Month: April 2011

Hedge Funds – to be Feared or Favoured?

As the biggest hedge fund insider trading case comes to a close, we are reminded of the risks of investing in the asset class. Ever since generating losses in 2008, the reputation of these ‘absolute return’ vehicles has been damaged. The Madoff scandal which topped off the year did not help. Nevertheless, whilst clarity in the markets remains illusive and with a wider range of tools to exploit opportunities, are they a form of investment to be feared or favoured?

A Tainted Asset Class

Disappointed and disillusioned, many investors are reluctant to revisit the asset class run by managers once hailed as the new “masters of the universe”. Sold on the promise of generating positive performance in any market environment or at the very least preserving capital in times of stress, losses generated in 2008 came as a shock. With the Madoff scandal came the realization that even funds that did consistently generate steady returns were not immune to trouble. There is even an aptly named “Hedge Fund Implode-o-Meter” website tracking the number of major funds which have “imploded” since late 2006 (out of interest the number at last look stands at 117, although this includes all funds suffering any form of “permanent adverse change”, not just total shutdown).

But Not All Are Created Equal

Not all hedge funds should be tarred with the same brush and although grouped within the same category, they can differ tremendously. From the investment vehicles in which they invest to the stringency of their risk management, not all are created equal. The Hedge Fund Association summed the situation up succinctly with the assertion that “investment returns, volatility, and risk vary enormously among the different hedge fund strategies. Some strategies which are not correlated to equity markets are able to deliver consistent returns with extremely low risk of loss, while others may be as or more volatile than mutual funds.”

Losses Were Often Greater Elsewhere

Putting aside the often misleading ‘absolute return’ banner, the average hedge fund was better able to preserve capital through the market downturn than a regular ‘long-only’ mutual fund. Whilst the MSCI World Index fell 42% in 2008, the Credit/Suisse Tremont Hedge Fund Index fell 19%, More impressive still were the 21% of funds which posted positive returns for the year (the majority of which were up double digits). Crucially, over a more appropriate investment horizon of 3 years, according to figures by EDHEC Business School, “The majority of hedge funds delivered better returns than the S&P 500 index”. Hedge Funds have shown themselves able of generating highly attractive returns.

The Tide Has Changed

Investors have demanded more. In 2008 they ‘spoke with their feet’ and the hedge fund industry suffered $782bn of redemptions. The Hedge Funds had to listen. What was requested, according to a report by Scorpio Partnership, was “transparency, simplicity and liquidity”. Likewise, the Hedge Fund Scandals were a wake up call to investors and much more focus is being placed on operational due diligence, to avoid investing in any future hedge fund failures.

Investment Insight: Well-Positioned to Exploit Opportunities

With the risk of future macro shocks clouding the horizon (read: Japan, Middle East, EU Sovereign Debt), the direction of the markets is somewhat hard to predict. Therefore investing with flexible managers able to react to the quickly changing environment and nimble enough to exploit opportunities when they present themselves seems an attractive move. Not all investments are created equal, some are more equal than others.

Libya – Oil, Water, Gold – The Real Issues

The oil price has sky rocketed over the past few months. The finger has been pointed at the troubles in Libya and claims of supply disruptions have dominated the press. However, are these claims grounded in fact or are we watching yet another sentiment driven bubble? What are the issues we should be aware of and how should we best invest in the face of such turmoil?

Expectations are often more damaging than reality

Libya’s contribution to global oil production is in stark contrast to the column inches it has been awarded in the press. As quoted by the National Journal, the country produces around 2% of the world’s oil. OPEC (Organization of the Petroleum Exporting Countries) has claimed that they have managed to “accommodate most of the shortfall” and instead attribute the rise in the oil price to fears of a shortage rather than any genuine supply issues. Oil reached a 2.5 year high last Friday. This is against a flattish demand side dynamic. Paris-based International Energy Agency and the U.S. government’s Energy Information Administration left fuel demand growth for this year unchanged and OPEC only raised their forecast by a relatively small amount (to 87.9m b/d from 87.8m b/d).

Note - this chart also highlights the Crude vs. Brent trade with the discount at record levels. Source: http://www.tradingnrg.com/crude-oil-price-forecast-recap-for-march-and-outlook-for-april-2011/

EU Sanction: A further boost for the oil bulls

On Tuesday, the EU extended sanctions against Libya to include energy companies, freezing assets in an attempt to force leader Muammar Gaddafi to relinquish power. Phrased another way, by the German Foreign Minister, this is a “de facto embargo on oil and gas”. Approximately 85% of exports are for delivery to Europe and importers will now have the task of finding potentially more distant and/or expensive alternative sources.

The pent-up downside risk

Nevertheless, many are not paying attention to the downside risk to the oil price as we move forward. Libya has Africa’s largest proven oil reserves but 75% of the country’s petrol needs are met with imports because of limited refinery capacity. Any improvement on this front, if a regime change is eventually secured, could significantly reduce imports and boost global supplies.

 Is water the next oil?

In addition to oil reserves, one asset belonging to the Libyan government which is rarely mentioned is an ability to bring water to the desert. With the largest and most expensive irrigation project in history, the $33bn GMMR (Great Man-Made River) project, Libya is able to provide 70% of the population with water for drinking and irrigation. The United Nations estimates that by 2050 more than two billion people in 48 countries will lack sufficient water, making this an enviable asset indeed.

How can the US pay for the Libya intervention?

It is interesting to note, with all the claims being made that the intervention is oil motivated that, Libya has another form of ‘liquidity’.  According to the International Monetary Fund (IMF), the country’s central bank has nearly 144 tonnes of gold in its vaults…

How to best invest: Retain context

The tide is starting to turn, Goldman Sachs has called the top for commodities in the near-term and oil fell by 4.5% on Monday and Tuesday alone (Source Bloomberg) . With this amount of volatility, short term noise can sometimes overwhelm. For a long term investor, looking for steady and stable returns, an ability to cut through the sentiment (whilst acknowledging it’s importance in driving returns in the shorter term) is valuable. Often many factors are at play and it will ‘pay dividends’ to be well-informed as they become wider known and priced in by the markets. Knowledge may be king but preparation will come up trumps.

How to Invest in These Markets

Click HERE to see Gemma Godfrey on CNBC\’s European Closing Bell

Gemma Godfrey, Chairman of the Investment Committee and Head of Research at Credo Capital, and John Authers of the Financial Times on CNBC’s European Closing Bell. Discussing how you should invest your money.

Join Guy Johnson and Louisa Bojesen for a fast-paced, dynamic wrap up to the trading day. “European Closing Bell” gives an in-depth analysis of the day’s market action and includes expert analysis from the major players in the European business and financial world.

The ‘Surprises’ of the Japanese Crisis and the Investment Lessons to Learn

Success is not final, failure is not fatal: it is the courage to continue that counts – Sir Winston Churchill

The human suffering of the earthquake and following tsunami in Japan is well documented. Exceeding the magnitude of Kobe both in strength and structural damage, the final cost is unknown and the aftershock which occurred yesterday did nothing to abate the concern. Surprise consequences have revealed significant weaknesses in both the word of politics and business and from an investment point of view, there are lessons we can learn…

A Political Surprise – Germany

The ruling party in Germany was voted out of office in one of its most prosperous states after almost 58 unbroken years in power. If they lose one more state election in September, Merkel could face a “blocking majority”. Despite voter concerns over the EU rescue fund (which they see as a potential ‘bottomless pit’) and claims leaders are out of touch with business, the surprise came as instead the loss was blames on Japan. After extending the life of 17 nuclear power stations and then calling a 3 month ‘thinking period’, politicians claimed the nuclear crisis swayed voters towards a Green anti-nuclear coalition.

 

A Business Surprise – Car Makers

The other surprise came to the heads of car making companies. Reliant on tight inventory management and a high proportion of electrical components, the supply chain interruptions from suffering Japanese suppliers hit these firms hard. What surprised them the most was the fact that a lot of these electrical components came from a single source. Since these were often parts sold to previous firms to be built into other parts then sold onto car makers, this concentration risk was not identified. In reaction Peugeot, Europe’s second largest auto maker by volume was forced to slow production at 7 plants in France and Spain. Japan’s Nissan saw the affects lasting for at least a month and started importing engines from their US plants – a reversal of a trend.

 

Source: Bloomberg – Since March 11 2011, the date of the earthquake, Peugeot (white) has caught up with the MSCI Wold Index (yellow) whereas Nissan (orange) is still struggling at a 13% lower level – all performance normalised.

The ‘Crisis Effect’– Luxury Goods

In reaction to the devastation, many in Japan are spurning conspicuous spending. Tiffany lowered their earnings expectations and expects Japanese sales (a fifth of their total) to fall by 15% in Q1 against retail demand rising 11% on average across the rest of the globe. Bulgari has now re-opened all but one of their 40 stores but, as one of their biggest markets, sees sales remaining weak for at least 6 months. This 6 month figure may have been derived from a comparison with the Great Hanshin earthquake, Kobe, back in 1995 where the after-effects were felt for approximately this length of time. However, this time around there have power cuts affecting populous areas, supporting concerns this is over-optimistic.

 

Source: Bloomberg – Bulgari (orange) hardly moved post-earthquake despite earnings concerns whereas Tiffany (yellow) was hit hard (-11%) but has also staged an impressive recovery (+11%)

The Bottom Line – Heightened Uncertainty

What this all highlights is the heightened level of uncertainty we are dealing with. There remains the potential for events few of us could predict, with consequences which come as a surprise and, those that are temporary, with a hard-to-forecast end date.

 

Investment Insight: The Lessons we can Learn

There are clear lessons we can learn. With a global recovery still open to macro shocks, it is prudent to remain active with an ability to protect your portfolio, whether through managers that can reduce their net exposure to markets or otherwise. And from a more stock specific point of view, know companies in which you invest well, including the full length of their supply chain and the true resilience of their client base. It’s true that crucial, often overlooked details are often only realised during times of stress, and this is by far one of the most tragic. Never stop learning.