PrefBlog

Goldman’s Global Alpha fund lost 22% in August:

The fund, managed by Mark Carhart and Raymond Iwanowski, has dropped by a third in 2007 and 44 percent from its peak in March 2006. Investors notified New York-based Goldman last month that they plan to withdraw $1.6 billion from the fund, or almost a fifth of the assets as of July 31.

Global Alpha’s biggest loss in the month stemmed from the managers’ decision to sell Japanese yen and buy Australian dollars. The so-called carry trade unraveled when the Australian dollar fell 6 percent against the yen in August. Equities holdings, including stocks in the U.S., Norway and Finland, declined 4.7 percent.

Red Kite, a $1-billion metals fund, lost about 20%.

In the junk world, financing is being arranged for KKR Boots, while negotiations continue on the $26-billion First Data deal (there is a late report that talks have been suspended for a week). Tom Graff has some historical commentary, focussing on the perils of market timing.

American ABCP outstanding continued to decline according to the regular Federal Reserve release. Yield spreads to government paper are still extremely high, however.

The news is good; it looks like things are starting to get moving again – creakily – but we’re by no means out of the woods yet. There will be lots of firms hanging on by their fingernails (Xceed Mortgage Corp., for instance, has just eliminated its dividend) and confidence is always slow to recover. However, it is nice to see that the hedgies have fulfilled their function by losing a lot of money and helping to stabilize things.

After the markets closed there were reports that Northern Rock, a UK mortgage lender, has received emergency funding from the BoE. This news had an immediate effect on New Zealand and Australian currencies.

Menzie Chinn has criticized Bernanke’s Savings Glut hypothesis:

To sum up, the Bernanke explanation for the US current account deficit relies upon a particularly small effect of budget deficits on current account deficits, and treats the US housing boom and associated mortage equity withdrawal as largely exogenous, or primarily a function of foreign excess saving. If you believe these points, then the saving glut story is the story for you.

And Brad Setser poked holes in the argument that China is forced to finance the US current account deficit:

The standard argument that China would shoot itself in the foot, financially speaking, if it stopped lending to the US is wrong.   China would certainly shoot its export sector in the foot if it stopped lending to the US.   And it is true that if China stopped lending to the US, the value of the RMB would rise relative to the dollar would increase and the value of China’s existing US assets would fall.  But China would still be better off, in the purely financial sense, if it took its lumps now.

That’s enough to make you feel good, isn’t it? The US economy is a Ponzi scheme. Maybe they should cut taxes, or something.

US Equities were euphoric over some indications that the credit crunch is less crunchy, while Canadian equities experienced similar dizziness over the prospect of oil at $80+. An ill wind will always blow some good somewhere!

Treasuries fell in a slight reversal of the flight to quality, as did Canadas.

It was a quiet day for prefs with not much volume.

There were five other $25-equivalent index-included issues trading over 10,000 shares today.

David Dodge made an interesting speech in London, England. Of most immediate interest was his hawkish monetary stance:

I want to be absolutely clear on one point: The actions that we took to provide liquidity to support the smooth operation of financial markets did not in any way signal a change in our monetary policy. In fact, it was a step in maintaining our monetary policy stance by keeping our target for the overnight rate at 4 1/2 per cent, which we judged appropriate for keeping inflation on target over the medium term.

… but the theme of the speech was transparency:

In this complex process, transparency about the underlying credit was often lost. Because the originators of the loans intended to securitize them rather than leaving them on their balance sheets, they lacked the incentives to carefully assess the creditworthiness of the borrower. And investors often lacked the ability, or did not make the effort, to see through the complexity of the instrument. Thus, investors were unaware of the creditworthiness of the root asset and the potential difficulties with the liquidity of the instrument itself. Compounding the problems was the fact that the models upon which these structured products were valued assumed that they could be readily traded in a liquid market.

So far so good – especially the bit about liquidity. Liquidity killed portfolio insurance in 1987, but people never learn!

Moreover, the complexity and lack of transparency in many of the structured products added to the market dislocations. It was extremely difficult for investors to peel back the layers of these securities and derivatives to determine, with confidence, both the creditworthiness of the assets backing a particular security and the market value of the security itself. Even supposedly sophisticated investors became extremely uncertain and that, in turn, led to fear.

So far, so good. But now he skates over to an unrelated point:

In my view, there is a clear case for transparency more generally in the operation of all financial markets. In most countries there are fairly clear rules requiring transparency in the operation of mutual funds, so investors can tell what they are purchasing. Hedge funds, by their nature, are less transparent. But there is also, I believe, a clear case for increased transparency, at least with respect to their objectives, operating procedures, and governance.
…
Let me now say just a few words about the importance of transparency in government-sponsored institutions, whether domestic or international. I will begin with a few words about sovereign wealth funds, which control increasingly large amounts of money and are significant global financial forces. Some of these funds, such as the public pension funds in Canada, already adhere to very high standards of transparency. But in other cases, there is often insufficient transparency in the operation of these funds. Too often, the objectives behind these funds are not clearly defined, and this can lead to misconceptions about their motives, particularly those that have their origins in foreign exchange reserves. As is the case with private pools of capital, high standards of transparency for reporting and governance, as well as objectives, would be helpful for these public pools of capital.

So he begins with the idea that maybe it would be a good idea if PMs had some vague idea about what they’re buying … and ends with a desire to poke his nose into sovereign wealth funds? Mark my words … something’s up. We’re not being set up for the Bank of Canada to form the nucleus of a national securities regulator, are we? And not even Harper & Flaherty would politicize the Bank of Canada by influencing Dodge to help advance a political agenda?

Be afraid. Be very afraid.

The recession probability continues to be debated – with some amusing 1998 headlines:

• Market Watch: Bracing For Mortgage Losses
• Despite Late Rally, Dow Ends A Bad Week Lower
• Shift To Capital Markets From Banks Brings Tumult
• Crisis Goes Beyond The Balance Sheet
• Banks Tighten Some Loan Terms
• Commercial-Mortgage Issuers Are Locked In A Deep Freeze
• Recession Fears Dominate
• Market Turmoil Hits Luxury Home Sales
• Heavy Spenders Take A Break
• Decade of Moral Hazard
• Emerging-Market Investors Get Full-Fledged Drubbing

… which goes to show two things:

• Plus ça change, plus c’est la même chose
• You can always count on newspapers and markets to get extremely excited about things.

The laissez-faire approach of the Bank of England has been compared to the more activist approach of the Fed:

The change in LIBOR is going to hurt bank profits, but the BoE is hanging tough:

“The provision of such liquidity support undermines the efficient pricing of risk by providing ex-post insurance for risky behavior,” King said today in written testimony to the U.K. Parliament’s Treasury Committee. “That encourages excessive risk-taking, and sows the seeds of a future financial crisis.”

Brad Setser has discussed Bernanke’s assertion that a savings glut will continue to keep interest rates low. He largely agrees, but puts more weight on official flows.

US Equities were flattish:

Analysts expect third-quarter earnings at S&P 500 companies to grow by 3.7 percent, down from an average estimate of 5.2 percent at the start of August, according to data compiled by Bloomberg. Growth at that rate would snap a streak of 20 straight quarters above 10 percent.

… but Canadian equities looked forward to higher oil prices.

Treasuries were off slightly and Canadas were downright boring.

Volume was fairly light in the preferred market, but Scotia pulled off a good sized cross. I was surprised to see that BAM.PR.M / BAM.PR.N did not exhibit ridiculous behavior on their ex-date … wow! Normal behavior from this pair!

There were eight other $25-equivalent index-included issues trading over 10,000 shares today.

There may be some spikes in commercial paper rates shortly as $700-billion in CP needs to be refinanced. There’s also a good chunk in Europe … so we may see some spectactular flame-outs.

We’re not over the hump yet, and won’t be for several months, as forecast by Ed Clark of TD. There are still lots of hedgies that haven’t blown up yet, although Y2K Fund has now halted redemptions:

The fund dropped 30 percent over June and July, according to data compiled by Bloomberg. It had been the best performing non- U.S. hedge fund investing in fixed income in the three years to the end of September 2006, according to Bloomberg data.

Maurice Salem, who founded Wharton in 1993 and runs the firm, didn’t answer calls to his mobile phone. Calls to the company’s offices in London weren’t returned. The Y2K fund was established in 1999.

Wharton’s Trio Finance Ltd. fund, which invests in real estate asset-backed securities, has fallen 46 percent this year, according to Bloomberg data.

Yesterday I mentioned Flaherty’s solution to the sub-prime crisis, namely: let the feds be in charge of capital market regulation. I was very pleased to see that there is at least one other person in Canada who noticed one vital thing about his remarks:

[Quebec Finance Minister] Ms. Jérôme-Forget said Mr. Flaherty has no business using the credit crisis to advance his campaign for a single regulator because there is “absolutely no link” between the subjects.

European Central Bank President Jean-Claude Trichet weighed in on regulatory reform:

Stressing the positive aspects of recent financial innovations to repackage and sell debt, Mr. Trichet nonetheless called the complexity of some debt products “overwhelming.” He said, “instruments and structures that cannot be fully understood even by those who bear the ultimate responsibility of the level of risk taken by financial institutions should not be acquired or set up by banks and investors who are lacking sufficient sophistication in the management of the risks.”

Mr. Trichet also called a dearth of ratings agencies problematic “for the present functioning of global finance” and suggested the agencies work out “benchmarks for improved behavior,” particularly on potential conflicts of interest. But he blamed investors equally: “An important lesson of the current risk re-pricing is that investors must never take the opinion of rating agencies as a substitute for their own credit analysis and due diligence.”

Well … I’d like to hear more about “benchmarks for improved [Rating Agency] behavior” … but three cheers for the rest of his comments! Who knows, if the hedgies take his advice they might last a little longer:

How often do hedge funds fail?
Lacking accurate data on the failure rate of hedge funds, most studies use the number of funds that stop reporting to the Lipper TASS database. According to this proxy, the average lifespan of a hedge fund is 40 months, with a median life of 31 months. Fewer than 15 per cent of hedge funds last longer than six years, while 60 per cent disappear within three years.

Meanwhile, US equities had a great day on hopes of a Fed easing and lots of consumer spending, aided by a Manpower report indicating jobs aren’t as scarce as all that. Canadian equities also rose on hopes that then we can sell them rocks and trees.

However, the Treasury market is now worried that it overshot but even with the rise in yields:

Yields on two-year notes, which are more sensitive to interest-rate changes than longer-term securities, are 131 basis points less than the Fed’s benchmark lending rate, near the biggest difference since January 2001.

Canadas followed.

There were ten other $25-equivalent index-included issues trading over 10,000 shares today.