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Stephen Tierney MBMG International Ltd.

 

Is QE the Titanic?

Indefinite stimulus cannot work - because it gets less and less effective each time, ultimately becoming counter-productive.

It was not difficult to notice just how quickly the announcement of a further GBP75 billion of Quantitative Easing (QE) on top of the GBP200 billion already done has already been turned on its head as almost the entire UK banking sector, and some of the commercial property sector, has been downgraded. This means the markets now know that there cannot be any more QE to come.

It would seem that at least someone recognises the fact that if you keep printing money again and again then, eventually, you will bankrupt your own banking system by creating easy money. It is a clear sign to the UK. Basically, the ratings agencies are saying: "This is madness - you have to stop this!"
The probability of this is that it will totally nullify the effect of the QE because people know that there is no more coming down the line.

A similar situation applies to Europe although there is the difference that QE in Europe is seen as a transfer mechanism of liquidity and security from the core nations to The Club Med. However, if anyone does their sums properly, they will see that the EFSF is, at its core level, really only able to fully support Greece and to assist Ireland and Portugal but it is certainly not big enough to deal with Spain and Italy as well.

For one, I absolutely agree with the ratings agencies - especially with S&P downgrading the US credit, even if it did prompt Timothy Geithner to go on TV behaving like a spoilt child who had just seen someone run away with his sweets. Yet they were right then and the agencies are right today and have been right with the downgrades to Greece, Spain, Italy and other European sovereigns and banks. If only they had done this a few years earlier when all the crazy credit was being given AAA ratings then a lot of the worst excesses would have been reined in before. Better than never I suppose and it will be a good thing, longer term, if the ratings agencies rein in the palliative effect of QE by making sure that no more can follow. GBP75 billion, in its own right, is so insignificant in relation to the size of the debt that it will not make any kind of a dent whatsoever.

Martin Gray of MitonOptimal echoed the idea that the UK’s second bout of QE will have a negligible effect on the performance of equities in the coming months.

"There could well be an asset rally maybe in the short-term, but I don’t think we’re going to see a sustained bull run or anything like that... Short-term surges don’t interest me; I’m not a trader, so I’m not going to try and time the market perfectly... I just can’t see how markets can rally, given the poor GDP figures we’re expecting towards the end of the year... Everyone is banging on about how cheap equities are, given that their price-to-earnings ratios are historically cheap. However, I’m not convinced US corporate earnings are going to be any good in the third quarter."
It's worth setting these remarks in the context of Martin's performance relative to that of his peer group:

PUT CHART HERE

While the CF Miton Special Situations Portfolio remains defensively positioned relative to its sector, Gray still sees potential for upside if the markets recover more quickly than he expects - "I’ve added around 10 percent in risk assets this year. I have 15 to 20 percent of the portfolio invested in Asia, which I’m very happy with... In August and September I added to my Asia and Japan weightings. I also wanted to increase my property exposure, but that hasn’t worked out for me yet... I won’t be adding to risk assets unless the markets drop away substantially."
Miton Special Situations Portfolio has 28 percent of its assets invested in equities - an underweight position of more than 40 percent relative to its sector.

Like me, Martin doubts whether QE will have a positive impact on the economic recovery:
"I really hoped they would come up with something a bit more inspired than buying up more gilts... By doing this, they’re essentially saying banks are in worse shape than they thought. It’s not going to help households with spending, and I don’t think its going to encourage lending or employment either... It’s a bit like giving a patient morphine; the more you give them, the more they are going to need in the long-term... This is potentially very dangerous. As we’ve seen in the Greek bailout, there comes a point when you run out of money... The UK government already owned a big portion of the gilts, but now it must be close to a third of the entire market, including index-linkers. It will be interesting to see if they plan on unwinding their share."

Whatever they plan they are now at the mercy of the markets. The ratings agencies have made sure of that when they suddenly discovered that they do have a spine after all.

Markets may have rallied but now that we know that there cannot be any more to come, the GBP75 billion will just disappear down the plughole - there one minute and gone the next. It is not going to have a lasting impact and it is not enough to spur a meaningful rally. If people believed in indefinite QE and support and stimulus then maybe there would be a rally until the folly and futility of this becomes evident but, as it is, everyone knows that this is an isolated, meaningless gesture. The ratings agencies have finally pulled the rug from under the central bankers and policy makers. If only they'd done it sooner then maybe QE would not be the Titanic. The problem is that trying to keep everyone in the life they have become accustomed to is just not sustainable. The inevitable consequence to printing money is inflation and, potentially, hyper-inflation and this is the iceberg we are heading straight for.

Cumulative performance (%) 1m 3m 6m 1y 3ys 5 ys
Miton Special Situations Portfolio (B Cls) +1.0 +2.0 +5.6 +5.1 +33.1 +47.3
Balanced Managed Sector -1.6 -10 -8.7 -3.6 +20.8 +6.4

 

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Stephen Tierney on [email protected]

 


Hedge Funds

Are hedge funds a separate asset class or a superior alpha generator within traditional asset classes? Or are they simply an expensive fee model for high frequency traders? This debate has raged since George Soros took on the Bank of England (and won). As an investor in global hedge funds and other alternative strategies since the mid 1990’s, we reflect on the changes in our approach, philosophy and implementation.

Since 2008, much attention has been given to hedge fund liquidity and transparency, and rightly so. Hedge fund of funds were aggressively marketed to retail investors around the globe leading up to the banking crisis and proved in many cases to fail on both of these counts, all for an extra layer of fees. Basically, many of them were a fundamental disgrace to the investment world.

However, the hedge fund universe is very diverse and “manager risk” is everywhere, so diversification of manager and style is paramount to the long term success in this investment space. The dilemma for multi asset investors is how to achieve the benefits of a diversified hedge fund portfolio, without the negatives mentioned above.

Within our global multi asset portfolio we have formed our own private fund of hedge fund managers. This is treated as a separate asset class for optimization purposes as the risk return profile is very different from traditional asset classes and currently has an allocation of 20% in the fund. The style of allocation within the hedge portfolio is modeled on past performance and includes significant macro/managed futures/active traders, as one of the prime objectives is low correlation to our other risk asset classes.

The portfolio is then allocated to 20+ managers to minimize “manager risk” and attempts to add alpha through top quality manager selection. Liquidity of underlying managers is care monitored and we have very little liquidity risk at the private fund level, as we are the only investor along with our family office joint venture partner. Transparency and cost is managed as this is an investment driven process, not a product marketing one!

The result is that we have a hedge fund portfolio that exhibits the low correlation and risk adjusted returns we require and which history has shown to deliver over long time periods, without the manager risk, liquidity headaches and lack of transparency that the retail hedge fund of funds industry exhibits in abundance. One should not be scared or cynical about hedge funds as the long term numbers show that it is an important asset allocation performance generator. The short term results table shows that index returns YTD have added value relative to French Banks but also that overweighting macro traders in volatile times adds sector alpha, with our portfolio still up for the year.

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Stephen Tierney on [email protected]

 


Where in the World?

Markets are all over the place at the moment so what to do? Well, for those that read this column regularly, you know that I am a great believer in putting as many of your eggs in as many different baskets as possible. So, here we go:

Global Cash

With the cash yield basically at zero in the US, Europe and Japan it is difficult to answer the question why one should invest in US Dollars or any other Western Hemisphere cash at present. However, the return of capital as opposed to return on capital may be the prevailing environment leading into Q4, as the European crisis threatens growth and adds to volatility. When all correlations move to one, holding US dollars is the safest place to be. However, Emerging Market (EM) cash rates are relatively high at 5% + yields and their government balance sheets remain strong. Recent weakness in these EM currencies has created a buying opportunity for us, as this is one of our favoured asset classes. Momentum will return once currency volatility settles down. This short term weakness in EM currencies has created a particular buying opportunity in South East Asian and Latin American deposits.

Global Fixed Interest

As discussed before, US Government bonds, European Bunds or UK Gilts are to be avoided at current yield levels, on a 30 year view. However, in the short term, Treasuries are a safe haven from volatility and further short term gains cannot be discounted. In our view the risk reward has run its course in this asset class and we have now moved underweight with the exception of EM bonds, which we believe are in a bull trend, not a bubble. They remain one of our high conviction positions. Currency volatility has made these local market EM bonds more attractive, now that we are at the bottom of the price range.

Global Property

An impressive arbitrage has opened up in the developed world commercial property market, particularly in London listed property. A 20% spread between the physical commercial property IPD index and the UK listed blue chip property REIT (Real Estate Investment Trusts) index has materialised over recent weeks, due to equities having sold off before the softening of the physical market. Asian growth remains intact and as such we are still overweight Asian commercial property, both physical and REITs. Singapore and Hong Kong are a risk from a residential perspective, but commercial rental growth appears solid in the region. Global Listed Property is now trading at an average yield of 5.45% p.a. Japan residential is an interesting sector which we are currently investigating. Special Situations in Europe abound, with big discounts to NAV with one of our largest holdings, Terra Catalyst, taking advance of the opportunities in this sector.

Global Equity

Valuations are back to 20 year averages but are still not cheap from a normalised earnings basis or 1930’s/1970’s valuation levels. Developed Markets (DM’s) were better value at the start of the year than EMs, but this gap is narrowing due to market performance and foreign exchange (FX) revaluation in recent months. Large Cap high dividend companies have solid balance sheets, but their earnings are the concern. The odds of a global recession are increasing each week but this is not currently priced into equity values and we feel it best to wait for Greece to finally admit bankruptcy, or for some other similar market panic to take prices closer to 1,000 on S&P500. Remember, if one must panic, it is best to panic first and to avoid European equities at all costs. Within global sectors, we still favour Technology as clear winners and losers makes the sector countercyclical. Re Insurance is trading at 0.8 times book and global large cap value is very attractive from a free cash flow and dividend yield perspective. To buy on valuation would mean relying on US and European politicians making the right decisions together with the non-materialisation of a slow-down in China, both of which remain uncertain to say the least.

 Alternative Strategies

Alternative Strategies had a difficult quarter. The Dow Jones Credit Suisse Core Hedge Fund Index finished down -4.23% in September, bringing year-to-date performance to -7.84%. In the Event Driven space, losses mainly stemmed from relatively concentrated long equity positions, related to special situations. Global Macro managers declined following sharp reversals in precious metals, such as gold which posted its worst monthly loss since 1983. Volatility of emerging market currencies/bonds has also added to the trend following funds underperformance. Compared to the year-to-date drop of -15.36% for the Dow Jones Global Index, hedge funds have provided some level of relative capital preservation to date this year; however, all strategies appear to be feeling the pain with market uncertainty at an all time high. The volatility and seesaw nature of equity markets since the initial early August collapse in risk assets is not helping, but unlike 2008 the liquidity and credit issues are not in evidence this time.

As we have learnt from Nassim Nicholas Taleb’s impressive book - The Black Swan: The Impact of the Highly Improbable risk models cannot guard against the occurrence of highly unlikely, extreme events. His example was the discovery of black swans by Europeans in Australia, when all previous experience suggested that swans could only be white. The improbable Improbable had transpired. Perhaps the Europeans can cause another unlikely event at the Rugby World Cup Final this year?

The past Quarter has been very difficult for risk assets, but we have not encountered any Black Swan events yet. Most asset classes were negative but, interestingly, not all were correlated or weak at the same moment in time. Problems in Greece and the sovereign debt crisis are well known and priced into European risk assets although perhaps not the Euro just yet. An improbable Unknown would be an actual sovereign default or problems within the ECB itself. The US recession is priced into risk assets, on a 50% probability basis, but a further Black Swan event such as an actual recession or social unrest is not. Finally, China is one big unknown Unknown.

To buy global equities at the start of this Quarter on the basis of good value requires a bet on two things: firstly the ability of European and US politicians to organise a booze-up in a brewery and secondly fears around a Chinese slowdown proving unfounded. Is this a finely balanced bet or a Black Swan event?

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Stephen Tierney on [email protected]