Assets Under Management Fall for Hedge Funds

According to eVestment LLC, investors in hedge funds and hedge funds of funds withdrew $30.8 billion in the first half of 2016, bringing down the total assets under management to $3 trillion for the entire industry.  Poor performance seems to be the driver for the redemptions.  The HFRI Fund Weighted Composite index fell 2.4% during the same timeframe.  Momentum investors, who search for "the latest hot hedge fund performer", have nothing to invest in.  Kenneth J. Heinz, president, Hedge Fund Research Inc., said that investors are also re-allocating assets due to a change in tactical or strategic investing strategy or even re-balancing assets.

The usual suspects comprised the list of the largest hedge fund managers:  Bridgewater, AQR Capital Management and Man Group.  Several managers were off the list because of divestitures (J.P. Morgan Asset Management), non-responsiveness to the survey (Davidson Kempner Capital Management, Appaloosa, Pershing Square Capital Management, Paulson & Co. and Third Point) and spin-offs (Black River Asset Management).

The same was evident in the list of hedge funds of funds manager:  Blackstone Alternative Asset Management, UBS Hedge Fund Solutions and Goldman Sachs Asset Management.  There were a couple of deals (Entrust Capital Management and Permal Group) and (Aberdeen Asset Management and Arden Asset Management) that changed the rankings of the biggest managers.  The first merger was a response to competition from investment consultants.  The strategy is to "offer specialized, unique, niche-y strategies" according to Gregg Hymowitz, chairman and CEO of EnTrustPermal.

For the first half of 2016, 58% of hedge fund managers and 63% of hedge fund of fund managers had a decline in assets under management.  Investors dissatisfaction continues as they have become increasingly focused on short term performance.

The source for this article can be found here.

Assets Decline at the Largest Fund Managers

The results of the annual money management survey of the 500 largest asset managers were published in the May 30th issue of Pensions & Investments.  Last year, their assets under management dropped 2.8%.  Factors causing the money outflows were:

• Defined Benefit Plans - companies continuing the trend towards defined contribution plans
• Demographics - aging of the general population
• Decline of Oil Prices - caused petroleum based sovereign wealth funds to sell assets to make up national budget shortfalls
• Diversification - institutional investors are moving away from the largest asset managers; they are selecting smaller, niche managers to get uncorrelated returns
• Disappointing Stock Market Performance - the return of the Dow Jones Index was flat for the year
• Insourcing - sovereign wealth funds have started to manage their assets with internal investment teams or firms

The articles can be found here.

Liquidity Risk in the Bond Markets

According to an article in the March 21 edition of Pensions & Investments, hedge fund strategies focused on bonds such as relative value and long/short credit are facing increased liquidity risk due to unintended consequences of regulations such as Dodd-Frank and Basel III.  This is especially true in the junk bond arena.  The legislation closed the proprietary trading desks of the banks and increased capital reserve levels have caused a liquidity crunch.  In the past, the proprietary trading desks were the primary trading counterparties for hedge funds.  Some funds that have closed include Claren Road Asset Management, Third Avenue Focused Credit Fund, and Lutetium Capital.

Fund managers have responded in a variety of ways.  They have traded in smaller amounts, reduced their leverage and expanded their counterparties.  According to Aaron Dalrymple, head of credit at Cliffwater, smaller transactions of $5 million in capital are easier now.  There has been some outreach to pension funds and endowments as new trading partners, either directly or through a dark pool in Liquidnet.

Until the liquidity issue is resolved, firms are scaling down or closing credit strategies.  Investors have agreed.  In the second half of 2015, alternative investment data provided eVestment stated that there was no demand for credit strategies.

The Return of Funds of Hedge Funds

According to the March 7th issue of Pensions & Investments, investors are using fund of fund managers to manage their hedge fund portfolios.  They are turning to the largest managers such as BlackRock Inc., Blackstone Alternative Asset Management, Grosvenor Capital Management, Mesirow Advanced Strategies, J.P. Morgan Alternative Asset Management, Pacific Alternative Asset Management and UBS Hedge Fund Solutions.  There are several reasons for this change from the trend of directly investing in hedge funds:

• Internally managed portfolios have earned poor returns or are getting fund of hedge fund returns
• Investors are outsourcing their allocation models for niche, specialty or capacity constrained portfolios
• Florida State Board of Administration investing $300 million in the commodity trading advisor (CTA) niche
• Investors are allocating more to their alternative investment assets and want customized solutions
• Fresno County Employees' Retirement Association is adding to its portfolio - $156 million
• Plymouth County Retirement Association is increasing its hedge fund allocation by $10-20 million
• New investors want customized solutions
• Japan Post Bank wants to allocate $10 billion by March or April
• Illinois State Universities Retirement System hired Pacific Alternative Asset Management Co. and KKR Prisma to manage $500 million

According to Joshua Levine, managing director and head of business development, of BlackRock Inc., the new investors and existing investors allocating more assets are onboarding using separate managed accounts that "offer more control, better pricing and improved transparency".  The article does note that the largest, most well known fund of fund managers are receiving most of the new business.  Medium and small sized managers are not part of this trend.

Fund Managers Differ on the Impending Devaluation of the Chinese Yuan

In January 2015, the Swiss Franc rose dramatically in value as the Swiss National Bank removed its exchange peg to the Euro.  Many fund managers believe that the Chinese Yuan will be devalued in 2016.  There is a difference of opinion on how.

Some macro hedge funds believe the Yuan will be devalued by 20 - 50% in the coming months.  They include Corriente Partners and Omni Macro Fund and will be looking at investment flows after the Chinese New Year next week.  If the outflows continue, then they are predicting a one-time devaluation of the Yuan.  Other fund managers think that the Central Bank will manage a gradual devaluation.  The former set of managers are buying out of the money options.  The latter set of managers are selling these same options as a hedge.  They are buying options based on a 10% depreciation of the currency.

The source for this article can be accessed here.

There Are Buyers of Master Limited Partnerships Even in Commodity Sell-off

A fallout of the the crash in on oil prices has been the performance of Master Limited Partnerships (MLPs).  According to the January 11, 2016 issue of Pensions & Investments, the Alerian MLP Total Return index was down 43% from its peak in August 2014.  In the first two weeks of January alone, the Alerian MLP index is down 18%.  Anthony Merhige, general counsel and chief operating officer of Harvest Fund Advisors ($7.5 billion in MLP AUM), and Todd Williams, senior vice president, portfolio manager and senior research analyst of Westwood Holdings Group ($500 million in MLP AUM), are seeing interest from some investors even in this difficult environment.  Valuations have become lower and are attracting institutional investors.

Here are some investors that have made investments in the product in 2015:

• December 2015 - Ohio School Employees Retirement Systems invested $50 million with Harvest Fund Advisors
• December 2015 - Colorado Fire & Police Pension Association invested $25 million with Kayne Anderson Capital Advisors' Midstream MLP fund
• October 2015 - Dallas/Fort Worth International Airport Board invested $15 million with First Trust North American Energy Infrastructure Fund

In addition to the lower prices, institutional investors are buying because of the current yield, potential growth, diversification trends into real assets and the safety net of real asset collateral such as pipelines and storage.  Mr. Merhige believes that MLPs are transitioning from a retail to institutional investor dominated base that is less worried about the short term volatility.  The ten year return of the Alerian MLP index is 8.22% annually.  Adding the yield portion would give an investor a double digit return.

The source for this article can be accessed here.

Are Oil Prices Off the Cliff?

Oil is in an intense bear market.  The price for U.S. West Texas Intermediate Crude hit $29.93 per barrel recently due to concern about lowered demand from China and the ongoing supply glut.  "...Standard Chartered said fund selling may not relent until it reaches $10."  This has affected the oil sector, OPEC and the oil producing countries and the prices of certain investment products such as MLPs and High Yield bonds.

Energy companies such as Exxon Mobil and Royal Dutch Petroleum have seen their stock prices slide.  The sector has been down 9% in the last 9 days of trading.  Others are cutting capital expenditures and workers.

Countries affected negatively by the price slump are Russia, Saudi Arabia and the OPEC nations and shale oil dependent states in the U.S.  These include Alaska, North Dakota, Oklahoma, Louisiana and New Mexico.

As always, there are some buyers trying to catch a falling knife.  Gary Bradshow, portfolio manager of Hodges Small Cap Fund, is buying natural gas firms in the belief that oil will rally to $55 per barrel.

The source for this article can be accessed here.

Favored Hedge Fund Strategies for 2016

In the Hedge Fund Outlook article in Pensions & Investments, the fund strategies most likely to outperform in 2016 were global macro, long/short equity and long/short credit.  The survey included chief investment officers, strategists and allocators.  Excess returns would be generated by several factors:  differences in the economic recoveries of developed and emerging markets, volatility and the current high yield credit and energy situations.

Let's review each of the strategies' opportunities:

• Global macro - Dominic Wilson, managing director and head of strategy and research for MKP Capital Management, likes going long in US dollar and Euro and shorting currencies in emerging markets countries that are reliant on commodity exports.  He predicts that developed countries' economic growth will be higher in 2016.
• Long/short equity - Christopher Pucillo, CEO and chief investment officer of Solus Alternative Asset Management is shorting energy, minerals and mining companies.  He sees that sector as being in distress. There are companies that would be a great value to buy.
• Long/short credit - William Ferri, group managing director and head of global products of UBS Asset Management, and Daniel Och, CEO and executive managing director of Och-Ziff Capital Management, are bearish on corporate credit.  UBS does not like it generically.  Mr. Och is focused on the energy sector and is predicting that " a lot of (energy) firms will be experiencing distress" and may be attractive investments in 2016.

A Look Ahead to 2016

In the December 28th issue of Pensions & Investments, a group of investment strategists was polled regarding their outlook for the markets in the new year.  The panel consisted of Krishna Memani, chief investment officer and head of fixed income of OppenheimerFunds Inc.;  James Paulsen, executive vice president and chief investment strategist of Wells Capital Management;  A. Gary Shilling, president and economist at A. Gary Shilling & Co. Inc. and Tim Hopper, managing director and chief economist of TIAA-CREF.

• Mr. Memani is modestly bullish on equities, predicting returns in the mid- to high single digits only.  He is negative on fixed income.
• Mr. Paulsen likes international equities and real assets - real estate, commodities, etc.  He is negative on fixed income. 
• Mr. Shilling likes 30-year Treasury bonds and the U.S. dollar.  He is short commodities.
• Mr. Hopper likes international equities.  He is negative on fixed income.

The issues discussed included the list below:

Factors for 2016

• U.S. economic growth
• Different actions by Central Banks
• Falling commodity prices
• China
• Geopolitics

US economic growth is being forecast between 2% and 3%.  Mr. Shilling is at the low end and Messrs. Hopper and Paulsen are at the high end of the spectrum.  Mr. Shilling views this as the continuing deleveraging process from the credit crisis.  "...we are eight years into..." a ten year process.

Much ado has been made about the Federal Reserve's raising the interest rate by a quarter point.  Elsewhere, in Europe, China and Japan, the central banks have been adding monetary stimulus to their economies.  Mr. Paulsen said, "...the U.S. is at full employment and is going to have to tighten...The U.S. has crossed over (into) full employment, while no one else is even close to it."  

The other stimulus for the world has been the fall in commodity prices, especially crude oil.  There has been an excess of supply in the world with U.S. shale oil production, Iranian sanctions to be lifted and no cooperation among OPEC members.

China will continue to slow down according to Mr. Memani and may place "deflationary pressures...That will depress prices and create intense bouts of volatility".  Mr. Shilling pointed out that it is still an export driven economy despite the efforts of the Chinese government to change to a consumer based economy.  If the western economies are growing slowly, then China and the emerging markets will be impacted.

The strategists did not view geopolitics as affecting investments, even with the ongoing U.S. presidential race.  Investors should be have enough diversification in their portfolios to handle any events.  Mr. Shilling did not agree.  Investors buy Treasuries and the U.S. dollar in these instances, same as in 2007.

Oil Drops 56% Since June: What to Do

The hot topic in the new year has been the falling price of oil.  A barrel of oil to $48 for West Texas Intermediate crude.  Fund managers are positioning their portfolios to take advantage and protect themselves from the situation.  Some opinions and investment ideas were presented in two articles in Pensions & Investments on January 12, 2015.

Winners:

• Countries that import oil in the emerging markets (Turkey, Indonesia and India) 
• Stocks in the consumer discretionary sector
• Infrastructure investments

Risky:

• Countries that export oil in the emerging markets (Russia, Venezuela and Nigeria)
• Oil industry stocks
• High yield bonds
• Index investors for UK and emerging markets

The sources for these ideas can be found here and here.

Hedge Fund Hopes for 2015

Since the global credit crisis of 2008, the central banks of various nations have been using various utilities (i.e. non-existent interest rates, quantitative easing and expanding their definitions of conservative debt) to prop up asset values to protect the banking industry according to Frank Brosens, co-founder and risk manager at Taconic Capital Advisors in New York.  These actions reduced asset price volatility and hedge funds' opportunities to produce alpha.  This is now ending.  The last three months of 2014 saw increased volatility and portfolio managers are predicting it to continue in 2015.

Managers with different strategies are seeing good investments:

• Long/short
• Joel Greenblatt, managing principal and co-chief investment officer of Gotham Asset Management in New York, believes there are "..good opportunities on the short side with currently very expensive stock prices if the market drops."
• Eric Mindich, CEO of Eton Park Capital Management in New York, is long in Japanese and Chinese markets.  Both countries will benefit from cheaper oil prices and valuations are very low in China.
• Global macro - Kenneth Tropin, chairman of Graham Capital Management in Rowayton, Connecticut, is monitoring the quantitative easing initiated by Japan's and European central banks, the improvement in the US economy and unrest in various political hotspots around the world.
• Multi-strategy - Michael Hintze, CEO and senior investment officer of CQS (UK), sees short trades based on geopolitical situations (i.e. Ukraine and Russia), failling oil prices and terrorist activities.
• Credit - Several fund managers are positioning their funds on different themes.  The most interesting one is from Paul Twitchell, partner and global head of event strategies of Whitebox Advisors.  He is looking at energy-related distressed debt.  He is interested in "...supplying secured debt to energy companies at a certain price..."

The source for this article can be found at here.

Emerging Managers To Launch in 2014

Several hedge fund industry service providers are predicting 2014 to be the year of the emerging manager launch according to an article in Pensions & Investments.  These include consultants, fund of fund managers, law offices and capital introductions departments.  Experienced managers are launching new firms because their former firms are closed to new investors.  Not only are managers starting new firms, they are also hiring their investment teams at their former firms. Banks continue to divest from proprietary trading desks and hedge funds.  Investors are seeking emerging managers to meet their asset allocation target or replace their current funds according to Stephen Nesbitt, CEO of Cliffwater LLC, an alternative management consultant.   As most investment is based on relationships, they are more willing to invest with managers with a shorter history according to Dean Backer, managing director of Goldman Sachs.

Asset raising will be easier for these intact teams according to Robert Kaplan, co-CIO of the Permal Group.  The largest ones are Three Bays Capital ($500 million in assets under management) which is run by Matthew Sidman, an alumnus of Highfields Capital Management and Junto Capital Management ($317 million in AUM) which is run by James Parsons, an alumnus of Viking Global Investors.  On the horizon are Aravt Global with Wui Yen Liow, formerly of Ziff Brothers Investments, and Anand Desai, formerly of Eton Park Capital Management.  It is anticipated that they will launch with $500 million to $1 billion in AUM.  Everyone else will need to provide incentives for their seed money such as reducing their management and performance fees and offering investors equity in their business according to Tracy McHale Stuart, partner and CEO of Corbin Capital Partners, a hedge fund of funds manager.

A Sampling of Hedge Fund Views on 2014

Hedge fund managers are predicting financial markets to be more volatile and, thus, afford them more opportunities for improved investment returns in 2014 according to articles in Pension & Investments 2014 Outlook report.

Central bank intervention from the Federal Reserve, European Central Bank and Bank of Japan has kept interest rates low and caused equity prices to rebound impressively in 2013.  Their policies, along with the US budget accord and a recovered housing market, will continue to help the world economy to strengthen.  This will give investors confidence to pursue more risky assets such as emerging markets and small cap stocks.

According to Lee Ainslie of Maverick Capital, equity long/short will have better performance as the correlations between securities' returns will be lower.  Managers relying on fundamental analysis of corporates will have their positions less influenced by macro economic factors.  Other hedge funds are looking at complex strategies for returns.  Farallon Capital is investing in distressed European debt, event driven equity in merger arbitrage and US commercial real estate.  They are buying foreclosed properties and flipping them to other investors after rehabilitating and finding renters for them.  DW Investment Management will continue to hold positions in single corporate credit securities, structured corporate credit, residential and commercial mortgage backed securities and student loan backed instruments.  Magnetar Capital will invest in the US energy build out caused by the explosion of hydraulic fracturing.

A Summary of Sovereign Wealth Funds and Their Alternative Investments

As of October 2013, the total assets under management for sovereign wealth funds was estimated in the Preqin 2014 Sovereign Wealth Fund Review to be $5.38 trillion.  The entire alternative investments universe has $5.5 trillion in AUM.  To sum up, these are national investment funds originating from foreign exchange/ reserve assets or revenues from commodities, especially oil.  They are used to diversify the country's economy from oil, maximize their return on revenues and stabilize their economy despite the volatility inherit in commodities.

More and more funds are being created.  66% of the funds were launched since 2000.  Asia and Middle East North Africa, an investing region known as MENA, have 47% of the sovereign wealth funds with 67% of AUM.  These regions have large natural resources i.e. oil and include China, which has a huge US dollar reserve balance to stabilize the yuan to dollar currency rate.  These funds are continuing to grow and allocate to alternatives.  Below are some findings from the report:

• 31% invest in hedge funds.  They are trending towards direct investments and away from fund of funds - as is everyone else.  The most popular strategies are distressed, equity long/short and global macro.
• 51% invest in private equity with 7% investing directly.  The most popular strategies are leveraged buyout and venture capital.
• 54% invest in real estate with most doing direct investments.  The most popular strategies are opportunistic and value added.
• 57% invest in infrastructure.  Of these investors, 34% invest directly only and 50% invest directly and by using funds.

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.

Innovations in the Fund of Hedge Funds World

The fund of fund managers that have survived the redemptions stemming from the 2008 financial crisis have updated their methods of delivering value to investors.  There were five new ways listed in the September 16th issue of Pension & Investments, Managers in Midst of Metamorphosis article.  They are:

• Hedge fund mutual funds with daily valuation and liquidity - Aurora Investment Management LLC in Chicago has launched a hedge fund mutual fund in March with $145 million in assets under management 
• Hybrid hedge fund/private equity funds of funds with 3 to 5 year lockups - Mesirow Advanced Strategies Inc. has launched opportunistic hedge fund of funds using five strategies:  corporate liquidations, European credit and structured products, secondary collateralized debt obligations, distressed non-agency retail mortgage backed securities and distressed emerging markets debt arbitrage trades.  The lockup period allows for the manager to retain cash reserves in order to take advantage of mispriced markets while allowing for the manager to hold positions during times of market stress.
• Hedge fund beta strategies to be used with alpha generating hedge fund portfolios - GAM created the hedge fund beta portfolios based on Barclays PLC risk premium indices.  They actively manage left-tail risk during market downturns of 1 to 2 standard deviations.
• New investment capabilities to create broader alternative investment boutiques - Grosvenor Capital Management LP offers customized separate managed accounts across many alternative investment strategies
• Single strategy hedge funds with concentrated positions for institutional investors 

Timberland: Factors Are Positive for Investing

In the most recent issue of the Alternative Investment Analyst Review, there is an article regarding investments in a specific sector of real estate named Timberland Investing in the US: What You Need to Know Now.   It was written by three timberland asset managers:  Timothy Corriero, Managing Director at FIA Timber Partners; Tom Healey, also Managing Director at FIA Timber Partners and Scott Bond, Vice President and Director of Marketing and Client Relations at Forest Investment Associates.  They studied several topics on the state of timberland investing.

Historical returns can be split into 4 phases.  From the 1987 to 1998, returns ranged from 10% to 37% annually.  The asset class was new and there was little investor interest.  As was detailed in a separate post, the opportunity was presented to investors when corporations started selling their land in order to concentrate on their core businesses.  From 1999 to 2003, returns ranged from 4% to 10% due to the recession of 2001 even though timberland investment management companies were created.  From 2003 to 2008, returns ranged from 8% to 20% as the real estate bubble caused land values to rise.  Corporations sold their land at what we now would call inflated prices.  After 2008, returns ranged from 1% to 8%.  This coincides with the crash in the housing market which lowered the demand for timber.

These returns were further analyzed against inflation as measured by the Consumer Price Index over 10 year investment periods.  They always were higher.  The same cannot be said of the returns of equities and bonds.  Equities lagged during the credit crisis and in the 1970s.  Bond returns were lower in the 1980s.

Timber is split geographically by product:  Pacific Northwest and Southern.  The Pacific Northwest has been performing better in 2013.  This is due to its proximity to Chinese demand and lowered competition from Canada.  Canadian production has been cut in half by a pine beetle epidemic in British Columbia.

The future for timberland investing in the Pacific Northwest is promising.  The recent recovery in the housing market will cause increased demand for homebuilding, a main consumer of wood.  That, combined with the loss of Canadian wood, should cause timber and timberland land prices to rise.  The improved returns and ability to hedge against inflation make this an attractive asset.

Of Volatility and Tail Risk Management

On April 15, 2013, Pensions & Investments published a special volatility management section.  Ever since the credit crisis of 2008, institutional investors have been seeking protection against volatility.  In the article Investors adapting portfolios to volatile environment, Christine Williamson and Kevin Olsen identified eight ways investors were solving this:

• Portfolio diversification using traditional or risk factor asset allocation
• Liability-driven investment - have a bond portfolio to match the institution's liabilities and an equity portfolio for enhanced returns
• Risk parity - set target risk levels and divide equally across diversified, low volatility and uncorrelated assets; use leverage to enhance returns of the low volatility assets.  AQR Capital Management has $25 billion in assets under management with this approach.
• Invest in low volatility equities and bonds.  Some fund managers in this strategy are AJO LP ($1 billion in equities), Acadian Asset Management ($5 billion in equities) and GAM USA ($15 billion in fixed income).
• Invest in active volatility trading strategies to hedge against tail risks and to provide extra returns. PIMCO ($20 billion AUM) and Capula Investment Management are two funds in this sphere.
• Tail risk hedging from drawdowns of 20% or more
• Use derivative overlays to protect portfolios from downside volatility.  The practitioners in this space are Russell Investments ($5 billion) and NISA Investmtne Advisors ($20 billion).
• All-in-one solutions that use the some or all of the above methods

Other investors are using the all-in-one approach.  Healthcare of Ontario Pension Plan (HOOPP) is using a liability hedged portfolio of liability-driven investment(government and real return bonds), portfolio diversification (real estate), equity derivative overlay and absolute return.  From 2003 to 2012, their annual return is 10.3% versus 8.9% for their benchmark.

The Fairfield County Employees' Retirement System is using liability-driven investing (leveraged fixed income portfolio and equities), portfolio diversification (real estate and commodities) and absolute return (global macro, multi-strategy and distressed credit funds).  Their 10 year return is 10.4%.

In the Alternative Investment Analyst Review, Andrew Rozanov, CAIA, Managing Director, Head of Permal Sovereign Advisory recommends using global macro hedge fund strategy to hedge tail risk instead of investing in a tail risk fund.  Global macro fund managers have more flexibility than tail risk managers.  They can be long or short volatility.  They are cheaper and have the potential for better returns.

Mike Sebastian, Partner at Hewitt EnnisKnupp, Inc. and Zoltan Karacsony, CFA, Investment Consultant at Hewitt EnnisKnupp, Inc. like low volatility equities, managed futures and global macro strategies for tail risk protection.  The issues with low volatility equities strategy are that it is difficult to predict the future volatility of a stock, trading costs weigh down returns, the strategy is not effective at all times and not proven to outperform the benchmarks conclusively.  Managed futures are good hedges in low volatility and bad markets.  They tend to underperform in high volatility and trendless markets.  They agree with Rozanov and like global macro for its flexibility.

Four people from SSgA:  Robert Benson, CFA, Senior Quantitative Research Analyst, Advanced Research Center; Robert Shapiro, CFA, CAIA, Investment Solutions; Dane Smith, Investment Strategist, Alternative Investments and Ric Thomas, CFA, Head of Strategy and Research, Investment Solutions analyzed nine variations of four tail risk strategies.  They were long volatility (VIX 1 month futures, VIX 5 month futures, variance swaps on the Standard & Poors' 500 for 1 month and 3 month 6 month contracts), low volatility equities (long low beta stocks and short high beta stocks of the Russell 3000 Index and short bias strategies), trend following (Barclays CTA Index) and equity exposure management (buy out of the money puts of the S&P 500 and go long/short when 10 month moving average is below/above the trend line).  The strategies with the highest certainty of protection and lowest performance drag were trend following and long low beta and short high beta stocks strategies.

Investors should take an overall approach that encompasses a diversified, risk-based model with sufficient hedging (against inflation, deflation and interest rate risk) plus a global macro allocation to be long volatility.

The sources for this article can be accessed below:

Investors adapting portfolios to volatile environment by Christine Williamson and Kevin Olsen

Investors keep a watchful eye on the horizon for risk by Christine Williamson and Kevin Olsen

Alternative Investment Analyst Review, Q1 2013

"Long Term Investors, Tail Risk Hedging and the Role of Global Macro in Institutional Portfolios" by Andrew Rozanov, CAIA, Managing Director, Head of Permal Sovereign Advisory

"Tales from the Downside:  Risk Reduction Strategies" by Mike Sebastian, Partner at Hewitt EnnisKnupp, Inc. and Zoltan Karacsony, CFA, Investment Consultant at Hewitt EnnisKnupp, Inc.

"A Comparison of Tail Risk Protection Strategies in the U.S. Market" by Robert Benson, CFA, Senior Quantitative Research Analyst, Advanced Research Center, SSgA; Robert Shapiro, CFA, CAIA, Investment Solutions, SSgA; Dane Smith, Investment Strategist, Alternative Investments, SSgA and Ric Thomas, CFA, Head of Strategy and Research, Investment Solutions, SSgA.

Update on TXU Corporation LBO

In 2007, a group of private equity firms and investment banks bought TXU Corporation for $45 billion in the largest leveraged buyout transaction.  The company changed its name to Energy Future Holdings Corporation but the fact remains that it is in trouble.  This is due to lower gas prices (the U.S. fracking expansion) and demand (from the recession and jobless recovery).  Two years ago, the debt associated to the deal was trading at a discount.  As of March 31, 2013, KKR has thrown in the towel and is valuing the bonds at 0.05 of cost.

On April 15, the company proposed to re-structure its $32 billion in debt.  Equity owners would be wiped out and the senior debt owners and the original private equity consortium would split the company 85%/15%.  Already, distressed debt managers Franklin Templeton Investments, Apollo Global Management LLC, Centerbridge Partners and Third Point LLC are buying debt which would be converted to equity stakes in case of re-structuring or bankruptcy proceedings.

A few institutional investors were unlucky enough to have negotiated terms to invest directly in the buyout.  Others were only invested in the private equity funds leading the deal.  Some of them are the biggest pensions such as California State Teachers' Retirement System, California Public Employees' Retirement System, Washington State Investment Board, Oregon Public Employees' Retirement Fund, New Jersey Division of Investment and Pennsylvania State Employees' Retirement System.  According to TorreyCove Capital Partners LLC of La Jolla, California, KKR 2006, the fund with the TXU deal, will still have a higher return than the S&P 500 in 2012.  KKR 2006 returned 7.09% versus 3.25% for the index.  The privileged co-investors included California State Teachers' Retirement System and Government of Singapore Investment Corporation.  There is no word if either managed to offload their direct investments through the secondary market.

In another twist, some fund managers think that Energy Future Holdings could extend its debt into the future. Since 2009, the company has re-financed $25.7 billion of its debt.

The source for this article can be accessed here.

Gold: Is the Bubble Popping?

On Friday, May 17th, gold futures dropped to $1,358.30 per ounce;  retracing its steps from a high of $1,920 per ounce in September 2011.  Year to date, it has dropped about 18% on the COMEX in New York.  Money managers such as BlackRock, Northern Trust, Farallon Capital Management, Whitebox Advisers and Soros Fund Management have reduced or hedged against gold as represented by the exchange traded product:  SPDR Gold Trust.

BlackRock and Northern Trust sold more than 50% of their holdings and Soros Fund Management sold 12% as of March 31, 2013.  This follows a quarter where Soros Fund Management sold 55% of their gold position.  Whitebox Advisors sold 90% of their smaller position.  Farallon Capital Management used put options on the SPDR Gold Trust as their negative view.

On a high level, the number of short futures and options contracts on gold is growing.  According to EPFR Global of Cambridge, Massachusetts, $21.1 billion in gold and gold-related funds have been sold by investors.

On the other hand, Paulson & Company, Schroder Investment Management Group and Elliott Management have held onto or bought SPDR Gold Trust.  They are looking at increased demand from India and China as a catalyst for a recovery in the asset.

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