In my opinion, a lot of the turmoil is being created by how the market will respond when Federal Reserve exits QE2. Investors are asking themselves will interest rates jump, will the risk trade continue, or will equities sell off? If equities sell off, investors will move back into risk-free assets driving Treasury yields back down. In sum, the market needs clarity on the QE2, and will there be a QE3. This uncertainty is causing not only problems from a pure macro level, but also for large active investors like hedge funds which try to employ top-down investing strategies.
Hedge funds shut down
There has been a lot of news recently regarding hedge fund performance and several funds returning capital back to investors. I like to address these two issues.
Regarding hedge fund performance: several funds have underperformed the market year-to-date. I also like to note all hedge funds are not created equal, but what all hedge funds have in common are a unique strategy to each; several hedge funds employ a top-down strategy. A top-down strategy is the firm forecasts a certain view of the economy and implements bets the view will come to fruition. Given all of the "black swan" events recently (i.e. Mid East turmoil, spike in oil prices, uneasy U.S. economic data), running these funds are just becoming too dificult. In addition, several funds operate using a more traditional activist investing strategy. Thus, before active investing that hedge funds employ starts the generate outperformance, the markets will need to tame down.
Returning capital back to investors: the biggest news related to this Carl Icahn. Carl Icahn is returning capital back to investors; this change is primarily due to the increase in regulation of hedge funds. An article from DealBook included the following on this topic:
More broadly, the industry has been wrestling with changes as it moves from a constellation of maverick start-ups to a body of increasingly institutionalized money managers. It is growing — money continues to flow in and its total assets stand at $1.9 trillion, near the peak before the financial crisis. But it finds itself subject to more regulation.
New rules are to go into effect this summer that will force greater disclosure, and investors are demanding more transparency and questioning funds’ fees. And a sprawling investigation into insider trading has ensnared a number of hedge funds.
IN CARL ICAHN'S CASE, THE HEDGE FUND IS BECOMING THE FAMILY BUSINESS!
Hedge Funds Titans Struggle To Survive (click here)
Icahn Capital to Return Outside Money in Hedge Fund (click here)
Public vs. private
In previous posts, I have highlighted various mechanisms that companies have used to stay private longer or skip the traditional IPO process. Key reasons why companies do not want to go public include the increased government regulation and the minimum size a company must be to go to market (this has increased over the years). Ways that have aided the prolonging include the rise of exchanges for private companies, or companies skipping the IPO process by using "reverse takeovers."
Below is a video from CNBC why some companies are not going public. Herb Greenberg, CNBC commentator, highlights three key reasons that have been expressed in previous posts:
- Firms can raise money elsewhere (i.e. venture capitalists, private equity)
- Avoid regulatory headaches
- Build the business versus playing Wall St. games. By going public, it becomes a game of not what can you do for me in the next 40 quarters, but what have you done for me last quarter.
Public vs. Private (click here)
Uncle Ben says "no" to a bubble!
Mr. Bernanke was asked whether or not he sees a new asset bubble forming, and his answer was there was no evidence. As we all knokw, the steep drop in stock prices in late 2008 to early 2009 indicated the market was in panic; in other words, the market was oversold. When the Federal Reserve came to rescue by pump-priming the system with liquidity, it only led to a recovery not many have seen. But do market watchers agree that this rise is not leading to a new bubble?
Evidence several market watchers have used includes: 1) bubbles occur when there are high valuations; markets do not indicate high valuations; 2) the average bull market is up over 160%; this market has not yet hit "middle-age"; and 3) corporate balance sheets are in great shape with huge cash balances; companies can use this cash for increased dividends, share repurchases, or acquisitions (all three of these things make stocks more valuable).
Is The Two-Year Stock Rally Just Creating Another Bubble? (click here)
Bill Gross moves into cash
To essentially quote the article, Bill Gross has sold off all Treasuries in the flagship PIMCO Total Return Fund and moved into cash. The thesis behind this move is that QE2 will be the last of quantiative easing. Once the market stops QE2, the large mechanism that has pushed government bond yields down will cease and interest rates will rise. Mr. Gross thinks the U.S. Treasury market is the most overvalued part of the bond market right now. Mr. Gross stated:
Bond yields and stock prices are resting on an artificial foundation of QE II credit that may or may not lead to a successful private market handoff and stability in currency and financial markets. 15% gratuities may lie ahead, but more than likely there is a negative two-bit or even eight-bit tip lying on the investment table. Like I did 45 years ago, PIMCO’s not sticking around to see the waitress’s reaction.
PIMCO Goes to Cash, Exits Treasuries (click here)
Howard Marks: time to be cautious?
Howard Marks, one of the founders of Oaktree Capital, believes it is time for investors to be cautious. Mr. Marks believes the Federal Reserve will stop quantitative easing after QE2; the Fed will not pursue QE3 because there will be no appetite for it in the market. Thus, after QE2 stops, the market will be as he says, "woozy."
According to him, investors ought to know the future is uncertain, so it is important to diversify, not employ leverage, and hedge.
Oaktree's Howard Marks Says It's Time To Be 'Cautious' (click here)
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