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Wednesday 30 November 2011

Headwinds and Tailwinds: An Opening Salvo...

On the date of posting this initial comment of a series of collective thoughts about the investment climate ahead, the US equity markets closing headline from Bloomberg is 'Dow Jumps Most Since 2009 as Central Banks Take Action on Crisis'. The investor cheer was largely to do with announcement of concerted central banks action to pump more liquidity in the financial system. An engine doesn't run without oil. 

As a contrarian to such ill-warranted and purely short-term speculative enthusiasm by market practioners, FPM is prescribing  for the discerning investors a  dose of economic reality-check from the man who doesn't 'talk in absolutes'. Yes we mean Texas Republican and Rebublican nomination candidate  for  the 2012  presidential elections Ron Paul. This article and CNBC interview with Ron Paul from TheStreet.com about today's world wide quantitative easing announced by prominent central banks, is the on-the-money dissection of existing financial policy measures (as pioneered and practised to death by the Chicago Business School professors and alumnus during the Reagan era and onwards to present day).

The man we’re backing for president: FPM supports Ron Paul as the GOP / Republican candidate for President in 2012 general elections. He is a credible, strong and self-willed politician with real reform plans to address the disastrous economic global highway "the western hegemony" is heading down. United Kingdom had such a bold leader in Prime Minister Margaret Thatcher in the 1980s. She was making hard decisions towards much-needed economic reforms (that also admittedly introduced the unfortunate runaway capitalism of today, and blindly unchecked by her vote-pandering weaker successors).

The other front-running Republican candidate Mitt Romney is backed by  powerful hedge funds and other heavyweights. Mr Romney only has plaster-fixes for the economy which  most hedgies, such as John Paulson (of sub-prime fame), knows preserves status quo of financially exploitable opportunities i.e. creative-destruction. Radical reforms of Ron Paul's manifesto would undermine the cosy crony capitalism, and represent an uncertain upheaval in policy direction of the past 30 years or so.
 Pointedly, remember that Mitt Romney was a founding partner of global private equity behemoth Bain Capital in 1984.A shadow-banking partnership which now manages $66 bn in assets (as at end 2011),  across its various platforms. Platforms that also include multi-billion dollar hedge funds Brookside Capital, Sankaty Advisors and Absolute Return Capital. These financial affiliates pull strings in economic affairs as campaign sponsors and financiers of lobby groups. Such financially entrenched organisations and their leaders can only openly predicate a economic setup for the wealthy i.e. a socio-eco-politcal establishment organised for the benefit of the 1% of world population. Where does that leave the man on the street or the 99%ers?

In full-picture FPM style we briefly introduce the other main candidate for the  Republican nomination . Newt Gingrich is a mixed bag electioneer with persistent political pedigree with many successes and a few skeletons in the proverbial closet. 


Addendum 02 Feb 2012: In joined-up thinking FPM have incorporated two current headlines and a glue. The glue being an idea from a pertinent short-story by Charlotte Perkins Gilman, written 100 years ago and entitled "When I Was a Witch". A feminist writer who in this story imagines how she would deal with some of the 'wrongs' of her day.
So on my seeing a list of mainly capitalist financiers backing Mitt Romney for US Presidential candidate (see Federal Election Commission of USA full list), and then seeing "Texas Fund Eaten Alive By Hedge Fees May Curb Costs By Hiring In-House", I had a premonition. What if all the contributors to Romney's campaign had all their proceeds 'eaten-up' in massive promotional campaigns that came to no fruition. That is, their man was not elected for Republican presidential candidate, and instead business reformer Ron Paul was eventually elected President. This would be an ironic lesson to hedgies et al who take maximum performance fees when luck is in and then continue to collect minimum management fees when markets are against them and their investors lose out. The voting US public still have power over this premonition.They can squarely stymie the swagger of the mover-shakers protecting status quo.

Monday 31 October 2011

The Search for Alpha: Soros of the Euro?

We know hedge fund managers are out there but are they "really out there", say with with a macro play to break-up the Eurozone's common currency the Euro? Like the one George Soros spearheaded causing the exit of the British Sterling from the European Exchanage Rate Mechanism in 1992? 

It's pertinent question for all money managers following the 3-pronged EU deal this week to address the uncertainties about the Euro debt / currency crisis:

1) Leverage the European Finance Stability Facility (from Euro 440 bn to Euro 1 trillion+).
2) Recapitalise the Banks to withstand provisions for debt losses.
3)  Debt relief for Greece of 50% from private sector debt holders.

The macro play is also pertinently linked to concerns about the the validity of alpha creation and generation in the hedge fund and wider alternatives space. That is, do managers herd around common  trades, or do they go out on a limb with research or applying other edge? 

George Soros, the billionaire hedge fund investor, renowned for his macro trade of betting against the British Sterling is well documented. What may now be mere detail and packaged neatly into the recess of memory as "Black Wednesday" should have resonance as an important lesson for today. The interpretation that the British pound was  deigned as overvalued in its entry into the ERM, from macro fundamentals research, was something that eventually undid the Bank of England. Earning Mr Soros the title of "the Man Who Broke the Bank of England", for making the astute judgement and wager, which reportedly earned him $1 billion dollars.

Similarly, Greece's entry into Eurozone was under false premise about its fiscal deficit, which was understated by as much as half of Greece's actual debt. Whether Greece’s entry was politically and discretely made expedient is for the regulators and other investigators. This malfeasance with Greek ascendancy to Eurozone membership did come to light and the 'truth outted', plunging Europe  into ongoing exacerbated currency and debt difficulties. Not to mention the spectacle provided for the public and media by the Germans and Greeks to exonerate any suspicion of misdemeanours (see picture below).

From even basic / preliminary research and insight, FPM understand there are strong possibilities for Euro restructuring i.e. of countries exiting and entering the status quo 17 member common currency union within the next 1-2 years (yes the art of forecasting is to indeed tell both the date and event not just either / or!). And over a longer horizon, that an eventual complete break-up of disparate countries making up the European Union is a probability. FPM is of the summary view that EU has once again kicked the real issues of Euro currency and debt into the long grass, through its latest bail-out plans. The 3-pronged response of the EU (listed above) awaits a few days’ market reaction before setting-in-stone the announcement at the G20 summit in Cannes on November 4, 2011. The market reaction was not good, as few days after the Greece-fix, Italy’s borrowing costs hit record highs. The next target for bond vigilantes since Greece debt default is seemingly shored-up – a pyrrhic victory.

Before emerging markets’ currencies were forced to devalue often it was preceded by an IMF-prescribed attempt to restructure internal and external deficits while the country’s central bank defended its exchange rates. Extrapolating from such market behaviour, the Greece saga is a prelude to the single currency restructure, with ironically now stronger emerging markets countries such as China  invited to contribute to the improved EFSF!

Two op-eds in the Financial Times in February 2010 serve as an FPM research benchmark for its views. The first article is by Ottmar Issing, described as “one of the fathers of the euro”, entitled Europe cannot afford to rescue Greece and the other is by Mr Soros entitled The euro will face bigger tests than Greece.

Without concerning this FPM thought piece further about the multitude of factors surrounding the Euro's break-up or restructuring possibilities, the other point of this article, as hinted in the investment feasibility note, is indeed whether there are bona-fide hedge fund managers with a long-term fundamental alpha strategies? The Euro currency break-up would be great alpha play in the creative-destruction mode. FPM expected and understands the windfall short-term trading flows on Euro policy news. Demonstrating alpha capture or simply independent thinking, global debt problems was initially unravelled by the US-housing bubble bursting through subprime sector activism by John Paulson et al.

There have been many numerous researches about hedge fund managers not seeking or capturing real alpha, and that most hedge funds are really beta in alpha clothing, with simple crowding around particular themes and plays. This paradox even questions whether active management is indeed occurring, as opposed to “closet trackers”. Please refer to excellent truth-outting investigative journalism “Don’t believe the fund manager’s hype” by Alice Ross writing in a weekend FT Money supplement in the Serious Money section.

A caveat about the much touted link between hedge funds and alpha, is that traditional long-only portfolio managers may also seek alpha strategies, or simply lead or stand-out from the investment herds. Unashamedly Bill Gross, manager of the world’s largest bond fund ($242 bn FuM) for Pimco - a subsidiary of Allianz group of companies, was on record as wagering on a rise in US interest rates this year 2011. Though this contrarian view contributed to 10 months of poor performance and hardly representing alpha-type returns, such a leading bond investor can take an “out there” view – even if on this occasion a wrong-way bet. Since Operation Twist, of Federal Reserve policy of controlling long-money rates, Mr Gross is betting on falling interest rates.   

FPM draw parallels between the evolving hedge fund industry  and the investment era at the beginning of the current Millennium. At the turn of the centuary the investment bandwagon to ride was all things "dot.com" related. An example folly of this era was when Time Warner, a respectable giant media corporation, merged with the then new and highly valued e-commerce company Aol.com. The merged company changed its name even to AOL Time Warner (Editor's texting moniker: ROFL!). In a similar way there are many new and emerging asset managers jumping on the "hedge fund" bandwagon Considering negatives, these emerging managers may be mere “me-too” players. The positive potential in these emergent managers may be to discover a unique long-term trade and attribute their name to it.  Actually discovering a novel strategy in their investment process and generating alpha would set themselves up in the premier league of instutionalised hedge funds. As John Paulson did with Paulson & Co., betting on the subprime before this financial crisis.

As a final citation about the state of hedge funds and the character of the principals behind them and subsequent investment strategies, I defer to FPM’s select gurus of hedge funds, Ray Dalio of Bridgewater Associates. In his long presentation I refer to his comments from 3.20 minutes onwards about independent thinking and alpha.

Also, this article is not simply posing a rhetorical or hypothetical question but an actual one – please email FPM (fpm@talktalk.net) if you are, or know managers, with the Euro break-up as long-term macro strategy. Who’s really out there?

Sunday 25 September 2011

Implications of Operation Twist on Asset Allocation

While main stream media and popular press "bang on" about sovereign debt, economic slowdown and downgrades in unison head-scratching about mid-year market declines, the practical aspects of trading these volatilities in capital markets is the management expertise of leading investors.

Leading asset managers re inevitably embroiled with global policy makers to best ascertain future policy impetus and implications for asset allocation shifts. For every twist and turn of central bank and government policies market participants get their heads around it and react with asset allocation decisions. Such as the implications of August 2010 annual Jackson Hole speech by Federal Reserve head Ben Bernake, which paved the way for what became Quantitative Easing 2 (QE2).

Since the 2H 11 global economic headwinds reflect possibility of re-entry into recession if not a slowdown, Ben Bernake and company have this time introduced Operation Twist as the subtle tinkering tonic for the capital markets aiming to ultimately restore economic confidence. Operation Twist attempts to control long-term interest rates instead of the usual monetary tool to direct short-term interest rates.

FPM's read on the intended consequences of this policy impetus is that the debt maturities are being extended or cheap money is available with longer time to re-pay it. The policy implementation is via open market operations to sell short-dated treasuries and use the proceeds to issue long-term bonds. If this action were applied and compared to a corporate credit referenced by default swaps it would be deemed by the International Swaps and Derivatives Association, the trade body for the derivatives market ISDA as “credit restructuring event”. I am reminded of bond tender plans e.g.. by Anglo Irish Banks and ISDA's verdict.

FPM’s high conviction belief is that in the week beginning 19th September and especially since Wednesday 21st September’s FOMC statement at 2:30pm announcing Operation Twist, portfolio realignment is underway. A shift into accessing cheap long-dated credit is currently the modus operandi of select institutional investors. Equities, and even safe-haven gold and to some extent commodities have been sold off  in anticipation and reaction to the Fed’s “twist” on the policy of using its balance sheet to boost financial assets – QE3 became a no-go policy! FPM bases this market opinion on the liquidity cycle’s observation about the flow of money between asset classes.

Remember that QE2’s support for fundamental issues such as jobs growth and on wealth effects seem uncertain. The financial asset purchases created mini asset bubbles which peaked in late April for equities, as indicated by bellwether S&P 500 reaching 1363. Since July 22 the same benchmark has been down-trending.

Notwithstanding the distraction of the ongoing Greek tragedy, together with this week’s downgrading of Italy’s credit rating by S&P, and contemporaneous credit downgrades of bellwethers financial services Citigroup and Bank of America, a new uptrend in investment assets is in the offing, at least until there is a new twist from economy and markets.

Monday 12 September 2011

Credit Markets @ Workout Inflexion Point

During the private equity leveraged-buyout boom and the housing bubbles in the US and other developed countries, and up to the height of the financial crisis, demand for leveraged- and mortgage  loans came mostly from structured finance offerings such as collateralized debt obligations (CDOs) and mortgage backed securities (MBS). Since the 2007 sub-prime driven unravelling of structured credit portfolios, with inherent flawed model assumptions, the subsequent clearing of debt markets has been incessantly underway. The ‘workout’ in identifying fair-value of these hard-to-value assets, which had been battered in the ensuing ratings downgrade and plummet in mark-to-market valuations, is showing dividends. 

As a turning point and until the sovereign debt turbulence of August 2011, there are both obscure and vivid examples of the clearing of credit market. Adjectives for loans, credit and debt have become prominent in recent financial vocabulary, with descriptions such as “delinquent”, “non-performing”, “in forbearance”, “distressed”, “credit quality” etcetera. The premise for FPM’s inflexion in credit assertion is based on interest rate and credit cycle and plethora of credit-related market activity.

Micro Workout Amid Macro Stability

The micro-economic aspects of asset bubble economies of 1998-2007 are and were being fixed amid macro-economic monetarist stimulus, introduced by the then chairman of the Federal Reserve, Alan Greenspan. Asset bubbles bursting, whether related to emerging markets-, technology / TMT, or sub-prime housing, inevitably leads to recession and recovery periods.  Recent stimulus included the massive re-capitalisation of banks to preserve their regulatory capital requirements from the effects of withering asset quality valuations in structured securities (and ‘ballooning’ notional CDS exposures – look out for “CDO vs CDS”, an FPM note to follow). The new paradigm of easy credit from central banks’ “pump and prime” such as low interest rates and government tax relief prevented asset bubble recessions spiralling into protracted deep ones while solvency issues were sorted at the micro level.

FPM has collated some evidences of active loan markets including the purchase, unbundling and selling of pooled loans, and higher recovery values. Also indicative of restoring economic order and confidence are the multiple legal cases surrounding mortgage securities mis-selling etcetera. Litigation and settlements may not seem a credit quality issue other than its confidence-restoration link to the structured securitization debacle. FPM’s insight suggests these litigation and resultant outcomes affect investors holding these mortgage debt or leveraged loan secuirities, at least their recovery values in situations of loss-making positions. Mortgage litigation losses remain a dark cloud looming over financial services. As is the impact of forebearance. The Bank of England warned in its semi-annual Financial Stability Report this year that it may explain the lower rates of arrears and repossession for homeowners in this recession than in the last (See FT article: Iceberg of soured loans hides true losses).

Mortgage Loss Litigation 

After the fire-fighting period post-Lehman 2008, the SEC started initial investigations into the mortgage-bond selling by suing Goldman Sachs in April 2010 over the Abacus 2007-AC1 deal. Then broad-based investigations and subpoenas ensued in the autumn / fall of 2010. The results of law suites, litigation and settlements are now unfolding in the 2H11; as are independent fresh cases such as the July 2011 lawsuit filed by China Development Industrial Bank. CDIB claims that Morgan Stanley "misrepresented the risks" of CDO called Stack 2006-1 Ltd.

Some of litigation workout examples augur mixed fortunes for indicted banks. In June 2011, it was reported that JPMorgan Chase agreed to pay $153.6 million to resolve US SEC charges that it misled investors in a mortgage-related CDO, named Squared CDO 2007-1, it constructed for Magnetar, an Illinois hedge fund. Similar settlement later that same month when Bank of America completed an agreement to pay $8.5 billion to settle claims related to subprime-mortgages securitization (via mortgaged backed securities). This last settlement represents one of the single biggest, related to 20 institutional investors including fund management behemoths BlackRock and Pimco. Clearly such steps, ‘clears the slate clean’ of the malfeasance in securitization and ensuing financial crisis. As caveat, this author’s optimism is tempered by headline risk of such reported settlements.
Stop Press: FPM told you so! As of 2nd of September 2011, Federal Housing Finance Agency of the US is suing 17 banks for losses related to mortgage security mis-selling. Adding to the current on-going market jitters, the 17 listed global banks including securitised mortgage players such as GE and Countrywide Financial and First Horizon National, had their stock prices marked down between 2 and 8 percent on the news. These traded lower due to additional liability to banks’ capital stemming from the potential new litigation losses (up to $20 billion mentioned) related to the selling of some $120 billion of RMBS.

FPM long-memory research reminds us that banks churned out $1 trillion plus of CDOs and the like. These structured ABS with multiple ‘tranches’ led to some $2 trillion of writedowns and credit losses for global financial firms since the start of 2007.
Also, since 2000 the leveraged loan market grew significantly, and at the end of 2007, the market for leveraged loans was worth $1,061 billion, making it the largest corporate debt market.

As for the biggest asset-play market, US mortgages not held by Government Sponsored Entities (GSEs) but in private mortgage conduits accounted for nearly $3,000 billion at the end of 2007. These non-agency MBS in the US accounted for $1,800 billion at the end of 1Q2011, according to the Federal Reserve. Remember the total mortgage debt outstanding held by major financial institutions, Federal and related agencies and mortgage pools or trusts is $13,700 billion at end-March 2011 (similar in size to the entire US GDP).    

CLOs Transform into Mutual Fund Offerings

The institutionally-held investments in securitised debt, rashly generalised as ‘toxic assets’, are being repackaged into simpler mutual fund structures (both closed-end and open-ended varieties). These portfolios’ constituents are primarily private-equity leveraged loans and/or securitized home equity loans with short- to medium-term refinancing instruments.
Indicative of credit workout, noticeable that in March 2011 Apollo Global Management, a top 5 global private equity firm providing loan-financing; and a large exchange-traded fund (ETF) manager Invesco PowerShares, both launched portfolios where the underlying is ‘legacy’ loan paper.

Apollo’s closed-end fund (CEF), a long-only mutual fund with limited issuance of shares and traded on exchanges, constitutes floating rate notes or FRNs.
FPM’s new-trend-notice reflects that FRNs have become “attractive option for refinancing loans”, as confirmed by Paul Hatfield on Creditflux.com. The pre-financial crisis model of borrowing short-term through asset-backed commercial paper (ABCP) market, and lending / investing in longer-term higher yielding assets (such as CDOs andCLOs), is a model that broke down during the financial crisis, by its functional seizure.

Invesco Powershares’s offering became the first ETF for corporate bank loans. The ETF tracks the S&P/LSTA US Leveraged Loan 100 Index, a basket of the 100 largest and most liquidly traded loans.
Investors have allocated cash into mutual funds that buy such loans, increasing the assets managed to $37bn as at February 2011, according to Lipper the fund tracker.

AXA Investment Managers in Paris, with a division specialised in structured credit, were one of the early users of the CEF structure for ABS investments via its Volta Finance (ticker: VTA). Which invests in corporate credits, CDOs, ABS, leveraged loans, and infrastructure assets. Since the launch in October 2006 pre-crisis and the systemic crash in 2008 there is an up-trending price recovery (See Chart 1). Another Amsterdam listed CEF, Tetragon Financial Group (ticker: TFG), launched in 2007 also experienced similar price slump in the 2008 but has bounced back stronger (see Chart 2). Further primary fund analysis is required to understand the performance difference, whether due to better underlying loan picking or refinancing etcetera.    

Another notable structured products CEF vehicles is the Carador fund (ticker: CIF) managed by GSO Capital which is owned by the Blackstone Group.

FPM believe this repackaging of underlying credit is better suited to CEFs as opposed to open-end vehicles or the defunct and complex CDO model. With mutual funds the investor acquires only stock / equity in a regulated, pre-defined product life-cycle with access to the performance of underlying commingled loans. Unlike CDO structures there is no holding of subjectively rated tranche debt paper or “waterfall payment” of interest or principal related to seniority of bond-holding and correlation of loan defaults etcetera. All investors in mutual funds have equal economic interest as equity shareholders with income and capital growth expectations, ceteris paribus.

Distinguishing between open-end and closed-end mutual fund structures investors are advised to consider CEFs as long-term investments. A secondary market in CEF fund sales-trading ensures possibility of liquidity. Where the bid-offer price for the underlying CDOs, inclusive of securities transaction cost, is perhaps referenced to a proxy benchmark, say Markit CDX North America Investment-Grade Index. Already analysts have expressed some concern at illiquidity in the underlying loan market.

Structured-Debt Hedge Funds

According to HFRI hedge fund indices and FPM analysis the top-performing investment strategy is the Relative Value Fixed Income Asset Backed.  This strategy’s benchmark produced 39.8% compound over 4 years ending June 2011 (or 8.7% annualised). FPM research recommend performance and diversification strengths of eight hedge fund managers with expertise in fixed income and particularly securitised ABS, either in mortgages and/or leverage loans (as listed below). For example, the mortgage funds’ securitised debt strategies may specialise in pre-payment sensitive mortgage-backed securities, which show little correlation to other markets. Leverage loan plays include Par structure CLOs.

Aladdin Capital
The Aladdin Opportunity Fund was launched in mid-2008 with the goal of profiting from knock-down value across asset-backed securities (ABS) markets.
Cairn Capital
European ABS and leveraged loan specialist launched its Cairn Capital Structured Credit Fund “to capitalize on current dislocations and opportunities across the spectrum of structured credit”
Cambridge Place Investment
Cambridge Place specialises in asset-backed debt and related instruments, including private investments and real estate.
Chenavari Financial Group
Toro Capital 1 has produced gains of 27.8% over the first six months of 2011 and 338.7% since inception in June 2009, and managed by 36 years old Frederic Couderc.
The CQS ABS fund has returned an annualised 35 percent since launch in October 2006 to date end-June 2011.
GSO Capital
The credit trading arm of Blackstone Group launched GSO Capital Opportunities Fund in 2008, and gained 13.5% net internal rate of return. They have launched a second fund in June 2011.
Structured Portfolio Management (SPM)
SPM's mortgage backed arbitrage fund Structured Service Holdings claimed top spot for 2010 in Bloomberg’s Top 100 Hedge Funds with gains of +49.5% (following the fund's 2009 returns of +134.6%)
Tetragon Financial Management (formerly Polygon Credit Management LP)
Senior secured bank loans (aka leveraged loans) constitute the main assets of Tetragon Financial Group.  TFG gains exposure to these assets through existing and new investments in the residual tranches of CLO and CDO products.
Table1: Source: FPM

Plethora of Credit-related Market Activity (See also Addendum below)

The unbundling of securitized debt and subsequent realization of value is the credit market propping mechanism or trend that FPM are highlighting in this note. Repackaging debt is in itself is not a new financial solution: remember the Brady bonds of the late 90s, where an emerging markets bubble and subsequent debt overhang from bank issuers, were resolved by the debt being wrapped with IMF guarantees and sold into the market.

The equity tranche or first loss tranche of structured ABS is even in some leveraged loan structured products showing value. The above mentioned Volta Finance fund managed by Axa Investments reported in June that its CLO residual holdings or CLO equity positions were being marked at 75% of par on average. CFlux’s secondary CLO index levels of Dollar denominated equity tranche shows 46 cents on the dollar as at end August 2011. This suggests an entry point in such plays. Arbitrage across the spectrum of structured credit certainly exists. CLO management agreement transfers is an active market due to nuances of terms contained in the structures and discounted prices of these assets with inherent time-value if not as yet intrinsic value. (Await forthcoming structured product “CDO vs CDS” FPM research).

Citi Capital Advisors, a unit of Citigroup, led firms taking over the management agreements of $4.5 billion of CLOs in the US in August alone. There are also plenty evidences of fund raising to get in on the action. CQS, a hedge fund mentioned above, announced in June that it is capping the CQS ABS fund, launched in 2006, after it has raised $2 billion. The fund then managed $1.6 billion. Other fund-raising efforts announced at similar times this year are by GSO Capital, planning to raise up to $3 billion, and Avenue Capital aiming to gather as much as $2 billion to focus on investing in the debt of US companies. Remember this secular trend started in early 2010 of the credit cycle, where Fortress Investment Group bought two businesses with a total of $13 billion in CDO assets. Carlyle Group acquired the collateral management contracts for 11 CLO funds managed by Stanfield Capital Partners. Carlyle also took a 55% stake in a long-short credit hedge fund Claren Road Asset Management.

Also indicative of credit comeback is the Rothschild Asset Management take over of credit manager Elgin Capital. Elgin’s other credit funds had closed during the credit crisis, with the remaining business being the management of four CLOs. Consolidation in the structured products by larger well-backed institutions capitalizes on fund-raising difficulties weaker rivals face. This trend is natural and expected in the credit cycle and FPM has highlighted its significance for investors.

An obscure but relevant statistics about the state of credit markets is the level of balance sheet write-downs or write-ups of credit assets. FPM noticed that US banks’ revenues from credit trading were lower in 1Q11 on quarter-to-quarter basis with 2010. Office of the Comptroller of the Currency reported in its 1Q11 Quarterly Report on Bank Trading and Derivatives Activities:

“…The relative absence of these write-ups in 2011, compared to both 2009 and 2010, explains the difference in trading revenues in these periods.”
FPM interpret this “relative absence of write-ups” on legacy credit assets as signal that fair-value in mark-to-market is now accomplished, and further that credit issuance and trading is set for revival. Less credit business explained the overall lower bank trading revenues, therefore means of growing credit revenues will be an imperative for banks.
However, FPM author feels that this may come from higher interest rate environment, but that not being a credible policy option now; other credit flows will need to be substituted. Possibly, increasing syndication and trading in sovereign debt, as witnessed in August and into September this year.  

FPM’s Contrarian Credit View

The corporate credit-boom, credit-crunch and subsequent workout in the financial services sector have been cyclically profitable – with entry points provided by uncertainty in economic fundamentals, such as current concerns about policy makers’ ability to deal with sovereign deficits and debts. A case-by-case analysis is certainly warranted rather than the broad-brush treatment. As this if to highlight this concern, Bank of America through its acquisition of Merrill Lynch and Countrywide Finance still faces a situation of dealing with $1 trillion of problem home mortgages.

The final positive note is that the credit comeback started in mid-2010. Singling out the largest corporate debt markets as an example – see Chart 3 below, FPM feel confident in confirming Credit Markets @Optimistic Workout Inflexion Point, despite August sovereign debt news-flow. This assertion is time-stamped using US Market screen-shot from Google finance page on 9th September, 2011: alternative for FPM to being a contrarian cash investor (Chart 4). 
Chart 3

Chart 4

Lloyd Bank (UK) is accelerating its sale of bad commercial property loans. In 2010 it sold about £4 bn of real estate loans through "forcing an administration or encouraging and investor exit". In May Lloyds  marketed its first sale of a portfolio of distressed property assets, making £1.8 bn in 1H11 propety disposals.
The Bank still has about £23.7 bn of troubled real estate loans, while Savills estimate about £350 bn of outstanding debt in the UK commercial property market. The sale is expected to managed by  JPMorgan Cazenove and is currently in early stages.

Friday 5 August 2011

Global Stock Markets Are In A Funk

As a current turning point, there are both obscure and vivid examples of the market clearing of bad loans (referred to by degrees as delinquent, non-performing, forbearance, distressed etcetera) as reaching its conclusion.

Stop Press: Due to the Splash Crash Precipated by Dow Jones Index Average's -4.3% Crash Yesterday... This article is a digression from other piece I was completing "Credit Markets @Optimistic Workout Inflexion Point"

The microeconomic aspects of the bubble economies of 2003-2007 are and were being fixed at the expense of macroeconomic monetarist expansion policy, kick-started by Alan Greenspan. This in some cases leaves countries overly indebted and exposed to short-selling attacks. Led by feral bond vigilantes and crowding bond traders, using bond-shorting and –leveraging devices like credit default swaps (CDSs), can bring vulnerable corporations and even countries to their knees. Similar to housing monolines and CDOs being shorted through CDS during the housing asset devaluation by MichaelBurry, John Paulson et al. 

Coincidentally, while global stock markets are in a funk (@time of writing the Dow was closed after plummeting -4.31% for the day!), the remedy now has to be tough love. So that means NO QE3! Monetary policy predecessors served only to create bubble in commodity asset plays while aiming to restore confidence in a widely acknowledged and prolonged de-leveraging cycle. Quantitative easing et al has arguably produced a soft-landing since 2007, but unless non-monetary self-preservation policies are in place, monetary-plaster-fixes are not the intrinsic value solutions. Economic soft-landing via monetary policy fix for a problem created by money-gamers politicking is only a pyrrhic victory. An oft used analogy criticising Friedman-type Monetarism (versus say Keynesian Fiscal) is of giving uncontrolled heroine to an addict to help him out of addiction. In some instances and under certain circumstances this has worked as a remedy, so social and drug workers inform us.

If I was President of the US, my policy response now is a threefold intrinsic value solution:

1)      The shock-treatment of increasing Federal rates by 25bps. Yes initially painful, but as dust settles inflation is introduced into the system; and as Barton Biggs commented: reducing debt by devaluing it through inflation is less painful than capital destruction. 
2)      Dampening capital markets’ clear over-exuberance by restricting naked shorts of sovereign and strategic-interest corporate bonds for foreseeable future
3)      Introducing a fiscal expansion programme (rather than a monetary one) of rebuilding housing sector by initiating and funding programmes to improve existing housing-stocks’ energy efficiency (I seriously don’t believe climate change is solely a phantom problem). 

So here I have conjoined monetarist, fiscal and regulatory fixes to stop befuddling through this deleveraging cycle (which is expected to last 10 years according to economists Reinhart and Rogoff, who penned “This Time Is Different: Eight Centuries of Financial Folly”).

Monday 11 July 2011

Hedge Fund Performance Since July 2007

Studying the last four years of hedge fund performance ending-June 2011, we at FPM are able to notice strategic investment trends, as depicted by various hedge fund strategies and their dynamic risk metrics.

Click to view chart

 In Numbers: All Hedge Fund Strategies:  

Table 1: CLICK (and zoom) to view full Table
(or email FPM to receive Word format version: Kristian)    

Performance Observations:   

Based on above chart and  table we can identify many investing trends. In the table the green and yellow highlights reflects best and worst performance metric under consideration.

  • The top compounded performance of Relative Value Fixed Income Asset Backed  strategies, gaining 40% over 4-Years to end-June 2011, might be unexpected and warrants analysis. Structured credit isn’t toxic after all! (See FPM's Credit Markets @Workout Inflexion Point).
  • Emerging Markets Russia / Eastern Europe Index cumulatively lost 19% versus 12% loss for the S&P 500, deserves scrutiny over use of hedge fund label - more likely “a beta masquerade”. Latin America-focused emerging markets hedge funds did better, up 22%.
  • Macro hedge funds (especially Systematic Diversified) offered the best protection against the worst of the credit crisis, down 0.6% in the worst 12-month period. The aforementioned proxy on Russia/Eastern Europe Index lost 88% between Mar’08 and Feb’09.
  • Of Equity Hedged strategies, Short Biased Index  as expected had the least correlation to the general market as proxied by S&P 500 and also the Hedge Fund Composite Index.
  • FPM’s forward looking analysis suggests directional strategies may benefit most from on-going debt-overhang workout, reform and confidence-restoration trends (e.g. the Russian / Eastern Europe sub index has bounced back 47% over 2-years to end June’11).
  • Due to the effects of currency fluctuations, the hedge fund weighted composite index performance, based in Swiss Francs (CHF), is half that of the US-dollar composite index.  The appreciation of the Swiss currency to the US dollar diminishes dollar-based returns.    

 The four-year window of observation was chosen as it coincides with when the FPM author last practised in institutional investments, allocating treasury money to hedge funds.
During this sojourn, as a self-starter initiative, K Kristian Siva is designing and developing the Fund Portfolio Management (FPM) programme for Alternative Investments enterprise implementation. 

Saturday 28 May 2011

The Media's "Straw-Man Fallacies" about Madoff and Rajaratnam

The Straw Man Fallacies  is a list of falsehoods in logic and rhetoric.

It’s not a coincidence that during financial crises there is often continuous and focused attention in the popular and specialist financial media about white-collar corporate crimes. Press articles about the leaks, allegations, investigation, charges, court proceedings and even about lengthy jury deliberations. Such articles' overall purpose is to seed the suggestion that retribution against corporate misdoings is in process. The publications’ other subtext purpose might seemingly be that “crime does not pay!” etcetera. We are reminded that institutional media can often be less about informative, didiactic or anecdotal stories / news, and more about hidden agenda-driven entreaties. 

During the last downturn, dubbed “TMT-bubble” between 2000-2003, we heard much about Enron, Paarmalat and other frauds; yet the lessons were evidently not learnt.  In 2007-2009 the global capital markets nearly collapsed with imminent global systemic financial failure. An all important, global commercial paper market for short-term funding, used widely in the economy by corporations and financial services, literally ground to a sytemic halt. The real assets were different from the dotcom era bubble, this time it was housing and the financial sector bubbles. The similarity was the prevalence of the notorious structured products from securitization tied to housing and off-balance sheet liabilities. 

The media attention on one or handful of cases and /or figures being made a scapegoat serves only to propagate a distorted, exaggerated or misrepresented premise. Hitler’s contrivance was that, “All effective propaganda has to limit itself only to a very few points and to use them like slogans.” Relating my article’s headline point to one of the many Straw-man fallacies, the best fit was with the fallacy of “Biased Sample”. Also Known as, Loaded Sample, Biased Statistics, Prejudiced Statistics, Loaded Statistics, Biased Generalization, Biased Induction.

Clearly, the mass air-time and clolumn-space focusing on the long-running insider trading court case against Raj Rajaratnam, of Galleon hedge fund, and the notorious Bernard Madoff, using the Ponzi scheme fraud, is intended to convey justice prevailing. However it detracts attention from the persistent and on-going white collar mischief in financial markets (or for that matter any professions, for example, UK parliament member’s expense scandal unfolding in 2010). Also, such decoy-news takes focus away from regulatory battles taking place between hardliners and laissez-faire believers.   
Also, diverting attention “to a very few points” of reference like Madoff and Rajaratnam helps deflect stark negligence or sheer incompetence of those charged with looking after the fort i.e. executive management, quasi regulators and other authoritative oversight entities. Not quite the holistic picture is presented.

So why does the Financial Times newspaper visit Madoff in prison? Not that Gillian Tett the FT's well regarded journalist is undiscerning, but more that she is compartmentalised in her thinking and publications by an age-old institutional media machinery, designed to serve the community which it represents – in this case the financial services versus all others. Media savvy, in using investor relations, public relations, lobbyists etcetera, are the key function in diseminating straw man fallacies about a position. 

To give statistical evidence to my point  about “iceberg theory of financial crimes” and media’s role, I cite these: Since the beginning of 2007 there have been 70 fraudulent cases in hedge funds alone, including Madoff, as shown in HedgeTracker Hall of Fraud listing). That’s almost 20 cases of fraud a year in hedge funds (HedgeTracker data ends with last fraud listed in June 2010, with Luis Felipe Perez’s Lucky Star Diamonds, operating yet another Ponzi scheme).

Also, FT’s Alphaville column reported in “Insider trading investigations, continued” :

            “…We’re now approaching 40 people charged with insider trading in the sweep of Galleon, PGR and other employees, and it’s worth pausing to reflect that these have come about via an incredibly narrow field of investigation: mostly via one expert network’s activity across one sector (tech) with relatively paltry amounts of alleged illicit profits. It’s moving from the periphery to the core, but the scope remains small.”

Just to clarify, the Galleon case has swept-up 40 people related to one “expert network”, namely Primary Global Research LLC, an independent research firm that links experts with investors seeking information in primarily technology and health-care.
Any effort to identify in list-form the number of pending Securities and Exchange Commission investigations of insider trading focused on other hedge funds and other sectors... well its an impossible task! - as SEC cannot publish these investigation due to wrongly inflicting irreparable reputational damage on parties concerned, before the verdicts. However, OnWallStreet.Com they have given some indications in "FINRA Clamps Down On Insider Trading, Expands Communication". FINRA is the acronym for Financial Industry Regulatory Authority, and their work has “resulted in more than 250 referrals for possible insider trading cases sent to the SEC ” in 2010 alone.

The reader of this article is advised to make the clear distinction between the Madoff and the Rajaratnam cases. One is outright fraud and other challenges the market-integrity under securities trading rules. Two very different segments of corporate crimes. Both offences being in financial services should not subconsciously be interpreted as all wrong-doings are caught. 

Stop press, what’s this? Hot-off the press on 25th May 2011 from SEC website: 

These SEC rules regarding whistle blowers was marginally voted in by 3-2. The new regulations required under the Dodd-Frank Act are supposed to give bounties / incentives for employees to come forward with information that helps towards cutting out securities problems. At the same time, the rules are intended to enforce internal compliance efforts to be bolstered. So it seems the authoritative oversight entities are fighting back! However, the cynicism of this author doesn’t allow too much glee, as he knows “the devil is in the detail”. 

So for who does this blog article mean “economic work creation”? – obviously for the legal profession and compliance departments, but by implication also for hedge fund due diligence staff.
The due diligence work of multi-manager / fund of hedge funds operations becomes critically crucial in determining the “moral compass” of fund management operations. Those managers who operate in unspectacular but morally modest ways are beneficiaries of intended clean-up in securities operations. Some critics of hedge funds may suggest that the “edge” in hedge funds come from unfair means. Implying that increased regulation of formerly unregulated asset managers (“shadow banking!”) might take the wind out of hedge funds, and for that matter private equity sails. The author of this insight hesitates in his assertion, since industry regulation amendments tend to come and go. Once upon a time, the first Glass-Steagall Act of 1932 came on the back of the Great Depression, and moving fast-forward in time to the start of this Millennium we saw Sarbanes-Oxley, and now the Dodd-Frank Act. 

In light of the media's iceberg-theory  presentation of frauds, insider trading and regulatory changes, those making institutionalised direct allocation to hedge funds without sufficient infrastructure, or in-depth industry relationships or longevity of game better watch out. Investors with institutional due diligence on boutique asset management operations shouldn’t just conduct tick-box exercises, but relevantly, understand what I call “process-principles” i.e. understanding the micro an macro aspects of an operation’s processes and principles, so as to be able to identify inconsistencies and irregularities in systems. Indeed the institutionalisation of hedge funds has provided many positives, among them  is the greater transparency of managers, but this may equally let in complacency .i.e. tick-box due diligence.

In conclusion, “creative-destruction in economic cycles” moves in alternating waves and trends, Madoff and Rajaratnam are just two names, like a festive sacrifice to the powers. I believe in an impending tsunami of alternative investment personalities and entities in difficulties. Notice the current trend of numerous offshoots of proprietary desks, whether originated from global investment bank desks, like Goldman Sachs luminaries, or from Julian Robertson’s “Tiger Cubs”. 
The continuum of evolution and adaption by the alpha-seekers, fairly or dubiously, makes it implicit that principled understanding of micro cycles in the big picture enables them to stay ahead of the game, whether by deploying media fallacies or despite them.

27th May 2011
By K K Siva