29 October 2010

Currency Wars - A high Fix and How to launch a hedge fund – or invest in one

Today we have a special report  from Scott Campbell – Fund Manager Miton Optimal  and Tim Price – Director PFP Wealth Management 

Scott Campbell, Managing Director and Fund Manager MitonOptimal

Currency Wars – A high Fix

Recent rhetoric has all been about strong emerging market currencies, a weak dollar, fx manipulators and the need for coordinated financial reform and the rebalancing of the global economy. At the beginning of the month, Brazilian Finance Minister Guido Mantega stated an “International currency war has broken out” as governments around the globe complete to lower their exchange rates to boost competitiveness.

Sao Paulo comment has followed a series of recent interventions by central banks, in Japan, Taiwan, South Korea and Thailand in an effort to stem currency strength. This has promoted currency choice to the very pinnacle of current global asset allocation decisions. What can we expect going forward?

The following chart from Cross Border Capital, we have shown before, but it again highlights a very important point. The FIX or measure of currency  volatility is at high levels when compared with time since the 1950’s, but is nowhere near the levels reached from 1915-1949. The US$ soared by  29.4% against the British pound between 1931-32, but then skidded by 30.4% in the years 1932-34. Then from 1934-1940, the US dollar climbed again by 37.6% against the pound, rocketed a whopping 95% against the Japanese yen from 31-34 but tumbled 40% vs the French franc. Finally the US$  jumped a dramatic 128% against a weak franc form 34-38 before war engulfed Europe.

The Euro has already depreciated 17.3% and appreciated 17.6% against the US$ in 2010 whilst the Singapore $ and South African Rand have appreciated 8.3% and 6.4% v the US$ over the same time period. We state again, this has promoted currency choice to the very pinnacle of current global asset allocation decisions. Anticipating secular emerging market currency moves and hedging out more volatile cyclical major currency fx moves appears to be the best strategy in a high FIX environment.

Tim Price , Director of Investment  PFP Wealth Management

How to launch a hedge fund – or invest in one

 “We took risks. We knew we took them. Things have come out against us. We have no cause for complaint.”
  - Robert Frost.

 “Never let a serious crisis go to waste.” These words are credited to former White House Chief of Staff Rahm Emanuel in November 2008, when the banking and financial emergency (not entirely yet put to the sword) was at its most virulent. No shortage of books has tumbled out of publishing houses subsequently, exquisitely detailing the whys and wherefores of the crisis, so it was with a somewhat heavy heart that your correspondent received news of the latest book offering investment counsel, David X Martin‟s „Risk and the Smart Investor: using the principles of de-risking to make better investment and financial decisions‟ (McGraw Hill, 2010). Happily, the scepticism was unwarranted: the book is an excellent read, and refreshingly free of the risk analysis jargon that its title threatens – and which in large measure helped the crisis to vault to its giddy heights in the first place.

Mr Martin was formerly Chief Risk Officer at AllianceBernstein ($450 billion under management) and had also held senior risk management positions at Citibank before it became a basket case. Notwithstanding these credentials there isn’t a single equation or algorithm in “Risk and the Smart Investor” and if there is, I missed it. What there is in spades is the judicious anecdote, which is a lot more engaging and certainly more relevant than the pseudo-science that helped precipitate the world’s biggest financial crisis in 80 years.

If the business (art ?) of investment comes down primarily to an assessment of risk and return, the former gets a pretty poor press from the typical industry practitioner. „Lip service‟ tends to be the traditional treatment of the prospect of (downside) risk, which is otherwise covered by bland boilerplate in the sell side marketing material; that same material tends invariably if understandably to focus on returns, whether historic, prospective or both. As Mr Martin observes, casually firing another nail into the coffin of the Efficient Market Hypothesis,

“..the notion that we rationally determine risk is just as inaccurate as the theory that the markets are rational mechanisms, moving in response to prudent decisions made by investors on the basis of information available to all participants. If the events of the past decade have taught us anything, they have taught us that this simply isn’t so.

“To begin, loss aversion describes a basic human tendency.. the willingness to forgo an opportunity for gain rather than risking a loss, or the desire to accept what you have rather than reaching for more, and perhaps ending up worse off than you were to start.”
At the risk of sounding like a broken record, we would suggest that loss aversion has never been more pertinent to the situation at hand – nor more difficult to achieve, in an environment where the prices of all financial assets and even the currencies in which they‟re denominated are being either manipulated or debauched by robo-Keynesian government administration gone mad.

In the spirit of never letting crises go to waste, the last few years, particularly during the Lehman bankruptcy black comedy weekend fever pitch phase, have given investors an opportunity in real time to experience end-of-the-world-style asset pricing volatility, and therefore a rough assessment of their own tolerance for white-knuckle losses, realised or not. Since almost none of the underlying financial causes of the crisis has been sensibly addressed, while many have been perpetuated if not exacerbated, it seems plausible that at least one comparable aftershock looms.

On the topic of third party investments, Mr Martin provides a checklist that is practically worth the cover price on its own. For anyone considering investing into a fund or hedge fund, or fund of hedge funds, the checklist is invaluable (and note the emphasis on the qualitative as much as upon the quantitative):

1. Is there a free flow of information ? How often is the fund‟s net asset value reported ? Traditional funds report at the end of every trading day; a good hedge fund will report its NAV at least once a month.
2. Does the hedge fund have premier suppliers (as prime broker; custodian; accountant; legal advisor) ? Brother-in-law does not meet this requirement.
3. Does the fund have the ability to stay in the game ? New hedge fund managers may find capital raising more difficult than planned, or may adopt initial strategies that imperil the fund through lack of capital.
4.  What is the nature of the fund‟s investor base ? Is it loyal ? Will it stay loyal when the going gets rough (which it inevitably will) ?
5. Does the fund depend on a single stock picker, or is its success based on a broader competence ? Does the fund conduct its own research or rely on data supplied to it ?
6. Does the fund have a consistent approach ? Does the fund have a track record of at least three years ? Or is performance merely pro forma, and the strategy untested in the real world ?
7. Does the fund have an exploitable niche, and if so, is that niche sustainable ?
8. Where is the firm in its growth cycle ? Look for a fund on the upswing. “If you invest in a fund at the top of its arc, you‟ve got to wonder whether the managers still have the same fire in their bellies they once did..” This touches on perhaps one of the biggest and most pressing challenges, not least moral, facing fund managers: do they ultimately want to be asset managers, or asset gatherers ?