Sunday, August 12, 2012

Are Hedge Funds Doing the Splits?

Tim Kiladze of the Globe and Mail reports, Rocky markets make hedge funds 'do the splits':

Frustrated with these erratic markets? You aren't alone. New data shows that even supposedly sophisticated hedge funds are scratching their heads.

Consider their aggregate positions in commodities. July numbers from the Commodity Futures Trading Commission show hedge funds are doing "the splits" -- a term suggested by Societe Generale, which compiled the data -- because they are positive on things like oil and natural gas, but negative on copper, which is typically a barometer of the entire economy.

Adding another wrinkle, hedge funds are also net long gold at the same time they are bullish on crude and natural gas -- a rather contradictory position.

As for agricultural commodities, hedge fund activity shot through the roof. In July, they established record net long positions in things like soybeans and wheat on the back of a severe drought that arose from scorching weather conditions.

Then there's the VIX. Even though the volatility index is currently sitting at only 16 per cent, hedge funds sold it at record levels last month to limit their exposure to erratic price moves during the less liquid summer.

Add all of that up and you get quite the complex trading environment. But these figures are just a taste of what global investors must deal with every single day, proving that it really isn't easy to make money right now.

It is indeed proving to be a frustrating environment for hedge funds. Even the best of them are finding these markets tough to navigate. Katya Wachtlel of Reuters reports that July was a letdown for hedge funds reaping big returns this year:

After several months of strong performances by many of the best known names in the $2 trillion hedge fund industry, July was a letdown.

Lee Ainslie's $2.9 billion Maverick Fund inched up 0.14 percent in July. Andrew Feldstein's BlueMountain Credit Alternatives Fund moved 0.67 percent higher. And one of David Tepper's Appaloosa portfolios gained 0.89 percent.

But the figures were atypical. The Dallas-based Maverick fund, for example, has gained almost 20 percent this year, according to data from HSBC's private bank. It is a major turnaround for Ainslie, who lost 14.85 percent in that portfolio in 2011.

Other funds that managed to produce only small returns last month, such the $4 billion Bluemountain credit fund and Tepper's almost $5 billion Palomino fund, are still up 10.92 percent and 14.31 percent, respectively, for the year through July 31, HSBC data showed.

The average hedge fund gained 1.05 percent in July, according to Hedge Fund Research, trailing the broader stock market, which rose 1.26 percent. Hedge funds have gained 2.88 percent this year, on average, while the S&P 500 stock index is up 7.41 percent.

"The returns were not terribly high in July, but according to our data, 75 percent of all hedge funds that have so far reported a return for July have reported a profit," said Sol Waksman, president and founder of BarclayHedge. "An up month, but not a barn-burner."

Several other managers who have posted strong returns through in 2012 barely made it into positive territory last month as the U.S. economy showed signs of slowing and the euro zone crisis continued to plague global financial markets.

James Simons' Renaissance Institutional Equities fund rose only 0.32 percent in July, although the fund is up almost 10 percent for the year. Third Point's Ultra fund, managed by Daniel Loeb, is up 8.98 percent this year, but only crept up 0.2 percent last month.

Other managers posted stronger performance over the period.

Longtime investor Michael Hintze, whose CQS fund was up almost 20 percent for the year through July 31, gained 2.25 percent in July. Grandmaster Capital, run by Patrick Wolff, a former managing director at Peter Theil's Clarium Capital, is up 18.14 percent for the year after gaining 3.8 percent last month, an investor note reviewed by Reuters showed.

Meanwhile, Steven Cohen's SAC Capital has risen about 6 percent this year through July, according to someone familiar with the numbers.

For other brand name hedge funds, 2012 has not been as sweet.

A $7.6 billion Caxton Associates fund is still down 3.42 percent, even though it rose 0.84 percent last month.

John Paulson saw more losses in his Advantages funds in July, although his merger arbitrage-focused Enhanced Fund is in the black, with gains of 6.71 percent after rising 1.42 percent in July.

And one of Louis Bacon's hedge funds, the Moore Emerging Equity Fund run by Greg Coffey, dropped 13.35 percent through July 1, even after a small gain last month.

"Prior to the month-end rally, July was challenging for directional equity strategies and those with a long bias lagged significantly," hedge fund tracking firm evestment|HFN noted this week.

Are hedge funds in trouble? I don't think so. While large global macro funds are experiencing difficulties bringing home the bacon, think that long biased equity funds, which make up a huge percentage of the hedge fund universe, will do fine as the 'Mitt Ryan' reflation trade takes hold.

But will hedge funds outperform broader market? I seriously doubt it. Most investors are conservatively positioned and many are bolting out of equities at the worst possible time. Only the best funds will outperform in this environment.

For some top money managers, it's a cornucopia of returns in corn:

The worst Midwest drought in a half century and resulting damage to the U.S. corn crop are creating an investment opportunity for some hedge fund managers.

Hedge funds Galtere, a $550 million commodity-focused global macro fund led by Renee Haugerud, and Woodbine Capital Management, a $500 million fund led by former SAC Capital Advisors portfolio manager Joshua Berkowitz, are among the winners on this summer's so-called "corn play."

And Friday morning, the outlook for corn farmers got even grimmer with the U.S. Department of Agriculture slashing its forecast for this year's harvest by 17 percent to 10.8 billion bushels. If borne out, that would mean the lowest level of production since 2006 and the lowest average yield for U.S. farms in 17 years.

Already, shares of the Teucrium Corn fund, the main exchange-traded fund that tracks the price of corn, are up more than 46 percent since mid-June. Corn on Friday traded at a record $8.33 per bushel for the December contract, up more than 60 percent since mid-June.

"Rains have been sporadic here in the Midwest for the past week with one to two inches falling, which for corn is not enough. I think corn is going to trade up to $9.50-$10.00 over the next couple of months with the next leg perhaps beginning after Friday's report and to $12 if an export ban is put in place," said Larry Jeddeloh, founder and chief investment officer of the North Oaks, Minnesota-based TIS Group, an institutional research firm that also manages client money.

Galtere earlier this year began betting the forecasts of a bumper corn crop would fall short, in part because of changing weather patterns.

"We got in a little earlier than some funds," said Geoffrey Fila, an associate portfolio manager at Galtere. "We thought it was erroneous of the market to assume a record yield, especially after the global weather challenges of the last 12 months."

Beginning in early April, Galtere began increasing its exposure to December 2012 corn futures contracts in the expectation of higher grain prices. In July, Galtere's flagship fund rose 5.3 percent. For year, the fund is up 9 percent.

By comparison, hedge funds overall are up 2.88 percent on average this year, according to hedge fund tracking firm HFR.

Woodbine Capital Management posted a 3 percent gain in July, largely because of bullish bets on rising grain prices, said a person familiar with the fund.

In an investor letter reviewed by Reuters, Berkowitz said "an expanding drought in the U.S. Midwest has dramatically increased the likelihood that crop yield losses will exceed government forecasts."

DROUGHT'S SEVERITY

On Wednesday, the U.S. government reported that July was the hottest month ever in the continental 48 states.

With the U.S. election three months away, President Barack Obama said separately that Congress needed to complete work on a new five-year, multibillion-dollar farm bill. Republican leaders in the House of Representatives, however, proposed a $383 million disaster package for livestock producers before adjourning for the summer.

Much of the interest from hedge funds in corn has come in the past month or so.

The gross exposure of hedge funds and other large speculators to corn futures as of August 1 was $11.3 billion, up from $3.2 billion as of June 20, according to U.S. Commodity Futures Trading Commission reports.

The thinly traded Teucrium Corn ETF has seen a surge in activity from hedge funds and proprietary trading firms. As recently as July 24, some 570,000 shares of the corn ETF were traded. In April, average daily trading volume was well under 100,000 shares.

Major buyers of the ETF during the first quarter were proprietary trading firms such as Jane Street Capital and Susquehanna Financial Group, as well as investment arms of big banks, including Wells Fargo, Citigroup and UBS. On August 14, hedge funds are required to report their U.S. stock holdings as of the end of the second quarter.

BETTING ON CORN DERIVATIVES

Corn futures and the corn ETF are not the only corn investments attracting interest from hedge funds and speculators.

Hedge fund industry analysts said managers also are looking to play the spike in corn prices by betting against shares of companies that are particularly sensitive to rising food prices, such as grain processor Archer Daniels Midland Co and The Andersons Inc, which produces ethanol from grain and other products.

Ian Horowitz, an agribusiness analyst at Topeka Capital Markets, said, however, that fertilizer companies, among them Mosaic Co, may benefit from the higher price environment, as farmers spend more on fertilizers and crop nutrients. Mosaic, has gained about 9 percent this year.

But Malinda Goldsmith, a partner at Dallas-based Four Seasons Commodities, where she oversees a $50 million portfolio, said in that in corn, "the easy money has been made."

Goldsmith's fund specializes in agricultural investments, with about a third of its capital allocated to corn. The portfolio gained 10 percent in July after rising 6 percent in June.

"We have not started shorting the (corn) market. But we've got a little more conservative" on the bullish side of the corn bet, Goldsmith said.

I agree, the easy money has been made in corn. Time to look elsewhere, like playing coal vs. nat. gas. The article above also makes me think of the risks pension funds face when investing in farmland. A long drought can cripple crops and significantly lower yields.

Finally, there are already articles discussing what hedge funds have been buying recently. I track quarterly activity of top funds very closely to get ideas on what to buy or avoid and will publish a comment shortly. Never buy indiscriminately based on these quarterly filings. If you do, you will get creamed.

Below, as hedge funds do the splits, leave you with a clip of Epke Zonderland. The "flying Dutchman" took gold in the high bar final at the North Greenwich Arena - the first Dutch gymnastics gold for 84 years. Watch his amazing gravity defying routine below.

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