Hedging your hedge-fund bet

The current economic climate seems not to be the best environment for wishful thinking in Hedge funds.

Here is the intro of the article that both the figures and the problem shows:

Hedge funds are suspiciously popular these days among financial cognoscenti. The Institute for Private Investors' survey of extremely wealthy investors indicated that about 80% have some investment in hedge funds and nearly a third have more than 25% of their assets in them. Private and public pension funds are increasing their stakes in hedge funds in the hopes of scoring double-digit returns on investments. This raises public policy concerns as poor performance will not affect just rich investors but also put employee pensions and taxpayers at risk. 

Let it be clear that of course some of the hedge funds will produce excellent returns, but in aggregate they will be disappointing. Many people are familiar with big profits, but they have to agree that stocks and bonds will not continue to produce the double-digit returns they have had in the past three decades. In the article they call it ‘collective folly’ when everyone believes that his hedge fund is exceptional, so the question now is: Why do people still throw money at them?

Here is a summary of some interesting reasons they give in the text about why people still believe in hedge fund, why they support wishful thinking:

-          “Winner’s curse”, named for the tendency of people to overbid in auctions (ultimately the winner often feels cursed). The hiring of hedge funds is like an auction. The result is that each fund is valued by those who are the most optimistic about its prospect.

-          Overconfidence, the second peculiarity, aggravates this problem.

-          People do not believe that the interest you now get with hedge funds are the same as those you can get anywhere in today’s economic status, but with a lower or no risk.

-          People overvalue hedge funds because millions of dollars are being spent convincing us that they are good investments. Much less is spent arguing the contrary.

-          “The Lake Wobegon effect”. Studies have found that almost all of us believe that we are safer-than-average drivers. Similarly, all hedge-fund investors believe their fund is above average.

Personally, I can agree with those reasons. Maybe it is not a bad idea to wait for better financial times before we return to the hedge funds.

http://www.latrobefinancialmanagement.com/Research/Hedge_Funds/Hedging%20Your%20Hedge-Fund%20Bet.pdf

Matthijs Vanrapenbusch

Rescuing the American monetary system.

On November 3rd, the FED’s chairman Ben Bernanke announced that the FED will undertake a second round of Quantitative Easing, in order to restore the American economic system. The principle is based on a series of consequences, starting with the FED buying long-term bonds with newly created money.

The consequences are the following:

1: long-term yields lower.
2: investors tend to riskier investments.
3: the dollar’s exchange rate drops, due to the lower yields.
4: share prices rise

In theory, these consequences should boost the economy in three ways:

1: since the long-term yields are lower, people are spurred to borrow and to invest.
2: increased share prices result in higher wealth for the households, which leads to more spending.
3: a cheaper dollar stimulates export.

The first result is a questionable one. Many households are not able to get a loan from a bank given the fact that the market value of their homes has fallen, and the banks are not too eager to lend them money. On the other hand, the third result was already reported by exporting companies. So even though the FED has to deal with a lot of criticism on its monetary policy, it does look like its working.

Sarah Duurloo

Down the slipway
The Economist
6^th November 2010

BP and Exxon share prices after oil spills

On 20 April 2010 a British Petroleum oil platform in the Gulf of Mexico exploded, killing 11 men and spilling an estimated 172 million gallons of crude oil into the sea. A disaster similar to the Exxon Valdez spill 21 years ago?

Let’s go back to 1989. The Exxon Valdez, an oil tanker owned by ExxonMobil (then still known as Exxon), crashed into a reef nearby Alaska and spilled approximately 11 million gallons. Exxon’s stock price fell slightly (by 7%) in the first weeks after the accident but it soon bounced back and ended with a 7% profit.

Investors who thought BP shares would react similar were wrong. After the news of the explosion, BP’s share price sharply dropped and after one month it was only worth a third of its value before the spill.

Another notable fact is that the fall in market value is not only due to estimated costs for cleaning and punishments, which had been the case with other environmental disasters such as the Exxon Valdez spill. BP’s market value decreased with 65 billion, when estimated costs are only 30 billion. This difference is probably due to a damaged reputation, especially because  BP was known as one of the most ‘green’ oil companies (compared to ExxonMobil, Shell,..). This would be the first time an environmental accident would have such an impact on a company’s reputation and therefore also on its market value.

http://www.economist.com/node/16270972

http://www.express.be/business/nl/management/helft-koersverlies-bp-lijkt-reputatieschade/130975.htm

Sander Van Ouytsel

America’s bond-insurance industry in deep trouble.

To start, a small introduction: American cities and counties finance themselves by issuing municipal bonds.  If a person chooses to invest in such a bond, he can insure it by a so called monoline-insurance.
These monoline-insurances are considered safe, because they rarely defaulted.

Now, what is the problem?One of the largest insurers, Ambac, skipped an interest payment this November and filed for bankruptcy within the month. Other insurers find themselves in an equally bad situation.
The problem was simple: Ambac had a debt of 1.6 billion and only 76 million in cash.
Such an inequality cannot hold for a very long time.

Where did everything start to go wrong? At the beginning of monocline-insurance, think 1970’s, they only insured safe, municipal bonds.
But along the way they started to expand their insurance to, among other bonds, risky, mortgage-backed securities. When things started to go wrong, a domino-effect initiated.  As you all very well know, the subprime mortgages were bound to backfire. So when they did, Ambac and the others had to pay up. This made their credit ratings drop, so people were less willing to have them for insurers. And that’s how we got to the big, gaping hole the monoclines have to deal with today.

The conclusion I draw from this story is that insurers can be useful, but only if the problems aren’t too big and structural.

Sarah Duurloo
The Economist
November 6^th 2010.

A year of wishful thinking..

This post is about the financial crisis. Wishful thinking is without any doubt one of the main causes.

Some people called the  period from March 2009 as the year of wishful thinking. Central banks cut interest rates and the governments started providing the financial economy with a flood of cheap money that gave the illusion of recovery. Or like they call it in the article: “Pouring a lot of water into a bucket with a large hole.”

Greece was the first country on the chopping block. There were damaging disclosures that Greece has used derivatives to manipulate its debt figures and markets began shorting Greece. Much of its debt is owed to investors outside the country, what means mainly banks and investors in other European countries. If Greece defaulted on this debt, then the resulting losses would have serious consequences for the affected banks and the whole banking system. Other countries, such as Portugal, Spain and Ireland , with similar economic problems are up next.

A problem of too much debts was being solved with even more debts what resulted in the economic situation we face today…

http://www.nakedcapitalism.com/2010/06/satyajit-das-the-year-of-wishful-thinking.html

Matthijs Vanrapenbusch

Gold is the ultimate bubble

George Soros is an investment guru who doesn’t share the same opinion as his former partner Jim Rogers. George thinks that the gold price isn’t going to skyrocket forever. After the financial crisis and the burst of the house price bubble in the United States, people were searching for safe investments and they invested a lot in gold. The majority of the people saw it as a safe haven and the price of gold reached peak after peak. According to George it isn’t a safe refuge at all, it may be a new bubble that is going to burst in the future. Many people don’t believe his theory, well let’s see in ten or twenty years if he was right.

Maybe he can bring the price of gold down on his own, just like he did it before. By speculating on the pound sterling, he brought this currency down and a devaluation followed. Maybe he can do this over?

Jonas Van der Slycken

http://netto.tijd.be/sparen_en_beleggen/beleggen/-Goud_is_de_ultieme_zeepbel-.8290086-2213.art

The wishful thinking about house prices smacks of dotcom delusion

We all know that investments in the housing market has made many people ‘rich’. However, there is no rational reason to expect property to always be a good investment.

In the UK the property agents pretend like they are back to the races of huge gains for the first time since 2007. More of them now expect prices to rise then fall because the asking prices are going up monthly. Unfortunately the agents accentuate only the grounds for optimism.

First of all, they do not communicate to the people that the house prices are still above their historical trend. Secondly, the lifeblood of the housing market, credit, has drained away. The base rate may be 0.5pc, but that means nothing to someone looking to take out a fixed-rate mortgage. Third, the downturn in the housing market since its peak in 2007 is short by historical standards. Probably it will take some more years.

I suppose it’s clear that the housing market optimism is a rose-tinted view and we have to be aware for all the false beliefs. The housing market story is maybe very similar to the dot.com bubble history. People also think that shares can only rise, what means that investors only see buying opportunities. The argument that house prices at least will hold their value is also a false belief. In Japan, house prices already fell by 68 pc in real terms between 1991 and 2006.

All this together learns us that maybe a similar dot.com bubble is coming...

http://www.telegraph.co.uk/finance/comment/tom-stevenson/5880282/The-wishful-thinking-about-house-prices-smacks-of-dotcom-delusion.html

Matthijs Vanrapenbusch