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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