Tag Archives: hedge funds

cooling the Chinese stock market fever

April 17, 2015 By in "naked" short selling, Banks, China, commodies speculation--stabilizing or destabilizing?, Investment firms, Margin, securities markets, short selling, stock market Tags: , , , , , , , , 1 Comment

In the 1990s, Alan Greenspan, the head of the Fed back then, famously warned against “irrational exuberance” in the US stock market, but did nothing to stop it   …this even though he had the ability to cool the market down by tightening the rules on margin lending.  This is the stock market  analogue to raising or lowering the Fed Funds rate to influence the price of credit, but has never been used seriously in the US during my working life.

The  Bank of Japan has no such compunctions.  It has been very willing to chasten/encourage speculatively minded retail investors by tightening/loosening the criteria for borrowing money to buy stocks.

 

We have no real history to generalize from in the case of China.  But moves in recent weeks by the Chinese securities markets regulator seem to indicate that Beijing will fall into the stomp-on-the-brakes camp.

Specifically,

–at the end of last month, the regulator allowed (ordered?) domestic mutual funds to invest in shares in Hong Kong, where mainland-listed firms’ shares are trading at hefty discounts to their prices in Shanghai

–highly leveraged “umbrella trusts” cooked up by Chinese banks to circumvent margin eligibility requirements have been banned,

–a new futures product, based on small and mid-cap stocks, has been created, offering speculators the opportunity to short this highly heated sector for the first time, and

–effective today, institutional investors in China are being allowed to lend out their holdings–providing short-sellers with the wherewithal to ply their trade (although legal, short-selling hasn’t been a big feature of domestic Chinese markets until now, because there wasn’t any easy way to obtain share to sell short).

What does all this mean?

The simplest conclusion is that Beijing wants to pop what it sees as a speculative stock market bubble on the mainland.  It is possible, however, that more monetary stimulus–to prop up rickety state-owned enterprises or loony regional government-sponsored real estate projects–is in the pipeline and Beijing simply wants to dampen the potential future effects on stocks.

I have no idea which view is correct.

It’s clear, however, that Hong Kong is going to be a port in any storm, and that it is going to be increasingly used as a safety valve to absorb upward market pressure from the mainland.  So relative gains vs. Shanghai seem assured.  Whether that means absolute gains remains to be seen, although I personally have no inclination to trim my HK holdings.

 

 

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?

 

 

what will a soft dollar-less world look like

February 12, 2015 By in economics, Industry Analysis, Investment firms, Portfolio management, securities markets, Securities regulation, sell-side analysts, soft dollars, stock market, Trading Tags: , , , , , , , 3 Comments

Yesterday I wrote about an EU regulatory movement to eliminate the use of soft dollars by investment managers–that is, paying for research-related goods and services through higher-than-normal brokerage commissions/fees.

Today, the effects of a ban…

hedge funds?

I think the most crucial issue is whether new rules will include hedge funds as well.  The WSJ says “Yes.”  Since hedge fund commissions are generally thought to make up at least half of the revenues (and a larger proportion of the profits) of brokerage trading desks, this would be devastating to the latter’s profitability.

Looking at traditional money managers,

 $10 billion under management

in yesterday’s example, I concluded that a medium-sized money manager might collect $50 million in management fees and use $2.5 million in soft dollars on research goods and services.  This is the equivalent of about $1.6 million in “hard,” or real dollars.

My guess is that such a firm would have market information and trading infrastructure and services that cost $500,000 – $750,000 a year in hard dollars to rent–all of which would now be being paid for through soft dollars.  The remaining $1 million or so would be spent on security analysis, provided either by the brokers themselves or by third-party boutiques (filled with ex brokerage house analysts laid off since the financial crisis).

That $1 million arguably substitutes for having to hire two or three in-house security analysts–and would end up being distributed as higher bonuses to the existing professional staff.

How will a firm pay the $1.6 million in expenses once soft dollars are gone?

–I think its first move will be to pare back that figure.  The infrastructure and hardware are probably must-haves.  So all the chopping will be in purchased research.  The first to go will be “just in case” or “nice to have” services.  I think the overwhelming majority of such fare is now provided by small boutiques, some of which will doubtless go out of business.

–Professional compensation will decline.  Lots of internal arguing between marketing and research as to where the cuts will be most severe.

smaller managers

There’s a considerable amount of overhead in a money management operation.  Bare bones, you must have offices, a compliance function, a trader, a manager and maybe an analyst.  At some point, the $100,000-$200,000 in yearly expenses a small firm now pays for with soft dollars represents the difference between survival and going out of business.

Maybe managers will be more likely to stick with big firms.

brokers

If history is any guide, the loss of lucrative soft dollar trades will be mostly seen more through layoffs of researchers than of traders.

publicly traded companies

Currently, most companies still embrace the now dated concept of communicating with actual and potential shareholders through brokerage and third-party boutique analysts.   As regular readers will know, I consider this system crazy, since it forces you and me to pay for information about our stocks that our company gives to (non-owner) brokers for free.

I think smart companies will come up with better strategies–and be rewarded with premium PEs.  Or it may turn out that backward-looking firms will begin to trade at discounts.

you and me

It seems to me that fewer sell-side analysts and smaller money manager investment staffs will make the stock market less efficient.  That should make it easier for you and me to find bargains.

 

 

 

hedge funds and investment research

January 29, 2015 By in Getting financial advice, hedge funds Tags: , , , , , , Leave a comment

On Monday, the Wall Street Journal ran an interesting article, “Hedge Funds Learn Secrets Not So Safe.”  It’s about brokerage house research reports on individual companies.

Brokers provide research to customers either by giving them access to a research website, which contains all a broker’s research reports, and/or by responding to requests for specific research items, including meetings with analysts.  The problem with this is that brokers collect and analyze all their points of contact for the information they contain.  Conclusions will certainly wind up on the firm’s sales desk and can easily end up on the firm’s proprietary trading desk, too.

The same written  information is also available to authorized customers through third-party information services like Bloomberg.  I can use my Bloomberg account not only to call up a chart of a company’s stock price, see summary financial statistics and find out who a company’s major suppliers and customers are.  I can also read brokerage research from the brokers I do business with.  Not having read the service agreements they’ve signed, hedge funds have apparently assumed that if they read brokerage house report on a given target investment using a third-party information service, the broker never finds out.  By doing so, they’ve outwitted the broker and avoided information leakage.

Not so.

The third-party information providers supply such usage data to brokers, sometimes being as specific as what person at a given firm has accessed a report.  In fact, the article cites an instance of an unnamed analyst finding out his research wasn’t as stealthy as he’d thought when the broker whose report he’d been reading called him up and offered to arrange a meeting with the target company.

 

What I find odd is that there’s an obvious way to prevent information leakage–do the research yourself.  There’s a ton of relevent information available from the SEC’s Edgar site, as well as from government agencies and industry trade associations.  There are also suppliers and customers to talk to.  There’s gossip on the internet, too.

In my experience, except for a narrow set of highly technical areas (where you can always hire a consultant), the picture you create yourself will be more accurate, relevant and in-depth than anything a brokerage report can provide.  Yes, the brokerage analyst may be willing to say things on the phone or in person that he wouldn’t care to commit to paper, but that’s another issue.

Two issues:  compiling a thorough analysis of a company may take a week or two, as opposed to taking an hour to read someone else’s work.  Also, the analyst has to have the skill and experience to do independent work.

I can’t imagine that taking an extra week is the crucial variable.  That leaves the possibility that the firms the WSJ is writing about are so weak they don’t know how to do research themselves.  Hard to fathom.  I guess they’re just great marketers.

 

 

 

 

reading the paper yesterday morning…

January 21, 2015 By in Energy, hedge funds, Portfolio management, Trading Tags: , , , , Leave a comment

I’m postponing writing about my early days as an oil analyst until tomorrow.

An article in the Wall Street Journal,  “Investor Bind:  How Low Can Oil Go?,” struck my eye as I was waiting a doctor’s office yesterday morning.  Two aspects:

The article quotes a Swiss oil trader as saying the current market for petroleum is “irrational.”  He explained that the craziness consisted in the market concentrating solely on bad news and ignoring any possible ray of sunshine.

Yes, this is irrational.  But, more to the point, this is the essence of a bear market, that good news gets ignored and only bad news gets factored into prices.  (A bull market is just the opposite.  In a bull market, all the bad news goes in one ear and out the other; only the good news has an influence on prices.)  I wonder why he didn’t just say that.  Maybe he did, but the reporter didn’t understand.  On the other hand, maybe he didn’t realize.

Second, the article leads off with hedge fund Tusker Capital, LLC of Manhattan Beach, California.  The fund had been betting heavily on a decline in crude oil prices since at least the middle of last year and has just cashed in its chips after cleaning up oin a major way on the subsequent 60% fall in the oil price.

According to the article, Tusker gained 17% overall in 2014 and is up by 10% for 2015 through mid-January.  Implied, but not explicitly stated, is that the largest part of the +10% this year comes from the bet against the price of crude., with is down by 8.6%.  Why else would it be the lead in a sotry about a crashing oil quote.

The occupational disease of analysts is that they analyze.  As I sat in the waiting room–and waited–it became increasingly clear that I couldn’t make the Tusker numbers make sense.

Tusker has “roughly” $100 million under management now (I take that statement to mean the assets under management are just shy of $100 million, but let’s say $100 million is the right figure).  This means it had $91 million under management on December 31st and $78 million at the end of 2013–assuming no inflows or outflows.

Let’s say all of the $11 million gain in assets under management in early 2015 comes from the negative bet on oil.  If the same bet were maintained through the second half of 2014, it should have produced a gain of about $55 million.  But Tusker’s assets were only up by $13 million in 2014.  Either a lot of customer money left, or something really horrible happened in the rest of the portfolio, or “all” is too high a number.  My hunch is that at least the last is correct.

Let’s say half the 2015 gain comes from the negative bet on oil (regular readers will know that 1/2 is my default guess on most things).  If so, then the bet should have produced a profit of around $27 million in 2014.  Same story, although with somewhat less draconian figures–something else happened that caused $14 million in assets to disappear–disaster or withdrawals, or both–or maybe Tusker initially had a much smaller bet gainst oil that it expanded as crude began to sink.

I later Googled Tusker and found an article, from the New York Post, of all places, that said Tusker had assets of $105 million at the end of June 2013 and that the firm strongly believed that the end of quantitative easing in the US would cause a collapse in commodities prices.

To sum up: Tusker made a hugely successful bet against oil that likely made it $40 million – $70 million.  Yet it now has less money under management than it did 18 months ago (a period during which the S&P 500 went up by about 30%).  There’s certainly a story here.  It may not be about oil, though.