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Thursday, 28 November 2013

No Smoke Without Fire: Of Reputation Risk

Below is a chapter excerpt from a draft of FPM's "NSWF: Of Reputation Risk". The research chronicles Alternative Investment Management industry's misnomers and myths through the case study of Blackstone Group's Fund of Funds unit 'BAAM' and reputational relationship with Steven A. Cohen's eponymous SAC Capital. The demystification we focus on is in-depth systemic analysis of corporate and personnel reputation or headline risk. We critically ask why reputation of corporate culture should matter in context of insider trading and other frauds in the pursuit of alpha performance AIM. 

It embodies FPM's commercial manifesto motto of: 

“Industry Intelligence into Due Diligence for Enterprising Execution”

Where The Wind Blows: The Next Chapter

Monday, 30 September 2013

No Smoke without Fire – A Denouement

FPM insiders are somewhat surprised at the impending final resolution or clarification of the 'SAC-saga'. A multi-year investigation led by the US Department of Justice which is imminently unfolding – with the next fixed date November 18, being the commencement of criminal trial against senior portfolio manager at SAC Capital Michael Steinberg. The climaxing of the largest investigation and prosecution into insider trading in the United States may tantamount to a mere null and void result! Are Steven Cohen and SAC Capital going to receive a ‘get-out-of-jail’ card? Really, we are always aghast at the masquerading theatrics without substance - and we’re not referring to Hollywood films! Read our full “No Smoke Without Fire” to see exactly how aghast.

The critical point from the recent financial press about SAC Capital, is that the web of securities fraud manager may evade criminal conviction. Simply by letting money talk, that is by entering negotiations for a settlement of the prosecution’s case. As was reported in the Reuters noise on September 25th : SAC Capital and prosecutors have since opened preliminary settlement talks in an attempt to resolve the criminal indictment.... (Click below url link Cohen's SAC Capital up 13 pct for year for full Reuters story. A simple thinking individual with pursed lips may nod his head acceptingly and claim nothing tremendously new or interesting about an out-of-court financial settlements as regards financial moguls, especially in aftermath of the US housing-led financial crisis malfeasance. Malfeasance or misdemeanours, which FPM repeatedly likens to the proverbial tip-of-the-iceberg; mainstream reported financial wrongdoings are only the visible tiny portion and not reflecting the unseen gigantic portion submerged.

SAC which was charged with separate criminal and civil charges, at the 11th-hour on 19th July 2013 before the 5-year statute of limitation kicked-in, seems now to be offering one final ‘global’ settlement for insider-trading case related to SAC to end.
Presumably such a final settlement is intended for current outstanding cases and to prevent any future prosecution of Mr Cohen himself. Remember it was only on 15th March this year that Mr Cohen personally forked out a record total $616 mn to settle two separate civil cases related to SAC sub-fund PMs.  Mathew Martoma of CR Intrinsic and Jon Horvath of Sigma Capital cases settled for $602 mn and $14 mn respectively. Mr Martoma’s criminal indictment case has been rescheduled from November to January 2014. In our restricted report ‘No Smoke Without Fire’, FPM speculate on the likelihood of this close associate of Mr Cohen squealing before the grand jury or proffering evidence in exchange for leniency in his sentencing. Alternatively, how much personal pay-off may be needed for Mr Martoma to accept prison time to fit the crime? Prison time may be sore point for ‘cute’ looking Mr Martoma! Of course while

While Mr Cohen himself has been implicated in past and pending US criminal cases of insider trading, he has not been directly named in criminal indictment documents or has ever been charged. FPM skews the old adage into The bigger they are the harder they are to fell, especially where money is concerned. In “No Smoke Without Fire” we mention other hedge fund luminaries and executives that have had the grace of political and financial clout and connections to avoid conviction and prison sentence. Among others we identify those potentially having engaged in insider trading. Such as hedge found founder billionaire Arthur Samberg of Pequot Capital Management and prominent Wall Street executive John Mack, who also chaired Morgan Stanley.

FPM’s restricted circulation of “No Smore Without Fire”, together with extracts and supplements published on this blog, have been successful in conveying the negative reputation risk of being invested with an asset manager in ongoing insider trading investigations. Via word-in-your-ear enquiries with Blackstone Group affiliates we believe we were indicatively influential in the private equity giant redeeming investor money from SAC Capital. Following our active resistance modus operandi, FPM associated Blackstone’s alpha-at-any-cost savvy and / or slack due diligence in being long-invested and vehemently committed to Mr Cohen, amidst multi-year investigation by prosecuting federal authorities. In most scenarios most investors faced with reputation risk would reasonably be expected redeem investments first then ask questions later. We think the fall-out from even a financial settlement without acknowledgement of culpability to the SACs saga will indelibly tarnish Blackstone’s reputation in hedge fund investments. Not to mention irrevocably damaged reputation to other less high profile partners of SAC, who have vocally and publicly allied themselves. We know that kowtowers and sycophants to the 117th richest man in Forbes ranking lists inevitably exist, but FPM in naming and shaming propound our reputation risk thesis by highlighting one such specimen. Anthony Scaramucci, managing partner of SkyBridge Capital, a fund-of-funds manager, has been particularly unabashed in supporting the monied-class of Mr Cohen. On the day of SAC’s federal indictment on criminal charges of insider trading, Mr Scaramucci appeared on CNBC's "Halftime Report" to lend his smarmy affiliation to SAC – see this transcript:

"So I think right now I think we just have to feel bad for the employees there and for the families associated with this. I have said long ago that if they have a case and it's a substantial one, let's bring it. Obviously, the presumption is still on innocence both for the firm and for Steve. That's the way our criminal justice system works. But the government has that case. I hope Steve and his team will get the opportunity to say their side of the story as well. But as it relates to public policy and things like that, fraud is a terrible thing, and I hope to God that they will be innocent, but if they're not, obviously we'll do what's prudent for our investors as everyone else would."

And watch this video link to compare Mr Scaramucci’s - affectionately known as the "The Mooch" - excitement and enthusiasm about vehemently supporting SACs in November 2012 as CNBC discuss: Will SAC Face Redemptions?

Of course FPM filches the above assailant points buried in obfuscating headline stories. This time the misleading Reuters noise mentioned above had headline about SAC’s year-to-date performance, see Cohen's SAC Capital up 13 pct for year -source. The dumbly published story under mainstream financial media Reuters, with Matthew Goldstein as ‘jobsworth’ lead-writer, is the kind of pandering journalism that is tantamount to mere paid-for financial propaganda. Of course at the centre of such tripe is SAC’s PR-firm Sard Verbinnen & Co and lead-spokesman Jonathan Gasthalter. How many unofficial and official lunches have Reuters had at the PR-firm’s expense, we rhetorically ask! While cognisant of motto “No such thing as a free lunch!”. So the story is not just ‘dumbly’ edited but connivingly intended, one may reasonably suspect. This kind of concealed reporting of the key facts assuages financial herd that SAC’s multi-year case is proceeding and business as usual at the firm. Starkly, FPM point out that no criminal charge has been brought to the door of the man presiding over the web of fraud, Mr Steven Cohen. FPM is not alleging fraud at SAC or by Mr Cohen but merely explosively enunciating the July 19th, 2013 criminal indictment against SAC Capital, which states …insider trading that was substantial, pervasive and on a scale without known precedent in the hedge fund industry. And if that’s thrown out in case closure as unsubstantiated libellous verbiage, then we corroborate with US Manhattan Attorney Preet Bharara’s , recital describing SAC as “a veritable magnet for market cheaters”. FPM network would not believe Mr Bharara’s personality and character is given to hyperbolic statements.

Monday, 8 July 2013

Half-Time Equity Sector ETFs Perspective

Figure 1. Equity Sector ETFs - Overlap Performance (Part 1: 60/70 ETFs)

This research forms the basis of FPM’s top-down  cross asset allocation for 2H13 into 2015. We examine expectations for the global equity sector based on rear-view mirror look at ETFs performance. The window period of scrutiny is June 2007 to now, as at end-May 2013. This period is arguably poignant since it heralded the financial crisis, peaking in Sep 2008, and now with global equity indexes testing pre-crisis record levels. Presented below are life-history charts of the S+P 500 and its proxy ETF SPDR S+P 500 (SPY). We think this is “half-time” based on the prognosis of the approximately 10-year cycle that we entered, according to the Rogoff and Reinhart assessment of the state of global economics.

Chart 1. S+P 500 and its proxy ETF the SPDR S&P 500 (SPY) - Source:Yahoo.com and FPM

Also, the period from June to May tends to excludes “window-dressing” price-action. For comparison sake, the analysis window is also dictated by latest ETF inception, for the “Overlap Performance” analysis. Master limited partnerships or MLP sector ETFs as represented by “Alerian MLP ETF (AMLP)” launched in Sep 2010, hence why the overlap performance period starts Sep 2010 to end-May 2013. This is 3 months short of 3-years’ analysis period. The second analysis is “Inception Performance” of the sector-proxy ETFs. For the full half-year ETF sector analysis to end June 2013, or for any other customized portfolio and study-period please contact FPM.

We’ve calculated 12 statistical risk-return metrics for 70 ETFs, each serving as benchmark for equities, with a bias on US markets. Using Noah’s Ark amalgam of the best of breeds, we selected the two largest capitalized ETF proxies for 35 equity sectors, as classified by Etfdb.com. We’ve added qualitative analysis to the quant metrics in terms of geopolitical considerations, among other issues such as globalization and climate change. So we discuss less about idiosyncratic company fundamentals and risks, and more about the big picture ideas. We also bias our analysis towards Sociably Responsible Investment themes. Our ideological corporate reputation matters even if we fall short of that in practical matters.

At this market juncture, equities are in vogue and promoted as the great rotation away from credit investments. This research forms the basis of FPM’s top-down equity asset allocation for 2H13 into 2015

FPM found Health+Biotech sector equity performance of near 100% total returns, on compounded basis for the study period based on adjusted closing prices of select ETFs.
Refer to Fig.1, highlighted by green in first column against “iShares Nasdaq Biotechnology Index Fund (IBB)”. Note that these returns reflects dividend and splits adjusted Yahoo.com historical prices performance at month-end. We have not examined the underlying constituents of the discussed ETFs to confine this note to top-down sectoral research.

From our “Mirror View Thesis” of this sector analysis, FPM believes that an inverse image is in view for the next half of the Health & Biotech industry fortunes. Based on tougher industry regulation from restricting pernicious industry practices we expect this sector to experience slower growth. We are not shy of supporting controversy but there are healthy trends which check the growth of traditional pharmaceutical companies. Such as the growth of ‘alternative therapies’ of homeopath and naturopath sciences.  As well as the advent of ‘genome mapping’ of individuals with DNA-biotech and geneology. These evolutions in the human health and well being industries generally present a challenge to the existing establishment of big pharmaceutical. For instance a drug for epilepsy was directly found to cause babies of the drug-taking mothers to be born with severe disabilities of retardation. See UK Guardian national newspaper revelation. The crux of the story was that because pregnant women cannot be used as guinea-pigs for epileptic drug testing, this drug was allowed to pass FDA drug approval and be sold internationally to pregnant mothers! So now we know who were deceived to be guinea pigs and with tragic disastrous human consequences, perpetrated by those involved with the Epilim drug coming to market.  What obscure legislative loop-hole that flagrantly allowed the next generation of patients to be born dependent on health and biotech innovations. No small wonder that the naturopath and homeopath alternatives medicines are being pursued. The human tragedy from corruption-riddled corporate activities are generally being checked but it is a David and Goliath battle. Life-changing technology of viral memes in information from the internet permeates via the whistle-blowing industry. The mega pharmaceutical company bubble that will burst for this solitary reputation indiscretion, but by no small means the only example of “willful blindness”, is Sanofi-Aventis. We don’t feel we need to look at the underlying constituents of ETFs or other funds to know that this large market-capitalized pharmaco is in major savings portfolios.

Monday, 22 April 2013

No Smoke Without Fire!

FPM's Bells and Whistles!

No Smoke Without Fire: Of Reputation Risk

Q. How can an investment firm be really worried about reputation risk and at the same time cavorting with a web of securities fraud affiliate?

A. Because ‘institutionalisation’ has created ‘big fish’ with manageable concern about the fall-out from ‘smaller fish’ troubles...

Fund Portfolio Management (“FPM”) have been observing the financial news about the vehemently committed affiliation of publicly listed Blackstone Group (“BlackStone”) and the web of securities fraud surrounding hedge fund heavyweight SAC Capital Advisors (“SAC”) and its billionaire eponymous founder Steven A. Cohen. Forbes recently ranked Mr Cohen as the 117th richest man in the world with net worth of some $9 bn.

Blackstone formed in 1985 specializing in private equity, with current asset under management (“AuM”) of $218 bn, as at end-March 2013. “Blackstone is sensitive to reputation”, was recited like a mantra to the author of this research during a due diligence meeting in 2007. With any sense of responsibility to its investors, the market reputation of SAC or related headline risks should have sent Blackstone scuttling for the exit doors and severing links long ago. At time of writing, with extended SAC redemption date approaching on June 3, Blackstone is astonishingly still invested with its client’s capital in SAC.

SAC Capital Advisors started out as opportunistic long / short equity and is now multi-strategy hedge fund formed in 1992 and with current AuM of approximately $15 bn. More than half of the assets belong to Mr Cohen and SAC employees. For investors who’ve had their head in the sand, SAC has been on the back-foot about insider trading other securities fraud cases for six years. The recent arrest of SAC’s most senior fund manager Michael Steinberg by FBI agents, has escalated the court proceedings with trial date set for November. To date nine current or former SAC employees have been charged by the US investments regulator the Securities and Exchange Commission (“SEC”), with convictions, jail sentences, fines, forfeitures and in one case the largest insider trading settlement of $602 mn. Mr Cohen has been portrayed as at the centre of this web of securities fraud but as yet only implicated and still uncharged.

As hedge funds are a people business, with ‘key man’ concerns, the character and moral compass of the principal at SAC is the categorical imperative to reputation. Even far back as 1986 Mr Cohen was investigated but not charged for insider trading. See the exclusive ‘Litany of Litigation’ compiled in the full research.  More than a quarter of a century later the US investment services regulator, the SEC and other government agencies are still targeting him in securities fraud. For this FPM alternative independent restricted research entitled ‘No Smoke without Fire’, we draw affirmative conclusions about Mr Cohen’s part in a long history in a web of securities fraud.

By Blackstone publicly allying itself to controversial capital-outsourcing vehicles such as SAC and other convicted insider-trading funds in the past, such as Diamondback Capital and Harbinger Capital – the inflicted reputation or headline risk could conceivably be more than a minor due diligence embarrassment. In fact FPM have recommended a downward stock price target for Blackstone (BX). Blackstone, via its Hedge Fund Solutions group / BAAM (founded 1990, AuM $48 bn as of 31 March 2013) is reportedly the largest or one of the largest ‘outside-money’ investor in SAC with $550 mn allocated.

Reputation damage, like forest wildfires, once started can quickly spread, given the right conditions.  Adverse reputation can indeed cause material damage to the hedge fund and its investors, litigated-stock investors (class action law suites from insider-traded stockholders) and the AI industry reputation again tarnished. In the end, FPM foresees SAC forced to close doors to external money. For SAC’s last mid-February redemption window, notices were submitted for $1.7 bn of asset withdrawals. FPM doubts SAC offset those ‘guilt by association’ redemptions through inward subscriptions, while ensnared in battle with federal regulators of the US.

In March, US District Judge Victor Marrero had ethically questioned the record $602 mn settlement being a satisfactory verdict in the long-running litigation of Matthew Martoma and CR Intrinsic of SAC by stating:

"There is something counterintuitive and incongruous in a party agreeing to settle a case for $600 million—that might cost $1 million to defend and litigate—if it truly did nothing wrong…" Judge Marrero, April 2013

Given that majority of securities fraud proceedings have not delivered a culpability or innocent verdict in ridiculously numerous lawsuit complaints related to financial services, Judge Marrero broadly raises question of standards in US legislature

For the full 25-page research FPM covers a multiplicity of aspects: FPM articulates the long relationship between Blackstone and SAC in ‘reputation risk’ terms and securities fraud within a wider paradoxical context of institutionalization of alternative investments (“AI”). The implications drawn from our research are for immediate action concerning Blackstone and SAC, but also for consideration of long-term AI issues; not just issues of securities fraud and its regulation but asset class performance from convergence of alpha and long-only beta strategies. 

The full FPM research incorporating urgent action recommendations regarding Blackstone Group and SAC Capital Advisors is available on sponsor request.

“No Smoke Without Fire!” substantiates the likelihood of Steven Cohen evading the authorities in an orderly fashion and the negative implication on investor confidence 

To ignore FPM findings is to be dismissive of the numerous independent consultancy warnings about Madoff and his now infamous ponzi scheme.

FPM predicts an imminent hedge fund scandal and fallout from SAC Capital’s trading irregularities and 5-year regulatory investigations.

FPM’s research is an importunate reminder that Galleon Group founder’s 11-year incarceration for securities fraud is merely a ‘scapegoat’ and only the tip of the iceberg.

FPM seeks to liaise with Blackstone and SAC Capital as a matter of confidential courtesy before disseminating the timely research to investors and media.

 ‘You are failing to understand the facts of the case,’ the priest said. ‘The verdict does not come all at once, the proceedings gradually merge into the verdict.
(“The Trial” Franz Kafka)

Friday, 1 March 2013

Managers of the Alternative Universe

FPM is discerning trends and themes in the fund managers metamorphic landscape. Especially vigilant of established themes as well as emerging ones . Established trends are both at once an issue of concern and an exploitable transaction opportunity for investors and rain-makers alike. The commercial premise of this article arbitrages between Established Alternative Managers (EAMs) and Fledgling Emerging Managers (FEMs).

The process of institutionalization of alternative investment managers, namely, hedge funds, private equity et al is mired in paradoxes and oxymoron. How can a once boutique nimble investment management team producing above-beta absolute returns become an unwieldy behemoth and still produce alpha? In philosophical terms:

"You cannot step into the same river twice: you will not be the same person and it will not be the same water" Heraclitus 500 BC 

These large institutional asset managers whether Ken Griffin of Citadel or Clifford Asness of AQR started as small partnerships with an edge. To FPM that’s what the ‘edge’ in hedge funds should mean! Whether it was their innate talents (almost autistic character traits of principals, such as card-counting and astute gambling skills), and / or the ability to identify, exploit and strike at big opportunistic game, allowed these once hungry-and-angry origin whizz kids to become masters of the universe while compounding 20-30% annualized returns.

The increasing amount of evidence to support FPM’s thesis of the paradox of institutionalization is mounting. We are aware of some giants from the pantheon of hedge funds returning outside investors’ money and reverting to family office status. George Soros and Stanley Druckenmiller are two prominent examples from 2011 ahead of adherence to new SEC rules on registration in March 2012; there are many others. This operational reversion to origins is obviously de-institutionalization. Though managers may cite change as being for regulatory purposes, i.e. to evade the watchful burden of increasing scrutiny from financial watchdogs, it is clear that the financial landscape since the financial crisis of 2007-08 has changed for the venerable old timers mentioned and the like.

However, some heretofore secretive asset managers have not so much thrown in the institutionalization towel as elected to join the process (which we at FPM previously highlighted as the ‘Convergence Story’). To perspicacious FPM principals this evinced ‘asset gathering’ strategic impetus rather than ‘absolute return performance’ efforts. Our due diligence in the past has distinguished between ‘asset gatherers’ and ‘performance harvester’ or ‘alpha generation’ operations. The former tend to have numerically less and even relatively lower paid investment professionals. Asset gatherers are characterized by bigger marketing department budgets, perhaps wielding big hitters in its sales force and / or using specialist brokerage / distribution outlets. By implication the star marketer would also be a partner.
For instance, the once esoteric Farallon Capital Management is marketing itself with a nine-page Institutional Investor article under the financial news service EuroMoney publications. Using the back-story of its illustrious founder Thomas Meyer stepping down at fifty-five years of age, and successor Andrew Spokes being announced as the chief. This is a process of institutionalisation via branding. In corporate lifecycle terms it is a precursor to eventual floatation and other business exit strategies. Perhaps a chance for founders to pocket or release some self-vested equity capital in 10 years or so. In February 2007, Fortress Investment Group became the first U.S. hedge fund to go public. Other one-stop alternatives managers also saw the exit door like Blackstone (BX), Och Ziff et al. Some EAMs had the exit door firmly shut in their face by the ensuing financial crisis which they strangely could not foretell from their capital markets tea leaves, though they were managing multi-billion dollars of institutional money under the premise of economic and financial savvy - Doh!

Of the many ‘pulled’ IPO alternative managers, the potent example I cite is quantitative algorithm guru Clifford Asness’s AQR Capital. His fames needs little introduction to hedge fund aficionados, and needless to say the firm is a heavyweight and managing in excess of US$50 bn at end 2012. FPM foster pioneer strategies and managers as they tend to display their real depths of spirited enterprise. Mr Asness is not only a Ph.D professor who led the group that developed statistical models in 1989 which eventually formed the Global Alpha at Goldman Sacs, but is an advocate against exorbitant fees prevailing in AI. We have tracked that he has been spearheading the charge on high fees at least since 2010. Fee reduction is a necessary feature of the convergence story between mutual fund, hedge funds, exchange traded funds et al. Whatever Mr Asness’s motives, even if not altruistic, he seemingly is admitting that his own technology-based alpha is not especially genius! Perhaps partly the rationale for AQR’s unsuccessful planned cash-out of 10% stake as early as July 2007. We commend his fee integrity (yet as a made-billionaire backstabbing late hedge fund entrants as barriers – You’re ‘Avin Laugh!). In his own words about the state of the fees from a recent conference speech:

"Most hedge fund strategies are more about very competent implementation and fair fees and terms [institutionalization] than they are about 'genius’… Hedge funds generally offer a nice portfolio (gross of fees!) of passive beta, alpha, and a middle ground we call hedge fund beta or style premia; but unfortunately, managers like to charge fees as if it's all alpha” 
At FPM we view the ‘branded institutionalization’ of the alternative investments (AI) industry trend with diligent skepticism. Concerned that a) founding principals with the innovative investment technology wits are operationally and executively not at the helm henceforth and b) merely seeing institutionalization as a stepping-stone opportunity for retirement and/or cashing out from the global institutional operations they painstakingly established and developed. In private equity investor partnering parlance ‘divorce and separation’ is the end. FPM’s reservation on this trend cogitates on the idiom that institutions are now content to invest in the golden egg but not the goose that laid it! Hence why there is naturally a lot of noise about backing fledgling emerging managers in the burgeoning alternative space.

Other than institutionalization features relating to key man, fees, cashing-out, and regulation there are other salient aspects of transparency and reputation. These cannot be irrelevant or ignored concepts, especially now in neural/viral wired-up multi-media cyber globe. Whistle blowers, disgruntled staff, disillusioned investors, anti-capitalism activist, email trails etcetera all become source of unofficial non-public information.  The prevailing reputation of a manager with small asset under management (AuM) is all important to its preservation. Otherwise even any alleged fraud can change its fortunes quite quickly, for the better or worse. Therefore with partnership self-interest they are less inclined to risk their good repute with fraud or other corporate misdemeanor mischief or downright shenanigans. Managers consciously protect and preserve the firm in positive light to the privy circle of co-participants in the ‘edge’ investment game. Degree of transparency to regulators, or institutional publicity in media is often minimal in niche partnership family-office type investment operations. Indeed investment regulation limited whom unregistered investment vehicles could market itself to (‘qualified investors’ only), and to whom the manager had obligatory reporting duties.

Since this note's premise explores why size matters in investments. Investment flexibility and alignment of interests are other considerations when deciding to park with large managers. For instance, on investment position sizing, the principals of the partnership may decide that a high conviction risk-on trade is permissible. Institutional policy tends to be compliant with oversight regulatory bodies. Bodies which monitor and dictate risk parameters to larger registered money managers. An essential feature of alternative investment mandates is the scope of flexibility in investment asset and strategies, within given private placement memorandum. This flexibility is further watered-down in larger institutions as key man / principals may delegate investment risk decisions to vested investment committees.

Blackstone Alternative Asset Management (BAAM) is the world’s largest discretionary allocator to hedge funds, with $46 billion in assets under management as of December 31, 2012.” Source: blackstone.com

For example, BAAM started out as family size operations:  In 1990, Blackstone created fund of hedge funds business to manage the internal assets and that of its senior managers of the then mainly private equity core business.
FPM’s due diligence identifies institutional managers by the degree of the managers’ alignment with its clients / investors, essentially by a ratio measuring principals’ and internal capital to that of the fund or firm AuM: 

"Most importantly, our interests are always closely aligned with our clients' with over $1.3 billion of the firm's and employees’ assets invested alongside those of our clients." Source: blackstone.com

So US$1.3 bn of “firm’s and employees” assets of a total US$46 bn in AuM is the extent of alignment of BAAM fund of hedge funds business to its clients. This is much much lower ratio than at the turn of millennium, when alternative investments and industry bellwether Blackstone Group came into institutional prominence, at the height of the DotCom bubble. BAAM acknowledges its own asset  gathering impetus on the Blackstone website “Over Ten Years of Asset Growth”. To FPM’s long memory BAAM’s current ratio of mutual investment interest is poor evidence of economic alignment between a firm and its clients. Further, asset growth is not the same as asset performance.

Often profitable niche business is kept close to one’s chest and a privy few as a closely guarded money-making secret. How many professional investors understood or had ‘the edge’ in exploitatively spotting the US housing bubble through the sub-prime market in 2007-09, and then were also able to make an ‘absolute’ killing? Certainly only handful of investors, from reading the Gregory Zuckerman book “The Greatest Trade Ever” concentrating on Paulson and Co.

Damaging reputation to a manager with large asset-base can lead to assets walking out of the door, which can be successfully public-relations-managed as an operable hemorrhage, given time. This mega asset base providing a substantial buffer / margin against sudden multi-million liquidity shocks is the implicit explanation as to “why big hedge fund gets bigger”.  In the same scenario smaller AuM hedge fund firms founder. Large institutional investors tending to pile into the perceived relative safe-haven of hedge funds and other alternatives are sacrificing absolute performance for cash preservation mandate. Understandable that strong absolute return performance is incompatible with cash preservation, but here’s the bewilderment. Even accomplished pension or proprietary capital administrators allocating to hedge funds are overlooking ‘alpha generation’ while allocating in an ‘all-about-alpha asset class!’ Further, these savings administrators believe they have to pay “2/20” fees for core low volatility portfolio cash preservation mandate. Why don’t they invest directly in cash bonds! It’s the same mockery and folly as an airline marketing its premium first class seats as plane-crash-risk-proof. All the seats are the same in the aero plane and subject to the systematic risk of it going down (unless the first class seats are re-enforced with steel bars like that cockpit of fast-car drivers or fitted with parachute ejection seats).

Performance of hedge funds as an asset class, as indicated by a benchmark index average, fared only marginally and negligibly better than equity market index, such as the S&P 500, over the recent systematic financial crisis. Then as stock markets recovered from an approximately 50% drawdown, hedge funds underperformed (and some threw in the towel unable to reach high water mark and thus earn performance fees). In the long-run the convergence story depicts falling alpha and alignment of hedge fund performance with market, asset, or strategy index. Achieving index returns by hedge fund portfolio managers (like conservative FoFs) in absolute return investments is a misnomer or sheer debauchery of AI. Similar to to turning a thoroughbred racing horse or stallion  into a rocking-horse! The tilt in favour of hedge funds comes from alternative managers being able to acknowledge gross of fees…

[ For a complete business proposal based on this note please email FPM with link]

Friday, 8 February 2013

Investment Sector Outlook for 2013: “Credit is a Lover on the Re-bound?”

FPM considers the macro speculation that policy makers’ credit cycle stimulus is in musical terms at a moderata end in 2013. The high flying segments of the credit asset class are behaviourally like a spurned or unreciprocated lover on the rebound to the next ‘pick-me-up’ lover. FPM’s analogy is that eventually this new quickly formed, on the bounce love-affair is checked. And in the end not lasting or enduring, as it was a hastily formed affair from hurt ego and pride following a more secure stable relationship or courting. We feel the stellar ‘dead-cat bounce’ from credit-bubble bursting in 2007-08 should unwind. Especially so in mortgage credits and leveraged loans. Not forgetting that these segments of credit were in greater proportion the underlying constituents of structured products dubbed ‘toxic’ CDOs, CLOs et al. The credit collapse should eventually be precipitated by the un-leashing of inflation expectations. Turning off credit stimulus is the first step. This view rhymes with some professionals predicting a strong equity market rally. Also, in this article we review our credit opinions expressed in September 2011 in “Credit Markets @Optimistic Workout Inflexion Point”. The hedge funds we recommended in that article, such as the Chenavari ABS Toro and the CQS ABS funds FPM put on “Review / Redemption” rating.

Our view is based on policy-lead from the US Federal Reserve and understanding of cyclicality in capital markets. The Fed’s minutes of its recent Federal Open Market Committee’s (FOMC) December 11-12 meetings hinted at reversal of policy by some of its members. Particularly toward halting the policy of monthly purchases of US$45 bn in Treasuries and US$30 bn in mortgage related securities.  Minute extracts:

“Several others [of the FOMC members] thought it would probably be appropriate to slow or to stop purchases well before the end of 2013… citing concerns about financial stability or the size of the balance sheet, which has grown from $869 billion in 2007 to over $2 trillion.”

In hindsight, policy makers or establishmentarianism turning off the bankers’ credit tap has been inevitable, or put another way long-time coming. Especially when considering the subsequent bargaining in ‘fiscal-cliff’ discussions at end-December 2012: whether to continue Bush-era tax holidays for all except US$400,000+ earners. In budgeting terms, something often has to give, or philosophically “be sacrificed”. FPM are aware that until final budget and national debt discussions are concluded in late February /early March there might yet be other compromises in American austerity drives. Set your calendar alarms to March 1st announcements on this.

After all, how long can the prime-and-pump machine churn-on towards inducing improved confidence and sentiment in economic activities and capital markets. The Great Depression could not be one if it was over in five year! Despite reserve-currencies ‘printing-money’ and the associated moral hazards in an increasingly interconnected global economy, concerted economic policy response has been credit expansion.  Inflation could still well be a scenario for debt devaluation. Inflations has been abated/ repressed or even manipulated in reserve-countries. Statistically, inflation is failing to measure a relevant representative basket of goods and services. Multiple academia and statistical research have distortedly indoctrinated professionals and public that ‘perceived inflation’ was higher than ‘actual’ reported cost of living because the basket constituents that were rising were repeat purchase items like food and other living day essentials. So price of cars or other durable goods and services deflating would be less noticeable, yet these heavily-weighted goods in the inflation basket more influence the ‘actual’ inflation. So like manipulation in LIBOR, we may understand that inflation measurement baskets are not representative to most of the population, who do not buy new cars repeatedly! Admittedly there are other prevalent inflation-mitigation factors than simply a pacifying behavioural finance explanation for biased inflation data. For example, China and other developing countries are globally exporting deflation through the activation of lower cost-base economy and globalisation trends in general.

The above mentioned moral hazard comes from the value of money becoming meaningless.  Capital is meant to be a finite resource in most economic models, even in an open economy.
Yet modern finance practice has advocated printing money aggressively to stave-off recessions and depressions. Castles in the air capital can be written-down to realign assets at fair value. Remember that majority of capital is ultimately quantified and recorded in global accounting and banking systems as assets and liabilities in global forex terms at any one time – excepting “fringe economy” / black-economy activities.

Writing-off of all bad debts based on bubble-valuation of certain house and financial asset prices was not an option for the banks at the onset of the financial crisis. Propping-up valuations interferes with laissez-faire market principles. Cited in ‘main stream media’ due to the strategic importance of housing and financial sectors to the wider economies (…remember even the short-term commercial paper markets froze at height of crisis due to the helm of the then capitalism masters). Even though some $600-800 bn of ‘bad vintage’ subprime was inevitably written-down signalling the catalytic economic downturn. Almost like a script from past crisis. Write-downs are no longer an option, as bank-sponsored toxic assets are now in the hands of taxpayers as collateral for government guarantees and loans. Unsecured lending is not feasible with fragile confidence in counterparty-risk. The better quality credit tranches have been hand-picked by cash-rich investors like Blackstone, Blackrock and other asset managers at fire-sale or heavy discount prices. For now it seems to be a pirate’s or vulture’s bonanza for them and their investors. FPM envisages a probable scenario in which these re-capitalised assets and their underlying debt obligations become distressed as the government credit taps is turned-off. As general interest rates tick higher so will bad debt problems.

If the ‘toxic or legacy asset’ collateral against which Governments have been lending to banks do not continue to perform in line with overall reasonable economic expectation when ‘Quantitative Easing’ stops, then another wave of write-downs and blowup-entities should follow. Fear may persist keeping capital expenditure and corporate deal making shallow. FPM certainly believes in this probability of ‘multiple-dip recession’ cycle started in 2007-08. Markets are reflecting this in sideway trending benchmarks with intermittent bull-runs, flash-crashes and dips. Economists Reinhart and Rogoff have suggested a 10-year of de-leveraging process.

Remember that allegedly towards fiscal-boosting the economy amid a bubble-de-leveraging cycle, the emergent alternative media libertarians (enabled by blogging and internet at large), have slavishly and bearishly flagged and criticised policy maker plaster-fixes. Government will no doubt have assets and liabilities in their ‘bail-out’ accounts that do not match, and therefore require further deficit-funding to keep fundamental balance sheet integrity. Together with ‘austerity’ impact and other public repression possibly causing populist uprising in mainstream European Union and American states, geopolitical risks are high on the cards. Already this is occurring in fringe states. Where protests and demonstrations occurs in UK and US, authorities have only been too quick to quosh it. Witness ‘Occupy Movements’ in London, New York and other cities.

If only vigorous and unabated expansion of fiscal and national deficits of global Governments could continue! To bring the vividness through a comparably simpler model, think of pension funding mis-match in assets and liabilities for settling retirement policies and the consequences on retirees. Many pension-dependent hopes and expectations have again been dashed in these too often de-leveraging cycles. Resulting in postponing retirement or reduced perpetuity income in effect living poorer than promised. Even if retirees were money-wise and fortunate to have multiple assets such as properties and investment portfolios they will still feel wealth destruction. Less retirement homes in the sun are being bought in affordability terms to settling for a mere sunshine holiday.

This is why we believe banks and other financial intermediaries are siphoning off / farming-out money to other institutions as investments. Hedge fund and buy-out firms are filling the void of traditional bank lending and securitisation. This shift in liabilities has hidden risks too. Consider the effect and implications of Volker rule as evidence. The global banks themselves have still to maintain sufficient ‘individual bank-tested’ reserve capital to insure against future non-performing loans and gradually correcting house and financial asset prices. Hence why traditional global banking prospects have and are in the mire (in spite of upbeat ad hoc quarterly earnings reports). Alternative financial firms are rampantly being established as the shadow banking system. If Volker is acting in a  middle-man / double-agent role between financial and government interests, then who is serving? The newly-established asset managers mentioned above and host of others are known to FPM via its Fund Manager Transactions proposals.

Following on from our last thought-leader: Investment Sector Outlook for 2013: “Volatility in Vogue”, some of the above mentioned political market-interference has caused Vix-measured implied-volatility to drop to a five-year low in S&P 500 equities. And no doubt other financial and capital asset volatilities have also markedly diminished. Simply from lower economic activity caused by current and future macro economic uncertainties.  These fundamental uncertainties are referred to in financial cant as ‘sentiment and confidence’. Whether one is a consumer, investor in capital, Government employee or importer/ exporter (gdp=c+i+g+[x-m]), doubt causes catharsis or stagnation until resolve is found in endeavours to carry on economic transactions. The current economic stagnation, or euphemistically anaemic growth, is a macro fundamental fact which has been alleviated to-date by Governments, and therefore by implication future taxpayers. Though we are economically not out of the woods, policy-makers can no longer interfere with free money or ‘crowd-out’ capital investors by effectively capping interest rates. Fundamentally disrupting creative-destruction by controlling the price of capital to save Strategically Important Financial Intermediaries at the expense is taxpayer is moral obliquity and lacking sense. FPM believe policy-makers’ job is done after having successfully prevented economic freefall post-Lehmans 2008, now we feel they should let go off the economic reins and let free markets indulge in creative-destruction. FPM has less care for QE supporting banks and more will for interest rates to rise - yes it does matter whether one is a still net lender or borrower after maelstrom of the past five years.

As if to affirm direction for the economy at this forward-looking time in the Gregorian calendar, we in the UK have seen the headlines about the almost final demise of yet another long standing high-street retailer. His Masters Voice or HMV, a music and media distributor with a 90-years history and currently 230 stores employing 4,000 staff went into administration. This was after failing to secure a £300 mn credit line from its suppliers in a last ditch effort. The bank had breached its banking loan covenants in December. This circumstance surrounding its failure, not too dissimilar to the closure of the venerable Kodak company at the beginning of 2012, not only highlights flaws in its commercial raison d’etre but to us reflects a ‘zombie’ company unable to improve deteriorating asset values on balance sheet while outweighed by its liabilities. Creditor call was triggered without recourse to sufficient internal restructuring. We hope restructuring of the old business is possible in administration and emerging as a leaner brand. We had witnessed other UK high-street brands disappear, mostly new arrivals but also back in 2008 an age-old Woolworths. Behavioural finance suggests that when investors are apathetic to corporate and market foundering news over time then they are also expectant of real good news.  

So we have ultimately predicated that the credit asset class will become increasingly volatile before an eventual correction in prices from a) speculation and eventuality about the inevitable interest rate hikes and b) subsequent credit-quality concerns and defaults in the economy overall and c) triggers / catalysts in distressed credit sectors that have thus far re-bounded and propped-with-stimulus. Such as sovereign debt in European fringe countries with contagion into Spanish and French sovereign debt concerns, student loans in US, credit and consumer loans, commercial mortgages, leveraged loans.

Credit souring is as inevitable as re-bound affair not lasting. Lastly we leave you with a vogue investor’s voice on the credit cycle. Ray Dalio, founder of US$120 bn AuM Bridgewater Associates, speaking at a conference in December 2012 said “The biggest opportunity will be shorting bond markets around the world”. He also suggested that interest rates will rise in late 2013.

PLEASE DO CONTACT US: kristian.siva@gmail.com