Hedge Funds did well in August. Should we worry about EM?

This year has been terrible for funds short the stock market and a great year for those who bought bargain price bonds. It seems that the central bank money is helping out the fixed income funds- convertible arb has had an amazing year with 35% returns YTD.

Below is a summary of the action so far, expect more analysis later.

Credit Suisse/Tremont Hedge Fund Index (“Broad Index”) will finish up +1.68% in August
This is the sixth straight month of positive performance.

Wide dispersion in returns across global equity markets last month- EM in trouble?
Shanghai equity markets closed down over 20% , US and European markets peaked mid-month, reaching their highest levels since October 2008.
-This is concerning. I am going to look at more EM markets and see if we have an EM crisis coming up.... The EM central banks are weaker and cannot print money to support their debts... As the G-10 countries start saving more will the export oriented EM countries have a much harder time?

Small caps in Japan do better after elections
In Japan, markets rose modestly following the country’s national election and Japan-focused Long/Short Equity hedge funds were up approximately +1% for the month on average, benefiting primarily from stock selection and outperformance by the small-cap sector of the equity markets.

As a whole, Long/Short Equity managers had a generally positive month, finishing up an estimated 1.42%, while Emerging Markets returned an estimated 2.18%.

Event driven reaping benefits of special situations area
Event Driven managers returned approximately +2.46% for the month as managers continued to take advantage of tailwinds in equity and credit markets in the distressed environment. The majority of investment opportunities in the space currently appear to coming from the special situations area.

Global Macro, Futures etc. continue to do well
Managed Futures posted returns of 0.79%, representing their second positive month of performance so far this year (the sector was up +0.85% in May). Many managers in the strategy have struggled for most of this year, although trend followers appear to be beginning to show profits as models gain more traction. The Global Macro sector also experienced positive returns in August, posting a +0.94% gain as commodities-focused managers capitalized on rallies in metals, sugar and certain other softs.

Convertible Arb is back over this year after a horrible last year (up 35% over the year)
Convertible Arbitrage extended its run of positive performance to eight consecutive months, finishing up 3.37% in August, as opportunities in the space remained strong. Performance was muted, however, in comparison to returns of the past four months, when the strategy posted consecutive monthly returns of greater than 4%.

Fed helps Fixed Income funds do better
The US Federal Reserve and US Treasury announced an extension of its $200 billion term asset-backed securities loan facility (TALF) program, adding an additional three to six months from its original end-of-year expiration date. This was welcome news to many fixed income investors and relative value managers who had an overall positive month. Fixed Income Arbitrage managers are now up 2.39% year to date.

I will be back! with lower risk premia do we say hurrah?

So I am... passed my generals for the Ph.D. Loads of academic papers read.. few retained :) I am now going to think through this "rally" that has failed to cross 1000. Views on FX where the dollar has gone down against the Euro. Commodities etc. also included.

Interestingly funds have been having a good time..quite a bit of which comes from lower risk aversion- notice how the risk premia has narrowed and closed end fund discount- another measure of risk premium is narrowed down. In fact various risk premia narrowing is the key point/theme in all the "news" below.

- For the third consecutive month both equity (+10.28%) and fixed income (+4.58%) closed-end funds (CEFs) posted plus-side returns. Both macro-groups posted eye-popping returns for the three-month period ended May 31, 2009.
- On the stock side Mixed Equity Funds (+13.81%)-catapulted by Income & Preferred Stock Funds-and World Equity Funds (+13.39%) outpaced the Domestic Equity Funds (+7.76%) macro-classification.
- For the month 99% of all CEFs were able to post plus-side returns, with 100% of bond CEFs and 99% of equity CEFs chalking up returns in the black.
- Bond investors continued to be less risk averse and yield seeking in May, pushing Loan Participation Funds (+7.74%) and Global Income Funds (+7.29%) to the head of the class.
- In May the median discount of all CEFs narrowed 73 basis points (bps) to 7.96%. The largest narrowing of discounts (454
bps) was seen in the World Income Funds macro-group.

Bond Funds getting money and large cap stocks are facing redemptions

- The bond funds macro-group (+$13.8 billion) was the only macro-classification attracting net flows in February, while stock and mixed-equity funds handed back $24.9 billion and money market funds witnessed $6.7 billion of net redemptions.
- Large-cap funds (-$6.4 billion) continued to be the pariah of the U.S. Diversified Equity (USDE) funds group, while small-cap funds (-$1.2 billion) mitigated outflows better than the other capitalization groups.
- In February the Mixed-Equity Funds macro-group (-$3.9
billion) suffered its fifth monthly redemption in eight. The mixed-asset target horizon funds group's inflows (+$2.7
billion) were swamped by the net redemptions witnessed in the mixed-asset target allocation funds group (-$6.4 billion).
- For the year-to-date period World Equity Funds, shedding some $8.9 billion to net redemptions, handed back the largest amount of the four equity macro-classification breakouts.

Em Hedge Funds

Just checking that I can upload graphs now! Yaay...

This is the graph of factor loadings of Emerging Markets Hedge Funds... interesting how much of their returns can be explained by BRIC MSCI, Put Call ratio, Istanbul Index, Fama French Size Factors, and U.S. GDP growth...
We did know that there is little diversification in EM funds, but we didn't know that the EM funds were quite dependent on the U.S. GDP to this extent...

Credit Card Defaults

The S&P is rallying back and we are full of confidence... I am still bearish and think that credit card defaults are a big reason to be so...

U.S. Credit Card Delinquencies At Record Highs: Same Dynamics As Mortgages?
• U.S. credit card defaults rise to 20-year high. Analysts estimate credit card charge-offs could climb to between 9 and 10% in 2009 from 6 to 7% at the end of 2008. In that scenario, such losses could total $70bn to $75bn in 2009. The $5 trillion in outstanding credit card lines (of which $800bn is currently drawn upon) are being trimmed even for credit worthy borrowers with Meredith Whitney estimating that over $2 trillion of credit-card lines will be cut in 2009 and $2.7 trillion by the end of 2010
• Losses are particularly severe at American Express and Citigroup amid a deepening recession. AmEx, the largest U.S. charge card operator by sales volume, says net charge-off rate rose in February 2009 to 8.7% from 8.3% in January 2009 as job losses accelerated and the economy deteriorated. For Citigroup, one of the largest issuers of MasterCard cards, default rate soared to 9.33% in February 2009 from 6.95% in January 2009

What's going on?

The S&P has slipped below 800 to 750 levels with such ease that I fear we are indeed going to 600 as I thought earlier.


Here are the main views:
Real Economy

* Pain in the real side of the economy. Look for S&P to keep going lower

* The stimulus package will be moderately ineffective, inefficient and quite small. I think the market is falling in part because the REALIZATION of Obama's plan was far lower than the EXPECTATION!. We were hopeful but are disappointed that he, the smart new prez, has no magic bullet

- Currency views:

* EUR is under severe danger over the medium term- all the differences in various countries' political economies will come to fore... the interest rates will have to be drastically cut for a longer term than is currently priced in AND the stability of EUR currency itself is threatened.
* The short EURUSD trade has made a lot of money so far. Also long USDJPY may be the trade to get into... with Japan's horrible GDP numbers.

Below is something I read in a publication that shows how badly the small countries are doing...

Dubai Receives Capital Injection To Ease Debt Burden
• As concerns about the emirate of Dubai's financing needs mount, it launched a bond issue, the first tranche ($10b) of which was fully subscribed by the Central bank of the UAE. Dubai is estimated to have $14b in interest and principal payments due in 2009 (EFG-Hermes via WSJ) and it is slated to run a fiscal deficit in 2009
• Central bank of the UAE had $44.5 billion in fx reserves in September (most recent data) but has since provided liquidity to several of the country's banks. Instruments are five-year bonds that carry an annual interest rate of 4 percent
• The loan, the first major step of a long-anticipated support from oil-rich Abu Dhabi via the federal government, should ease the cost of insuring against a default, which in recent weeks saw five-year credit default swaps on Dubai debt rising to levels similar to Iceland (FT) Doing so might also lower risk premia on Dubai banks

JPY view from I Banks

Below is the view of one of the investment banking analysts that is quite respected in the industry-

Essentially the analyst is saying that the yen is done rallying. It may definitely seem that way looking at the fact that USDJPY hasn't moved from the 88- 90 range. My view is that USDJPY will move in that range 85- 92 for a while. ...



Cyclical and Structural Drivers of the Yen

Since the credit crisis broke in the summer of 2007, the Japanese yen has
been by far the best performing major currency. Since its lows in July
2007, the yen has risen by 43% in trade-weighted terms, 37% against the
dollar, 40% against the euro and it doubled against sterling and the New
Zealand dollar. Over this period, the yen outperformed the other risk
aversion currency, the Swiss franc, the second best performer, by a hefty
30%.

This strong performance reflected the confluence of a set of supportive
factors: cheap initial valuation, narrowing yield differentials, rising
risk aversion and, in the initial stages, a strengthening basic balance.
Just prior to the onset of the credit crisis in July 2007, the yen had
cheapened against the dollar to 20% below fair value, which we view as the
boundary in our valuation lines-in-the-sand framework. The yield
disadvantage of the yen narrowed as first the US and then other countries
cut policy rates. The appreciation reflected the risk aversion role of the
yen, outperforming during periods of heightened volatility. The initial
phase of the appreciation also reflected improvements in the Japanese
basic balance, which we view as the medium-term or structural driver of
the currency, as the current account surplus continued to grow and there
were limited FDI outflows from Japan.

Is the yen done? We take stock of valuation and prospects for the cyclical
and structural drivers of the yen.
(i) The yen is no longer cheap against the dollar but it is not unduly
expensive either, while it is near fair value against the euro and
approaching very expensive levels against sterling.
(ii) The policy rate differential has already narrowed (completely)
against the dollar though it has further to go against the euro, sterling
and commodity currencies.
(iii) Equity volatility has fallen from its peaks, but it remains high and
has further to fall over the next two quarters. We expect FX vol to
follow.
(iv) The Japanese basic balance has deteriorated dramatically on the back
of continued FDI outflows, while the trade surplus has given way to a
deficit. While we expect the basic balance to improve as capital outflows
diminish, with the trade deficit persisting through the global recession,
we expect the basic balance to remain well below recent peaks, arguing for
a weaker yen.