Friday, 15 February 2019

China M2 turns the corner, but its time to devalue

China M2 growth is off the lows. But M2 is around 220% of GDP, so 8.5% M2 growth this year is the same as 19% of GDP. Meanwhile if GDP grows 6% real and 2% CPI, so 8% nominal, M2 is growing 2.4x as fast as GDP. FAI is still over 42% of GDP and Construction 17%.

Meanwhile CNY is one of the most expensive REER FX rates with growing BoP pressure to devalue.

Devaluing, at least on a trade weighted basis including against the Yen and Euros would be a massive boost to the corporate sector in the face of sanctions and would support higher nominal GDP, wage growth, CPI and help reduce the credit intensity of growth.

My medium term JPY/CNY target is in the 7c's and 8c's later from 6.1 now. Its also a positive risk off trade as the Yen should rally in risk off.


Wednesday, 9 January 2019

US Fed funds futures and the credit cycle

Jan 2020 Fed funds futures are currently pricing in a lower EFFR than today's one, ie pricing in a chance of a rate cut in 2019... 

The market is pricing 2.325% vs current EFFR of 2.4%... 

Meanwhile, the US labour market is blistering and corporate margins are near all-time highs. 

Perhaps the last 3 months were just about retail investors getting into a twist. Or perhaps its just post-QE valuations resetting lower in jolts. Or markets fearing a fall into the deflationary recessionary gap as the US transitions between a QE/ credit led economic cycle and a wage/ investment/ inflation cycle going forwards.

The US credit cycle is also still very strong.

As per H8 survey from end November to the 26th December bank credit grew ~11% of GDP and bank total assets (BTFD!) grew 17% of GDP annualised. That was after a strong October and November as well. 

The magic elixir of a Trillion $ late cycle deficit and still loose Fed

Monday, 10 December 2018

EURGBP near to breakout

All time high was 98.05 on EURGBP.

May has given up on her Brexit deal. I have no idea about what will happen but it wouldnt take many investors to derisk for a few months to push Sterling meaningfully lower, at least against the USD.

Friday, 7 December 2018

US oil exports, Indian loan growth

The US was a net oil exporter last week, the blue line chart is only up to the prior week. Over the next 5 to 10 years I expect the US to go to a current account surplus as well. 

It is China who is short oil and the US can take market share by disrupting the Gulf in particular Iran.

Growth also looks to be accelerating into next year in India

Friday, 30 November 2018

Brazil post-Bolsonaro election? Macri redux?

Whats the risk that Bolsonaro triggers a credit contraction/ FX tail spin ala Macri in say H2-19? M3 is circa 320% & rising

Im guessing a bit more yield compression first though so curve flattens first and equities rally on hope

With investor flows into EM expected in H119 there is scope for the curve to bull flatten into early next year

But this will make the yield pick up over USTs even more minimal by H219

Some macro numbers had been weakening this year, but a good dose of hopium recently and we could see a bounce into H1-19 the could aling with investor flows into EM

The BOVESPA on a mid-teen P/E is breaking out by the looks of it

But H2 is where the question marks would start to arise

But with final demand dependent on the private sector picking up or the government maintaining its deficit, there is the risk of recession if govt cuts back, if iron ore/ oil prices drop or if confidence falls

With high M3/GDP there is the risk of an Argentina style FX tail spin

Despite USDBRL having devalued, it doesnt look particularly cheap on a REER basis

Wednesday, 28 November 2018

Vene slips lower

Vene should be a prosperous, investment grade, OPEC member 

Instead, its a bankrupt, socialist, terrorist financing, narco state run by a small cadre of oligarchs 

At 20c on the $ the debt is still fairly widely owned... At 20c the government and PDVSA debt is worth about $20bn

If it drops to 10c next year it will only be ~$10bn, which is peanuts if regime change happens. But who knows when that will be

Friday, 9 November 2018

Pro-forma vs realised hedge fund portfolio returns

Most hedge funds promise high uncorrelated returns but many dont deliver, or performance erodes over time. What impact does this have on investor returns?

When buying new managers/ maintaining existing ones you need to think about the probability of the realised return scenarios. Versus recent history, what's the probability the fund makes;
  • more
  • the same
  • less
  • blows up
Small confidence interval funds
If you buy an investment grade bond fund with say 3 years duration, then likelihood of achieving the running yield over say 3 years is very, very high, lets say 90% probability. Interest rates could rise or fall, but you also have bonds maturing and can reinvest proceeds.

In a high yield bond fund its still fairly high despite the risk of a default/ spread blow out cycle. In a normal spread widening cycle high yield bonds might see 500bps of widening, so 10-20% price drop, but you will have a much higher running yield after that and if the manager avoids defaults then you get to reinvest coupons at the higher yield. So on a longer term basis you could be confident of generating a return that is similar to the running yield but with uncertainty over the path and the potential for a 1-2 year drawdown at some point.

Hedge fund returns have a large confidence interval
Hedge funds however are unbenchmarked strategies. With the exception of stressed credit there is no anchor or 'pull to par' for returns. Equity bear markets can last years and recoveries can be even longer.

As such the confidence interval for the return for an individual hedge fund has to be large.
Anecdotally the HSBC hedge weekly report by year end often has an 80% plus spread between the top few hedge funds and bottom few. Its not uncommon for certain managers to frequent both lists in different years.

Question: What percentage of hedge funds meet their double digit return goals?

My experience with low beta/ uncorrelated institutional portfolios is that realised returns, by the time you have redeemed underperforming hedge funds, are about half of the pro-forma returns.
I.e. if you want to realise 7-8% you need to buy funds making 15% at the point in time that you buy them. This raises an issue if you buy low returning funds.

Question: What if I buy 'conservative' funds that lose less when they go wrong? Generally speaking the average return is lower in my experience and you can see that in the HFRI indices.

Let's assume we buy a portfolio of 9 funds that has an expected/ recent return of 7%, what is the expected outcome of that portfolio:

3 funds make 7%
3 funds make 2%
3 funds average 0%

What is the weighted return of that portfolio? Its 3%, or less than half of the expected 7%, before costs.

What evidence can I supply for portfolio realised returns being roughly half pro-forma expected returns? Simple look at the HFRI FOF index returns and the UCITS index returns.

The UCITS market is dominated by absolute return funds targetting 7%. What is the return for the UCITS index in an environment of QE and ZIRP that has supported asset classes?
The UCITS index has made approximately 10% or an annualised 1.1% since 2010. Meanwhile 'successful' UCITS funds make 7% annualised.

What if there is a bear market?

3 funds make 3%
3 funds make 0%
3 funds average -3%

Weighted return drop to zero. In a market crisis like 2008 the returns could be worse.
So what if we buy double digit returning funds?

3 funds make 12.5%
3 funds make 7%
3 funds average 3%

The average is 7.5%, even though all the funds bought had been making 10-20% prior to being bought. For this to work you need to avoid bad blow ups though.

To boost these returns:
  • If you can average a higher hit ratio than 1/3 that it would boost returns significantly
  • If you have one outlier high returning fund, say 25% IRR, then it would boost the portfolio return to 9%
  • If you aggressively redeem low returning funds, that would boost portfolio returns
  • If you want to take beta bets then thats a slightly separate issue but you can use that to push up the IRRs

What if there is a bear market?

3 funds make 10%
3 funds make 4%
3 funds average -3%

Portfolio still makes almost 4%. It really helps if you have some funds that can make double digit returns in a bear market like 2008, or if there are funds that can exploit opportunities like the 'Big Short' in sub-prime.

So there you have it: buying low returning funds and running them for years.

Its the answer as to why UCITS investors and consultant led institutional investors have hardly made any money from hedge funds.

Why do they keep doing it? Or are they now rotating the money into 'return free risk' in conventional private lending strategies, thereby setting up a great secondaries opportunity when defaults rise.

As for institutional interest in hedge funds I just wonder how it works if QT pushes many asset classes into synchronised grinding valuation bear markets.

The best thing for the hedge fund industry's returns would be for these institutions to exit enmasse and reduce the level of me-too competition in markets.