Weekend Link Summaries - 5/25/05

Below are the weekly link summaries for the usual groups: commodities, derivatives, hedge funds, private equity, quantitative finance and financial engineering, and trading. As usual, hopefully you find some articles that you may have passed over, but might be interested in reading. Enjoy the long holiday weekend.

Commodities

Oil's tense trading scene may sway a move to Dubai
Myra Saefong - MarketWatch.com
* The Dubai Gold and Commodities Exchange will begin trading crude-oil futures on Tuesday. This planned commodity trade is turning out to be a timely move given the talk from Congress and elsewhere about the regulation of speculators in the commodity markets. As with many actions in Congress, there are unintended consequences. The movement of trading off-shore may be one such consequence. Without really affecting the overall problem, the move may just end up taking the control of the issue out of our hands - to the extent it can even be controlled. Liquidity and volume are low in comparison, but in a few years the Dubai exchange could see an increase in volume as traders look for a friendly environment.

Derivatives

Citigroup Says Swaps Mania in Muniland Is Finished: Joe Mysak
Joe Mysak - Bloomberg
* Sales of synthetic fixed-rate munis, used to help the municipal market hedge their bond issue interest rate risk, are being scaled back, in part due to counterparty risk, but mainly due to inexperience. Many local municipalities are realizing that they don't have the experience and knowledge to understand the risk involved, the money to hire professionals, or the ability to know if the professionals (if hired) are taking advantage of them. As a result, they are eliminating one type of risk, but are in some instances now leaving themselves without a hedged position.

World Watches EU's Carbon Trading Scheme
Leigh Phillips - BusinessWeek
* Another article about the law of unintended consequences. This time with carbon trading. When Europe first implemented carbon trading, the scheme resulted in windfall profits for energy companies, drops in the price for carbon credits (due to over-allocation), and a disincentive for the industry to increase expenditures on clean energy infrastructure and efficiency measures. The result were higher consumer prices, higher energy company profits, and higher carbon emissions. Hopefully the EU experiment will provide lessons. They are currently taking measures to correct mistakes.

Derivatives Market Grows to $596 Trillion on Hedging
Abigail Moses - Bloomberg
* Data shows that derivatives on debt, currencies, commodities, stocks, and interest rates has increased 44% compared to last year, to $596 trillion. Amazing numbers indeed. CDS protection doubled during this time to $58 trillion of debt. Interest rate derivatives were up 35%, foreign exchange derivatives were up 40%, equity derivatives were up 14%, and commodity derivatives were up 26.5%.

OTC platform to offer iron ore access
Javier Blas - FT.com
* Both Credit Suisse and Deutsche Bank are teaming together to create an off-exchange over-the-counter (OTC) market to trade iron ore swaps. The swaps will have initial maturities out to December 2009 and be cash settled on a monthly basis against an iron ore index published by the Metal Bulletin. Iron ore was one of the largest commodities without a market, and given the rising demand and prices for steel, it makes sense that a new hedging (and speculation) contract would be offered.

Hedge Funds

Global Hedge Funds Rose in April as Worldwide Stocks Gained
Tomoko Yamazaki - Bloomberg
* Overview of global hedge fund performance. Of interest is how hedge funds worldwide were up in April as global stock markets recovered. In particular, managers of long-short equity fund were the best performers.

Age is key to hedge funds
Anuj Gangahar - FT.com
* A recent study finds that hedge funds that are less than two years old produced higher returns on average than older funds (11.7% per year to 10.2% per year), but that older funds tended to have returns that were more steady. In a sense, as managers get older, return is given up for risk management. It was not mentioned in the article, but this may results from the manager having so much of their wealth in the fund the he or she starts to get a little more conservative.

Hedge Funds in Swaps Face Peril With Rising Junk Bond Defaults
David Evans - Bloomberg
* Interesting article on the problems with trading in swaps in the current market. This is a longer article, but well worth the read. In part, it discusses how given that the swap markets are basically unregulated, counterparty risk is not only present, but it is difficult to quantify. But this is not stopping the swap market, which has doubled every year since 2000, and is currently larger in dollar value than the entire NYSE. As of now, 40% of credit default swap protection sold worldwide is on companies or securities that are rated below investment grade. Estimates have hedge funds selling about 31% of all CDS protection, yet many have not been asked to post adequate collateral to back up their positions, and no set regulations are in place. Many hedge funds do not have the necessary funds in place if a problem does develops.

Ex-Amaranth Trader Hunter Helps Deliver 17% Gain for Peak Ridge
Saijel Kishan - Bloomberg
* Well, if you are wondering why anyone would hire Brian Hunter, the hedge fund trader that helped bring down Amaranth Advisors in 2006, this is why: His new fund returned 17% last month using a similar strategy as that employed at Amaranth. The fund is using option spreading strategies on natural gas prices, nearly the same strategy to that was used at Amaranth. The quote of the day comes from energy analyst Kent Bayzaitoglu: "To have lost that amount of money and get back into the market with a similar-type trade takes a lot of confidence, if not arrogance."

Private Equity

Mideast Private Equity Looks to India
Saikat Das - BusinessWeek
* Middle East sovereign wealth funds are beginning to focus on the country of India as a result of believing that the country’s long-term growth prospects are good and that the country is decoupled from the United States. Areas of interest include real estate, health care, retail, and education. The number of private equity deals in India for the first four months of year were 156 ($4.94 billion) compared with 136 deals ($3.42 billion) over the same four months in 2007.

The year of the vulture
Allan Sloan and Katie Benner - Fortune
* Article on private equity, discussing how those that will profit are most likely to be the firms that profit from other's misfortunes. In particular, firms are "double cropping," or in other words, making a second profit from the buyouts already done by offering capital to the institutions that financed the original deals and now need help. In a sense, they are buying their own debt back from the banks at reduced cost, given that the banks were unable to unload it after the credit crunch, not only eliminating the extra commissions and fees, but also now exposing themselves to credit risk. Ah, the old golden rule - those with the gold make the rules, and in this case, profit from the misfortunes in the market. Those with capital truly can buy when things look the worst, and not just pray on others, but also help them out of difficult positions.

Quantitative Finance and Financial Engineering

Quantitative funds aim to retool models
Mark Copley and Ben Wright - WSJ
* Interesting article on how quant funds suffered as the credit crisis unfolded, causing many of their models to breakdown. One aspect that has the quant managers worried is how many of the quant strategies that are being used seemed to be affected in the same way at the same time for certain market conditions, suggesting that the models were using the same techniques - a kind of quantitative herd mentality. It is believed that one of the problems is that they tend to use the same type of academic research, and be trained by the same set of researchers. Many are now trying to considering non-traditional public information (at least non-traditional for quants), such as short interest, quality of R&D, and insider buying.

Quant to Double Assets This Year After Beating Hedge Fund Peers
Netty Ismail - Bloomberg
* The rise of the quants from the ashes. Well, not exactly, but the QAM Asian Equities fund, a small Singapore-based quant hedge fund is doing well by betting against stock index futures. The QAM global fund rose 44.5%, while the Asian portfolio gained 66.2% in 2007. Not bad in the current market, especially for a fund not concentrated totally in energy. The fund has only $150 million in total assets under management, but is growing at 30% per year. The fund manager has a Masters in computer engineering, among other graduate degrees.

Trading

The Most Promising ETF's? Russia and Coal
Dash of Insight Blog
* A discussion of various ETFs, with an emphasis on an ETF from Russia and a Coal EFT. A sector ETF report is also provided by Dash of Insight. Of interest, not surprisingly, are that energy and international EFTs continue to rise to the top of the list.

Straddle Strangle Swaps
Condor Options Blog
* A nice overview of the straddle strangle swap, which is a specific type of double diagonal that involves selling a front month straddle and buying a back month strangle. Too much detail (see the article) without reprinting everything in the article, but the position has a number of positive attributes. In particular, it has a larger width (more profit opportunity) and positive vega, but only half the theta of a swap (for the example given). It can also be entered for a credit rather than a debit. Nonetheless, it does require more commissions.