S&P

Economic ‘Potholes’ Ahead

Gemma Godfrey highlights the factors that could cause a pullback in markets and provide buying opportunities, on CNBC’s Fast Money. Published on cnbc.com by Bruno J. Navarro.

Disappointing growth in Germany, the potential for political deadlock in Italy and corruption allegations in Spain appears to be increasing risk.

Market elation has been a little bit too early, moved a little bit too far, and there are these potholes that actually could cause markets to stumble, at least in the shorter term. Markets do not like uncertainty, and the longer this continues, the longer the uncertainty is over the markets, the more likely is it will have a pullback.

The U.S. stock market is approaching 500 days since a 10 percent-plus correction, which she said was the tenth-longest time in history that such a bull run has occurred.

And it means when we’re looking at where valuations are , they’re no longer cheap with respect to the U.S. market, growth isn’t coming through as we thought it was going to come through, and you’ve got this level of uncertainty, meaning that it is more likely that these momentum followers – for example, the hedge funds are buying into financials – that they’re going to start to stumble.

But I do think that that means if we do see a correction, it could be muted because it’ll be a fantastic buying opportunity for those investors that are looking to rotate back into risk assets because over long-term, we’re actually more bullish about equities.

Low interest rates, credit spreads at multiyear lows and the prospects of a return to growth could still bode well for equities.

What the market needed was confidence and the return of depositors to put their money into European banks, something that hasn’t happened sufficiently.

All of that gives us slight cause for concern, meaning that we’re growing more cautious shorter-term, although, obviously, more bullish longer-term.”

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And just a reminder of why Spain has been able to withstand bailout pressure and markets have shrugged off European woes until recently…

How to handle hedge fund investing

Whilst at GAIM, the world’s largest alternative investment & hedge fund conference, it was hard to ignore both the issues the hedge fund industry face and the opportunities from which they can profit. So how can you, as an investor, handle hedge fund investing? Be strategic, be sensible and speak up….

Fees – How can you challenge them?

Bigger isn’t always better. Instead it was the larger funds that had trouble liquidating large positions to meet redemptions in 2008 and this was amplified in Fund of Funds structures. The resulting side pockets and gates, which locked up investor capital, burned bridges. Therefore, funds merely offering access to large ‘star’ fund managers with limited attention to downside and liquidity risks no longer appear to be as wise an investment as once perceived.

A due diligence downfall.  Some funds of hedge funds had exposure to Madoff and other hedge fund failures. Therefore, ‘outsourcing’ hedge fund investment to a dedicated fund manager did not always reduce risk.

Strategy choice – Does it matter?

A ‘typical’ hedge fund does not exist. A hedge fund index is an artificial averaging of a wide range of performance data. In fact, over the past 2 years, the best performing hedge fund strategy has generated 160% more return than the worst. Yes, 160%! Even year to year the rankings change. By investing in completely different assets, implementing vastly different investment processes, hedge funds can perform in entirely different directions in a variety of market conditions.

Source: http://www.advisoranalyst.com. Hedge fund strategies ranked by performance each year, showing the variability in strategy leadership.

Value – How can hedge fund investments benefit your portfolio?

Well-equipped. With doubts over the sustainability of the ‘recovery’ in the developed world shaking equity markets; turmoil in the middle east creating volatility in commodities and the sovereign debt crisis rocking the bond markets, having a wider range of tools to exploit the uncertainty is valuable

A diversifier.  Widespread fear and the increase of speculators in certain markets has resulted in heightened correlation between asset classes, for example, equities and commodities have been moving inline…. An active manager who can provide uncorrelated returns to diversify a portfolio and steady the return profile again is attractive

Differentiating. In contrast, correlations between investments within each asset class are falling. The FT recently reported that the correlation between stocks in the S&P 500 index has fallen to levels not seen since June 2007. This means there is a widening divergence between returns.  Therefore, the ability to differentiate between opportunities within a subset is a strength of active over passive investing.

So what can you do?

Be strategic: strategy choice matters so utilize your views on the macroeconomic environment to help determine which strategies in which to invest

Be sensible: ensure funds deserve the fees they are charging, e.g. are focused on portfolio construction, generating returns from niche strategies, and structured appropriately with the redemption frequency matching the liquidity of the underlying investments.

Speak up: it is as important for BOTH sides to manage expectations to avoid redemptions from investors, and side pockets from funds.

Emerging Markets – Crucial Points to be Aware of When Investing in the “Region”

What Investor Excitement Is Ignoring….

Inflation is like sin; every government denounces it and every government practices it – Frederick Leith-Ross

One of the most interesting market moves in 2010 was the significant outperformance of US equities over Chinese, despite far weaker GDP growth numbers. What many missed is the fact that it is not absolute values but relative figures / surprises which move markets. With this in mind, is it worrying that the consensus for China’s long term earnings growth is forecasted at 18%? Not much room is left for upside surprises, but there’s plenty of space for disappointment!

Source: "The Surprising truth about Investing in the BRICs" on Nicholas Vardy's The Global Guru, http://www.theglobalguru.com/article.php?id=340&offer=GURU001.

Therefore, it is important to be aware of the issues and risks associated with the region to be able to decide not only what to invest in but how to size the investment accordingly, inline with risk / return targets. As expressed above, it is crucial to judge what you believe is already priced into the markets and what pose as upside or downside potential.

Short-Term EM Risks

Short-term cyclical factors can overshadow long-term structural trends

INFLATION: the index used to calculate inflation in EM has double the exposure to food prices than in the G10 (developed countries). Using the price of wheat as an example – an all time high was reached at the beginning of this month, highlighting the magnified pressure felt in the region which may spook investors. From another angle, fiscal policy in China led to a 30% growth in the money supply (M2) in 2009, increased by almost as much again last year, stoking inflationary fears (since with more money around, it becomes worth less and more of it is required to buy goods i.e. goods become more expensive)

ALLOCATIONS: a record percentage of portfolio managers are overweight Emerging Market equities. The combined net assets of the two largest EM ETFs are now above that for the S&P 500, despite the US equity market being ~4 times the size of the investable EM universe.

Long-Term EM Risks

Long-term demographics may negatively affect the working population

AGE TRENDS: the biggest drop in the young working age population is “set to take place in China,” a result of its one-child policy.

ACCESS TO EDUCATION: Of the top 50 universities, only 3 are based in emerging market countries and the highest stay rate is among Chinese students. This means that in order to get a top quality education, the youth of Emerging Markets may have to study abroad and if they do so, may end up staying, greatly limiting the young, well-educated working class of their homeland.

EM Stock Risks

Do due diligence on the companies you pick – you may not be getting the exposure you want

EXPOSURE: just 14% of EM market cap is represented by domestic-facing sectors (i.e. not all EM stocks give investors exposure to the rise of the Consumer and the “Domestic Demand” growth story, a main reason for investment)

GOVERNMENT INTERVENTION: Within the EM stock markets, government ownership of companies is significant. For the Chinese market, 67% of its market cap is government owned (35% in Russia, 29% in India and 14% in Brazil). Putting this in context, in the US, at the height of the financial crisis, government ownership was about 3.7% of market cap. The importance of this should not be underestimated. It means that at times, within EM, a majority government owned entity may not be acting entirely in the interests of the investors.

STOCK EXAMPLE: Petrobras (PBR):  Brazilian government and its affiliates own about 64% of common voting shares. The offering documents state that “the government, as our principal shareholder, has and may pursue in the future, certain of its macroeconomic and social objectives through us.”

INVESTMENT INSIGHT

Therefore, in conclusion: Be aware –

Short-term cyclical factors can overshadow long-term structural trends

Long-term demographics may negatively affect the EM working population

Do due diligence on the companies you pick – you may not be getting the exposure you want