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

FDIC sends vital message: speculate at your own risk.

The Federal Deposit Insurance Corporation (FDIC) has established new rules that should stop companies from taking excessive risks. Taxpayers should no longer suffer from mistakes made by managers, which did happen a few years ago when companies like AIG almost went under due to risky deals that were made by staff people and often based on wishful thinking. The American government had to take over firms in problems and civilians who had nothing to do with it, became victims. To prevent this in the future, creditors and other business partners will be punished stronger: when a company goes bankrupt, they won’t see their invested money back. FDIC declares that the fear that creditors and shareholders will leave a company in trouble is misplaced because managers will be more careful and not make too risky deals.

Because of the fact that many of these giant financial companies are global firms, these new rules will need to correspond with rules in foreign countries. That’s why the FDIC requested these nations to point out further remarks on its proposal.

http://www.boston.com/bostonglobe/editorial_opinion/editorials/articles/2010/10/18/fdic_sends_vital_message_speculate_at_your_own_risk/

Sander Van Ouytsel

The problem with China’s monetary reserves.

It is commonly known that China holds by far the world’s biggest stockpile of foreign-exchange reserves. You might think this is good for country, which it off course is, but there is a downside to it. These reserves consist of foreign currencies. To be more specific: about 65% of these holdings are in dollars. In the current economic and financial situation, China finds itself in a bit of a pickle. Over the past weeks, the US have pressured China to release the Yuan, in order to let it appreciate against the dollar. Now, if China does such thing, it would have to deal with severe losses on its dollar holdings. So China wants to get rid of the dollars and diversify its reserves. But if it sells its dollars to buy for example yen, the dollar’s exchange rate might drop. And currently both currencies are still tied, so if the dollar drops, the Yuan does too. So it looks like China’s sky-high monetary reserves were merely wishful thinking,

Sarah Duurloo

In need of a bigger boat
The Economist
October 16^th 2010

I believe in raw materials

Quantum Fund was founded by Jim Rogers and George Soros. They had an enormous success with this fund and had a yield of four thousand %. Since then Jim and George were considered as guru investors. Jim Rogers says that raw materials such as gold, silver, oil, sugar, coffee, orange juice and wheat are the future, which means that you can better invest in these raw materials than in stocks. Jim Rogers believes in these materials, it doesn’t matter what the evolution of the world economy is. If the economy goes up or down, the prices of raw materials will jump anyway, while shares only benefit from bull markets. Recently, the price of gold has been rising and rising, it reached peak after peak and yet Jim is still not selling his gold. What if this is just another bubble? There are also other interesting materials such as wheat, silver or sugar. These three are far below their historical peak and are likely to rally.

So Jim, we should invest in raw materials? No, don’t listen to me. You should only invest in the things you know and you don’t have to follow the markets or chase opportunities.

Is investing in raw materials a human investment? In my opinion it isn’t. It is possible that people in developing countries are not able to buy their necessary nourishment because of the fact that food prices are getting too high after all our speculations. 

Jonas Van der Slycken

http://netto.tijd.be/sparen_en_beleggen/beleggen/-Ik_geloof_niet_in_aandelen-_wel_in_grondstoffen-.8948748-2213.art

Three reasons to be very wary of wishful thinking

Why do we keep on believing in things we want to be true and delude ourselves rather than to face what really is? Tom Stevenson gives us three reasons why people make bad investments and blames wishful thinking to cause them. I will focus on one aspect.

2006. Although data predicts a downturn in 2007, people are still talking positive about a decrease in interest rates saying this is good for equities. However this could be true, it is also known that low interest rates have a bad effect on the GDP and reinforce a downturn. Why do investors still put their bets into markets while knowing their value will go down?

It’s because markets don’t immediately feel the effect of changes in interest rates. The first months after the decrease shares are likely to rise, making investors optimistic about the future. This optimism is misplaced. Eventually the consequences will come and profits will decline, making people who, based on this optimism, invested at a wrong time lose their money.

Although history gives us enough evidence to conclude interest rates are linked with profits, wishful thinking still makes people deny or underestimate the consequences of changing interest rates.

http://www.telegraph.co.uk/finance/2948314/Three-reasons-to-be-very-wary-of-wishful-thinking.html

Sander Van Ouytsel

The superboy of the next decade

Latin America is for many investors and multinationals the place to be in the following ten years.

Why? First of all, these countries achieved strong growth and were able to reduce the poverty among the people. On top of that, Lula da Silva turned his country, Brazil, in the last eight years into a real economic super power. In addition, western companies see Latin America as an alternative for China. Most of the Latin American countries are democratic and there isn’t a language barrier. Finally, this Latin American soil is plenty of natural resources.

That is why big companies don’t want to miss this trend and are investing a lot in this continent. Volkswagen and Fiat have built vast factories there and also AB Inbev, Arcelor Mittal, etc. are represented in the region.

These companies and conglomerates are all expecting extremely fast growth. But what if you invest in a  country that isn’t that democratic such as: Venezuela, Bolivia or Ecuador? Or what if next elections change the political balance completely? What if Mexican drug wars start to affect the whole continent? What if education and the national infrastructure aren’t that developed to maintain, support or secure this strong economic growth? Isn’t the Latin American economic growth threatening our ecological balance by chopping down a vast number of trees in the Amazon Rainforest?

Jonas Van der Slycken

http://www.tijd.be/nieuws/politiek_-_economie_economie/De_superboy_van_het_volgende_decennium.8984251-3153.art?utm_source=picks&utm_medium=direct

How trustworthy are stop-loss orders?

First of all I’d like to inform you why I chose this topic.
On May 6^th of this year, the Dow Jones fell by almost 10% in little over an hour. I saw this happening live on the internet and was dumbfounded for a cause. It was then, that I was told of stop-loss orders. Now, what exactly are these financial creatings and how is it possible that they have such an influence on the exchange rate?

A stop order is an order to buy or sell a share at an agreed exchange rate called a trigger. So let’s say, you give your broker a stop-loss order to sell your shares when the rate goes beneath $50, and if the rate does, the order must be executed.  

On May 7^th, the news said that a broker had accidentally typed three 0’s too much, and had thereby sold shares to the value of 16 billion instead of 16 million. This caused the rate to plummet and to trigger a vast amount of stop-loss orders, causing the rate to plunge even further. Even though the stock exchange reinstated itself in a few hours, there had been losses.

Personally, I find this explanation a bit too trivial. How do we know that these stop-loss orders haven’t been triggered on purpose?  One might see a very lucrative business in buying shares when the rate is at its low, knowing it will recover quickly. And aren’t profits the one thing the stock exchange is all about?

Sarah Duurloo

http://nl.wikipedia.org/wiki/Stop_order

http://925.nl/archief/2010/05/07/handelaar-tikt-drie-nullen-teveel-en-de-beurswereld-stort-in-of-

Gold prices soaring, but it may plunge soon

In these bad economic times, there are only few markets with rising prices, so called bull markets. The most remarkable one is definitely the gold market, which kept on increasing and reached an all time peak at 1,264 dollar per ounce. GFMS (Gold Fields Mineral Services), an independent consultancy specialized in metal market research, announced it will even reach 1,3 dollar by the end of the year. Although a nonstop increase encouraged investors to put their bets on gold, well-known investor George Soros is rather cautious saying this situation could come to an end very soon. He predicts that the gold price will plummet soon after this peak and advises investors not to put all their money in the gold business.

http://www.thaindian.com/newsportal/business/gold-prices-soaring-but-it-may-plunge-soon_100429609.html

Sander Van Ouytsel

Bad beat

Traders control a lot of money and they actually have a huge responsibility in the world economy because we are talking about billions. Maybe you have not heard about trading or traders yet, well, they buy and sell shares, futures, options, currencies, obligations and other financial products. While doing this, traders try to make as much yield as they can. Most of the people will like this, traders will give you an interesting yield, so what is the problem?

The problem is that traders sometimes take extremely high risks and most of the time their employers aren’t aware of these risks. What if it goes wrong? Well, in that case you can lose lots of money. Kerviel, Hunter, Meriwether, Hamanaka and Leeson are 5 great examples of how big these risks and losses sometimes are. These people lost all together 15.7 billion dollars, brought their bank down or were sent to jail. These are definitely not examples to follow. So think twice before you take unjustified risks in financial markets.

Jonas Van der Slycken

http://netto.tijd.be/sparen_en_beleggen/beleggen/De_5_grootste_-losers-_van_de_beurs.8225185-2213.art

Wishful thinking and betting of Verizon iPhone and Apple.

This link refers to a recent article that deals with the rumors about the wishful thinking of Verizon iPhone.  It is not an example where selling & buying shares,  hedging or something else is the link to the topic of this blog.  It is a decent example on how a decision can affect the success of various companies.

There is a raising possibility that Apple’s treasured iPhone is making its way to Verizon Wireless.  It is told that there could be legitimate plans for Apple to drop its exclusivity contract with AT & T. Both Verizon and AT & T have their niche but some people say it doesn’t sound like Verizon exactly needs the iPhone...

AT & T earned some of the worst reviews of its network and business management. Furthermore, the latest  rumors could be the culmination of Steve Jobs’s frustration with the provider but it is confirmed that there is a five-year contract between Apple and AT&T that doesn’t end until 2012. It is now up to Apple to make its best financial bet.

http://www.minyanville.com/businessmarkets/articles/verizon-iphone-apple-steve-jobs-verizon/6/30/2010/id/28999

Matthijs Vanrapenbusch