I will not be posting for a few days. See you soon.
As reported in a Reuters article and elsewhere, the SEC is expected to propose a new short selling rule in the next few weeks that will be broader than the original temporary order that protected 19 financial stocks (17 major Wall Street firms, along with Freddie Mac and Fannie Mae). SEC Chairman Cox is quoted as saying the proposed rule "will focus on market-wide solutions," implying not only larger breadth, but possible other restrictions or changes affecting the markets that reach beyond just widening the number of stocks and sectors affected. One possible change is to require investors to publicly disclose large short positions, similar to the current requirements for disclosing large long positions. Whether a more encompassing rule will prop-up the markets longer-term and give some non-financial stocks a boost is difficult to predict. Even with crude oil continuing to sell-off, the Financial Select Sector SPDR (XLF) has given back some of its gains and is near short-term, yet technically-weak support. With the S&P 500 having trouble getting above 1,300, and the DJIA having difficulty around the 11,750 level, another SEC-induced short covering rally that is now more inclusive may be just what the market needs short-term to break resistance, even if not the original goal of the SEC. While potentially beneficial short-term, one can only hope that any new regulation will not have any harmful or unintended consequences for the market long-term. Then again, sometimes hope is all you have to work with.
According to a report from HedgeFund.net, total hedge fund assets increased 4.41% in Q2 of this year to $2.973 trillion. Of interests is that investors added an estimated $34.21 billion to hedge funds in Q2, while performance gains added another $91.28 billion to total assets. These gains would no doubt be higher if it were not for the correction in commodities that negatively impacted hedge funds in July (see previous post). Also of interest is how the dollar amount of fund liquidations in Q2 was actually larger than new fund launches by an estimated $8.52 billion, resulting in the third largest level of fund closures on record. This is not unexpected given the recent moves of some hedge fund investors from smaller to larger, more established funds (see previous post). In fact, large funds are attracting enough capital to grow the industry at a organic growth rate 11.06% over the last year (with organic growth defined as the change in total assets not including increases due to performance).
When broken down by regions, European hedge funds saw increase organic growth, while Asian hedge funds saw negative growth. In addition to investment funds moving around the globe, allocations to emerging markets have also continued to slow over the last three quarters, with Q2 allocations only increasing 0.64% over Q1, with Asia and Latin America funds seeing net redemption. Developing Europe saw funds increase 9.39%, while Africa and the Middle East experienced Q2 increases of 18.78%, as Goldman Sachs and others move into the region (see previous post). Finally, investors continued to reduce allocations to equity strategies and move money into fixed income related strategies. Broad commodity exposure increased organically once again in Q2, but energy sector hedge fund assets continued to drop in Q2, falling 6.63%, the third straight quarterly decline. Many of these funds have equity focused managers, so the decline matches some of the general decline in equities. Nonetheless, with the high run-up in energy prices these funds are still at an estimated $122.49 billion, the largest specific group. No doubt a combination of lower energy price and profit taking is contributing to the decline in these funds.
The 3-month London Interbank Offered Rate reached 2.81 percent Monday, the highest it has been since mid-June (see Financial Times article). The Libor is elevated compared to the Federal Funds rate, currently at 2 percent. The difference of 81 bps between Libor and the Fed Funds rate compares to an average spread of just 12 bps that occurred before the beginning of the credit crisis last year, indicating that there is still a lot of stress in the financial system, and that banks are still restructuring. Given that the market has been lowing its expectation of a Fed increase, the rising Libor may be an indication of more problems ahead in the financial system.
As reported in a UK Telegraph article, Goldman Sachs has launched a new proprietary fund to invest in select assets within the Middle East. While just one instance, and coming from one of the stronger U.S. investment banks, this is nonetheless a nice and encouraging reversal of fortune considering the amount of sovereign wealth funds that have come from the Middle East, often to support struggling U.S. banks. The fund, called the Goldman Sachs Middle East Investments, currently has about $300 million to invest, but this figure is expected to grow. While the fund investments will be varied, the focus will initially be on the area's strength in financial institutions and energy assets.
Former SEC Chairman, Harvey Pitt, has teamed up with two others to create a web site that provides a real-time electronic stock lending and location service to help sellers and brokerage firms comply with SEC rules on naked short selling. The SEC recently limited the practice for 19 of the larger financial institutions, and there is an expectation the order will increase to more stocks. The web site, called RegSHO.com, matches traders with stock available for borrowing for short sales and provides data on the short-sell market. The creators of the web site believe it will help sellers reduce their costs because transactions are done electronically, and not over the phone as is still often the case. The site also helps to alert subscribers to any possible compliance problems they may be encountering, as well as offering advice and solutions. Access is also given to LocateStock.com, providing a real-time lending and borrow marketplace specializing in hard-to-borrow stocks, and Buyins.net, which helps to identify the demand for borrowed stocks. As mentioned in the Washington Post article, other companies that offer similar services include ShortSqueeze.com and Stock-Borrow.com. What's the kicker? Clients to the RegSHO.com site pay a monthly fee of $995 for standard access, along with an additional per-share fee for locating stock. New regulation? No worry. We can solve your problem ...... for a fee of course. You have to love capitalism.
It seems that Sovereign Wealth Funds (SWF) are accumulating cash, but are having a difficult time managing it. As mentioned in a recent Financial Times article, even some of the smallest SWFs, such as the Timor-Leste Petroleum Fund, have already grown to over $1 billion. Estimates put the total amount of funds globally at $3,000 billion. Although the larger established funds have managers with ties to the hedge fund world, some of the smaller ones do not, and are at times struggling to keep up. While the SWFs appear to be attractive due to the scale of the available capital, the fees can be quite low compared to traditional hedge funds that are used to a 2-20 structure.
The shear magnitude of the size of each fund, as well as the increasing number of funds, could be a shot in the arm for a few depressed sectors regardless of how they are managed. Traditionally the SWFs have been conservative investors, putting most of their money into fixed assets. As they start to look at longer-time horizons, they initially step into the global equity arena, and then begin to move to more illiquid assets, such as private equity and real estate. Look for this trend to continue, and look for the influence of SWF in helping to keep companies and depressed sectors a float to continue. Of note is that while the limited influence of SWF investments can help deploy capital to certain sectors of the economy, the funds are less likely to find their way into commodities, especially crude oil. Many of the SWF are funded from commodity and crude oil revenues and are looking for ways to diversify their holdings. Therefore, those areas with low correlation to commodities are the ones most likely to see the benefits from the capital these funds can provide.