Thursday, June 30, 2016

Hedge Funds' Brexit Pain?

Christopher Langner of Bloomberg reports, Hedge Funds' Brexit Pain:
Hedge fund managers won't admit it, but they live for the quarter. While some of the bigger firms update clients more often, regular outfits provide an update four times a year, after which investors often decide to redeem their holdings or leave things as is.

So it couldn't be more unfortunate that Brexit happened just five trading days before the end of the second quarter. Even the savviest of money managers would struggle to recoup the kind of losses seen over the past two sessions. And a smaller gain, or a negative return, could spur outflows from an industry already under fire.

Hedge funds globally saw a net $15 billion exit from January to March, reducing assets under management to $2.86 trillion from $2.9 trillion, Chicago-based Hedge Fund Research said in April. In Asia, investors redeemed $2.9 billion in the first quarter, the most in seven years, data from eVestment show. That was after big outflows in 2015 as well. Given the massive jolt that just happened, chances are there will be another round of investment calls.

For the broader market, that could extend Brexit pain a little longer. Investors should watch for liquid assets that hedge funds may sell to meet redemptions in July and August. The rocky start to 2016 has already spurred record sales of U.S. Treasuries by Caribbean-domiciled investors, who are often seen as a proxy for hedge funds and other leveraged accounts. Gold, or highly liquid corporate bonds, could also lose ground because they're easy to sell.

It's true that some winners are emerging, and as usual, when it comes to hedge funds, they're quick to trumpet any success. But outside of machines and a handful of contrarians who picked a Brexit vote, most money managers will have to wear the shock referendum's poor timing.

Had the polling happened on July 1, it would have been a whole other story, giving firms at least a couple of months to recover before having to fess up to investors. If David Cameron wanted a referendum so bad, he could at least have made the timing better.
This article is silly on many fronts. First, investors don't redeem from hedge funds based on quarterly returns following a major event risk like Brexit. They redeem because of lousy risk-adjusted returns over a longer period.

Second, Brexit? What Brexit? As Keith Bliss of Cuttlone & Co reports, after getting crushed on Friday and Monday, stock markets came roaring back :
If you fell asleep Thursday night and did not wake up until this morning, you would assume that the UK voters elected to stay in the EU. Certainly as we look at the behavior and complexion of the market today, it’s as if nothing happened. As the S&P 500 (SPY) is only 2-3% below last Thursday’s close, the market has voted that Brexit is not that big a deal ... so far.
Sell the rumor, buy the news

The ability of global markets to shrug off what many considered to be a disaster reinforces an important axiom that “news traders” live by: Sell the rumor, buy the news (the converse is true depending upon the situation).

In this case, the rumor was that the Brexit is the first very large crack in the global order that will lead to pestilence, destruction, and economic chaos. The news is that we really still don’t know the ultimate effects and outcome from the decision, and we won’t know for many months. On that news, investors re-engaged the risk markets and picked up massively oversold bargains.

The other important lesson is that hysterical hype rarely drives markets longer term. Even in the most stomach churning market episodes of the recent past — 9/11, Iraq Invasion, financial crisis of 2008, and now Brexit — the equity markets have always shown their resilience. Once calmer minds have a chance to contemplate and game out situations with rational thought, the situations are never as dire as the initial knee-jerk reaction suggests they are. What we are witnessing right now is the quintessence of risk markets: true price discovery based on facts at the moment—not hype or hysteria.
Don't dismiss the Brexit, though

Now, I am not suggesting that the UK’s pending exit from the EU is a sideshow to be dismissed to the historical dustbin. Quite the contrary is true. This is a monumental event which cuts against the grain of global political and economic thought of the last 60 years. This will spawn many questions about the future economic direction not only for the UK and Europe, but also for the US, China, and the rest of the globe.

Undoubtedly, at some point, it will lead to economic disruption and distortion — even if the breakup is handled with intelligence and thoughtfulness. Heightened market volatility and low rates will be with us for an extended period of time. And, it may lead to a dramatically different global security map than what we currently know.

All of these things will happen … just not now … and that’s what the market cares about.
No doubt, the stock market is rejoicing probably because most optimistic people believe that Britain will remain in the EU. But make no mistake that Brexit vote was Europe's Minsky moment and if Britain does leave the EU, others will follow and chaos will ensue, which is why central banks are lining up to do the wave.

In fact, I agree with George Soros who recently told the EU Parliament:
Brexit may now be a "greater calamity" than the refugee crisis. He added that the UK's shocking decision has "unleashed a crisis in the financial markets comparable in severity only to that of 2007/8."

He continued: "This has been unfolding in slow motion, but Brexit has accelerated it. It is likely to reinforce the deflationary trends that were already prevalent." 
I'm not sure this vote unleashed anything comparable to what happened in 2007-2008 but Soros is right, Brexit will reinforce deflationary trends that were already prevalent. This is why bond yields following the vote dropped to record lows and haven't budged since. You can read the full text of his speech here but nobody is paying too much attention to Soros these days.

Although it's still too early to tally up who profited and who lost big following the Brexit, there are some clear winners and losers emerging. On Monday, I discussed who profited from Brexit, alluding to well-known titans like Soros and Druckenmiller but also to lesser known hedge fund managers like Nancy Davis of Quadratic Capital Management.

Now more news is trickling out on who made and lost money following Brexit. Stephen Gandel of Fortune reports that Bill Ackman, one of the world’s worst performing hedge fund managers of the past two years, is once again emerging as one of the biggest losers of the group of elite investors. His fund had lost more than half a billion dollars following Brexit.

And Laurence Fletcher of the Wall Street Journal reports, Equity Hedge Funds Find Themselves on Losing Side of Brexit Moves:
Hedge funds that bet on stocks are starting to emerge as some the biggest losers in the immediate aftershock of the U.K.’s vote to exit the European Union.

Equity funds posting losses were heavily weighted toward so-called cyclical stocks, such as airlines or financial firms, which were hard hit in the selloff, according to company filings and industry experts.

Some were also betting against defensive stocks, such as pharmaceuticals or tobacco, that were already expensive but rallied as investors rushed for havens.

The $2.9 trillion hedge-fund industry has been buffeted by the broad market turmoil sparked by the referendum’s surprising outcome. Details of the how individual funds have coped are just starting to emerge.

“Equity funds are fighting a battle of cyclicals versus defensives,” said Nicolas Rousselet, head of hedge funds at Swiss investment firm Unigestion. “Brexit has been tougher on the cheaper stocks.”

Some equity funds at Man Group, which manages $78.6 billion in assets, suffered losses.

Man Group’s GLG Alpha Select fund, which invests in U.K. stocks, lost 3.5% on Friday, after the results of the June 23 referendum were in. The fund is down 3.8% this year. Its European Long-Short fund, run by Pierre Lagrange, one of London’s best-known managers, lost 1.9% on the day, taking it to a 4.2% loss for the year.

The FTSE fell 3.1% on Friday, while the Stoxx Europe 50 slumped 6.7%.

Egerton Capital also lost money. The hedge-fund firm was co-founded by John Armitage and is one of London’s biggest with $14.7 billion in assets.

The firm, based close to Man Group in the heart of London’s Mayfair district, is down 4.5% this month to Friday after losing around 1% last week. The losses mean it is down 8.5% this year. A spokeswoman for the firm declined to comment.

Lansdowne Partners, one of the world’s biggest equity hedge funds, saw its flagship Developed Markets fund extend losses in recent days. The fund is down 4.1% this month, according to performance numbers sent to investors and reviewed by The Wall Street Journal. Year to date, the fund is down 13.7%.

Marshall Wace’s $10.5 billion Eureka fund extended losses in recent days and was down 1.5% this month by Friday, said a person who had seen the fund’s performance numbers, taking losses this year to 3.6%.

Equity hedge funds inside and outside the U.K. fell an average 2.1% on Friday alone, according to data from Chicago-based Hedge Fund Research.

Most equity hedge funds decided not to buy protection against market swoons because of the high cost of doing so, said Lyxor Cross Asset Research.

In contrast, hedge funds that bet on big moves across foreign-exchange and bond markets are starting to emerge relatively unscathed, with some posting gains.

Many funds that have been hoping for another U.S. interest-rate rise benefited from longstanding bets on the dollar, which soared against the pound and strengthened against the euro in the wake of the referendum result.

So-called macro funds, which place wagers across different types of assets, slipped 0.5% on Friday, according to HFR, better than hedge funds as a whole, which lost 1.1%.

Tudor Investment Corp., of Greenwich, Conn., has gained 0.9% this month to Friday, said a person who had seen the numbers. That gain reduced year-to-date losses to 2.3%. A spokesman for Tudor declined to comment.

Man Group’s $4.6 billion AHL Diversified fund, a computer-driven fund that follows trends in global markets, gained 1.3% on Friday.

Brevan Howard, one of the world’s biggest macro funds, gained around 1% on Friday, taking gains this month to 1.2%, said a person familiar with the fund’s performance.
Indeed, as Reuters reports, British billionaire Alan Howard's main hedge fund, one of Europe's largest, gained 1 percent on Friday after Britain voted to leave the European Union.

The big winners from Brexit, however, were quantitative systematic (CTA) strategies. Nishant Kumar and Saijel Kishanof Bloomberg report, Machines Lead Hedge Fund Traders in Brexit Chaos, Braga Wins:
As more details emerged on how hedge funds fared following Britain’s surprise decision to leave the European Union, computer-driven hedge funds led the winners. Human traders appeared to have limited losses by reducing risk.

Lynx Asset Management, which uses mathematical models to decide when and which securities to buy and sell, posted a 5.1 percent gain on Friday in one of its funds, according to its website. Capital Fund Management, a $7 billion firm in Paris, gained 4.2 percent that day in its Discus fund, while Systematica Investments, the $10.2 billion fund run by Leda Braga, gained 1.35 percent in its main BlueTrend fund, people with knowledge of the matter said.

Trillions were wiped from global equity values and the pound slumped after the Brexit victory, with the U.K. stripped of its top credit grade by S&P Global Ratings. Hedge funds overall lost 1.1 percent on Friday, according to the HFRX Global Hedge Fund Index. In a sign traders had prepared for the event, options-derived measurements of market stress fell Monday despite a second day of weakening stocks.

“We are entering a new regime of higher volatility where prices are vulnerable to sharp reversals and breakout of new trends,” said Nigol Koulajian, founder and chief investment officer of Quest Partners, a $650 million quantitative hedge fund. “Years of aggressive Central Bank policies suppressed volatility across markets and this is now changing as macro and political risk begin to rise.”

Quest, based in New York, gained 1.6 percent on Friday and 3.6 percent on Monday in its main fund, AlphaQuest Original Fund, a person familiar with the matter said. (click on image)

Quantitative Investment Management, a computer-driven firm based in Charlottesville, Virginia, gained 3.6 percent on Friday and 12 percent this month before fees in an equity strategy that manages about $500 million, a person with knowledge of its returns said. The performance adds to a gain of almost 30 percent after fees in the first five months of this year.

The firm’s main futures strategy, which manages about $2.5 billion, also made money on Friday, bringing gross returns for June to 4.2 percent. Before this month, it had gained 7.7 percent, net of fees, in 2016.

Man Group Plc, the world’s largest publicly traded hedge-fund firm, reported a 1.3 percent gain in AHL Diversified Programme and 0.9 percent rise in AHL Alpha Programme. Its AHL Evolution Programme lost 0.5 percent, while the AHL Dimension Programme declined 0.7 percent, according to the firm’s website.

Other computer-driven funds that profited include Winton Capital Management in London, whose founder David Harding gave 3.5 million pounds ($4.6 million) to the Remain campaign.

Officials for the hedge funds declined to comment on performance. Many funds will update investors on their June performance this week and next.

Macro Funds

George Soros, the billionaire who gained fame by successfully wagering against the pound in 1992, said he was betting on the currency leading up to the vote. In the days before, Soros had warned that sterling could slump more than 20 percent against the dollar as voters were grossly underestimating the true cost of the U.K. quitting the EU.

Soros made money on other investments that were designed to profit from falling markets, a spokesman said Monday. His Soros Fund Management took a short position in Deutsche Bank AG of about 7 million shares Friday as bank stocks tumbled.

Soros built his reputation as a macro investor, a strategy that seeks to profit from economic events and trends by trading everything from currencies to commodities. Macro funds that made money on the U.K. vote include Graticule Asset Management, run by Adam Levinson, people with knowledge of the firms said.

Macro hedge funds had a low level of risk on before the decision, according to a survey last week by research firm Drobny Global Advisors LP. Such funds are likely to have posted performance ranging from losses of 2.5 percent to gains of 0.5 percent in the aftermath of the vote, Philippe Ferreira, head of research at Lyxor Asset Management, said in a report.

Nonetheless, a macro hedge fund run by H2O Asset Management slumped 14.4 percent on Friday, according to data compiled by Bloomberg. The H2O Vivace fund had managed about 209 million euros ($232 million) at the end of May, according to its website.

Stone Milliner Asset Management, the macro fund run by Jens-Peter Stein and Kornelius Klobucar, lost 0.2 percent in the Class A shares, Series I version of its fund this month through Friday, according to an investor update. It has lost 1.2 percent this year.

‘Surprising Turn’

Discovery Capital Management LLC, the macro fund run by Robert Citrone, posted a 0.5 percent gain for the month in its Global Opportunity Fund through Friday and a loss of 2.5 percent for the year, according to an investor update. The fund said the highest conviction short wagers in its portfolio are in the U.K. and European equity markets.

“With a Remain vote, we had believed risk assets in general would have had a sharp rally over the next 3-4 weeks, from which a meaningful correction would have unfolded,” the South Norwalk, Connecticut-based firm said. “This surprising turn of events has accelerated our roadmap that we had for the August-October time frame.”

Hedge fund manager Crispin Odey, an advocate of a British exit, posted a 21 percent gain over Friday and Monday in his main fund, according to an e-mail to investors. Odey had conducted a private poll ahead of the decision showing the vote was much closer than financial markets expected.
I hope Crispin Odey locked in those big gains because markets have been on fire since Tuesday and he's a well-known Euro bear who was down huge in the first four months of the year.

But it looks like once again the quants are thriving in this uncertain environment. We'll see if they can keep it up in the second half of the year.

Speaking of quants, the king of quants, James Simons, Renaissance Technologies founder and billionaire philanthropist, made a rare appearance on CNBC to discuss markets, politics and his comment on what the next president's No.1 priority should be.

Normally I don't pay attention to the political views of hedge fund gurus but I must admit, I really enjoyed listening to Simons speak his mind on markets, Brexit, Trump ("He has a terrible Sharpe ratio") and more importantly on the need to build America's crumbling infrastructure (I think US public pensions should be part of the solution). Watch the clips below.

I also embedded a clip where George Soros told the EU Parliament Brexit has aggravated looming dangers in the markets, including a crisis in financial markets.

I end by wishing my many supporters who congratulated me on my blog's eight year anniversary a big thank you. Eight years later and over 5 million viewers, I'm still blogging away and enjoying it. Not bad for a guy with progressive Multiple Sclerosis (it's been 19 years since my diagnosis in June 1997) which goes to show you, if you put your mind to something, nothing will stop you except for your own fears and self-doubt.

On that note, please remember to show your support for this blog via your PayPal contributions on the right-hand side under my picture.

I'm taking a break to celebrate Canada Day tomorrow and mourn the loss of P.K. Subban who was traded away to the Nashville Predators in a shocking move that left Habs fans dumbfounded. Oh well, Go Habs Go but it won't be the same without P.K. in the lineup. Enjoy your long weekend and Happy Canada Day and 4th of July!

Wednesday, June 29, 2016

Teachers Wage War on Hedge Funds?

Brody Mullins of the Wall Street Journal reports, Teachers Union and Hedge Funds War Over Pension Billions:
Daniel Loeb, Paul Singer and dozens of other hedge-fund managers have poured millions of dollars into promoting charter schools in New York City and into groups that want to revamp pension plans for government workers, including teachers.

The leader of the American Federation of Teachers, Randi Weingarten, sees some of the proposals, in particular the pension issue, as an attack on teachers. She also has influence over more than $1 trillion in public-teacher pension plans, many of which traditionally invest in hedge funds.

It is a recipe for a battle for the ages.

Ms. Weingarten started by targeting hedge-fund managers she deemed a threat to teachers and urged unions to yank money from their funds. Then she moved to Wall Street as a whole.

Her union federation is funding a lobbying campaign to eliminate the “carried-interest” tax rate on investment income earned by many money managers. It is trying to defeat legislation that would increase the charitable deduction in New York state for donations to private schools. And it has filed a class-action lawsuit accusing 25 Wall Street firms of violating antitrust law and manipulating Treasury bond prices.

Some pension funds have withdrawn money from hedge-fund managers criticized by the teachers union. And some hedge-fund managers stopped making donations to advocacy groups targeted by Ms. Weingarten.

Hedge funds, reluctant to buckle to the pressure, say Ms. Weingarten is doing a disservice to the teachers she represents, because funds should aim solely to earn the highest possible return on their assets. The personal beliefs or donations of hedge-fund managers, they argue, shouldn’t be a factor in that decision. At least one manager, Mr. Loeb of Third Point LLC, has increased his donations to a charter-school group, citing Ms. Weingarten.

Sander Read, chief executive officer of Lyons Wealth Management, which hasn’t been targeted, likened what Ms. Weingarten is doing to “hiring a dentist because of their political beliefs. You may see eye to eye on politics, but you may not have great, straight teeth.” None of the hedge funds targeted by the teachers unions would discuss the matter publicly, a sign of how sensitive the battle has become.

Ms. Weingarten said in an interview: “Why would you put your money with someone who wants to destroy you?”

The battles are rooted in a political fight over how to improve public education. Republicans have long sought major changes, such as creating new competition for public schools, including charter schools. Democrats largely have supported solutions backed by the unions, particularly increased spending for existing schools.

About a decade ago, some liberals joined conservatives in pushing to expand charter schools. Those efforts received financial support from hedge-fund managers including Mr. Loeb, Mr. Singer of Elliott Management Corp. and Paul Tudor Jones of Tudor Investment Corp., who together kicked in millions of dollars.

Some of those involved in the effort cast public-school teachers and their unions as obstacles to improving education. The reputation of the teachers union took a beating.

When Ms. Weingarten was elected president of the American Federation of Teachers in 2008, she aimed to restore public trust in public-school teachers and their unions.

As she rose in the union, she got close to Bill and Hillary Clinton. Last summer, the federation became the first union group to endorse Mrs. Clinton’s presidential campaign. Ms. Weingarten sat on the board of the super PAC supporting her candidacy, and the American Federation of Teachers has donated $1.6 million to the Bill, Hillary and Chelsea Clinton Foundation.

Ms. Weingarten’s federation represents about two dozen teachers unions whose retirement funds have a total of $630 billion in assets, a big chunk of the more than $1 trillion controlled by all teachers unions. The federation doesn’t control where that money is invested; the unions themselves do. But Ms. Weingarten can make recommendations.

She instructed investment advisers at the federation’s Washington headquarters to sift through financial reports and examine the personal charitable donations of hedge-fund managers. She says she focuses on groups that want to end defined-benefit pensions. Many of the same entities also back charter schools and overhauling public schools.

In early 2013, the union federation published a list of roughly three-dozen Wall Street asset managers it says donated to organizations that support causes opposed by the union. It wanted union pension funds to use the list to decide where to invest their money.

The Manhattan Institute for Policy Research, a think tank that supports increasing school choice and replacing defined-benefit pension plans with 401(k)-type plans for future government employees, is one of the groups to which donations were viewed unfavorably.

Lawrence Mone, its president, says the tactics amount to intimidation. “I don’t think that it’s beneficial to the functioning of a democratic society,” he says.

After KKR & Co. President Henry Kravis made the list in 2013, Ms. Weingarten got a call from Ken Mehlman, an executive at the private-equity firm and former chairman of the Republican National Committee.

Mr. Mehlman said KKR had a record of supporting public pension plans, according to Ms. Weingarten.

Ms. Weingarten agreed, removed Mr. Kravis’s name from the list and invited Mr. Mehlman to talk about the firm’s commitment to public pensions at a meeting in Washington with 30 pension-fund trustees representing 20 plans that control $630 billion in teachers’ retirement money.

When Cliff Asness of hedge fund AQR Capital Management LLC found out Mr. Kravis had gotten off the list, he called Mr. Mehlman, a friend. Mr. Asness also hired a friend of Ms. Weingarten’s: Donna Brazile, a vice chairwoman of the Democratic National Committee who has been a paid consultant to the American Federation of Teachers.

Ms. Brazile arranged a lunch meeting between Mr. Asness and Ms. Weingarten, where they discussed ways to work together. Not long after, Mr. Asness’s firm paid $25,000 to be a founding member of a group that KKR’s Mr. Mehlman was starting with Ms. Weingarten to promote retirement security.

Mr. Asness was removed from the list. A year later, when Ms. Weingarten noticed he continued to serve on the Manhattan Institute board, she considered putting him back on.

In September of last year, when the California State Teachers’ Retirement System, or Calstrs, considered increasing its hedge-fund investments, Ms. Weingarten saw another chance to apply pressure.

Dan Pedrotty, an aide to Ms. Weingarten who runs the hedge-fund effort, spoke to a Calstrs official about Mr. Asness’s continued service on the Manhattan Institute’s board. The Calstrs official then called Mr. Asness.

In December, Mr. Asness said he would step down from the Manhattan Institute board. His spokesman says he already had made the decision at the time of the call, after reassessing time spent on the boards of several nonprofit groups.

“Randi is committed to helping hard working employees achieve the secure retirement they deserve,” Mr. Asness said in a written statement.

Mr. Loeb, founder of the $16-billion Third Point fund, has been more combative. He is a donor to the Manhattan Institute and chairman of the Success Academy, which operates a network of charter schools in New York City.

In a March 2013 letter to Mr. Loeb, Ms. Weingarten noted his support of a group “leading the attack on defined benefit pension funds” and said she was “surprised to learn of your interest in working with public pension plan investors.” Seeking business from union pension funds while donating to the group, she wrote, “seem to us perhaps inconsistent.”

The two agreed to meet.

Mr. Loeb emailed Ms. Weingarten, noting his fund’s average annual return of 21% over 18 years. “I completely respect the political considerations you may have and understand if other factors dictate how funds are allocated,” he wrote.

A week later, Ms. Weingarten wrote back to reiterate that unions were wary of investing with Mr. Loeb “given the political attack on defined benefit funds.”

In response, Mr. Loeb asserted that it must be “frustrating” for unions to invest with funds that “have different political views or party affiliations.” He added: “At least we can rejoice in knowing that as Americans we share fundamental values that elevate individual opportunity, accountability, freedom, fairness and prosperity.”

The meeting was called off, and Mr. Loeb was added to the list.

At a fundraising dinner that May for his charter-school group, Mr. Loeb stood up and said: “Some of you in this room have come under attack for supporting charter-school education reform and freedom in general.” He called Ms. Weingarten the “leader of the attack” and pledged an additional $1 million in her name.

“Both Randi and I believe America’s children deserve a 21st century education, and I hope the day comes when she embraces the positive change created by public charter schools,” Mr. Loeb said recently in a written statement.

In late 2013, state union officials pressed a Rhode Island pension fund to fire Third Point. The following January, the pension fund did just that, pulling about $75 million from Mr. Loeb’s fund. A spokeswoman for the state treasurer said at the time that Mr. Loeb’s fund was too risky.

Roger Boudreau, a member of the teachers union and an elected adviser of the Rhode Island fund at the time, says the donations played a role. “It’s fair to say that those kinds of donations are going to be looked at very critically,” he says.

Around that time, a giant billboard appeared above Times Square. “Randi Weingarten’s Union Protects Bad Teachers,” it read above a picture of her scowling face.

Ms. Weingarten immediately assumed the hedge-funders were behind the attack. The entity listed as the billboard’s sponsor is the Center for Union Facts, a Washington-based advocacy group. The group declines to disclose who paid for the billboard.

“We all guessed it had to be people like Dan Loeb,” Ms. Weingarten says. Mr. Loeb declined to comment.

The billboard kicked off a campaign against Ms. Weingarten by the Center for Union Facts, including radio and newspaper advertisements. “She’s the head of the snake, so it was appropriate to go after her personally,” says the group’s president, Richard Berman.

The ads directed people to a website that said she oversaw a “crusade to stymie school reforms and protect the jobs of incompetent teachers.” It listed her salary and called her a “member of the elite.”

In September 2014, Mr. Berman sent a 10-page letter to lawmakers, union officials and opinion leaders charging that Ms. Weingarten‘s “ineptitude is a threat against America, against hard-working teachers, and especially against our nation’s children.”

Lorretta Johnson, secretary-treasurer of the American Federation of Teachers, responded in a letter to union leaders that Mr. Berman represented a “front group whose mission is to vilify and destroy unions.”

After the billboards appeared, Ms. Weingarten opened several new lines of attack. Her union group helped launch an advocacy group, Hedge Clippers, that lobbied against proposed New York legislation to increase the charitable deduction for donations to public and private schools. The group publicized donations that it says several Wall Street executives made to the governor, who supported the legislation, and named the elite schools it says their children attended. The state senate hasn’t acted on the proposed legislation.

Last fall, Ms. Weingarten’s union group published a report criticizing hedge funds, called “All That Glitters Is Not Gold.” Among other things, the report claimed that the high fees charged by hedge funds made them unattractive investments.

The report said that 11 big pension funds it analyzed paid an average of $81 million each in annual fees to hedge funds. Those pension funds, it said, earned better returns on money that wasn’t invested in hedge funds.

AQR’s Mr. Asness, in a presentation to the Ohio pension board in March, acknowledged that some hedge funds charge high fees, but said that didn’t mean “the net deal for investors is a bad one, just that it could and should be better.”

Earlier this year, an Illinois public-pension fund cut its hedge-fund investments. In April, one of New York City’s public-pension funds voted to dump its investments in hedge funds. Ms. Weingarten tried to get a big Ohio fund to follow suit. It voted recently to remain invested in hedge funds, including in Mr. Loeb’s.
Wow, so much drama, where do I begin? Well, the first thing I would say is this article bolsters the point I made in the New York Times back in 2013 that US public pension funds need independent, qualified investment boards.

There is way too much political meddling from unions, governments and rich hedge fund and private equity fund managers into the way investments are managed at US public pensions. This is done deliberately so that they can maintain the status quo and milk US public pensions dry.

The second point I'd like to state publicly is I'm tired of arrogant hedge fund managers, many of which are nothing more than glorified asset gatherers charging alpha fees for leveraged beta, taking on teachers' unions or any other public sector union. These idiots would have never made the Forbes list of rich and famous if it wasn't for the blood, sweat and tears of teachers, police officers, firemen, and public sector workers contributing to their defined-benefit public pensions.

And yet they have the gall to fund right-wing think tanks like the Manhattan Institute which promote dumb ideas like replacing defined-benefit plans with defined-contribution plans, totally ignoring the brutal truth on the latter plans.

My message to hedge fund managers who fund such think tanks is to educate yourselves and learn the benefits of well-governed defined-benefit plans like the ones we have in Canada.

If all these "brilliant" hedge fund managers were really the smartest people that money can buy, they'd be fighting tooth and nail to promote large well-governed defined-benefit plans.

What else? I highly suggest billionaire hedge fund managers and private equity managers remain apolitical. If you have political views, keep them to yourself and don't go public and donate millions to groups that want to destroy public sector unions. It's mind-boggling how arrogant and dumb some hedge fund managers truly are.

Don't get me wrong, public unions are just as much to blame for the pathetic state of US public pensions. They too are delusional if they think the status quo is acceptable. And they definitely need to stop meddling in investment decisions which are not in the best interests of their members.

Having said this, if I was part of a teachers' union or any public sector union and my pension contributions were going to enrich some rich arrogant hedge fund manager who was funding organizations looking to weaken defined-benefit plans, I too would be irate.

And to add insult upon injury, it's not like hedge funds are outperforming while they charge insane fees to their investors. The truth is hedge funds face their own day of reckoning and as I've been warning my readers, it's only going to get worse in a deflationary world.

Let me be crystal clear. I don't care if it's Dan Loeb, Paul Singer, Bill Ackman, Ken Griffin, or whichever Republican or Democratic hedge fund manager, my advice is to shut up, stay apolitical, and focus on your fund's performance. That's it, that is the only thing you should be obsessing about.

But I also have some harsh advice for Ms. Weingarten and public sector unions. Stop meddling in public pension fund investments, more often than not, you'll be doing your members a great disservice.

The problem in the United States is the lack of pension governance which separates public pensions from governments, public unions and elite asset managers. If they had the right governance model, like we do in Canada, they would be able to attract and retain qualified pension fund managers to bring most assets internally instead of farming them out to external managers which rake them on fees.

Still, even in Canada, public pensions do invest in external hedge fund and private equity funds when it serves their members' needs. Ontario Teachers' Pension Plan may have experienced some Brazilian blunders but there's no denying it's one of the best public pension plans in the world with a stellar long-term track record and it invests in top hedge funds and private equity funds.

In fact, if I was Ms. Weingarten, I would spend a lot less time waging public war against hedge funds and a lot more time studying the governance model at Ontario Teachers' Pension Plan which is the key reason behind its success.

One former hedge funder shared these thoughts with me after reading my comment:
Public policy isn't my thing but here are a couple rookie thoughts:
1) I think carried interest might be a bigger deal in PE than in Hedgefundistan.

2) Advocacy for charter schools is not really about the children. It is about how hedge fund guys think of themselves. They want power and attention. The children are secondary.

3) I don’t blame hedge fund guys for expressing political views. I blame US for listening. Who gives a damn what they think? Public policy is not their thing. But I would not demand their silence.
I agree but unlike him, I would demand their silence, especially if they are willfully ignorant on public policy.

Below, a CNBC clip from last year discussing how hedge fund managers are stung by 'class warfare' rhetoric. President Obama called the group "society's lottery winners", noting that the top 25 earning hedge fund managers made more in 2014 ($11.6 billion) than the roughly 158,000 kindergarten teachers in the US did combined ($8.5 billion).

If you ask me, most hedge fund and private equity managers are disgustingly overpaid for the mediocre performance they're delivering and that's another reason why the governance model at US public pensions needs to change to the one Canada's large public pensions adopted years ago.

Of course, that topic won't be discussed at today's Three Amigos summit. It's too bad because the US and Mexico can learn a lot about  pensions from Canada's politicians who just expanded the CPP.

Tuesday, June 28, 2016

Ontario Teachers' Brazilian Blunders?

Theresa Tedesco of the National Post reports, Buyer beware: How the Ontario Teachers’ Pension Plan got caught in the fallout of Brazil’s biggest scandal:
An investigation into money laundering at gas stations and laundromats that began two years ago in southern Brazil has since mushroomed into a wide sweeping corruption scandal, creating a national soap opera that has enthralled Brazilians as it reaches into the upper echelons of the country’s political and corporate elites.

Operation Lava Jato (Car Wash), launched by Brazil’s federal police, has ensnared top executives at Brazil’s powerful state-controlled oil giant Petroleo Brasileiro SA (Petrobras) who are alleged to have accepted bribes from a cartel of companies to enrich themselves while also channelling funds to politicians.

The fallout has included the recent impeachment of President Dilma Rousseff and the arrest of dozens of senior politicians and business leaders. But also caught up in the tumult are hundreds of millions of dollars managed by some of the world’s biggest investors, including Ontario Teachers’ Pension Plan, one of Canada’s biggest and most respected publicly funded pension funds.

Teachers’ is among a group of major global investors who own an 18.6-per-cent stake in Grupo BTG Pactual SA, the largest independent investment bank in Latin America, whose billionaire founder, chairman and chief executive, Andre Santos Esteves, was arrested last November for allegedly attempting to obstruct the corruption probe.

The charismatic 47-year-old, with an estimated net worth of US$2.2 billion according to Forbes Magazine, is the highest-profile business executive implicated in the widening corruption dragnet and was held under house arrest for almost four months until he was released in late April.

The current criminal charges against Esteves are still pending and he has vehemently and repeatedly denied any wrongdoing. Yet he was forced to resign from his executive roles at BTG Pactual, although he remains the controlling shareholder.

Shares of BTG Pactual, which are listed on the BM&F Bovespa and NYSE Euronext, have collapsed, losing more than 50 per cent of their value before recovering some ground although they are still down 42 per cent. The investment bank’s bonds have been downgraded to junk status by credit rating agencies Moody’s Investor Services Inc., Fitch Ratings and Standard & Poor’s.

BTG Pactual in May was also listed among nine financial institutions placed under “special surveillance” by Brazil’s central bank, which is closely monitoring the liquidity and stability of their operations, according to a report by Reuters.

The firm, which Esteves steered through an aggressive global expansion, has sold more than US$3.5 billion in assets, including loan books and its Swiss private-banking unit BSI, slashed dividend payments and cut costs at its operations in Brazil, Europe and Hong Kong.

Teachers’ original $206-million private-placement investment made in December 2010 is now worth less than $150 million.

Teachers’, which has a reputation for promoting good governance and principled investing, declined repeated requests to answer questions about its investment in the Brazilian investment bank and association with Esteves, who along with other business associates have a track record of being on the wrong side of securities laws.

“We very rarely discuss the mechanics of our decisions and rationale for specific investments in companies or assets,” Deborah Allan, vice-president of media relations, said in an email. “We’re a global and well diversified long term investor, and we operate with the principles of investment risk.”

There’s no doubt the pursuit of higher returns is increasingly propelling major Canadian pension funds to invest in emerging markets such as Brazil, said Malcolm Hamilton, an actuary and former partner at Mercer with 40 years’ experience in the pension industry.

“The pressure has just been getting worse and worse, especially as interest rates continue to decline, for public funds to try to get the returns they used to get,” he said. “They want to invest where they can achieve the best return for the risk they take, and this means looking beyond Canada and North America to opportunities elsewhere in the world.”

Those opportunities also bring heightened risk.

“Sometimes it’s hard to perform tough due diligence in developing countries, especially when people will always present you with the best possible picture,” said a senior pension expert who asked not to be named. “Sometimes you make mistakes and you’ve got to keep it even when it’s tricky.”

Added Keith Ambachtsheer, director emeritus at the Rotman International Centre for Pension Management at the University of Toronto: “When you’re in this type of situation, maybe the right way to go is to try to save the investment, clean up the situation and drive on.”

• • •

Andre Santos Esteves, also known as the golden boy of Brazilian banking, and his partners pulled off a major coup when they persuaded an impressive group of nine major global investors — mostly sovereign-wealth funds and rich families — to purchase an 18.65-per-cent interest in BTG Pactual for US$1.8 billion in December 2010.

But it seems Teachers’ held a special place in Esteves’ heart. During the annual Foreign Policy Association’s Financial Services Dinner at the Pierre hotel in midtown Manhattan for 400 well-heeled guests on Feb. 29, 2012, he introduced the evening’s guest of honour, James Leech, then the chief executive of Teachers’ as “one of the most sophisticated investors in the world.”

In his heavily accented English, the billionaire that Forbes ranked 13th richest in his country, declared that his bank has “a very special relationship with Ontario Teachers’,” adding that when BTG Pactual organized the largest private placement in Latin America, “Ontario Teachers’ was one of the cornerstone investors.”

Each of those investors — China Investment Corp., Singapore’s Government Investment Corp. Pte Ltd., Abu Dhabi Investment Council, J.C. Flowers & Co., RIT Capital Partners PLC, Colombia’s Santo Domingo Group, Exor, Inversiones Bahia and Teachers’ — invested anywhere from $25 million to $300 million.

In return, the investment consortium received three seats on the Sao Paulo-based bank’s board, one of which was given to Teachers’ (which has appointed people to the post, although it is been vacated since Esteves’ arrest). More importantly, the investors were guaranteed handsome returns down the line when BTG Pactual eventually went to the public markets.

A 2011 analyst report for Exor noted the investment company controlled by Italy’s Agnelli family was given “a guaranteed minimum IRR (internal rate of return) of 20 per cent for its commitment to the IPO.”

But two months before the private-placement deal was inked, central bank investigators and securities regulators in Brazil threatened to derail it.

In October 2010, a probe inside Brazil’s central bank recommended that Esteves be banned from banking in the South American country for six years due to “serious infractions” of banking rules between 2002 and 2004, according to a report by Reuters.

The investigation focused on US$3.8-billion worth of trades between Banco Pactual SA and a limited liability corporation known as Romanche Investment Corp. LLC in Delaware.

Brazil’s central bank director Sidnei Correa Marques ruled against the ban in early 2011, apparently because of the importance of BTG Pactual, the precursor to Banco Pactual, to the economy and the perception of disciplining the head of Brazil’s largest investment bank.

“When a bank is important systemically, important to the country, among the 10 largest, I have to be careful about getting rid of essential management at that financial institution,” the central bank director was quoted by Reuters.

However, Brazil’s securities market authority — the Comissao de Valores Mobilianos (CVM) — was less forgiving. In a separate case, the market watchdog concluded that Banco Pactual had illegally transferred profits to foreign funds to disguise gains and avoid taxes. In 2007, the CVM fined Pactual and Esteves about US$4 million although there was no admission of guilt or wrongdoing.

By the time the two decisions were rendered, Esteves had already persuaded Teachers’ and eight other well-heeled investors to give him the all-important credibility to eventually take his bank to market.

• • •

BTG Pactual’s initial public offering, the first for an investment bank in Brazil and the most high-profile and lucrative pubic offering that Brazilian capital markets had seen in almost a year, occurred April 26, 2012. The stock was priced at 31.25 reals and the IPO raised about US$1.96 billion.

That same year, Esteves was honoured as “Person of the Year” by the Brazilian-American Chamber of Commerce and one of the 10 most influential bankers in the world by Bloomberg Magazine, alongside Wall Street icons Jamie Dimon of JP Morgan Chase and Lloyd Blankfein of Goldman Sachs, as well as Gerald McCaughey, then chief executive of Canadian Imperial Bank of Commerce.

Behind the scenes, however, Esteves’s past brushes with securities regulators began to emerge.

A month before BTG Pactual’s private-placement deal was signed in December 2010, Italian market regulators had notified Esteves that he was the target of an insider trading probe dating back to 2007, when he was head of fixed income at UBS.

The Commissione Nazionale per le Societa e La Borsa alleged that Esteves used a private account to purchase shares in Italian meat producer Cremonini SpA after he heard about an upcoming joint venture with a Brazilian company.

Esteves denied and fought the allegations, but apparently did not inform his investors of the ongoing probe when they participated in the 2010 private placement. Nor was the probe disclosed to potential investors in BTG Pactual’s initial IPO prospectus in April 2012.

On April 4, 2012 — three weeks before BTG Pactual’s IPO — Italy’s capital markets authority fined Esteves 350,000 euros for alleged insider trading.

The findings and penalties against the Brazilian banking executive were “administrative,” however he was suspended nine months from serving as a director or executive officer of a company regulated by the Italian securities commission. As well, he was forced to return his alleged profits of US$5.4 million.

A day before the Italian regulator released its decision, BTG Pactual amended its IPO prospectus and issued a statement that read “our controlling shareholder is a subject of an ongoing civil, non-criminal investigation in Europe in connection with certain trades in the securities of a European market issuer made by him in his personal capacity in 2007.”

Notably absent is any mention of Esteves directly or that the controlling shareholder was also the chief executive and chairman of the board of BTG Pactual. (Esteves would file an “administrative appeal,” later withdrawn despite his protestations of innocence, citing costs and a loss of time as his reasons.)

Even so, Brazil’s securities regulator CVM issued a receipt blessing the IPO.

“Under those circumstances, why was the IPO even allowed to proceed?” asked a senior Canadian regulator who spoke on the condition of anonymity. “At a minimum, the Brazilian securities regulator should have demanded disclosure of Esteves’s role in the company. Any commission in Canada and the SEC [the U.S. Securities and Exchange Commission] certainly would have insisted.”

Sources say the private-placement shareholder group was broadsided by the revelations of Esteves’s track record of securities violations.

In the days following the Italian probe, principal investors were given the opportunity to back out of the deal and some took the opportunity.

For example, the Agnelli family, which invested US$25 million, sold 87 per cent of its 0.26-per-cent interest less than a month after learning of Esteves’ insider trading conviction, according to a 2011 filing. U.S. investment firm J.C. Flowers began slowly divesting some of its stake, as did RIT Capital Partners and China Investment Corp.

What they didn’t know at the time was that Charles Rosier, a partner at BTG Pactual in charge of client relations in Europe, had also been in the crosshairs of securities regulators while Esteves was gathering the consortium of investors back in 2010.

France’s market regulator was probing insider trading during the French state railway’s takeover of a logistics company called Geodis in March 2008, while Rosier was a managing director at UBS, which had advised on the deal.

The result was that the Autorite des Marches Financiers in October 2013 levied the largest fine in its history by penalizing Rosier 400,000 euros for tipping insider information to his cousin prior to the deal.

The investigation of Rosier and his subsequent conviction have not been disclosed in any of BTG Pactual’s corporate filings. Calls to a number of the consortium investors and BTG Pactual were not returned.

Since the revelations of Esteves’ insider trading convictions in 2012 and the bribery and corruption charges against him in 2015, sources familiar with the Brazilian investment bank say six of the nine principal investors have sold their interests.

The three remaining “cornerstone” investors are Singapore’s sovereign fund, Colombia’s Santo Domingo Group, which among other holdings held the second-largest stake in SABMiller PLC, the world’s second-largest beer company, and Teachers’.

At the end of 2012, Teachers’, which manages $171.4 billion in net assets, had $206 million invested and that exposure remained the same at end of 2013. The following year in 2014, it was down to $203.4 million and by Dec. 31, 2015, the value plunged below $150 million, mostly due to the fallout of Esteves’ arrest.

“We remain an investor,” Teachers’ spokesperson Allan confirmed in an email, adding, “it remains part of our relationship investing portfolio, in our public equities asset class.”

Ultimately, Teachers’ main function is to create value for plan participants and it has certainly done that. In the four years since BTG Pactual’s IPO, the pension fund has enjoyed annual returns of 13 per cent in 2012, 10.9 per cent in 2013, 11.8 per cent in 2014 and 13 per cent in 2015.

Teachers’ investment in BTG Pactual is relatively small, but it raises questions about its ability to properly vet investments far from home, and its troubles in Brazil are far from over. A multi-million-dollar lawsuit launched by a former executive against BTG Pactual in Hong Kong also threatens to drag the investment bank’s principal partners, including Teachers’, into another potentially unseemly mess.
So what is this all about? Basically André Santos Esteves, the golden boy of Brazilian banking, was able to schmooze Ontario Teachers and large sovereign wealth funds into buying a 19% stake of BTG Pactual through a private placement and now it turns out he might be another Brazilian con artist.

Remember Eike Batista, Brazil's rags to riches (back to rags) billionaire boy wonder? He too burned Ontario Teachers but at least they invested early on with him and made money in those investments before Batista's massive empire crumbled (a former colleague of mine who met Batista told me "he was an unbelievable salesman").

I'm sure Teachers made some money off BTG Pactual too. When I was working at the Caisse, we had invested in BTG Pactual's multi-strategy hedge fund and everything was kosher and it performed exceptionally well (don't think the Caisse is invested in it any longer; its hedge fund program has been slashed). BTG Pactual is a Latin American powerhouse when it comes to banking.

More importantly, this deal represents a small investment in Teachers' huge portfolio, so it will be able to absorb any losses and it won't make a dent in the overall performance which has been stellar in the last ten years.

Having said this, even if it's a small deal, the last thing Ontario Teachers or any big Canadian pension fund needs is headline risk.

Don't forget, back in February, news broke out that Teachers stepped on a German land mine, so the last thing Teachers needs is more negative press highlighting its supposedly weak due diligence.

The truth is Ontario Teachers has a great due diligence team but my sources tell me it might be stretched thin, covering everything from hedge funds, to private equity funds, private placements and PIPE deals. If this is true, OTPP's board and senior management need to rectify it.

I sent this article to Ron Mock, Ontario Teachers' CEO, and Jim Leech, the former CEO. Not surprisingly, they didn't reply but I already know what their reply would be: "Sometimes you find gems of deals and sometimes you get burned badly, it's the nature of taking risks in emerging markets and elsewhere."

That's true but Ive been very skeptical about Brazil's boom for a long time and think many Canadian pension funds were too quick to pull the trigger, even if these are long-term investments.

Investing in emerging markets isn't easy. You need to find the right partners and make sure they've got the right alignment of interests and aren't con artists. I don't trust many fund managers in Brazil and think there are a lot of blowhards there selling snake oil. Then again, Brazil is home of 3G Capital, arguably the best private equity fund in the world (at least Warren Buffet thinks so).

And while there's no denying Brazil has huge potential, it's currently experiencing a lot of political and economic turmoil, highlighted by the fact that the 2016 Rio Olympic Games are in dire straits.

The lesson for Canada's large pension funds? Choose your investment partners very carefully in emerging markets like Brazil, Russia, China and India but no matter how well you vet them, be prepared for headline risk if things go awfully wrong.

As for Ontario Teachers,  I have no doubt that Wayne Kozun and his team know what they're doing and while the article above raises a lot of red flags, you need to take everything you read with a grain of salt. I'm sure it's not all terrible or else Teachers would have dumped this investment a long time ago. Also, keep in mind, the media reports only bad news, not the investments that went well in Brazil.

Below, on February 29, 2012 nearly four hundred guests dined at the Pierre for FPA's annual Financial Services Dinner where André Esteves presented an award to Jim Leech, Ontario Teachers' former CEO. Listen to his introduction but more importantly, listen to Jim Leech's remarks, they're excellent.

Also, Joe Leahy, FT Brazil bureau chief, analyses the surprise arrest of billionaire banker André Esteves, and its impact on the nation’s economy and the scandal at oil giant Petrobras.

Keep in mind Brazil's economy shrank 5.4% in the first quarter of this year. CNN's Shasta Darlington explains how the economic crisis is playing out on the global stage as Rio gears up to host the Summer Olympics. I didn't embed this clip but you can watch it here.

Lastly, it's less than 40 days until the Rio Olympics and the list of challenges for the host city gets longer, CBC's Chris Glover reports.

I truly hope the Rio Games are a success and even though I'm not worried about Brazil's long-term economic prospects, the Olympic hangover might last for a decade, especially in a post-Brexit world.

Monday, June 27, 2016

Profiting From Brexit?

Rachael Levy of Business Insider reports, A select group of hedge funds made some serious money on Brexit:
The UK has voted to leave the European Union, a shock decision that sent markets crashing on Friday.

For a small band of hedge funds, the decision, and its impact on the market, led to outsize returns.

The gains are especially noteworthy, as many funds went in to the vote having reduced risk.

"An unusually low number of client incoming calls and modest trading volumes away from the Russell rebalancing may speak to the already light positioning ahead of the UK referendum," Credit Suisse said in a note Friday.

In addition, betting on a binary outcome such as Leave-Remain is a brave bet. Four out of five European hedge funds polled expected Britain to stay in the EU, according to a Preqin poll earlier this month, and most polling immediately before the vote suggested Remain would carry the day.

Still, several funds posted impressive returns. The NuWave Matrix Fund was up 12% on Friday, putting it up around 10% for the year, according to chief operating officer Craig Weynand.

The fund, which manages about $60 million, runs a CTA/systematic macro strategy, meaning it makes trading decisions based on historical patterns rather than gut decisions.

"It's true that Brexit was a binary outcome, but by the same token, history has a number examples of binary outcomes," Weynand said, citing the Federal Reserve decisions and shock events like tsunamis. "History doesn't repeat itself, but it usually rhymes."

Another macro manager, Quadratic Capital Management, posted its best ever returns since it launched in May 2015, according to a person with knowledge of the matter.

Quadratic didn't make money betting on a Leave vote, but rather by deploying options strategies that make money during risk-off events like the one Friday, the person said.

Quadratic manages about $428 million and is run by one of the industry's few female hedge fund managers, Nancy Davis.

Schonfeld Strategic Advisors, which manages two funds alongside billionaire Steve Schonfeld's money, also did well. The firm is performing in the low double digits this year and was in positive territory early Friday, according to CIO Ryan Tolkin.

He declined to share exact performance figures or assets under management, but said Schonfeld manages about $12.5 billion, including leverage.

Schonfeld, like many hedge funds, didn't take a concentrated bet on the outcome of the Brexit vote.

"We try not to take binary views on things like this," Tolkin told Business Insider.

Rather, the firm, which uses market-neutral equity and quant strategies, reduced its overall market exposure in hopes of capitalizing on post-vote volatility, Tolkin said.

"Now we're in a good position to try to take advantage of some price points that we've now got," he added.

Other managers seem to have taken advantage, too. Winton Capital's systematic trading strategy gained 3.1% Friday, according to Reuters.

And ISAM Systematic Master fund, launched by ex-Man Group manager Stanley Fink, gained 4% early Friday, according to a person who had seen the figures. ISAM didn't immediately respond to a request for comment.

Crispin Odey, who manages about $10.2 billion at his macro-focused firm, told Reuters Friday that his fund would gain 15% from the Brexit outcome, regaining some of its losses this year.

George Soros and Stanley Druckenmiller, both legendary investors, also profited from the market drop, according to CNBC. Spokespeople for Soros and Druckenmiller declined to comment.
Soros says Brexit has made the disintegration of the EU practically irreversible and has called for a thorough reconstruction of the European Union in order to save it. He has been very bearish this year and even returned to trading his views.

However, a Soros spokesperson said this in a statement following Brexit: "George Soros did not speculate against sterling while he was arguing for Britain to remain in the European Union. In fact, he was long the British Pound leading up to the vote."

Of the hedge fund managers named in the article above, the one lady that caught my attention was Nancy Davis (pictured above), a rising quant star who described her fund's approach as such:
We have a very differentiated approach to portfolio construction. I’d argue it’s quite innovative, as the whole portfolio is implemented with optionality. We primarily use options in our portfolio construction, which is a risk-based support approach to portfolio construction. We are a discretionary macro strategy that seeks to have a defined downside along with asymmetric risk-reward. The strategy is also typically long volatility. We aim to deliver uncorrelated returns in normal environments and also in risk-off environments.
Obviously being long vol (VXX) is a great strategy when event risk strikes but it's the way they construct their portfolio using options to limit downside risk which I find interesting. Also, unlike other big macro funds, I like the fact that Quadratic manages just under $500 million, which shows me they are managing their growth properly and focusing first and foremost on performance, not asset gathering (note: do your own due diligence but these are the types of funds I like when looking at hedge funds).

As far as other hedge fund managers named in the article, yes, Crispin Odey made 15% from the Brexit outcome but his fund was down over 30% in the first four months of the year, so he needs all the bearish news he can get to keep his fund afloat.

Who else gained following the Brexit vote? CNBC's Kate Kelly reports that Saba Capital, the credit hedge fund in New York run by Boaz Weinstein, was up primarily on positions that benefited from volatility:
[...] a combination of holdings that included equity put options in Europe and Asia and credit-default swaps, or insurance policies on debtors unable to pay off their debts, one of these people said.

With nearly 13 percent upside through the end of May, Saba is one of the better performing hedge funds this year, according to an industry poll conducted weekly by HSBC.  
You'll recall Saba was embroiled in a legal dispute with PSP Investments over how it marked down its investments when PSP redeemed from that fund after a few years of heavy losses. Since then, it's been loading up on closed-end funds and performing exceptionally well.

Speaking of PSP Investments and other large Canadian pension funds, they were right to worry about Brexit as they took a huge haircut on their UK investments when the British pound fell to a 31-year low.

But Matt Scuffham of Reuters reports, Canada's largest pension funds eye post-Brexit bargains:
Canada's largest pension funds see opportunities to invest in UK real estate and infrastructure at discounted prices following Britain's decision to leave the European Union, fund executives said on Friday.

The funds, which manage over C$1 trillion ($768 billion) of assets and are among the biggest investors in U.K. real estate and infrastructure, anticipate valuations falling as a result of Britain's decision to leave the bloc, presenting opportunities for investors willing to take a long-term view.

"The Canadian plans are great investors and I think, as opportunities present themselves, they will take advantage of them. It's at times of dislocation that people often get a really good deal," said Hugh O'Reilly, chief executive at OP Trust, one of Canada's 10 biggest public pension funds.

Canada's large pension funds have differentiated themselves from international rivals by investing directly in infrastructure and real estate as an alternative to choppy equity markets and low-yielding government bonds.

In the U.K., Canadian funds own or have a stake in assets including London City Airport, the High Speed One rail link connecting London to the Channel Tunnel, the country's National Lottery operator Camelot, Scotland's biggest gas network and the ports of Southampton and Grimsby.

Their long-term investment perspective means they can look beyond short-term volatility to invest in assets they believe will deliver strong returns in future years, executives say.

The Canada Pension Plan Investment Board, one of the world's biggest dealmakers and Canada's biggest public pension plan, said the fallout from the vote could provide compelling opportunities and the U.K. remained an attractive market.

"The U.K. and Europe continue to be very important and attractive markets for us. As any investor, we have a bias to stability over uncertainty, yet periods of dislocation can present compelling opportunities that short-term investors are unable to pursue," a spokesman for the fund said.

The funds continue to view Britain as a good investment over the longer term despite concerns over the impact that the decision will have on London's standing as a financial center.

"The economic fundamentals in the U.K. are very solid. We think there are, and may continue to be, great opportunities from an investment point of view. In terms of the position of the City (of London), I think what matters there is access to capital plus its talented people," O'Reilly said.

Lisa Lafave, senior portfolio manager at the Healthcare of Ontario Pension Plan, another of Canada's 10 largest funds and a big investor in U.K. real estate, also said she anticipated the vote to leave would present buying opportunities.

"There may be some positive opportunities in the short-term. Timing will be important to protect from any downside," she said.

A spokeswoman for the Ontario Teachers' Pension Plan, Canada's third-biggest public pension plan, said the fund was continuing to work on new opportunities in the U.K.

Earlier this year, a consortium of Canadian pension funds purchased London' City airport, effectively a vote of confidence in London's future as a financial center regardless of the outcome of the vote.
I thought that consortium went nuts over that London City Airport deal but in the end, they are very long-term investors who are going to work that asset to turn in a profit (in the short run, they're going to lose big money there and with other UK investments).

As far as opportunities in the UK go post Brexit, no doubt, public and private assets are much cheaper now and unless you think this is the beginning of the end of the EU, many interesting opportunities will present themselves in the months ahead.

But it's a very tough environment right now to make any long-term or short-term decisions. As I discussed on Friday, Brexit represents Europe's Minsky Moment and what happens next is anyone's best guess.

Some think Brexit could take ten years or that Brexit may not happen after all. Others are warning the Euro is gone within three to five years.

There's a tremendous amount of uncertainty which is why we're witnessing a massive flight to safety into US bonds and the Japanese yen. At this writing, global stocks are getting slammed and the yield on the ten-year US Treasury note hit 1.46%, which is the low reached back in July 2012 (click on image):

All this to say there is a lot of fear of contagion out there and I don't blame global asset allocators one bit. Brexit means a UK recession and more deflation in Europe, which will mean more deflation in Asia, which means the US runs the risk of importing more deflation in the years ahead.

So, you really think the Fed is going to hike rates in this deflationary environment? No chance, and if things get really bad, the Fed will be forced to cut rates or go negative. No wonder Financials (XLF), Metal and Mining (XME) and Energy (XLE) shares are getting clobbered on Monday but they're not alone (click on image to view various ETFs I track):

All I can say is be very careful buying the dips here. It's best to avoid some sectors altogether in this deflationary environment and focus on scaling into others which have pricing power and long-term growth.

Where do I see opportunities ahead? High beta biotech shares (XBI and IBB) and lower beta healthcare (XLV) but I'm in no rush to buy anything right now, just buying more of  the biotech stocks I already own and sitting tight as this Brexit mess works itself out. There is no rush to buy anything, stocks aren't going to melt up in this deflationary environment.

One thing Brexit has taught us is bonds are the ultimate diversifier when event risk strikes. If you look at the list above, all the bond ETFs (BND, TLT and ZROZ) are up on Monday while stocks are all getting slammed hard.

What will be the next major event risk? Frexit, Nexit or President Donald J. Trump? Who knows? All I know is it will be a hot and volatile summer and you'd better be prepared for anything going into the fall. A lot of experts (including me) got Brexit wrong, so we simply don't know what lies ahead.

Below, former Federal Reserve Chair Alan Greenspan discusses the potential fallout politically and economically from the Brexit vote, stating this is the 'tip of the iceberg'.

Also, Jeffrey Gundlach, Doubleline Capital, discusses where he's going to be investing following the vote to Brexit.Gundlach thinks there is a bear market in confidence in policymakers and he's been long gold and gold miners (GLD and GDXJ) in his macro fund all year.

What I find interesting in this interview is what Gundlach says about buying government bonds with negative yield. He rightly notes "bonds have been outperforming stocks" but he states he has "no interest" buying bonds with negative yield and "playing the greater fool theory on steroids." He also thinks negative rates are causing more global deflation and doubts they're coming to the United States or that the Fed will cut rates in the months head.

That all remains to be seen. If you ask me, bonds have entered the Twilight Zone and ultra low and negative rates are here to stay as long as fiscal policy remains in austerity mode.

Third, Larry Lindsey, The Lindsey Group CEO, discusses the outlook for big banks in a low-rate environment and shares his thought on why the leave campaign won. Lindsey has very balanced and excellent insights and he's right on the 'rule of law' in the UK being a major factor behind why so many long-term investors are going to seize the opportunity to invest there in a post Brexit environment.

Fourth, legendary investor Jim Rogers, chairman of Rogers Holdings, discusses why following Brexit, this will be the 'worse than any bear market you’ve seen in your lifetime'. Let's hope he's dead wrong on stocks but I agree with him that the endgame for the dollar bull run isn't near.

Lastly, Liz Ann Sonders, senior vice president and chief investment strategist at Charles Schwab, told Yahoo Finance’s Alexis Christoforous in the video below that the consequences of Brexit will be felt worldwide, warning an already sluggish global growth rate will likely slow even more.

“At this point our call is not for a global recession but a lessening growth rate relative to what was already an incredibly subdued growth rate,” Sonders says. I agree but if contagion spreads, we're heading into a global recession.

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Friday, June 24, 2016

Europe's Minsky Moment?

Herbert Lash and Marc Jones of Reuters report, World stocks tumble as Britain votes for EU exit:
Global capital markets reeled on Friday after Britain voted to leave the European Union, with $2 trillion in value wiped from equity bourses worldwide, while money poured into safe-haven gold and government bonds. Sterling suffered a record plunge.

The blow to investor confidence and the uncertainty the vote has sparked could keep the Federal Reserve from raising interest rates as planned this year, and even spark a new round of emergency policy easing from major central banks.

The traditional safe-harbor assets of top-rated government debt, the Japanese yen and gold all jumped. Spot gold rose more than 5 percent and the yield on the benchmark 10-year U.S. Treasury note fell to lows last seen in 2012 at 1.5445 percent.

Stocks tumbled in Europe. London's FTSE dropped 2.4 percent while Frankfurt and Paris each fell 6 percent to 8 percent. Italian and Spanish markets, and European bank stocks overall, were headed for their sharpest one-day drops ever.

Worries that other EU states could hold their own referendums were compounded by the fact that markets had rallied on Thursday, seemingly convinced the UK would vote to stay in.

Britain's big banks took a $100 billion battering, with Lloyds, Barclays and RBS plunging as much as 30 percent.

Stocks on Wall Street opened more than 2 percent lower but cut losses after about an hour of trading. The Dow Jones industrial average fell 340.24 points, or 1.89 percent, at 17,670.83, the S&P 500 lost 42.11 points, or 1.99 percent, at 2,071.21 and the Nasdaq Composite dropped 116.74 points, or 2.38 percent, at 4,793.31.

MSCI's all-country world stock index fell 3.5 percent.

Having campaigned to keep the country in the EU, British Prime Minister David Cameron announced he would step down.

Results showed a 51.9/48.1 percent split for leaving, setting the UK on an uncertain path and dealing the largest setback to European efforts to forge greater unity since World War Two.

More angst came as Scotland's first minister said the option of another vote for her country to split from the UK - rejected by Scottish voters two years ago - was now firmly on the table.

The British pound dived by 18 U.S. cents at one point, easily the biggest fall in living memory, to its lowest since 1985. The euro, in turn, slid 3 percent to $1.1050 as investors feared for its very future.

Sterling was last down 7.8 percent at $1.3719, having carved out a range of $1.3228 to $1.5022. The fall was even larger than during the global financial crisis and the currency was moving two or three cents in the blink of an eye.

"It's an extraordinary move for financial markets and also for democracy," said co-head of portfolio investments of London-based currency specialist Millennium Global Richard Benson.

"The market is pricing interest rate cuts from the big central banks and we assume there will be a global liquidity add from them," he added.

That message was being broadcast loud and clear. The Bank of England, European Central Bank and the People's Bank of China all said they were ready to provide liquidity if needed to ensure global market stability.


The shockwaves affected all asset classes and regions.

The safe-haven yen jumped 3.6 percent to 102.29 per dollar, having been as low as 106.81. The dollar's peak decline of 4 percent was the largest since 1998.

That prompted warnings from Japanese officials that excessive forex moves were undesirable. Traders said they were wary of being caught with exposed positions if the global central banks chose to step in to calm the volatility.

Emerging market currencies across Asia and eastern Europe and South Africa's rand all buckled on fears that investors could pull out. Poland saw its zloty slump 4 percent.

Europe's natural safety play, the 10-year German government bond, surged to send its yields tumbling back into negative territory and a new record low.

MSCI's broadest index of Asia-Pacific shares outside Japan slid almost 5 percent, Tokyo's Nikkei saw its worst fall since 2011, down 7.9 percent.

Financial markets have been gripped for months by worries about what a British exit from the EU would mean for Europe's stability.

"Obviously, there will be a large spill-over effects across all global economies ... Not only will the UK go into recession, Europe will follow suit," predicted Matt Sherwood, head of investment strategy at fund manager Perpetual in Sydney.


Investors stampeded into low-risk sovereign bonds, with U.S. 10-year notes gained two full points in price to yield 1.521 percent. Earlier, the yield dipped to 1.406 percent, only slightly higher than a record low 1.38 percent reached in July 2012.

“Right now it’s 'every man for himself' safety buying," said Tom Tucci, head of Treasuries trading at CIBC in New York.

The rally even extended to UK bonds, despite a warning from ratings agency Standard & Poor's that it was likely to downgrade Britain's triple-A credit rating if it left the EU. Yields on benchmark 10-year gilts fell 27 basis points to 1.0092 pct.

Across the Atlantic, investors were pricing in less chance of another hike in U.S. interest rates given the Federal Reserve had cited a British exit from the EU as one reason to be cautious on tightening.

"A July (hike) is definitely off the table," said Mike Baele, managing director with the private client reserve group at U.S. Bank in Portland, Oregon.
Fed funds futures were even toying with the chance that the next move could be a cut in U.S. rates.

Oil prices slumped by more than 4 percent amid fears of a broader economic slowdown that could reduce demand. U.S. crude shed $2.12 to $47.99 a barrel while Brent fell as much as 6 percent to $47.83 before clawing back to $48.60.

Industrial metal copper sank 3 percent but gold galloped more than 6 percent higher thanks to its perceived safe haven status.
A couple of days ago I wrote a comment to Brexit or not to Brexit where I stated my strong doubts that the Brits would opt out of the EU.

I was wrong, foolishly believing most people in the UK would vote rationally with their wallets. But in the end, populism won the day, which makes you wonder whether referendums should require 2/3 majority to set in motion any major decision impacting millions of people (Winston Churchill was right: "Democracy is the worst form of government, except for all the others").

However, in my comment on Brexit, I stated the following:
[...] let's say Brexit happens, then what? Well, investors will seek refuge in good old US bonds, they're going to sell the euro and pound and buy the yen. Markets will be in a tizzy and volatility will shoot up. Conversely, if Brexit doesn't happen, the euro and pound will rally, the yen and US bonds will sell off and global stocks and corporate bonds will take off.

Of course, if you ask Mr. Yen, the yen will strengthen past 100 per dollar this year, whichever way the UK votes in Thursday’s referendum. I hope he's wrong as the surging yen could trigger a crisis, especially another Asian financial crisis.

One thing is for sure,  David Cameron, the British prime minister, has no one to blame but himself for this vote. What else? The favorable opinion of the EU is plunging everywhere, especially in France.

In fact, regardless of the outcome in this week's referendum, Brussels has a huge problem, one that I see getting worse as the euro zone struggles to escape deflation.
The problem now isn't Brexit, it's the fallout from Brexit. The BBC reports that Brexit sparks calls for other EU votes:
The UK's vote to leave the EU has sparked demands from far-right parties for referendums in other member states.

France's National Front leader Marine Le Pen said the French must now also have the right to choose.

Dutch anti-immigration politician Geert Wilders said the Netherlands deserved a "Nexit" vote while Italy's Northern League said: "Now it's our turn".

The UK voted by 52% to 48% to leave the EU after 43 years. David Cameron has announced he will step down as PM.

Global stock markets fell heavily on the news and the value of the pound has also fallen dramatically.

The European parliament has called a special session for next Tuesday.

Analysts say EU politicians will fear a domino effect from Brexit that could threaten the whole organisation.

Ms Le Pen hailed the UK vote, placing a union jack flag on her Twitter page and tweeting: "Victory for freedom. As I've been saying for years, we must now have the same referendum in France and other EU countries."

She is the front-runner among candidates for the presidential election in 2017 but opinion polls suggest she would lose a run-off vote.

Alarm bells - BBC Europe editor, Katya Adler

The EU worries Brexit could reverse 70 years of European integration.

In all my years watching European politics, I have never seen such a widespread sense of Euroscepticism.

Plenty of Europeans looked on with envy as Britain cast its In/Out vote. Many of the complaints about the EU raised by the Leave campaign resonated with voters across the continent.

Across Europe leading Eurosceptic politicians queued up this morning to crow about the UK referendum result.

But the mood in Brussels is deeply gloomy. The Brexit vote sends screaming alarm bells, warning that the EU in its current form isn't working.


Last Friday, Ms Le Pen had told a gathering of far-right parties in Vienna: "France has possibly 1,000 more reasons to want to leave the EU than the English."

She said the EU was responsible for high unemployment and failing to keep out "smugglers, terrorists and economic migrants".

Mr Wilders, leader of the Party for Freedom in the Netherlands, said in a statement: "We want to be in charge of our own country, our own money, our own borders, and our own immigration policy.

"As quickly as possible the Dutch need to get the opportunity to have their say about Dutch membership of the European Union."

The Netherlands faces a general election in March and some opinion polls suggest Mr Wilders is leading. A recent Dutch survey suggested 54% of the people wanted a referendum.

Mateo Salvini, the leader of Italy's anti-immigration Northern League, tweeted: "Hurrah for the courage of free citizens! Heart, brain and pride defeated lies, threats and blackmail.

"THANK YOU UK, now it's our turn."

The anti-immigration Sweden Democrats wrote on Twitter that "now we wait for swexit!"

Kristian Thulesen Dahl, leader of the populist Danish People's Party, said a referendum would be "a good democratic custom".

European Parliament President Martin Schulz denied Brexit would trigger a domino effect, saying the EU was "well-prepared".

But Beatrix von Storch, of Germany's Eurosceptic AfD party, praising "Independence Day for Great Britain", demanded that Mr Schulz and European Commission head Jean-Claude Juncker resign.

"The European Union has failed as a political union," she said.If you ask me, heads should roll in Brussels, starting with Juncker. 
The EU is in a crisis and whether you like it or not, this uncertainty and wave of populism across Europe is going to threaten the global economy and financial markets for a very long time.

After Brexit, we will have to contend with Nexit, Frexit, Italexit, Swexit and one referendum after another, including another one in Scotland. And who knows, maybe Germany will just say enough is enough, we're out of here!

I sent an email to my close friends asking for their opinion. One of them, a cardiologist, replied: "This is really unbelievable.  The worst possible result…. not a clear majority overall with big regional differences between England and Scotland and Ireland. Horrible. It will tear the UK apart and probably destroy the EU.  I don’t know why they make these votes 50+1."

His brother who works in finance stated this: "The problem with the Euro is not Greece or any of the other PIIGS. It is actually Germany who is the 800 pound gorilla in the room. So, in my mind, there are two outcomes: the Euro falls apart or Germany leaves the Euro. Brexit is just the first symptom."

And my younger brother, a psychiatrist, stated this: "It's a binary outcome: either the Euro falls apart, or they tighten up and move towards a true fiscal , monetary, and political union. Status quo is now untenable. I'm betting it falls apart."

In these crazy markets, we need to listen more to psychiatrists and cardiologists and less to financial analysts. I remain short the euro and I'm keeping my eye on the surging yen. So far, despite the volatility, the reaction is one of relative calm (or complacency), but don't kid yourselves, this is the worst possible outcome for the UK, the EU, and the global economy.

One thing is for sure, the Fed is out of the picture for the remainder of the year and possibly all of next year depending on the global fallout of Brexit. Central banks are going to be pumping massive liquidity into the global financial system to limit the shockwaves but they are only doing damage control.

And that global deflation tsunami I warned of at the beginning of the year is now headed our way faster than I even imagined. If you don't believe me, listen to Bill Gross discuss the fallout of Brexit below where he rightly notes populist policies are deflationary.

Gross also discusses the ECB's policy following Brexit and the limits of negative interest rates but as I've stated bonds have entered the Twilight Zone and it could a very long time before rates normalize.

Also, a handful of other European countries say they want a referendum on the European Union. No doubt, Brexit will likely trigger a domino effect in the EU, one that could spell the end of the union.

Lastly, I embedded a Bloomberg clip (late April) where former Greek Finance Minister Yanis Varoufakis talked with David Gura about what he sees as potential Brexit fallout for the European Union and EU's ability to withstand another shock similar to the financial crisis of 2008.

Listen closely to his comments, he is absolutely right on "Brexit speeding up European disintegration, creating a gigantic deflationary vortex in Europe which will consume the UK" and possibly the world.

In this environment, you can forget about any melt up in stocks and you better understand why US bonds (not gold) are the ultimate diversifier. Also, ignore all the talk that the endgame for the dollar bull run is near.

Three years ago, Michael Sabia, the Caisse's CEO warned: "There’s a dark night going on in Europe, a dark and foggy night where bad things come out of trees and bite you. It’s a pretty scary place."

He was right. Welcome to Europe's Minsky Moment and be prepared for a long and volatile road ahead.