In organizing the posts on this blog, I've favored the label "alternative investments," as opposed to, for example, just "hedge funds." In the past, we've written one of the most widely read posts about the public's "Two Faces on Private Equity." Rereading this, it is ironic that Warren Buffett, a vociferous critic in print at the time, has now thrown in with Brazilian private equity partners 3G on major investments.
The Yale endowment fund, led by Dave Swensen, has been one of the institutional models for successfully using alternative investments, including hedge funds, private equity, and real estate. Harvard's endowment has been in the news recently because of its falling down repeatedly in its once legendary investment management. This post makes good background reading for today's issues about CalPERS.
CalPERS has assets of $298 billion in its investment portfolio to support 1.6 million members, either currently working or retired,or a stunning $186k per member, most of whom are working so the retirees should be quite comfortable. The trouble is that for all their shareholder activism, self-promotion, and expensive internal management, CalPERS cannot select, construct and manage an alternative investment portfolio, in this case specifically hedge funds.
According to the Wall Street Journal, the fund's fiscal year-ended June showed its hedge fund portfolio of $4 billion returning 7.1% versus Vanguard's Balanced Index return of 12.5%. The prior year too showed dramatic under performance at 7.4% versus 10.8% for Vanguard's Balanced Index.
The Journal notes that HFR's index of 2,000 hedge funds has been under performing its benchmark since 2009. It points out that even in the down year of 2008 hedge funds lost 19%, not much less than traditional equity investors who lost 22.2%. So, the $24 trillion hedge fund industry doesn't protect the downside in any significant way.
However, just to note that I got an interesting post from AQR's Cliff Asness which raises a very interesting point on which he has hammered for a while. To paraphrase, much of the institutional investor's market-like performance for hedge funds comes from the fact that their positions, whether in outside funds or in funds-of-funds, have too much of a net long position and therefore shouldn't be expected to perform too differently from traditional longs, like balanced funds. CalPERS and Harvard and others suffer from this disease of not being short enough in their hedge funds.
Proponents of hedge funds claim that there are good managers out there who can point to long-term out performance. Who are they? What's the basis for this claim? What are the strategies and processes in this opaque world that can produce this alleged out performance?
Even Morningstar rates hedge funds for individuals. If CapPERS concludes that hedge funds are too complex to manage, produce little diversification benefit, are too expensive and not scalable at their asset level, how can a small investor ever hope to benefit from these investments. You can guess my answer.
Wednesday, September 17, 2014
Thursday, September 11, 2014
Fed Announces Upcoming Clarification of Monetary Policy Outlook
Fed's rate guidance on chopping block, new exit plan nears
By Ann Saphir and Michael Flaherty(Reuters) - The U.S. Federal Reserve is facing perhaps its most pivotal meeting of the year next week, as it debates a potential overhaul of its guidance on interest rates and seeks to nail down a plan for exiting its extraordinarily easy monetary policy.
It remains to be seen whether decisions will be taken on either, but it is clear that details on a so-called exit plan are nearly complete, while discomfort is growing internally over a pledge to keep rates near zero for a "considerable time."
Investors will parse the central bank's words closely for any clues on the timing of the first U.S. rate hike in more than eight years. Any major tweaks to its policy statement could cause ructions in financial markets as investors recalibrate bets on benchmark rates in the world's biggest economy.
A strong run of U.S. economic data has led Fed Chair Janet Yellen and other top officials to acknowledge the possibility they may need to raise rates sooner than they thought just a few months ago, although a surprisingly soft reading on jobs growth in August could provide some breathing room.
"The discussion itself is a testament to the underlying shift in monetary policy," said TD Securities analyst Gennadiy Goldberg. He said ditching the "considerable time" phrase would open the door to a rate hike as soon as March, several months earlier than most investors currently expect.
The Fed has kept overnight rates near zero since December 2008 and has more than quadrupled its balance sheet through a series of bond-buying programs designed to push down borrowing costs and boost investment and hiring.
Fed policymakers have said they do not expect to raise rates until 2015, and their meeting next Tuesday and Wednesday looks certain to end with no change in policy beyond a well-telegraphed reduction in the central bank's asset purchases.
But officials will release fresh economic and interest-rate projections, extending their forecast horizon through 2017. Those, coupled with even minute changes in the Fed's post-meeting statement, could reshape expectations for how soon and how fast the central bank is likely to raise rates.
GROWING STALE
Fed officials from both ends of the policy spectrum have stepped up calls recently to change what Cleveland Fed President Loretta Mester termed the "stale" language on the likely timing of the first rate hike.
The Fed has said since March it expected a "considerable time" to elapse between the end of its bond buying, which is now slated for October, and its first rate hike. "I believe it is again time for the (Fed) to reformulate its forward guidance," Mester said last week.
A few hours after Mester's remarks, Boston Fed President Eric Rosengren, a stalwart backer of the central bank's aggressive monetary policy easing, also called for ditching the calendar-related guidance, while Philadelphia Fed President Charles Plosser, who dissented against the language at the central bank's last policy session in late July, reiterated his concerns on Saturday.
Top economists at a number of Wall Street firms, including Michael Feroli at JPMorgan, Paul Ashworth of Capital Economics and Lewis Alexander at Nomura, now see at least even odds that the Fed will drop the "considerable time" phrase.
It could simply note that it can be "patient" in determining when to raise rates or could emphasize, as Yellen did with a speech in August, that the timing of a rate hike could move forward if economic data comes in stronger than expected.
The guidance is only one of the tricky questions facing the Fed. Officials also need to finalize details on how they plan to move rates higher and keep inflation from igniting, given the extraordinary liquidity sloshing around the financial system from their purchases of government and housing-related debt.
Minutes from their July meeting show officials now generally agree on several important changes to a set of exit principles first published in 2011, including steps to prevent the Fed's balance sheet from shrinking before rates rise. Most of them also now think the Fed should hold on to most of the housing-backed securities it has purchased.
Still under intensive discussion is how to use a newfangled tool developed by the central bank's New York branch to help sop up excess liquidity when the Fed starts tightening policy.
Minutes of the last meeting show it is increasingly likely the Fed will relegate the new overnight reverse repurchase facility to a supplementary and maybe temporary role, in part due to worries it could spark "runs" from more risky markets in times of financial stress.
Agreement on that matter could pave the way for public release of an exit blueprint as soon as next week.
(Reporting by Ann Saphir in San Francisco and Michael Flaherty in Washington; Editing by Tim Ahmann and Paul Simao)
Wednesday, September 10, 2014
Dodge and Cox: Views on Fixed Income Markets
We recently received the periodic report for the quarter ended June 30, 2014 from the managers at Dodge and Cox Income Fund (DODIX), with $28 billion of NAUM and a performance record built on a long-standing investment process, a well defined process of internal employee development and portfolio manager succession, and a tradition of all the partners putting their money in their own stable of funds.
DODIX outperformed its benchmark, the Barclays U.S. Aggregate Bond Index by 70 bp, with the fund generating a total return of 4.6% for the six months ending 6/30/14.
It is hard to understand a fundamental, economic case for tightening in 2015. Indeed DODIX managers wrote about, ",,,the somewhat confounding environment of the first half of 2014--with a brightening macroeconomic outlook coinciding with rates declining to one-year lows--we reversed the duration extension of mid-2013."
The managers believe that the market rate structure fails to incorporate "the more positive underlying fundamentals of the U.S. economy or the possibility that Fed policy could deviate from the glacial pace of tightening currently reflected in market expectations." We'll have to see whether this is true or not, but the folks at Dodge and Cox are always worth listening to.
This fund made a brilliant move several years back when they positioned the fund massively over weighted corporate credits relative to the benchmark, with the issuers' strong cash flows, clean balance sheets, and strong management teams providing equity-like returns early in the economic recovery.
Today, they are making a more nuanced comment about corporate credits. DODIX has been reducing the corporate sector weighting on an issuer-by-issuer basis while shifting the sectoral composition of corporate credits away from Financials, for example. With regulators making comments about mega-banks "choosing" to get smaller, this rebalancing might be very prescient.
Mega-cap, global technology companies are outdoing each other with big share repurchases and rapid dividend increases. We've written many times about the formulaic, value insensitive manner in which these buybacks have proceeded. Dodge and Cox fund managers write, "This (higher amounts of leverage at a low cost) is a source of down side risk for holders of investment-grade corporate bonds." Further, they write that credits pruned from the portfolio will include those companies which "are likely to alter their capital structure in a manner adverse to current bondholders." (read buybacks and other financial engineering)
DODIX outperformed its benchmark, the Barclays U.S. Aggregate Bond Index by 70 bp, with the fund generating a total return of 4.6% for the six months ending 6/30/14.
"Demand rose for U.S. Treasuries which as a sector returned 2.7% in the first half, reflecting growing expectations that the Federal Reserve will raise the Fed funds rate at a slower pace compared to previous tightening cycles. with a lower end target."So, with the new paradigm of Fed Presidents and the Chair thinking out loud about monetary policy philosophy, tools and targets, this is how savvy, conservative, low turnover fixed income managers interpret the Fed's future policy pathway unfolding.
It is hard to understand a fundamental, economic case for tightening in 2015. Indeed DODIX managers wrote about, ",,,the somewhat confounding environment of the first half of 2014--with a brightening macroeconomic outlook coinciding with rates declining to one-year lows--we reversed the duration extension of mid-2013."
The managers believe that the market rate structure fails to incorporate "the more positive underlying fundamentals of the U.S. economy or the possibility that Fed policy could deviate from the glacial pace of tightening currently reflected in market expectations." We'll have to see whether this is true or not, but the folks at Dodge and Cox are always worth listening to.
This fund made a brilliant move several years back when they positioned the fund massively over weighted corporate credits relative to the benchmark, with the issuers' strong cash flows, clean balance sheets, and strong management teams providing equity-like returns early in the economic recovery.
Today, they are making a more nuanced comment about corporate credits. DODIX has been reducing the corporate sector weighting on an issuer-by-issuer basis while shifting the sectoral composition of corporate credits away from Financials, for example. With regulators making comments about mega-banks "choosing" to get smaller, this rebalancing might be very prescient.
Mega-cap, global technology companies are outdoing each other with big share repurchases and rapid dividend increases. We've written many times about the formulaic, value insensitive manner in which these buybacks have proceeded. Dodge and Cox fund managers write, "This (higher amounts of leverage at a low cost) is a source of down side risk for holders of investment-grade corporate bonds." Further, they write that credits pruned from the portfolio will include those companies which "are likely to alter their capital structure in a manner adverse to current bondholders." (read buybacks and other financial engineering)
Monday, September 8, 2014
Conflict Minerals and Costs to Shareholders
Here is the story from the Wall Street Journal:
"Good morning. Conflict minerals reporting can’t seem to get a break. First, the rule itself, required by Dodd-Frank, was found unconstitutional because it amounted to compelled speech, a ruling that forced the SEC to water it down. As a result, companies don’t have to declare whether conflict minerals are in their supply chains, but instead merely confirm that they’ve looked into it. But now the government has had to admit that it isn’t up to the challenge of figuring out which smelters are financing the violence in the Congo either.With all the potential benefits from improving disclosures that could meaningfully help investors assess the value and governance of their companies, our legal, accounting and political elites force the entire market apparatus to focus on things like disclosures on conflict minerals. Irrationality is said to invade the market psyche in bubbles, but what about our normal regulatory processes? Regulatory capture is not something that happens only from 'big corporations' lobbying for their own narrow interests.
The Commerce Department already missed its January 2013 deadline under Dodd-Frank to list “all known conflict-mineral processing facilities world-wide.” But on Friday, though the department published a list of 400 sites from Australia to Brazil and Canada, it also conceded that it “does not have the ability to distinguish” which are being used to fund militia groups, CFOJ’s Emily Chasan reports.
Companies including Intel Corp. and Apple Inc. said they spent years and millions of dollars investigating their supply chains for evidence of metals from mining operations that are paying for violence. A dozen companies acknowledged their suppliers may have obtained minerals from such mines, but the vast majority said they simply didn’t know. “At the end of the day, the conflict minerals rule creates the worst outcome—it has not helped lessen the conflicts in the Congo and creates economic harm in the U.S.,” said Tom Quaadman, vice president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness."
Institutional investors and fund managers have to pick their battles, and they don't choose to fight many. (see our post on the Sequoia Fund) Any institution that came out in opposition to these disclosures would be tarred as being insensitive, hostile to developing nations and poor miners, or worse. The impact on their marketing and potential loss in net asset value make opposition a bad trade. Just agree to pay tens of millions as a group, nod your heads in silence, and move on.
Legal firms and accounting firms have no downside to playing along, after all their billings increase from formulating, helping to create 'systems' and monitoring the meaningless disclosures.
Politicians love this, because they can take credit for addressing a real issue, which indeed 'blood diamonds' and 'conflict minerals' have been for many, many decades, without having to break a sweat or taking any interest in the real problems, which are not about disclosures.
The regulatory arena, in which players on all sides act rationally from a financial risk-reward point of view highlights the dead weight losses absorbed by our financial system from an incoherent, growing web of arcane regulations surrounding accounting standards and financial disclosure.
Saturday, September 6, 2014
Royal Dutch Picks A Page Out of Exxon's Playbook
Royal Dutch Shell plc appeared to be one of the relatively cheap stocks among the global intergrated majors; at the start of 2014, the share price of 20 EUR was below the 52 week low as of today. For the rest of 2014 year-to-date, the share price has rallied to the upper end of the 52 week range.
Why? Exciting new discoveries in existing territories? Another super giant oil field in the Saudi Empty Quarter? A huge new gas field in the U.S. Gulf? None of these.
No, it was probably a couple of speeches by new CEO Ben van Beurden in which the WSJ has him saying,
but pushing a return on invested capital mentality, translated down to the operating company level is something else entirely.
If RDS gets the Exxon playbook into its DNA, it will go from a stock that always looks relatively inexpensive to one that is 'fairly valued," which is a good thing.
Why? Exciting new discoveries in existing territories? Another super giant oil field in the Saudi Empty Quarter? A huge new gas field in the U.S. Gulf? None of these.
No, it was probably a couple of speeches by new CEO Ben van Beurden in which the WSJ has him saying,
"We cannot deny that our returns are too low," Mr. van Beurden said. "We don't have a [production] volume or capital-employed target. What I want to show is that we can grow free cash flow."The new message has resonated with Wall Street, as the Journal writes again,
" Since he said in January that Shell needs "better operational discipline," the company's shares have climbed 5.8% and hit a two-year high last week. Shell's 2013 earnings fell 38% from a year earlier to $16.8 billion, while its capital spending was 15% over initial projections, at $46 billion. Shell's refining profit was "simply too low" and the company's performance in North America wasn't acceptable, Mr. van Beurden said at the time."The emphasis on ROIC is a page right of Exxon's top corporate board, management, and operators' metrics. which we have written about for years. It's one thing to talk about 'operational excellence,
but pushing a return on invested capital mentality, translated down to the operating company level is something else entirely.
If RDS gets the Exxon playbook into its DNA, it will go from a stock that always looks relatively inexpensive to one that is 'fairly valued," which is a good thing.
A NATO Quick Reaction Force: Good Idea in Principle, But Caveats Apply
The news story about the creation of a NATO quick reaction force for Eastern Europe is a much better idea than that of moving underutilized U.S. troops from Germany,
Similar caveats apply, though. It will take time. Objections and 'concerns' have already been raised by Russian mouthpieces. This move, however, almost had to be made given prior statements by President Obama. Once a force is in place, count on the same Russian strategy of provocations and objections to the response and moves to protect those of Russian ethnicity wherever they may reside. The Polish government, in this case, as opposed the the Wall Street Journal scenario, has offered to provide bases and logistical support. This move is hopeful, but there's a long time from the press release to the implementation.
Whatever weaknesses there are in NATO, and they are significant, will be subject to exposure over the coming months.
Similar caveats apply, though. It will take time. Objections and 'concerns' have already been raised by Russian mouthpieces. This move, however, almost had to be made given prior statements by President Obama. Once a force is in place, count on the same Russian strategy of provocations and objections to the response and moves to protect those of Russian ethnicity wherever they may reside. The Polish government, in this case, as opposed the the Wall Street Journal scenario, has offered to provide bases and logistical support. This move is hopeful, but there's a long time from the press release to the implementation.
Whatever weaknesses there are in NATO, and they are significant, will be subject to exposure over the coming months.
Friday, September 5, 2014
US Troops to Poland: An Empty Gesture Now
The Wall Street Journal Opinion column makes an impassioned plea for putting our American troops in Germany into Poland:
This won't happen for several reasons. If something like this were to be implemented without any kind of coherent international foreign policy strategy around it, this would be inviting President Putin to call yet another of our many foreign policy bluffs. The strategy he would use is the same one he used in Ukraine. It works!
The fundamental issue regarding our German-based U.S. troops is a bilateral issue between our President(s) and the German Chancellor(s). Germany is a big, productive economy with a significant impact on world economic progress, but in the matter of foreign policy--national, through the European Union, and through NATO--Germany has been getting a free ride and they just have to pick up their own tab and act like big player on the world stage. Don't count on this. Yet, by not confronting them directly on this issue, a unilateral move would further confuse our allies around the world.
Finally, our military brass in Europe and our troops and their families are enjoying the status quo, thank you very much. They would be the first to lobby against this move, or at least to plead for a fifteen year ' phased draw down' to make it an empty gesture.
In case, the Journal hasn't noticed President Putin doesn't respond to gambits from weaklings, which is how he perceives our President and his foreign policy advisers.
Our brass, their troops and their equipment can certainly be put to a much better economic uses than vacationing in Germany. Asking the Poles to sign off on this meaningless gesture is an insult to their collective intelligence, because the strategy guarantees a loss for them, the only question would be how big.
"NATO would have done better to move the thousands of American troops sitting idly at German bases forward to Poland and the Baltic states. This would have sent a clearer message to Moscow of NATO's seriousness by creating a tripwire against a Russian attack."
This won't happen for several reasons. If something like this were to be implemented without any kind of coherent international foreign policy strategy around it, this would be inviting President Putin to call yet another of our many foreign policy bluffs. The strategy he would use is the same one he used in Ukraine. It works!
The fundamental issue regarding our German-based U.S. troops is a bilateral issue between our President(s) and the German Chancellor(s). Germany is a big, productive economy with a significant impact on world economic progress, but in the matter of foreign policy--national, through the European Union, and through NATO--Germany has been getting a free ride and they just have to pick up their own tab and act like big player on the world stage. Don't count on this. Yet, by not confronting them directly on this issue, a unilateral move would further confuse our allies around the world.
Finally, our military brass in Europe and our troops and their families are enjoying the status quo, thank you very much. They would be the first to lobby against this move, or at least to plead for a fifteen year ' phased draw down' to make it an empty gesture.
In case, the Journal hasn't noticed President Putin doesn't respond to gambits from weaklings, which is how he perceives our President and his foreign policy advisers.
Our brass, their troops and their equipment can certainly be put to a much better economic uses than vacationing in Germany. Asking the Poles to sign off on this meaningless gesture is an insult to their collective intelligence, because the strategy guarantees a loss for them, the only question would be how big.
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