economy will only work for another 2-3 period before a Calamity is brought into focus and fear is rife – no not just new orthodoxy of shorter business-cycles; but an irreverent tinkering has been delivered to economic workings. Just like more extreme weather events (hurricanes, cyclones) and seasonal volatilities is new fact of life from the Climate Change. Again we turned a blind eye or at least we tryust the Government’s lip-service, but really no concerted effort to tackles the heart of the carbon reduction problem. Enjoy the Calm.