Currencies

Nomura rounds up markets’ biggest misses in 2016

Forecasting markets a year in advance is never easy, but with “year-ahead investment themes” season well underway, Nomura has provided a handy reminder of quite how difficult it is, with an overview of markets’ biggest hits and misses (OK, mostly misses) from the start of 2016. The biggest miss among analysts, according to Nomura’s Sam […]

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Property

Spanish construction rebuilds after market collapse

Property developer Olivier Crambade founded Therus Invest in Madrid in 2004 to build offices and retail space. For five years business went quite well, and Therus developed and sold more than €300m of properties. Then Spain’s economy imploded, taking property with it, and Mr Crambade spent six years tending to Dhamma Energy, a solar energy […]

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Currencies

Euro suffers worst month against the pound since financial crisis

Political risks are still all the rage in the currency markets. The euro has suffered its worst slump against the pound since 2009 in November, as investors hone in on a series of looming battles between eurosceptic populists and establishment parties at the ballot box. The single currency has shed 4.5 per cent against sterling […]

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Banks

RBS falls 2% after failing BoE stress test

Royal Bank of Scotland shares have slipped 2 per cent in early trading this morning, after the state-controlled lender emerged as the biggest loser in the Bank of England’s latest round of annual stress tests. The lender has now given regulators a plan to bulk up its capital levels by cutting costs and selling assets, […]

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Currencies

China capital curbs reflect buyer’s remorse over market reforms

Last year the reformist head of China’s central bank convinced his Communist party bosses to give market forces a bigger say in setting the renminbi’s daily “reference rate” against the US dollar. In return, Zhou Xiaochuan assured his more conservative party colleagues that the redback would finally secure coveted recognition as an official reserve currency […]

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Archive | November, 2016

Swiss face up to cost of franc defence

Posted on 31 July 2012 by

Swiss National Bank

Switzerland is facing the consequences of a vow to keep the franc weak.

Figures released by the Swiss National Bank on Tuesday show that its euro holdings have ballooned in the second quarter of the year, as the bank battles haven demand from investors and struggles to maintain a ceiling of SFr1.20 against the single currency.

    Click to enlarge

    Switzerland has been accumulating foreign exchange reserves so quickly in recent weeks that it has been labelled “the new China”. The country has SFr365bn ($374bn) worth of foreign exchange, making it the sixth biggest holder of reserves in the world behind China, Japan, Saudi Arabia, Russia and Taiwan.

    But the cost of defending the franc limit is becoming apparent. The SNB’s policy of weakening the Swiss franc means that it is accumulating euros so rapidly it is unable to offload them fast enough. Crucially, the proportion of its reserves held in euros has risen from 51 per cent at the end of the first quarter to 60 per cent by June. Analysts say that is a warning sign the bank is finding it difficult to rebalance its assets.

    “There’s a logic that says they can print Swiss francs until the cows come home, but the problem is they’re not controlling the outcome on the euro side. There’s the risk they’ll be holding an asset that’s viewed as being very poor quality,” says Steven Englander, foreign exchange strategist at Citigroup.

    Switzerland’s swollen forex reserves are a relatively recent problem. While the central bank introduced the ceiling against the euro last September, it did not have to buy euros to defend the franc until the eurozone debt crisis intensified in the second quarter of this year. Indeed, most of the SNB’s euros were added in May and June as Switzerland embarked on a buying spree to keep the franc weak in the face of heavy demand for a haven in Europe.

    That buying has not been reflected in the value of the franc. Since the start of April, the franc has traded within a whisker of the ceiling against the euro, at around SFr1.2010. But the SNB’s own foreign currency reserve holdings started to show a different picture in June, with the bank buying an estimated SFr60bn worth of euros in May alone to keep the franc where it was.

    Analysts estimate that the bank is now buying about SFr3bn a day in euros. Elsa Lignos, foreign currency analyst at RBC Capital Markets, points out that if the SNB continues to accumulate euros at this rapid rate, in four years its foreign currency reserves will be higher than those of China, which has the largest forex stockpile in the world at $3.24tn.

    That impressive accumulation is also making the SNB a huge force in the forex markets as it seeks to shed euros and rebalance its assets, a process that many forex traders are trying to second guess.

    Analysts believe the SNB is responsible for some of the more unusual moves in the currency markets since the euro first started selling off in May. The SNB increased its holdings of “other” currencies in the second quarter from 3 to 4 per cent. Those currencies are defined by the SNB as the Swedish krona, Canadian dollar, Australian dollar, Danish krone, Korean won and the Singapore dollar. The SNB is believed to have contributed to the recent unusual strength of the first three currencies.

    Still, the SNB is not moving as fast as many had expected. Many analysts thought the central bank would have kept the proportion of euros it holds at closer to 50 per cent. The latest data suggest the SNB has a lot of “dud” assets on its balance sheet at precisely the time nearly all other investors are dumping their euro holdings.

    Geoffrey Yu, foreign currency analyst at UBS, suggests the SNB is “trying not to annoy people” by selling all its euros as soon as it buys them, which could lead to further downward and destabilising pressure on the single currency.

    The SNB is also creating a headache for other central banks, faced with rising demand for their currencies as Switzerland embarks on its rebalancing act. “Sweden will need to set monetary policy now with the SNB in mind,” says Mr Yu.

    Geoffrey Kendrick, foreign currency analyst at Nomura, estimates that, even if the central bank bought no more euros, it still needs to sell SFr20bn of euros to return to the same proportion of holdings it had in the first quarter. Offloading that could push the single currency sharply lower against other big currencies such as the dollar.

    Lighthouse loses vote to delist from Aim

    Posted on 31 July 2012 by

    Shareholders in Lighthouse have forced one of the few remaining publicly listed groups of independent financial advisers to abandon its attempt to delist its shares from Aim.

    Slightly more than 53 per cent of Lighthouse’s investors voted against the company’s plans to delist despite strong campaigning from the board.

      David Hickey, executive chairman, said he stood by the view that maintaining a quote on Aim was not in the group’s best interests. “The level of cost and intrusion involved gets in the way of the business,” he said. “But this is democracy and we will honour the outcome”.

      It had become increasingly clear in the days running up to the vote that shareholders holding close to a third of the group were unhappy about the proposals.

      Lighthouse was set to become the latest in a stream of small companies that have decided to leave the junior market in the past five years. Over that period, the number of companies on Aim has fallen from 1,694 to 1,114.

      In some cases, companies have been taken over, while others have moved up to join the main market.

      Aim analysts say the rate of delisting has been slowing but they also note that fewer companies are being taken over or moving to the main market and more companies have been delisting as a result of financial stress.

      Mr Hickey on Tuesday assured investors that Lighthouse was cash positive, debt-free and remained “in robust financial health”. But he said lowly valued companies with market capitalisations of less than £10m gained little from being listed.

      “Shares in companies valued at less than £10m or even £50m are in a liquidity trap. People can’t deal in lots of more than 400 or 500. Then people extrapolate from the share price to [get a] value for the business. Yet there is no logical connection to a company turning over £50m.”

      The Lighthouse board had told investors that the Aim listing would distract management just as it faced one of its greatest challenges bedding down the Financial Services Authority’s new rules on how financial products are sold.

      Some shareholders had pushed the company to buy back shares. However, Mr Hickey said: “We didn’t feel we could spend £3m or more buying in shares. We wanted to reserve the cash to withstand the next 12 months. A buyback would have benefited some shareholders who wanted to exit but it could have ended up jeopardising the whole business.”

      Nomura faces penalty over insider case

      Posted on 31 July 2012 by

      A sign is lit up outside a Nomura Securities Co. branch in the Shinjuku district of Tokyo, Japan

      Japan’s financial regulator is set to penalise Nomura for breaching Japanese financial law by failing to have proper internal controls and providing clients with insider information in order to solicit business.

      Japan’s Securities and Exchange Surveillance Commission is recommending administrative action against Nomura, after a special inspection revealed that the bank’s employees had regularly provided insider information to institutional clients as part of their sales activities.

      The regulatory penalty, which comes after an unusually long special inspection by the SESC, is the latest blow to the bank, which is undergoing a sweeping management reshuffle following its admission that staff had leaked non-public information about the new share issues of Mizuho, Inpex and Tokyo Electric Power ahead of their public announcement.

        Kenichi Watanabe, Nomura’s former chief executive, and Takumi Shibata, former chief operating officer, who led the bank’s overseas expansion, are stepping down on Wednesday, together with seven other executives.

        Mr Watanabe is being replaced by Koji Nagai, a veteran of Nomura’s vaunted domestic retail operations.

        The management changes, which are expected to substantially alter Nomura’s global strategy, were aimed at drawing a line under the bank’s involvement in the wide-ranging insider trading scandal and revamping its flagging business performance.

        Japan’s Financial Services Authority had sent a strong message that it expected management to take responsibility for the scandal.

        The revelations that Nomura leaked inside information led several of the bank’s major clients, particularly government agencies, to drop it from deals, such as the government’s sale of shares in Japan Tobacco, one of the largest capital markets deals this year.

        It is not illegal in Japan for a financial intermediary to leak insider information but it is illegal to solicit business on the basis of non-public information provided to the client.

        The FSA, which will determine the penalty, could choose to impose a temporary business suspension order, which would have a direct impact on business, but its penalty could also be as lenient as a business improvement order.

        SMBC Nikko Securities, which was found to have leaked insider information and solicited transactions on the basis of that information, was slapped with a business improvement order in April.

        However, the SESC, which conducted an unusually long three-month special inspection of Nomura, said Nomura’s breach was more problematic since it happened at its head office and involved the entire division that dealt with sales to institutional investors.

        The SESC found that Nomura employees responsible for securities sales to institutional investors regularly and aggressively sought information from employees in other divisions, who possessed insider information on new share issues and provided such information to clients as part of their sales activities.

        Employees in that division thought that as long as they did not mention the stock by name, providing non-public information on an upcoming new share issue, would not amount to providing insider information, the SESC said.

        Senior management was not, however, aware of this kind of activity, leading the regulator to conclude that proper management controls were not in place.

        UBS updates Facebook status

        Posted on 31 July 2012 by

        UBS PICN

        For the gaggle of banks involved, Facebook’s public listing was meant to be a money-spinner. In the case of UBS, it was not. The Swiss bank said on Tuesday it would take legal action against Nasdaq for a SFr349m ($358m) loss that it incurred as a result of the exchange operator’s “gross mishandling” of the social network’s IPO.

        According to UBS, Nasdaq’s delays in confirming trades in Facebook’s shares led to UBS placing some orders several times. In the event, all the orders were honoured, leaving the Swiss bank with far more shares than its clients ordered.

          The loss that UBS has taken is far larger than many people expected. When the float took place in May, market makers suggested that the overall loss could amount to about $100m split largely between the principal players – Knight Capital, which said its losses could amount to $35m, as well as Citadel, UBS and Citigroup.

          Two weeks ago Nasdaq offered to pay $62m to the brokers, 50 per cent more than an offer it made in June, and analysts are sceptical of UBS’s chances of winning a court battle because members of the exchange sign agreements that limit liability.

          Even if UBS manages to recoup some of its losses, the Facebook episode, which helped drag the investment banking unit to a SFr130m loss in the second quarter, will go down as another accident for the division. The unit suffered steep writedowns in the 2008 financial crisis, and last year was embroiled in the largest unauthorised trading loss in British history.

          The trading scandal led to the departure of Oswald Grübel as chief executive, and his successor, Sergio Ermotti took charge last autumn pledging to refocus the bank on its wealth management operations.

          By the spring, as investment bank boss Carsten Kengeter pursued an aggressive strategy of shrinking bits of the business that no longer looked profitable, Mr Ermotti gave the clearest signal yet of his intentions for the investment bank, hiring advisory banker Andrea Orcel from rival Bank of America Merrill Lynch as Mr Kengeter’s co-head.

          Observers have been waiting for the two men, who have been working together since the start of July, to clash. But so far, say some colleagues at least, the collaboration is working well. Beyond the eye-catching mishaps, a rebalancing is occurring. In the second quarter, the investment bank’s operating income fell precipitously, from SFr2.9bn to SFr1.7bn.

          This was in part due to persistent macroeconomic uncertainty, which depressed client activity: revenues at the bank’s fixed income, currencies and commodities business declined 27 per cent on the quarter, while – once the Facebook loss had been taken into account – its equities revenues suffered a similar decline.

          It is also partly due to UBS’s attempts to reduce the division’s risk-weighted assets. On a Basel III basis, these fell from SFr191bn to SFr170bn over the quarter, and UBS on Tuesday set a target of SFr135bn by 2016, SFr15bn less than the previous target.

          While Mr Ermotti remains committed to the idea of a strong investment banking division, the upshot of this year’s rebalancing may be that the division withdraws from some of its more capital-intensive and less profitable activities.

          The picture at UBS’s wealth management business is rosier. The division made a pre-tax profit of SFr502m from revenues of SFr1.7bn, and attracted SFr9.5bn in net new money, with strong inflows from the Asia-Pacific region, as well as Switzerland and emerging markets. At the US wealth management operation, it was a similar story, with profits of SFr200m and inflows of SFr3.8bn.

          In both divisions UBS said the economic backdrop discouraged clients from trading and as a result the closely watched gross margin figure fell by 4 basis points to 0.89 per cent for UBS’s non-US operations, and by 1bp to 0.79 per cent in the US.

          UBS warned on Tuesday that until the main sources of macroeconomic uncertainty (the eurozone crisis and the fiscal “cliff” looming in the US) were resolved, clients were unlikely to regain their animal spirits, which will mean margins remain under pressure.

          When, and if, that does occur, UBS expects business to pick up. “We will be rewarded for the time we invest in our client relationships today when market conditions improve,” the bank said on Tuesday. The challenge for the bank, as well as its peers, is that conditions might not improve for a while.

          Economic gloom puts pressure on MPC

          Posted on 31 July 2012 by

          The Bank of England’s base rate, at a historic low of half a percentage point for more than three years, may fall further, economists say, following strong signals from policy makers that such a move is under review.

          However, it is thought unlikely to happen at this month’s meeting of the central bank’s Monetary Policy Committee, which concludes on Thursday.

            A rate cut flies in the face of nearly everything that members of the MPC have said on the subject since March 2009 when the current floor was hit. Moreover, while its economic benefits are likely to be limited, a lower rate opens the door to uncertainty that could prove damaging.

            Nevertheless, with a third round of the gilts purchases known as quantitative easing under way and Britain’s economy contracting for three consecutive quarters, policy makers are under pressure to do as much as they can to stave off a much deeper recession.

            Economists note that the central bank has repeatedly rebuffed suggestions of rates below 0.5 per cent because of the effect that would have on profit margins on loans. While lenders would earn lower income from interest on outstanding loans, they may not be able to reduce what they have to pay to borrow money themselves. With lower profits, banks will have less to hold in reserve against future shocks.

            “The concern has long been about the effect of squeezing lenders while not affecting deposit rates which are close to zero,” said Simon Hayes, economist at Barclays Capital.

            That is precisely the argument that Sir Mervyn King, BoE governor, made to a Treasury select committee hearing in June, stating it could leave smaller building societies “vulnerable”.
            But by July, policy makers hinted at a subtle shift in their stance in minutes covering the MPC meeting that month. One thing that had changed was the announcement of the funding for lending scheme – which begins on Wednesday – aimed at lowering banks’ cost of borrowing along with a scheme to provide low-cost collateralised loans from the BoE. The minutes noted its effectiveness would take “several months” to assess.

            That immediately raised the prospect of a rate cut in November, economists said, noting that a new quarterly inflation report will be issued then.

            George Buckley, economist at Deutsche Bank, said banks may now have more flexibility; deposit rates have been rising steadily as banks compete for funds and lenders now have scope to respond to lower rates on loans by also cutting rates on deposits.

            Victoria Clarke, economist at Investec, does not expect a rate cut, as shaving a quarter of a point off rates is unlikely to have much economic impact. If anything, it could be damaging to money markets because investors may judge that returns are so low it is not worth parking funds in sterling overnight.

            Visa Europe confronted by Brussels again

            Posted on 31 July 2012 by

            Visa Europe has received a fresh antitrust complaint for overcharging retailers for credit card transactions, in Brussels’ latest salvo against card fees that allegedly violate competition rules.

            Joaquín Almunia, the EU’s competition commissioner, served the card payment group with an updated so-called “statement of objections” after it refused to voluntarily halve its credit card fees.

              His decision to deliver extra antitrust charges is part of a revitalised European Commission offensive against card payment groups, which could eventually lead to a wider overhaul of card services making fees more transparent for consumers.

              The commission action comes after an important legal victory against MasterCard last May, in which the EU’s second-highest court endorsed the conclusion that “interchange fees” hurt competition and inflate prices.

              Most consumers are unaware of these charges on merchants, which provide multibillion-euro revenue streams for card-issuing banks and fund consumer services such as security, insurance offers and loyalty rewards.

              After receiving its first antitrust complaint in 2008, Visa, a bank-owned group that is separate from its listed US counterpart, agreed to cut its debit card fees to 0.2 per cent in a 2010 settlement.

              However credit card rates – which Visa sets for all EU cross-border transactions and for domestic transactions in eight member states – were excluded from the deal.

              At issue was what comparator to use when calculating rates and whether such fees should be exempt from antitrust rules because they contribute to technical and economic progress.

              Mr Almunia called on Visa to voluntarily reduce their credit card fees from about 0.6 per cent to somewhere close to the benchmark 0.3 per cent level agreed in a settlement with MasterCard in 2009.

              But after a recent meeting with Peter Ayliffe, the Visa Europe chief executive, the competition commissioner decided to move to formal charges because talks were unlikely to bear fruit.

              Mr Ayliffe said he was “very disappointed” that the commission had taken “such a confrontational approach and was not willing to find a solution to support investment and innovation”.

              The commission’s updated objections now extend to charges between regions – such as those levied when a US consumer uses a Visa card in Europe – and rules preventing EU merchants from taking advantage of lower rates offered by banks in other countries.

              Brussels antitrust enforcers have fought Visa and MasterCard for more than a decade, with mixed success. The commission is now also examining legislative options to cut fee levels, require more transparency or open access to competitors.

              So far the competition cases largely revolve around “interchange fees” on cross-border card payments, which a consumer’s bank levies on a merchant’s bank for retail sales transactions. However the reform drive could soon move to relatively untouched domestic card fees.

              The commission’s investigation found that Visa’s interchange fees potentially “harm competition between acquiring banks, inflate the cost of payment card acceptance for merchants and ultimately increase consumer prices”. It plans to finish and release a long-awaited study on the cost of handling cash for merchants – which would be the main comparator for setting card rates – in 2013.

              Oil falls $2 a barrel on investor caution

              Posted on 31 July 2012 by

              Oil prices fell nearly $2 a barrel as investors adopted a cautious stance ahead of a series of crucial central bank meetings and economic data.

              Benchmark ICE September Brent crude fell as much as $1.68 to a low of $104.52 a barrel.

                The move reversed some of the sharp 20 per cent rebound in prices in the past month, helped by growing hopes of decisive central bank action to
                stem the crisis in the eurozone and boost the US economy.

                But JBC Energy, a Vienna-based consultancy, said the dip in prices could be “the calm before the storm”.

                It anticipated a strong reaction to two critical central bank meetings: the policy decision of the US Federal Reserve’s rate-setting committee on Wednesday and the meeting of the European Central Bank on Thursday.

                Hopes are high, however, following comments by Mario Draghi, ECB president, last week that he was “ready to do whatever it takes” to support the euro.

                But it has also led some investors to prepare for disappointment.

                “The positive macroeconomic sentiment triggered last week by verbal cues from policy makers has started to fade and the markets have switched to a more cautious mode,” said Miswin Mahesh, analyst at Barclays.

                “Our economists expect the likelihood of a disappointment to be significant, given expectations have been set quite high for action by central bankers.

                “This is likely to bring some headwinds to the upward momentum in the oil market this week.”

                The largest decline in Brent prices in more than a week comes after a sharp rally from mid-June, when the crude benchmark fell to an 18-month low of $88.49.

                The market has been buffeted by the competing pressures of expectations for weaker demand as global economic growth slows on one hand, and on the other by ever lower supplies from Iran, where US and European sanctions that came into effect in July have pushed production to a two-decade low.

                At around $105 a barrel, however, oil prices remain within the range where they have been trading for most of the past two years.

                Rostam Ghasemi, Iran’s oil minister, on Monday dropped calls for Opec, the producers’ cartel, to hold an emergency meeting, saying that $100 a barrel was a “fair” price, according to Mehr news agency.

                Nymex September West Texas Intermediate dropped $1.91 to $87.87 a barrel.

                Push to shed light on muni market

                Posted on 31 July 2012 by

                Regulators are pushing to enhance disclosure for investors in municipal bonds, often criticised as one of the most opaque areas of US finance.

                The Securities and Exchange Commission announced recommendations on Tuesday designed to shed greater light on the $3.7tn municipal securities market.

                  The muni market is highly complex with one million different municipal bonds outstanding that have been issued by some 44,000 state, local governments and authorities.

                  Muni bonds appeal to individual investors because their income is not taxed and the SEC estimates three-quarters of the market is held by “retail” investors.

                  But in spite of the crucial role played by municipal finance, it lacks the regulation seen in other areas of US capital markets due to broad exemptions under federal securities laws.

                  While the SEC is seeking stronger powers, such efforts have fallen foul of intense lobbying of Congress by states.

                  “It is essential that the market work well and that investors have confidence in it,” said Mary Schapiro, chairman of the SEC.

                  “While we have put in place measures to help investors make more knowledgeable decisions about municipal securities, we could do more for investors with statutory authority to improve disclosure and muni market practices.”

                  The report outlines potential legislative changes that could help improve disclosures to investors, namely that Congress consider authorising the SEC to set baseline disclosure standards and require municipal issuers to have audited financial statements.

                  The SEC also focuses on possible new rules designed to improve transparency, disclosures and practices across the market.

                  Our opt-in opt-out solution for the euro

                  Posted on 31 July 2012 by

                  The distressed countries in Europe’s southern periphery fear exiting or being expelled from the currency union, partly because they believe they would lose all the euro’s advantages permanently. This fear could be laid to rest by making the eurozone an open currency union.

                  The core idea is to offer exiting countries the status of associated member, allowing them to adopt their own currency temporarily with the option to return to the euro at a later stage. An associated member would spare itself the trauma of a real depreciation inside the eurozone, which can only be achieved through a reduction of prices and wages that almost unavoidably entails economic contraction and mass unemployment. Moreover, an associated member could receive financial help from the other eurozone countries. It could adjust its exchange rate quickly to restore competitiveness and, once it had fulfilled all reform commitments, could fully rejoin the eurozone.

                    A longstanding arrangement, the European Exchange Rate Mechanism II, could provide a basis for such a currency “association”. Conceived for EU member states that have not yet introduced the euro, the ERM II at present includes Denmark, Latvia and Lithuania. All countries that have adopted the euro since 2000 have done so on condition of spending a two-year period within ERM II without stress, staying within a range of ±15 per cent with respect to a central rate against the euro. This mechanism could be expanded to allow it to harbour, after a transition period, countries leaving the eurozone, too.

                    Any country that left the eurozone and introduced a national currency would immediately come under strong pressure to devalue. Once the exchange rate against the euro had settled down, joining the ERM II at a realistic central rate with more generous band margins could be considered. The ERM II could thus become a sort of “training space” for a subsequent return to the eurozone. As the depreciation and structural reforms of the countries affected began to make them more competitive, the band margins could be gradually tightened. Interventions by the European Central Bank and national counterparts (the ECB has such duties within the ERM II in any case) would remain manageable as the convergence with the now-smaller eurozone increased.

                    Historical examples show that such a scenario is possible. In October 1969, the Willy Brandt government in Germany decoupled the D-Mark from its link to the dollar in a matter of days, floating the exchange rate for a short period and later resetting it at a rate 9 per cent lower (ie an appreciated D-Mark). The British showed how not to do it in the early 1990s, when facing huge current account deficits they brought the pound into the parity grid at a rate that was much too high. After a short, intense wave of speculation, the pound had to withdraw from the programme. Argentina, which was forced to give up its 1:1 peg to the US dollar in 2002, experienced a stormy floating of the peso in the currency markets. In about 18 months, after heavy swings and depreciation, it found a new parity in the neighbourhood of three pesos to the dollar. Thus in 2004 at the latest, it would have been possible for it to re-establish a fixed exchange rate, within a band, to the dollar.

                    This proposal to open the currency union has a decisive advantage over either maintaining the status quo or allowing disorderly exits from the eurozone. It would give the countries affected a realistic, and therefore credible, hope of returning to the euro. Linking the new national currencies to the euro would support the operational efficiency of the single market. And countries would not be expelled from the club; their full membership would simply lie dormant for a couple of years.

                    That would be a significant psychological factor making governments, and their electorates, more willing to persevere with painful economic reforms.

                    The writers are respectively president of the Ifo Institute for Economic Research and professor at Bundeswehr University Munich

                    Perseverance sees equity funds through storm

                    Posted on 31 July 2012 by

                    It is hardly the most electrifying of hedge fund strategies: keep calm and carry on.

                    But amid the sometimes violent, sentiment-driven movement of equity markets, there have been signs this year that for some hedge fund managers – those content to keep their heads down and soldier through the macro headwinds and unfolding eurozone debt crisis – money is there to be made in stocks.

                      Hedge fund graphicClick to enlarge

                      Some of the world’s most prominent equity long/short managers, who base their investment decisions on fundamental analyses of companies, have been delivering steady returns, often far in excess of their peers.

                      Even in aggregate, long/short investors have comfortably outstripped the performance of “macro” hedge funds – those supposedly best equipped to navigate tough global economic turmoil through fleet-footed trading of bonds, currencies and derivatives.

                      It has been a tough two years. The average equity long/short manager made 2.15 per cent in the first six months of the year, according to Hedge Fund Research.

                      Hardly the kind of returns that hedge fund managers are best known for, but then, the average hedge fund, industry wide, fared even worse, returning just 1.87 per cent.

                      The average macro hedge fund manager, meanwhile, lost 0.5 per cent.

                      This is an important development, not least because equity hedge funds are so out of vogue.

                      HFR data show that in the second quarter, clients – these days as likely to be pension funds or public endowments as wealthy individuals – pulled $20.3bn from equity hedge funds and allocated $1.4bn to macro hedge funds.

                      The success of some of the biggest equity long/short managers makes it even clearer that such pessimism over equity strategies may be misplaced.

                      Lee Ainslie, a “Tiger Cub” protégé of former hedge fund superstar Julian Robertson, has seen his equities-focused US hedge fund, Maverick Capital, return nearly 15 per cent so far this year, according to an investor.

                      In Europe, Crispin Odey, who founded one of London’s first hedge fund managers, Odey Asset Management, has seen his flagship European fund rise 13.25 per cent.

                      GLG Partner’s flagship long/short fund, run by firm co-founder Pierre Lagrange and his colleagues, has returned an estimated 6.5 per cent this year, according to one investor, also in European markets.

                      Theleme, the $1.5bn hedge fund run by Patrick Degorce, a former lieutenant of high-profile activist Chris Hohn at TCI, has seen his main fund rise 10 per cent this year.

                      Marshall Wace’s emerging markets-oriented Global Opportunities fund is up 8.4 per cent so far.

                      What, then, has been behind such returns? How do some equity managers make so much money in such choppy markets?

                      Many hedge fund investors have latched on to correlation between stocks as a proxy for the success of equity long/short managers: when correlation dramatically dropped in the first quarter, equity hedge fund managers enjoyed a bounce in their performance.

                      Now, though, correlation is rising again and investors worry the spell of solid performance for equity managers will end.

                      However, those at the coal face disagree that opportunities to make money are diminishing.

                      “There has been lots of comment on how volatile markets have been and how much correlation has picked up and how difficult this makes it to be an equity long/short manager,” says Darren Hodges, co-fund manager of GLG’s European fund, which has been running money in Europe since 2000. “While we’re obviously aware of both, it’s not really about either of those. It is about dispersion.”

                      Dispersion, the degree to which related stocks are priced relative to each other, is the real measure of opportunity for equity long/short managers, says Mr Hodges. And dispersion is still high.

                      “Absolute return funds like ours are all about stock picking. Stock picking is all about using identifiable skills to make money from the persistent dispersion of stocks within a sector,” he says. “Picking the right longs or shorts should almost be correlation agnostic,” agrees Anita Nemes, global head of capital introduction at Deutsche Bank.

                      But if correlation does not help to indicate whether there are opportunities, it does warn of dangers.

                      “High correlations should inform risk management,” says Ms Nemes.

                      “The best managers have developed an extremely disciplined approach to risk management and not just by having stop losses and such … we are in the fourth year of extremely strong macro pressures, and good fundamentals-driven managers have become much more active in the risk management side of things as a result.”

                      Risk management breaks down into several components. Diversification is one of those elements.

                      The key, though, Ms Nemes and Mr Hodges note, is for managers to know when to cut their exposure to the market, even if their positions are winning. Funds that sell down their positions before a correction are in a much better place to take advantage of opportunities later.

                      “That takes guts,” says Ms Nemes. And guts are in short supply but great demand in the hedge fund industry.

                      “Timidity is the order of things,” says one hedge fund manager in charge of a top-tier fund based in London.

                      “And that is perhaps a good thing.”

                      “The world is in a very very unstable place. Most people probably agree on the likely scenario of markets muddling along for years ahead, but there are huge tail risks everyone is now aware of.”

                      In that sense, it is as much about the keeping calm as the carrying on.