Opportunities exist in the commodity sphere

On my recent trip to Switzerland, I sat down with Sander Bressers, Senior Portfolio Manager for the LGT Commodity Active Fund.

I began by asking him for an overview of the Fund.

SB - The fund in its present form is quite new, having been up until recently a managed account on behalf of the owners of LGT, the Prince of Liechtenstein.  Nevertheless, even in that short period of time, we have managed to outperform most of our peers.  Myself and colleague, Peter Sigg, run an actively managed
portfolio which is different to many other 'commodity' funds which at first glance people may view as similar.
 
We trade contracts, as opposed to the buying the physical commodity or owning associated equities linked to that commodity.

Our investable universe continues to grow as new markets and commodities become more institutionalised and liquid, and we expect this to continue as emerging markets take more of a share of the global economy.  This increases the demand for most commodities especially raw materials and agriculturals.

AVC - What are the reasons for the outperformance of the fund?

SB - We focus on three areas, one is curve positioning.  For example, there is massive potential for outperformance if you compare the UBS Energy Index values (basically a proxy of the spot price) to the same Index but for 3 month forwards. The disparity is caused in some part by the mechanical roll-over of the ETF's and other instruments who use the spot price.  We can usually take advantage of these 'passive' investments.

The second area we focus on is through relative value trades. A good example of this is the correlation between soyabeans and corn, whereby if corn is cheaper at the beginning of the year then spring planting may favour soyabeans leading to lower corn production and thus stronger corn prices. And vice versa.

Our outperformance compared to the Index can be explained by the two reasons above as well as the third reason which is strategic asset allocation, which is solely down to the expertise of the team I have around me.

These three factors have contributed evenly to the outperformance.

AVC - Where do you see short-term opportunities which you can exploit to continue the outperformance?

SB - Well, we have been pretty defensive in the last few months as the commodity markets focus on macro-economic pressures.

However we see opportunities, extra to the above, existing in things like diesel oil, and in relative trades we are short gold and prefer silver so we hold a long position in that, as it appears silver is undervalued according to historical data.

Citywire Interview with Sander Bressers

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Hedge Funds Still Misunderstood

Somehow the entire alternative investment trading universe, including both investment managers and their different funds, has wound-up being known as ‘hedge funds’. This nomenclature is still inappropriately used with a negative connotation.

We have had to explain to clients and and our wide network of outside agents that the name hedge fund is first of all is completely wrong….

Names are important because the public debate about financial regulation can be over-simplified, and basic words with emotional connotations can drive the results. Most people know what a bank is – they can see the branch or go to a site to conduct transactions. Most probably don’t know what an investment bank is – maybe a big bank with no branches? These views influence how we think when we hear the words ‘bank’ and ‘investment bank’, and how politicians and the press describe financial issues.

Most people have never seen a hedge fund and, worse, the name is unhelpful and confusing.

Private equity funds and venture capital funds have accurate and descriptive names. It is clear and obvious what both these types of investments are about. Even so, ‘venture’ funds sound somehow good and positive – surely they help new and exciting ventures. But private equity seems possibly mysterious and private. The Alternative Investment Fund Managers Directive (AIFMD) recognises these differences in perception, and gives preferential treatment to ‘venture’ funds, even though they are certainly as financially motivated as private equity funds.

JPMorgan’s recent trading losses have brought to light the question whether the trades were just ‘hedging’ other positions held by the bank, or rather ‘directional’ or ‘expressing a view’. More sophisticated news articles mention portfolio hedging, country hedging and hedging individual positions. On the other hand, some reports claim they were running a hedge fund inside the bank. In this case, using the word ‘hedge’ to mean the opposite of hedging: a pool of money funding a trading operation taking direct risks.

Clearly, the general meaning of hedging is understood: transactions or strategies that protect against movements in other holdings. ‘Hedging your bets’ is an easily understood expression for taking some positions that can pay-off if others don’t. The older fashioned diversification reminder was ‘don’t put all your eggs in one basket’ – another way to think about hedging.

‘Hedge fund’ would appear to imply a ‘hedged’ fund. But that is a vast over-simplification of the strategies employed by different alternative managers in their trading. Hedge funds may not be hedged at all, or if they are, only for specific risks or positions. If any were fully hedged, they wouldn’t have any return nor any investors.

We like to call alternative investments, which take short positions or other positions that are expected to move in the opposite direction of their main investments (negative correlation), hedge funds. This differentiates them from long-only or non-hedging funds. These funds may or may not use these positions to hedge other positions, however. So calling them hedge funds can be misleading and confusing to some clients and consultants.

To improve perception, we like to describe the funds activities - explain what, if anybeneficial, hedging takes place. Aware of the negativity associated with the term hedge fund, we get people thinking about the positive aspects of alternative investments. Think of ‘creative’ or ‘balanced’ investing’ or even ‘efficient capital allocation’. All those sound better and are more accurate than hedge fund, and help people better understand.

Author: Chris Davies

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Mongolia: The World's Fastest Growing Economy

            Mongolia is quickly becoming one of the world’s most promising economies.  This frontier market in resource rich Central Asia is expected to grow by 20-23% in 2012 with strong prospects to continue this growth trend.  Only Iraq has a comparable 20-year growth forecast. 

            Mongolia’s vast territory borders the world’s premier emerging market, China.  This territory is only 17% explored for commodities despite the abundance of coal, copper, gold, uranium, and iron discovered in these areas. China’s proximity and growing demand for such natural resources puts Mongolia in an ideal position.  Consequently, many analysts are expecting a large mining boom over the next decade in Mongolia. 

            The country’s stock market is open to foreign investors but much like its vast resource rich territory, this market remains underexplored by investors.  Mongolia’s equity market was the strongest performing in the world in 2010, increasing 174% from the prior year.  It continued this trend into 2011, during which it was the world’s second best performing equity market.  The Mongolian Stock Exchange (MSE) has a combined market capitalization of $2.3 billion dollars.  The Exchange has made a deal with the London Stock Exchange Group to modernize the MSE to make it meet world standards.

          

           Like all frontier markets, Mongolia serves as a hedge against global market movements.  It has a very low correlation with both developed and emerging markets.  In addition to its proximity to China, Mongolia stands to satisfy demand for natural resources in Russia, South Korea, and Japan.  Note the heterogeneity of its four largest trading partners.  Regardless of the global macroeconomic environment, the four major developed and emerging economies on its border will have a need for Mongolia’s resources.

            Mongolia presents investors with a relatively young, highly educated population.  Forty percent of the country is under 20 years of age and 98% of the country is literate.  Many of these young people will work near one of Mongolia’s 6,000 rare earth mineral deposits. 

MSE Top 20 Index

            There is, as with all frontier markets, a considerable amount of risk involved with investing in Mongolia.  Mongolia is currently dependent upon China for its exports.  Additionally, political concerns add risk to any investment.  Although Mongolia is a Parliamentary Republic, developing countries have a propensity towards populism and nationalism.  Nationalization remains an unfortunate risk.  However, the Mongolian government specifically has demonstrated a desire to modernize and become a reliable member of the global economy.

            Investors interested in exploring the possibility of investing in Mongolia should consult with their financial advisor to discuss risks and potential returns.  AVC Advisory can help interested investors find an appropriate, well-diversified Mongolian investment fund to invest in. 

            

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Новости мировых рынков

Китай – национальное правительство заявило, что, судя по показаниям внутреннего спроса, товарный избыток почти вдвое превысил индустриальные ожидания. Результаты свежих исследований показывают, что после февральского дефицита в 31,5 млрд. долларов США излишки имеют место уже второй месяц подряд.

Российский центробанк в очередной раз уже пятый месяц подряд отказался от снижения процентных ставок, что свидетельствует о нежелании развития монетарных стимулов для поддержки роста и сдерживания инфляции. Банк России оставил ставку рефинансирования на уровне 8 процентов..

США - дефицит увеличился в марте до своих максимальных за 10 месяцев показателей. Растущий уровень импорта нефти, автомобилей, мобильных телефонов и одежды способствовал 5,2%-ому росту экспорта. Несмотря на долговой кризис еврозоны, экспорт в Европу достиг рекордного уровня.

Греция – спасательный фонд еврозоны решил удержать 1 млрд. евро (1,3 млрд. долларов США) из своего последнего греческого транша. Это происходит от того, что большинство греков проголосовало против политических партий, поддерживающих страну. Как и в случае с предыдущими греческими выплатами, Европейский Фонд Стабильности (EFSF) будет передавать 4,2 млрд. евро на раздельные счета для обслуживания долга. Неопределенность с тем, покинет ли Греция еврозону или нет, держит в состоянии стресса инвесторов и вызывает гнев у европейских чиновников, считающих, что Греции необходимо придерживаться режима жесткой экономии.

Германия в марте увеличила свой экспорт, что происходит уже третий месяц подряд. Относительная слабость евро продолжает помогать национальному экспорту. Немецкие фирмы достигают наибольшего успеха на рынках за пределами Евросоюза, где они продемонстрировали рост на 6,1% по сравнению с прошлогодними показателями.

Португалия – правительство страны разозлило свой народ, принятием решения об отказе от 14 государственных праздников. Празднование двух религиозных фестивалей и двух других событий будут приостановлены на 5 лет, начиная с 2013 года. В прошлом году страна согласилась на 78-миллиардную (евро) сделку с Евросоюзом, ECB и IMF и продолжает проводить в жизнь политику сокращения расходов. Есть надежда, что приостановка государственных праздников поможет в деле улучшения конкурентоспособности и экономической активности. 

Золото - «Goldman Sachs» оправдал свой прогноз относительно обещанного в этом году золотого ралли, заявив, что данный драгоценный металл достигнет стоимости $1.840 за унцию в течение шести месяцев, и золото останется «валютой в последней инстанции».

Автор: Григорий Бабаков

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Frontier Markets

            In the early 1990s, Russia emerged from decades of socialism into the world economy as an undercapitalized new target for investors.  Those investors who were willing to accept the risks Russia presented during its decade of transition were able to earn large returns on their investments.  Today, Russia is no longer such a “frontier market” and is now seen by most economists as one of the world’s premier emerging markets.

            A similar story may be told about all developed countries today.  The United States was a country of marginal economic relevance to the rest of the world before its development began in earnest. 

Common Frontier Markets (MSCI FM Index Countries)

Across the globe, there are dozens of countries poised to begin the process of major development and emergence into the global economy.  Categorically, these frontier markets (or “pre-emerging” markets in some analyses) are countries with an investible stock market and relatively low market capitalization.  Common features of these countries include underdeveloped financial infrastructure, poor quality regulation, and inadequate reporting requirements.

Despite these risky features of frontier markets, an upsurge in manufacturing in these countries has caught the attention of investors. The workforce in these countries is generally young, relatively well educated, and cheaper to employ than its emerging or developed market counterparts.  Several multinational corporations are beginning to recognize this and are relocating their manufacturing operations to these emerging markets.

Risk remains an ever present concern however for investors in frontier markets.  In addition to the risk factors already mention, foreign companies face the risk of nationalization especially as these countries undergo political transition parallel to economic emergence.  The most prominent risk in frontier markets is illiquidity.  Because of undercapitalization and low trading volume, investors can find themselves stuck with a souring investment in some circumstances.  The return offered by emerging markets can offset this risk if investors are willing to bear this risk.

Frontier markets can also serve to further diversify a portfolio.  Generally, frontier markets are uncorrelated with developed or even emerging markets.  Given this characteristic, it should be no surprise that hedge funds are among the largest investors in frontier markets. 

 Blue=Frontier Market MSCI Index
Orange=World minus US Index
Green=G7 MSCI Index
*Note the lack of correlation between the FM index and developed world indices  

There is of course no guarantee that these new markets will develop like Russia or any one of the BRIC nations.  Within the MSCI frontier market index there are 23 heterogeneous countries.  These countries all have different economic histories, laws, politics, and geography.  Investors must as always carefully select investments based on fundamentals and personal goals within the context of reasonable expectations. 

Whether or not frontier markets will offer windfall returns to brave investors remains to be seen.  Investors interested in more information about frontier market should consult with their financial advisor to find a specific investment that is right for them.    

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QE and LTRO in Eurozone

Quantitative easing (QE) seems like a magic remedy whereby central bankers conjure up money out of thin air and use it to purchase assets. Such activity has the capacity to transfer toxic debt, stimulate demand for risk assets, devalue currencies – thus deflating debt – and maintaining low interest rates on government securities.

The European Central Bank’s (ECB) restrictive mandate does not allow it to print money (as opposed to countries' central banks) for any other purpose than lending, so QE is out of the question. Mario Draghi, President of the ECB, can therefore be said to have demonstrated the new resolve of the central bank under his leadership in unveiling his longer-term refinancing operation (LTRO) program within 8 weeks of taking office.

As we have seen in the case of Hong Kong in 1998 and Switzerland in 2011, decisive central bank intervention sends a message to the markets that there is a willingness to do whatever is necessary to achieve something that is worth fighting for.

Conversely, earlier ECB bond purchases were an indication of the weak resolve which caused the markets to gorge on negativity. LTRO delivered an infusion of liquidity at a critical time. Without it, a lot of otherwise solvent banks would have remained in a perilous position. However, structural issues remain and need to be addressed while the support of central bank liquidity is in place. Otherwise LTRO will simply prove a case of throwing good money after bad.

LTRO: An ingenious spin on QE

Source: Bank of England for illustrative purposes only.

LTRO ingeniously makes use of the Basel II accounting rules which allow sovereign nations in the European Economic Area a zero interest rate lending facility. Consequently, the ECB can lend unlimited quantities of funding to European banks, at a nominal interest rate, in the knowledge that there is more than one incentive for these banks to purchase government debt.

Firstly, banks can make easy profits from capturing the differential between the interest charged on the borrowed money and the yield in the government debt. Secondly, they can bolster their balance sheets from a regulatory perspective. Moreover, in buying sovereign debt the banks help achieve one of the critical aims of QE in maintaining low borrowing costs for indebted governments.

LTRO has also provided a timely boost to banks in their attempts to raise capital to satisfy an increasingly penal regulatory agenda. The launch of the program came just four days before the deadline for banks to submit plans for raising the cash needed to maintain capital adequacy levels.

More treatment is needed

Nevertheless, a boost in liquidity, like most pharmaceutical drugs, only works effectively in conjunction with complementary measures.  This contrasts with the example set by the US in March 2009, which used the Fed inspired rally to launch gazillions of equity.

At the national level, the rescaling of the Spanish budget deficit is challenging the resolve that is required for markets to believe in the planned reforms. The central bankers will be again solicited to control the markets, testing the government’s resolve. This is a perilous exercise at the best of times which is likely to be exacerbated by electoral and sporting distractions this summer!

In terms of further LTRO usage, most Spanish debt raised has been bought by domestic banks, and cross border confidence has not been boosted for long. Indeed, a variety of sources suggest that foreigners have used this window to divest from Spanish government bonds, and the domestic banks have been left mopping up the inventory, albeit with an attractive carry.

There is also increasing evidence that most of the monies from the LTRO have been spent or earmarked, more quickly than the markets thought, and we will soon need the next measure to prevent rates rising excessively in the periphery. As the private sector has already used a lot of its purchasing power, central bankers will soon, in spite of their reluctance, find themselves needing to buy government debt in the secondary market.

How they do it and what it leads to is important. There is a variety of tools they can use, from securities market programs (SMP) to a relaxation of ‘haircuts’. They can also allow Spanish banks to issue government guaranteed debt, essentially creating ECB eligible collateral, similar to what Italian banks have been able to do. SMPs were stopped after the LTRO, but can be reactivated, possibly sooner rather than later, as the markets need to understand the central banks are committed to preventing rates from spiralling out of control.

This summer has the added volatility of important and undecided elections, as well as distractions from football to the Olympics, that increase the risks of spikes on low volumes. Market interventions will need to be more stringent as a consequence.

Theoretically, there are few limits to what the ECB can do. They will likely test the market limits, as investors look through temporary fixes, and political limits, in respect of how much money the ECB can effectively create. This will test the resolve of politicians and central bankers from the north.

Author: Chris Davies

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Quick US market update

A flat reading from the jobs market sank stocks and plunged the Nasdaq to its biggest single-session drop since November. The Nasdaq Composite careened 67.96 points, or 2.3%, to 2956.34. Friday's losses punctuated what was the biggest weekly decline for the technology-heavy benchmark, which fell 3.7% this week, its steepest weekly loss in since December.

The Dow Jones Industrial Average and Standard & Poor's 500-stock index had the biggest drop in a month. The Dow fell 168.32 points, or 1.3%, to 13038.27, while the S&P 500 shed 22.47 points, or 1.6%, to 1369.10. Both benchmarks fell for the first week in three.

Crude-oil prices shed 4%, to $98.49 a barrel, while gold prices rose 0.6%, to $1644.70 a troy ounce. The dollar fell against the euro and the yen. The yield on the 10-year Treasury note fell to a three-month low, trading recently at 1.880%.

Author: Chris Davies

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