Global Investing

JP Morgan has an interesting take on the stupendous recent rally in the credit default swaps (CDS) of countries such as Poland and Hungary which are considered emerging markets, yet are members of the European Union. Analysts at the bank link the moves to the EU’s upcoming ban on “naked” sovereign CDS trades — trade in CDS by investors who don’t have ownership of the underlying government debt. The ban which comes into effect on Nov. 1, was brought in during 2010 after EU politicians alleged that hedge funds short-selling Greek CDS had exacerbated the crisis.

JP Morgan notes that the sovereign CDS of a group of emerging EU members (Bulgaria, Croatia, Hungary, Lithuania, Poland and Romania) have tightened 100 basis points since the start of September, while a basket of emerging peers including Brazil, Indonesia and Turkey saw CDS tighten just 39 bps. See the graphic below:

Spread tightening was of a similar magnitude in both groups before this period, JPM says (the implication being that traders have been selling some of their “naked” CDS holdings in these markets ahead of the ban):

The past few weeks have seen large moves in EM sovereign CDS that are in the EU compared to peers, in what we interpret to be the initial market reaction to the upcoming regulation…It seems reasonable to conclude that some of this effect is due to the short-sale regulation which only affects EU sovereigns. We can see this trend of EU EM sovereign CDS outperforming peers continuing over the coming weeks to November 1st.

Not everyone buys into this theory. Rob Drijkoningen, head of emerging debt at ING Investment Management, attributes the gains to the improvement in the euro debt situation last month (in fact JPM too acknowledges this as a possibility). Drijkoningen is inclined to downplay the impact of the regulation on central Europe, even though he, like many other fund managers, sometimes does use sovereign CDS as a “proxy hedge” when he holds corporate debt from that country. He says:

As the global markets consensus shifts toward a “basically bullish, but enough for now” stance — at least before Fed chief Bernanke on Monday was read as rekindling Fed easing hopes — more than a few investment strategists are examining the cost and wisdom of hedging against it all going pear-shaped again. At least two of the main equity hedges, core government bonds and volatility indices, have certainly got cheaper during the first quarter. But volatility (where Wall St’s Vix index has hit its lowest since before the credit crisis blew up in 2007!) looks to many to be the most attractive option. Triple-A bond yields, on the other hand, are also higher but have already backed off recent highs and bond prices remain in the stratosphere historically.  And so if Bernanke was slightly “overinterpreted” on Monday — and even optimistic houses such as Barclays reckon the U.S. economy, inflation and risk appetite would have to weaken markedly from here to trigger “QE3″ while further monetary stimuli in the run-up to November’s U.S. election will be politically controversial at least — then there are plenty of investors who may seek some market protection.

Societe Generale’s asset allocation team, for one, highlights the equity volatility hedge instead of bonds for those fearful of a correction to the 20% Wall St equity gains since November.

A remarkable string of positive economic surprises has boosted risky assets and driven macro expectations higher but has also created material scope for disappointment from now on. We recommend hedging risky asset exposure (Equity, Credit and Commodities) by adding Equity Volatility to portfolios.

More than a “nice to have,” investor sentiment is running heavily on the side of environment, social and governance (ESG) factors, according to the latest Thomson Reuters Perception Snapshot.

Feedback from 25 global buy-side investors found that 84 percent evaluate ESG criteria to some degree when making an investment decision.

The remaining 16 percent say ESG issues are not considered until a company’s ability to generate high returns is hindered by these factors.

It was the outcome most commentators were expecting.

Even Roger Lawson of the UK Shareholders' Association, which represented 150,000 small investors, admitted it was "not totally unexpected".

But the defeat for hedge funds RAB Capital and SRM Global and other former shareholders claiming damages for the loss of their holdings in Northern Rock when it was nationalised last year is nevertheless a hard blow to bear.

The former shareholders may appeal, but a valuation of the equity at zero or close to zero is now looking entirely possible.

There's no shortage of bad news in the financial world at the moment.

But one top hedge fund manager believes that equities could soon be heading for a very sharp rally.

Cazenove's Neil Pegrum -- whose fund made 9.4 percent last year while markets were plummeting -- believes UK equities could soon be enjoying a "March 2003" rally.

While it seems a long time ago now after the market's recent woes, March 2003 marked the start of a 4-year bull market which took the FTSE 100 from less than 3,300 to more than 6,700 and saw clever stockpickers reap huge rewards.

How bad will hedge funds’ year-end performance figures look?

According to Credit Suisse/Tremont, funds fell 6.30 percent in October after a 6.55 percent drop in September, taking losses for the first ten months to 15.54 percent.

Seven strategies are now nursing double-digit losses, with only two — managed futures and dedicated short bias — in positive territory.

Even global macro, which bets on the likes of global equity markets, world currencies, sovereign debt and commodities, is now back in the red. These funds are down 7.10 percent after substantial losses in September and October.

So star hedge fund manager Greg Coffey has opted to join established firm Moore Capital.

In April, when high-performing, high-earning Coffey resigned from GLG, the market was awash with rumours that he wanted to start up his own firm, pulling in billions from investors.

However, times have changed in the hedge fund industry.

The average fund is down nearly 20 percent so far this year, according to Hedge Fund Research’s HFRX index, while emerging markets funds have taken a particular battering as markets such as Russia and China have fallen.

It was not so long ago that hedge funds and commodities were the two red hot areas to invest in.

The credit crisis has shown that investor interest can quickly cool.

Many hedge funds betting on a so-called “super-cycle” have been caught out by a sharp pullback in commodities after a five-year bull market and are now facing the task of soothing anxious investors.

One of those to have suffered – hedge fund firm RAB Capital - is trying to strike a bargain with investors in its flagship Special Situations strategy, which has plunged 48 percent year-to-date after some bad bets on mining stocks plus a high-profile mistake at Northern Rock.

The heat is on for hedge funds with commodities bets.

Earlier this week Ospraie Management told investors it is shutting its flagship fund after it plunged 27 percent in August. The fund’s energy and commodities stock positions fell as investors worried if a global economic slowdown will mean less demand for resources.

And now RAB Capital’s Philip Richards is giving up the CEO role to focus on his funds after an awful period of performance for his once high-flying Special Situations fund.

Losses on small-cap mining stocks, as well as its high-profile error in buying into troubled bank Northern Rock, meant its listed feeder fund fell 38.1 percent from the start of the year to Aug. 21.

Things are going from bad to worse for hedge funds.

Having only just clawed back their losses after a dreadful March, the closely-watched Credit Suisse/Tremont Hedge Fund Index shows hedge funds lost a hefty 2.61 percent in July after being hit by a double-whammy of market movements.

These freewheeling funds had been betting for some time that banks stocks would fall as the credit crisis ate into their profits, while also betting that commodities would rise as demand for oil, metals and food soared.

This had been working well, but in July banks bounced back because they looked so cheap to some investors, while commodities fell from some of the dizzying heights they had recently reached.