Tag Archives: finance

uncorrelated returns: hedge funds as the new gold

March 18, 2015 By in Alpha and Beta, Current Market Thoughts, Gold, hedge funds, liquid alternatives Tags: , , , , Leave a comment

Every stock market person knows what beta is.

It comes from a regression analysis, y = α + βx, where y is the return on a stock and x the return on the market).  It shows how a given stock’s past tendency to rise and fall is linked to fluctuations in the market in general.  A stock with a beta of 1.4, for example, has tended to rise and fall in the some direction as the market, but move 40% more in either direction; a stock with a beta of 0.8 has tended to exhibit only 80% of the market’s ups and downs.

The professor in a financial theory course I took in business school asked one day what it meant that gold stocks had, at the time, a beta of zero.

The thoughtless answer is that it means they aren’t risky, or that they don’t go up and down.

A consequence of this thinking is that you can lower the beta, and therefore the risk, of your investment portfolio by mixing in some gold stocks.What’s interesting is that in the early days of beta analysis that’s what some institutional portfolio managers actually did with their clients’ money.

That didn’t work out well at all.

What should have been obvious, but wasn’t, is that the zero beta didn’t mean no risk–or that gold stocks are/were a good investment.  It meant what the regression literally indicates–that none of the movement in gold stocks could be explained by movements in the stock market in general.

The riskiness of gold stocks is there, but it came/comes in other dimensions, like:  how mines develop new supply, the ruminations of the gnomes of Zürich (in today’s world, Mumbai and Shanghai), the potential for emerging country craziness, the propensity of the industry to fraud.

Why write about this now?

I heard a Bloomberg report that institutional investors as a whole are upping their exposure to hedge funds, despite the wretched performance of the asset class.  Their rationale?   …uncorrelated returns.

It sounds sooo familiar.

Admittedly, there may be a deeper game in progress.  It’s impossible to say your plan is fully funded by projecting a gazillion percent return on stocks or bonds.  But who’s to say that a hedge fund can’t do that?

 

 

a dollar shortage?

March 17, 2015 By in currency effects, currency markets, securities markets Tags: , , , , , , Leave a comment

response to a reader’s question

A reader asked me to comment on this post on the Zero Hedge website about a potential US$ funding shortage.  The post was sparked by (is a rehash of) this recent commentary by JP Morgan’s currency strategist.

Let’s be clear that this is not my area of expertise.

Nevertheless, here goes:

the blogger

The Zero Hedge post, following the JP Morgan piece, observes that it has become unusually expensive to buy large amounts of US dollars.  The last time this happened was just as Lehman was failing, signalling serious problems with the world financial system.

The post author concludes that because dollars are again pricy we’re warming up for another round of severe banking problems.

JP Morgan

I don’t think the blogger is correct.  It seems to me he’s mixing up cause and effect.  Also, this is not what JP Morgan is saying.

history

Back in 2008-09, the main issue  was counterparty risk.

Bear Stearns, whose financial statements showed assets–mainly bonds, loan participations…worth about $80 ended up bankrupt, with those “assets” really worth close to nothing.  Lehman’s value was coming under similar questioning.

The conclusion the financial markets drew was that maybe all the banks’ financials were similarly not worth the paper they were written on–and that therefore anyone you lent money to, even for a few days or weeks, might go under before you were repaid.  So the wisest–and only–course was to lend to no one.   The world financial system froze up.

An important leading indicator of this mess was the increasing cost of borrowing dollars to finance trade.

today

Today’s situation is very different.  Two factors are involved in the current high cost of finding dollars:

–it’s cheaper to borrow in euros, hedge currency exposure and convert the loan proceeds into dollars than it is to borrow directly in dollars. (Similarly, in recent years it’s been cheaper for a Mets fan to fly to San Francisco to see the Mets play there than buy a premium seat at Citi Field.) Enough American corporations are doing so to dramaically up the cost of obtaining dollars.  They will presumably continue to do so until do so until this arbitrage makes no sense.

–today’s carry trade is sell euros (or just about any other currency)/buy dollars.

my conclusion

Today’s situation, unusual as it is in post-WWII history, doesn’t signal the onset of a new banking crisis.  Rather, it’s a function of differences in central bank monetary policy between the US and EU caused by differences in the relative economic health of  the two areas.

an aside

JP Morgan mentions one thing for which it has no hard information but that may prove important.

The corporate borrowing situation described a few lines above makes no net impact (in theory, anyway) on the fx value of the euro.  The currency hedging contract exactly offsets the effect of the purchase of dollars.

Suppose, though, US companies aren’t hedging.    After all, multinationals have tons of money in overseas banks and lots of physical assets in foreign countries.  Currency losses on both are currently ripping gaping holes in firms’ income statements.  Companies might consider that having, say, euro-denominated liabilities would neutralize some of the damage (I feel confident that the JPM strategist has either made, sat in on, or at least heard about, financing pitches arguing US companies should do precisely this).

If so, their dollar-buying isn’t  being offest by hedging contracts and  is putting upward pressure on the US$.

equity implications

If so, once converting euros into dollars becomes expensive enough, US companies will presumably stop doing it.  This could cause a significant bounce in the euro.  This would likely switch European stock market preferences away from dollar earners toward (beaten down) domestic issues.

 

 

want index underperformance …try an actively managed bond fund

March 16, 2015 By in Bond Environment, bond market, Investment firms, junk bonds, junk bonds, Portfolio management, securities markets Tags: , , , , , , 1 Comment

Indexology

‘For a while I’ve been following the Indexology blog written by S&P.

As the name and source suggest, the blog extolls the virtues of indexing–after all, S&P makes them and sells information about them.  I find the posts to be generally interesting.  My only quibble is that the Indexology people seem to be true believers in a strong version of the efficient markets hypothesis.  They’ve all drunk the Kool-aid and don’t stop to question how it can be that basically every professional active manager underperforms   …nor do they try to imagine what circumstances could create even a temporary burst of outperformance.

I’m well aware of all the figures about equity manager underperformance.  However, I’d never thought much about bond funds, the subject of the Indexology post of March 12th.

The numbers are stunning.

bond fund (under)performance vs. benchmarks

Here they are:

–in 2014, 97% of the government bond funds underperformed, as did 98% of the investment-grade corporate bond funds

–in both categories, over 95% underperformed over the past five- and ten-year periods

—73% of the junk bond fund managers underperformed in 2014; over the past five years, 88% underperformed; over the past ten, the number is 92%.

Bright spots?:

–among actively managed senior loan funds (which don’t contain bonds;  they hold pieces of syndicated bank loans to non-investment grade corporate borrowers), 70% outperformed last year.  Over the past decade, though, underperformers and outperformers are just about equal in number.

–61% of municipal bond managers outperformed in 2014.  55% did so over the past fie years.  However, over the past ten, 70% underperformed.

reasons for this woeful showing?

Indexology offers none.  Personally, I have no firm ideas.

Looking only casually at the results of Bill Gross over his years at Pimco left me with two impressions of the former Bond King:

— he continually bet very aggressively (and correctly) that interest rates would fall–sort of like an intelligent version of Jon Corzine, and

–a large chunk of his outperformance disappeared through the high fees Pimco charged for his services.

Indexology doesn’t talk about fees, which can’t have improved the situation for bond managers generally–and I presume the Indexoogy numbers are after them.

The better areas for relative performance are smaller and contain less liquid securities.  I wonder what role pricing–which I presume is not based on daily trading but on the theoretical models of third-party experts–plays?

 

dealing with a rising currency

March 12, 2015 By in economics, growth vs value, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , Leave a comment

As far as the stock market is concerned, there are two main strategies for dealing with a rising currency:

1.  try to make currency work to your advantage

Profit growth will be highest for a company in a changing currency environment if it has its costs in weak currencies and its revenues in strong ones. In today’s world, this means having costs in, say, yen or euros and sales in the US.

The “good” stocks in weak currency countries gain in two ways:   from stronger profit gains and from domestic portfolio managers rotating their holdings toward the “good” industries.

The obvious candidates are export-oriented firms with high labor content in weak currency countries.  In these areas, firms with high strong-currency import content that sell finished products into the domestic market are the worst ones to hold.

 

In strong currency countries, in contrast, purely domestic stocks are the best bet.  They benefit only from portfolio manager rotation, though.  But they avoid currency induced weakness.

 

2. ignore currency and look for secular growth names whose expansion prospects outweigh possible currency losses 

As a growth investor, this is my preferred strategy.  Historically, the majority of such stocks have been in the US.  In today’s world, however, the ideal investment would be in a hot EU tech company with exposure to the US.

Any ideas?

Happy anniversary!!! …six years since the bottom for the S&P 500

March 9, 2015 By in Current Market Thoughts, economics Tags: , , , 3 Comments

It’s hard to believe that it has been that long.  But the S&P 500, which closed at 2017 last Friday, hit an intraday low of 666.79 on March 6, 2009.

That was the market bottom.

As you may recall, world markets made a final severe downward lurch when Republicans in Congress blocked passage of a bank bailout bill–apparently condemning the country to a repeat of the Great Depression of the 1930s.  My sense is that even the grandstanding congressmen who cast the “no” votes were as horrified by the result as were the financial markets and constituents.  The rapid subsequent passage of the bailout marked the lows.

What I find most notable about the years since:

–the S&P has tripled, yet only appears to me to be appropriately valued

–the US economy is just getting close to normal now; Europe, whose banks were the ultimate “dumb money” holders of fraudulent mortgage securities created by their US counterparts, is still struggling

–the entire economic repair has been accomplished by the Fed, a feat that mainstream economic theory would have said to be impossible.  Other than the initial bank and auto company bailout, there has been no net help from either Congress or the administration.

–Millennials have surpassed Baby Boomers as the largest group of consumers in the US (not the wealthiest, but the largest).  This despite the role of the recession in delaying Boomer retirements

–according to the Economist the first month’s sales of the iPhone 6 last year represented 25x all the computer power that existed in the world in 1990.  For me, this one sentence explains the continuing disruptive power of the Internet.  It also highlights the role of the smartphone in causing the demise of the big, bureaucratic, cog-in-the-wheel, job-for-life corporation that arose after World War II

–despite the congressional call in 2009 for banks to bear full responsibility for the mortgage abuses they created, almost no bank executives have been brought to trial for the immense economic damage they did.  Yes, there’s Bernie Madoff and the occasional inside trader.  But these are outsiders, sort of like Michael Milken or Henry Blodget, not members of the financial establishment.