Hedge Funds Replace Mutual Funds

Hedge fund and fund of funds managers have been adding long-only as an investment strategy according to an article in the December 23, 2013 issue of Pensions & Investments.  These include such famous names as CQS, Lansdowne Partners, Lone Pine Capital, Maverick Capital, Tiger Global Management, Viking Global Investors, Winton Capital Management, Blackstone Alternative Asset Management and the Rock Creek Group.  The new strategy has been driven by institutional investors - of which, 44% invest in long-only funds.  The interest has been fueled by several other factors:

• Institutional investors' disappointment with mutual fund returns
• Since the financial crisis of 2008, shorting securities has been underperforming as an investment 
• strategy
• Confidence in hedge fund managers as stock pickers
• Performance fees are easier for the manager to attain as they are based on returns relative to the performance of an index i.e. S&P 500

Blackstone and Rock Creek have almost $7 billion in assets under management (AUM) in the long-only strategy.  Both companies launched the strategy a few years ago.  In 2007, Blackstone used hedge fund managers to trade the long-only components of one of Blackstone's commodity indices.  In 2009, Rock Creek launched an emerging markets equity fund.  This fund has grown to $1.8 billion in AUM.

Frontier Markets - the Next Growth Investment?

Five professional investors from four buyside firms believe that frontier markets have a greater opportunity set than emerging markets.  They carry less risk (i.e. less volatile) and have less correlation with the developed world markets.  According to Andrew Brudenell, portfolio manager at HSBC Global Asset Management, they are cheaper and have higher dividend yields.  Chad Cleaver and Howard Schwab, portfolio managers at Driehaus Capital Management agree.  In addition, the best opportunities are in small and mid cap stocks and in markets with native consumers.  These ideas have outperformed the MSCI BRIC index handily.  Since the summer of 2009, this index is flat or down slightly.  Other customized indices based on the above investing themes include ASEAN index, ANDEAN index and a consumer stock index.  The ASEAN index is comprised of Thailand, the Philippines and Indonesia.  It is up 70% for the same timeframe.  The ANDEAN index is comprised of stocks from Colombia, Peru and Chile and is up 65%.  An index comprised of consumer discretionary and consumer staples securities (50%/50% split) is up 75%.

Kemal Ahmed, portfolio manager at Investec Asset Management, adds another wrinkle to the frontier markets theme.  He has coined the term horizon markets which consists of frontier markets plus the 14 smaller countries in the MSCI Emerging Markets index.  He calls them Smaller EM.  The seven larger countries account for 80% of the index's capitalization and are called Large EM.  The BRIC nations make up 60% of the index.

According to David Stein, chief investment officer at Parametric, the correlations within the frontier markets has remained low (approximately 0.3) while they have been rising between countries in the developed and emerging markets.  While investing in a particular country in the frontier markets may be riskier, diversification among country risks should lead to safer and less volatile returns.

These factors make frontier markets a compelling alternative to a standard investment in the BRIC countries.

CalPERS Reviews Hedge Fund Strategy

The California Public Employees Retirement Systems (CalPERS) is in the midst of changing its allocation strategy for its hedge fund investments.  There are $5.2 billion in assets out of a total of $254.9 billion.  As part of its total portfolio, it is not that important but the absolute dollar numbers are impressive.  They are seeking to reduce their equity exposure by investing in assets that are not correlated with long only funds, private equity and high yield bonds.  Edigio Robertiello, senior portfolio manager of absolute return strategies, has proposed the following changes:

• CalPERS will have to raise the percentage of assets allocated to hedge funds to much more than currently
• Classifying the hedge fund allocation separately from the global equities allocation
• Limiting the beta to global equity markets to 0.20 
• Setting a standard deviation target for returns to 8%

While CalPERS is considering Robertiello's recommendations, he is reviewing the current hedge fund investments and making the following changes:

• Reducing the number of hedge funds to concentrate assets in fewer strategies
• Reducing the fund of funds allocation to 15% from 29%.  Emerging fund of funds will have a 10% allocation.
• Reducing the investments in Asia and Europe to 5% from 19%
• Increasing the allocations to equity market neutral and global macro to 10% each
• Adding an allocation to event driven to 5%
• Increasing the allocation to equity long/short to 15%

Since the portfolio has underperformed its internal benchmark by 2% since it was begun, Robertiello is hoping that the changes will improve its performance.  Against this backdrop, CalPERS is evaluating whether or not passive management is more efficient than active management.

The source for this article can be accessed here.

Opening China to Foreign Investors

The State Administration of Foreign Exchange of the People's Republic of China has eased the rules for investing in China's financial markets through the Qualified Foreign Institutional Investor program.  They eliminated the $1 billion limitation on investments and changed the minimum statistics of the investor.  The manager must have $500 million (amended from $5 billion) in assets under management and have a track history of at least 2 years (amended from 5 years).  The entire process to obtain entrance into the program is now about 7 to 8 months.  Previously, it would take a year and a half.  The changes have been targeted to long term investors such as sovereign wealth funds, central banks, monetary authorities, insurance companies, endowments and pension plans.  Fund managers with a high turnover rate, such as hedge funds, mutual funds and investment banks, were not included in the rules changes.  Overall, by 2015, consulting firm Z-Ben Advisors Co. Ltd. of Singapore is predicting that asset management firms and asset owners will dominate the landscape.  They will push out the investment banks, who now have 51% share in the program.  Also, last year the ceiling on the program was elevated to $80 billion from $30 billion.  About $6 billion has been invested since then.  It is expected that the remaining $44 billion will be invested over the next 2 years.

The article from Pensions & Investments may be accessed here.

A New Strategy for Investing in Emerging Markets

The BNY Mellon Investment Strategy and Solutions Group published a paper in July 2012 about revising investments in emerging markets.  Emerging markets are now large enough to contain subcategories in the same manner as investors consider sectors as subcategories of the US equity market.  There are four of them:  Consumption, Commodities, Manufacturing and Investment.  Consumption are industries that serve consumers such as hotels, media, household products, pharmaceuticals and tobacco.  Commodities include industries such as oil & gas, chemicals and metals & mining.  Manufacturing are industries that produce goods an services for the global market such as machinery, computer & peripherals, semiconductors and leisure equipment.  Investment include industries such as banks, electric utilities, airlines and infrastructure.

These different themes allow investors to react to macroeconomic conditions.  When the economy is doing well, Commodities and Manufacturing perform better.  On the other hand, Investment does better when the economy is doing worse because government spending increases.  This helps Investment stocks outperform. Having these different choices allow investors to buy their best ideas and avoid or short their worst ideas.

The research paper goes into great detail on how they created their themes by country and sector/industry.  It also analyzes their performance, risk, correlation, drivers of the returns and relative valuations.  The entire report can be accessed here.

Investors Uncertain about BRIC Countries

Many investors believe that any future long term stock market performance will be driven by the BRIC (Brazil, Russia, India and China) countries in the emerging world.  Opinions on the short term outlook have changed.  There is a split among managers due to the continuing Eurozone crisis and slowing global growth.  The returns for the four countries are less than the MSCI Emerging Markets index which has underperformed the MSCI World index by 834 and 124 basis points for the past one and three years through May 31.  Below is a table comparing each country's return versus the MSCI Emerging Markets index for the same time period.

BRIC Country	One Year Return	Three Year Return
Brazil	-823 bp	-703 bp
Russia	-1,130 bp	-544 bp
India	-802 bp	-785 bp
China	-24 bp	-540 bp

The managers on either side of the trade are:

Pro

Richard Titherington, managing director and chief investment officer for emerging markets equity and JP Morgan Asset Management ($33 billion in assets under management) is aggressively overweight China and sees the pullback to lower valuations as a buying signal.

Allan Conway, head of global emerging markets equities at Schroder Investment Management $23.2 billion in AUM); Manu Vandenbulck, senior investment manager and ING Investment Management ($3.3 billion in AUM); Christian Deseglise, managing director and head of institutional sales in the Americas for HSBC Global Asset Management ($32.2 billion in AUM) and Gary Greenberg, head of emerging markets at Hermes Fund Managers ($740 million in AUM) are overweight China.  They are relying on China's government to cushion any economic downturn.  The lower valuations of the Chinese stock market lessen market risk.  The BRIC countries are becoming non-correlated with the developed world.

Gaurav Mallik, portfolio manager for global active quantitative equity at State Street Global Advisors ($6 billion in AUM), is buying smaller companies in Russia and China.

Con
Todd McClone, portfolio manager at William Blair ($9 billion in AUM), says that lower commodity prices, the Eurozone crisis, inflation and slowing economies are negatively affecting the markets in BRIC countries.

Paul Bouchy, managing director and head of research at Parametric Portfolio Associates, is underweight BRIC and overweight in the frontier countries.

The source for this article can be accessed here.

Will China Have a Soft Landing?

Paul Gambles, Managing Partner of MBMG International, discussed the state of China's economy last month in a television interview with the Money Channel and on his blog.  He believes that there will be a hard or very hard landing.  A soft landing is not an option.  This is due to a number of factors:

• Lack of transparency in the economy - Chinese economic data is not reliable because of strong central government control of the data and economy.  The government determines where capital is invested, regardless of returns.  There may be bad investments that are priced incorrectly due to government stimulus and forced lending (which often turn into bad debts).  The GDP growth of 8.9% may not be real if the underlying loans are examined.  An example of government influenced pricing is when the Huijin Sovereign Wealth Fund bought controlling positions in the four largest banks:  Agricultural Bank of China, Bank of China, Industrial & Commercial Bank of China and China Construction Bank as a show of support in 2011.  Nobody knows what these banks are worth.
• Foreign Direct Investment is slowing in China.  It has become less attractive to investors and holding $1.5 trillion in US assets.  Exporting to Europe to diversify away from the dollar has become difficult due to the Eurozone crisis.  If the government had spent the US dollars, it would have increased inflation or the value of renminbi.  China was unwilling to accept either consequence and had to hold US assets.  China is repeating what Japan did thirty years earlier and both are similar to a currency hedge fund that is overexposed to the US dollar.
• China is predicted to become the world's largest economy by 2020.  A closed government and controlled economy will make it difficult to pass the US.
• Xi Jinping, the President-elect and successor to President Hu, did not get approved by the military.

Notes from a Hedge Fund Survey - Part I

Last month, SEI and Greenwich Associates published part 1 of the Fifth Annual Global Survey of Institutional Hedge Fund Investors.  There were several themes that emerged from the report for investors.

• Allocations to hedge funds are rising but at a slower rate than last year.  In 2012, they are projected to be 17.8% of investor portfolios.  They were just 12% in 2008.  The increase is led by endowments.
• The top goal for institutions for hedge fund investing is absolute return in 2011.  This was in response to the poor performance of the HFRI Index.  In prior years, the goal was to mitigate risk by investing in non-correlated assets.
• Investors use hedge funds to manage their investment risks through diversification among investments to decrease volatility
• More institutions are investing directly into hedge funds rather than funds of hedge funds.  According to Citi Prime Finance, investors are unhappy with paying an additional layer of management and incentive fees, are concerned that funds of funds are too diversified and want to have more control over their portfolio.  The larger institutions have the resources to invest directly.  Of the smaller ones (less than $500 million AUM), 64% use funds of funds.
• Most popular strategies are the simpler ones:  equity long/short, event driven and credit
• Limited interest in re-allocating to UCITS or mutual funds
• The most important challenge for hedge fund investors is having performance expectations met.  This is probably in response to the 2011 performance.  In 2010, when returns were good, then transparency was important.

Positioning a Fund for Slowing Growth in China

Some European hedge funds are predicting that China's growth will slow down in 2012.  The GDP growth forecast has been lowered to 8.7% for the fourth quarter of 2011.  From 2003 to 2007, growth was at least 10%.  One chief investment officer, Javier Pina of Javelin Capital, says that China is forced to stop their credit expansion.   According to Pedro de Noronha, managing partner at Noster Capital, he has noted the following reasons for the downturn:

• The US has not returned to pre-crisis consumption levels
• Lack of corporate governance in China
• Bad bank loans
• Real estate bubble

Other managers have positioned themselves to profit from the slowdown by:

• Shorting Chinese equity markets using futures
• Short positions in the yuan
• Buying credit default swaps on companies that export to China
• Shorting natural resource companies that export to China

The source for this article can be accessed here.

Institutional Investors Favor Emerging Markets and Alternative Investments

In an article published by Pensions & Investments, the Deutsche Bank 2011 Institutional Survey shows that investors are planning to shift their capital into the emerging markets and alternative investments (commodities, hedge funds, private equity and real estate) over the next year.  They will be moving out of the US stock and government bond markets.  The survey was conducted for 101 investors with $1.2 trillion in assets.

The source for the article can be accessed here.

Notes on China's Government Debt

In the November 2011 issue of Global Finance magazine, Thomas Clouse wrote an article about China's government debt.  As part of the stimulus plan enacted by Beijing, local governments must fund infrastructure and public projects.  Since they cannot issue bonds or levy property taxes, they use real estate to fund them.  Local government investment vehicles borrow money using the real estate as collateral.  Lately, the real estate market has been cooling down which will cause losses on these loans.  Who will take on the losses?  The banks, local governments or the central government.  There are $1.5 to $2.1 trillion in loans which is 70% of China's Gross Domestic Product.  Stephen Green of Standard Chartered Bank believes that the central government's balance sheet surplus and taxation authority can resolve this high level of debt without triggering a banking crisis - as long as there is strong nominal growth.

Private Equity Funds in India

Private equity investors have favored India as a source for their emerging markets investments.  Recently, China and Indonesia have supplanted it.  All three countries have a need to build out infrastructure, education and healthcare systems but a few trends that have tipped the scales away from India.

The Chinese government is supporting domestic, local currency private equity funds with less regulatory oversight and restrictions on ownership.  Carlyle Group, Blackstone and Texas Pacific Group have invested in joint ventures with Chinese state-owned enterprises and governments.  The Indian stock market is performing poorly and not conducive to IPOs.  Capital flows have been negative as foreign investors have been de-risking.  Meanwhile, China's markets are restricted to local investors which makes it easier to exit private equity positions.  Indian fund managers lean towards the deal-making side and not on generating high returns by adding value to the portfolio companies.

The Securities and Exchange Board of India (Sebi) has proposed some restrictive rules.  Private investments in public equity (PIPE), private equity and infrastructure funds should register with Sebi.  The general partner of a fund has to invest at least five percent of the fund assets.  This restricts large funds to be managed by the Blackstones of the world.

India has an inefficient stock market with many small and mid-cap companies that are not adequately covered by research analysts.  Unlike the standard private equity deal, some fund managers take minority stakes of 2% to 7% in these public companies and work with their managers to improve their businesses.  Meanwhile, they work with the sell-side to raise their companies' profiles to investors.  When the stock prices rise, they sell their position on the secondary market.

The source for this article can be accessed here.

Views on China: This Is What Makes Investing Interesting

China.  There is so much news about the country in the financial news.  We will pursue a couple of viewpoints in this post.  First is the article in the New York Times about China participating in the bailout of the Eurozone.  I hope China is smarter about it than the US Government in bailing out the banks in 2008.

In a post written by Burnham Banks at hedged.biz, China's GDP growth was 9.1% for the third quarter of 2011, well ahead of the 8% needed to keep stability in the county.  It is down from a previous figure of 9.5%.  However, inflation is rearing its ugly head.  In September, it was 6.1%.  If you look at its components, you see some worrisome numbers.  The price of food is up 13.4% with meat being up 28.4%.  The government has to walk a fine line between growth and inflation.

Managers of commodities funds are more positive since the September sell-off but are cautious about China's economic growth.  They believe that the government will loosen monetary policy later this year to keep growth at the 9.3% target.  Also, the drop in commodity prices is causing certain fund managers to see value in them, such as industrial metals and crude oil.  The source for this part of the article can be accessed here.

China perma-bear, Jim Chanos, says that the hard landing for China's economy has begun with troubles in its banks and real estate.  In a nationwide survey, home prices rose in less than 50% of seventy cities.  The number of home transactions has fallen 40% to 60% in the past two months when compared to last year.  But the performance of China's banks do not support his investment thesis.  Agricultural Bank of China, Industrial & Commercial Bank of China and Bank of Communications Co. reported huge gains in the third quarter.  Chanos' replied, "Western banks reported record profits in 2007 before collapsing."  Hard to argue with someone who shorted Enron in 2001, the homebuilders in 2007 and credit-related stocks in 2007.  However, we hear a lot about his successes.  What about his failures?  The source for this part of the article can be accessed here.

50% Chance of a Recession According to Dr. Doom

Nouriel Roubini, Dr. Doom and founder of Roubini Global Economics LLC, says that there is a 50% chance of recession in the United States, United Kingdom and the countries in the Eurozone within the next year.  A re-structuring plan for Greek debt will be published on October 26.  If the plan is not successful, Greece may default on its sovereign debt and put Spain and Italy as the next dominoes to fall.  Uncertainty as to which European banks are exposed to a Greek default are making their counterparties nervous and unwilling to extend them credit.

On the other hand, emerging markets have been aggressively fighting a recession with various stimulative measures.  Indonesia and Brazil's central bank cut their interest rates and the Philippines are embarking on a stimulus package of $1.7 billion.

The source for this article can be accessed here.

China's Banks Are Downgraded

Yesterday, Sanjay Jain, research analyst covering Chinese banks for Credit Suisse, wrote a negative report on that sector.  Bad loans to real estate companies, manufacturers, local governments and small/medium entreprises would cause losses of 40% to 60% of equity capital in the coming years.  I am surmising that many were made during the credit crisis of 2008 when the central government ordered banks to loan money to stimulate the economy.  The MSCI China Financials Index is down by as much as 43% in 2011.  To support the sector, Central Huijin Investment Ltd, part of China's sovereign wealth fund, is buying shares of the four largest banks.  The China Banking Regulatory Commission is watching the banks closely in case real estate prices start to fall as part of their effort to cool that market.

The source for this article can be accessed here.

China's Banks: A Crash Waiting to Happen?

Several institutional investors - including Kynikos Associates, Grantham Mayo van Otterloo and  Vontobel Asset Management - are predicting that Chinese bank stocks will fall off the cliff.  The MSCI China Financials index fell 24% in September.  They believe the banks have too many bad loans to local provincial governments, a slowing real estate market and a slowing economy.  In Liaoning province, 85% of the government financing vehicles are struggling to repay their debt obligations.  Real estate developers are also seeing higher borrowing costs as banks cut their lending.

Since 2008, the banks have loaned $3.8 trillion.  A major portion went into infrastructure and real estate.  In five years, real estate prices have risen 60%.  Jim Chanos of Kynikos has short positions on almost all the banks.  He believes that they will fall below the value of their net assets.  Currently, the banks trade at a 20% premium to their assets.  They still have bad loans from prior banking crises and the local government debt has grown to 200% of the gross domestic product.  As in the US, they may have to raise capital to reserve against bad loans and expanded lending.

A sellside analyst, Mike Werner of Sanford Bernstein, says that the growing Chinese economy will limit the amount of bad loans.  If these loans do increase greatly, the banks will be less profitable but will not collapse. The Beijing government would prop them up.

Some of the bank stocks include Agricultural Bank of China, Bank of China, China Construction Bank, China Merchants Bank and Industrial & Commercial bank of China.

The source article can be accessed here.

Frontier Markets

I recently came across a research report from Northern Trust Global Investments that was written by Greg Behar and Stefanie Hest, Senior Investment Strategists.  Due to the growth of non-US markets, they are advocating a higher allocation to frontier markets.  A frontier market is in a developing country that has a high economic growth rate and a small, illiquid stock market.  The country is not part of an index such as MSCI Emerging Markets.  Examples of countries classified as frontier would be Bulgaria, Croatia, Lithuania, Romania, Ukraine, Ghana, Kenya, Nigeria, Jordan, Kuwait, Qatar, Bangladesh, Pakistan, Vietnam, Argentina, Colombia and Panama.

Frontier markets had a real GDP growth figure of 4.79%, about equal to emerging markets and two times developed markets.  This trend should be continuing in the future.  From a valuation perspective, they are more attractive than emerging markets.  The trailing P/E (price to earnings ratio) is hovering at 10 (as of 2010) compared to 15 for emerging markets.

Frontier markets have a low correlation (0.54) to the Standard & Poor's 500 Index which improves a portfolio's diversification.  Compare this to emerging markets and small cap indices' correlation of 0.8.  The historical risk/return profile (standard deviation of returns) is attractive.  However, this may be the smoothing effect of having illiquid markets.

Some additional risks of frontier markets are operational (trade settlement), regulatory/market (capital flow restrictions and limits on foreign ownership), political and transaction costs (commissions, high spreads, taxes and less liquidity).

The report can be accessed here.

An Investment Outlook on China

I was alerted to an article by Albourne Village written last month for a blog called hedged.biz.  The topic was Asian Economies and Investment Outlook.  The writer is forecasting several trends based on Asia:

China will build its infrastructure until domestic consumption grows - In 2009, US consumption of Chinese goods fell off a cliff.  To replace this activity, China responded with a infrastructure stimulus plan with $2 trillion being in special purpose vehicles called Local Government Funding Vehicles.  Eventually, this government sponsored program will end.  At the time, the Asian consumer will replace the US consumer - hopefully.  In China, domestic consumption will grow when income inequality becomes less and when enough people move into the "middle class" and have discretionary income.

Domestic consumption is the best strategy in China - The investor should be prepared for volatility when investing in this theme in the short term.  In the long term, it should have great returns.  There are three ways to approach this:  Asia exporters to China, Chinese domestic companies and Indonesian and Australian natural resources.

BRIC: Underperformance Leading to Fund Outflows

Funds investing in Brazil, Russia, India and China (BRIC) have seen net outflows since March 2010.  Assets invested in funds have retreated to $28 billion from a high of $38 billion in 2007.  Other fund investing in gold and Non-Japan Asia have added about $4 billion in assets each.  BRIC funds have become standard investments.  Investors are always looking for a new thesis.  There are 350 funds, 2,000 offshore funds, local funds, and thousands of diversified funds that are allowed to invest in the area.  Performance has lagged as well.  India and China have experienced inflation.  Russia has underperformed due to the US debt crisis.  Brazil has tax issues and foreign investor outflows leading to capital controls.

The source for this article is here.

Credit Derivatives: Some Basic Information

In prior posts, we have looked at credit default swaps.  Let's take step back and look at credit derivatives as a whole.  They are financial contracts such as options, forwards, futures, swaps and credit linked notes that are used used by fixed income managers to hedge positions (credit protection) or to enhance portfolio returns (credit exposure).  Through credit derivatives, portfolio managers are able to isolate and transfer credit risk, get liquidity in the market and have transparent pricing by trading the underlying credit.  Previously, they would have to hold the underlying assets in their portfolio which is capital intensive.  To manage risk using this method, the manager would have to look at each company's financial statement and balance sheet to rate their soundness.  He would also look at the industries of the portfolio companies and diversify loans to companies in different industries or sectors.

What is credit risk?  There are three components:  default, downgrade and credit spread.  Default risk is the risk that the bond issuer or loan borrower will not pay the bond or loan in full.  A loan is in default if a scheduled payment is not made.  Downgrade risk is when a rating agency such as Standard & Poor's, Moody's or Fitch's lowers the credit rating of the debt.  Credit spread risk is when the market spread between the underlying bond or loan increases for the remaining debt.  Credit risk is usually measured by rating agencies or using the credit spread.

What are the underlying / reference assets that credit derivatives are used for?  They are high yield bonds, leveraged loans, distressed debt and emerging markets bonds.  These assets have low to medium correlation with US equities and low or negative correlation with US Treasuries.  They have a high exposure to large declines in prices.  High yield bonds a.k.a. junk bonds are rated below investment grade by the agencies (either below BBB by Standard & Poor's or Baa by Moody's).  Leveraged loans are bank loans made to companies of credit ratings below investment grade or with a spread of 150 basis points over LIBOR (London Interbank Offer Rate).  LIBOR is the interest rate at which banks borrow from other banks in London.  In addition to the three credit risks listed above, the borrower can pre-pay the loan by re-financing or pre-paying the balance.  This is call risk.  There are to types of loans - revolvers and term loans.  Revolvers are committed lines of credit that also back commercial paper loans of companies with high credit ratings.  Term loans are given to companies with lower credit ratings, are funded commitments with fixed amortization schedules and are based on floating interest rates.  In addition to credit risk, emerging markets debt is exposed to political risk.  Distressed debt is composed of bonds of companies that are in default because of a missed payment, bonds going through Chapter 11 re-organization, the company having cash flow problems or have low credit ratings.

Options, futures and forwards are known as binary options.  They are similar to equity options.  If an event occurs as dictated by the terms of the contract, then the option seller pays money to the holder.  A credit-linked note is a bond with an embedded credit option.  These notes have a higher interest rate than regular bonds but the holder of the note provides the issuer with some credit hedge.  The referenced asset is either a corporation or a basket of credit risks.

A total return credit swap allows an investor to rent a balance sheet.  The investor trades the return of an asset for a guaranteed rate of return, usually LIBOR plus a spread.    The seller of the swap retains ownership of the asset.  For example, an investor could be positive on Apple bonds.  A swap can be bought on the returns of Apple bonds.  The buyer would receive that return and pay the seller LIBOR plus a spread.  The seller has hedged his position in Apple bonds and is now receiving payments of LIBOR plus a spread.