As reported in a recent Asian Investor article, CQS has launched the CQS Global Volatility Fund. The fund is beginning with AUM of $160 million and has a strategy that tries to profit on equity volatility valuation anomalies within market indices and on market dislocations, including the volatility of individual global equities. Not surprisingly, the fund will rely on options and futures to take positions in the volatility-driven valuation anomalies. CQS had previously launched an Asian convertible arbitrage hedge fund in 2007 that focused on convertible bond and equity strategies in Asia, also with a global volatility bias. Whether this is yet another sign that volatility has peaked, as is often the case when new funds chase the next new thing, is yet to be seen.

Lehman Brothers (LEH) is considering shifting approximately $32 billion of commercial mortgages and real estate to a new company, nicknamed Spinco, using a good-bank, bad-bank model of the 1980s (see a recent SeekingAlpha article on the good bank, bad bank debate). Lehman would fund the bank with $8 billion of equity coming from Lehman (Korea Development Bank is in discussions to purchase 25 percent of Lehman for $6 billion), with the remaining $24 billion borrowed from Lehman or outside investors (see Bloomberg article). The Spinco option would allow Lehman to off-load 80 percent of its commercial mortgages, establishing a company capitalized and managed by outside investors. One benefit of spinning off the mortgages to its own shareholders is that Lehman can allow existing shareholders to benefit from any recovery in asset prices, thereby eliminating the need to sell at fire sale prices. If the plan fails, Lehman may be forced to seek out private equity funds and sell parts of the company, such as their asset management business Neuberger Berman (see previous post here and here).

While Lehman brothers certainly seems to be getting hit from every direction (see comments on Opsraie's problems here, of which Lehman has a 25 percent stake), they are certainly trying to be creative in how they pull the company out of potential failure. While taking the Merrill Lynch route of selling assets for 22 cents on the dollar (and financing much of the sale themselves) may have not even been a possibility for Lehman, current actions do indicate the they seem to think the worst is behind them, at least as far as the credit crisis is concerned. Maybe they have no other alternatives. Liquidity and confidence issues remain, but if they can get the needed capital, and keep from selling the entire company and its assets on the cheap, Lehman may in fact come out stronger, or at least be able to survive. Of course, this really depends first on staying afloat and not becoming the next Bear Stearns. Fortunately for Lehman, so far they have appeared to have a little less panic from their nervous investors (not much), a few more options available to them, and a little more time than a weekend to get something done. But as they say, paraphrasing, "act now - while 'capital' supplies last."

A new proposed SEC plan will overhaul oil and gas reporting rules that have existed since the 1970. The new rules will boost the proven reserves reported by oil companies, and in the process boost their shares and potentially increase interest in takeovers (see Financial Week article). The plans will essentially allow companies to book reserves from “unconventional” oil and gas sources, including oil sands and coal-bed methane. Some deep-water projects that to date have not been allowed to be described as “proven” will also now be included. Furthermore, firms will be able to publish data on what are called “probable” and “possible” reserves, where recovery is not as certain. The new rules obviously don't change the amount of oil and gas that is available worldwide, but they will help investors better calculate future cash flows and thereby place a proper valuation on a company. Needless to say, the oil companies are in favor of the new rules.

The plan will affect both U.S. and international companies that report under SEC rules, which often includes most of the larger international firms. Those with the largest non-traditional sources of future production are most likely to benefit. Analysts expect that Royal Dutch Shell is likely to benefit the most among the oil majors given that they are investing capital to retrieve crude from bitumen-soaked soil in Canada, as well as extract natural gas in coal beds in Australia and China, both of which can now be included as reported proven reserves. ConocoPhillips (COP), Exxon (XOM), and BP (BP) have also invested in non-conventional sources of oil. The reporting of non-traditional proven reserves could also have an impact on acquisitions and takeovers. As mentioned by Neil McMahon, analyst from Bernstein:

“We believe that these rule changes could be the catalyst for a wave of acquisitions, with those companies with the largest unproved resource bases making juicy takeover targets for some of the larger cash-rich majors.”

McMahon feels that Marathon Oil (MRO), with investments in oil sands and shale, and British gas producer BG, with its stakes in the deep-water Brazilian fields and a new 25% stake in Chesapeake Energy (CHK) and the Fayetteville shale, are potential targets. In fact, given that the changes will make the SEC rules more in line with European rules, the impact on UK-listed firms, among others, is expected to be positive.

The rule changes are likely to apply to 2009, and not 2008 year-end reporting since the SEC is still in a consultation period and has not committed to a time line for implementation. Given that the market is forward looking, share prices may nonetheless begin to see the impact of the proposed changes which are expected to be approved and put into place quickly.

The Harvard Management Company, in charge of the mighty Harvard Endowment, appears to be generating a return between 7-9% for fiscal 2008, according to sources familiar with the fund (see WSJ article). As a comparison, the S&P 500 fell about 15% during the same time frame. Performance has been good enough and long enough that other management companies are trying to mimic their returns (see previous post). One key to their performance is diversification. Harvard invests in 11 non-cash asset classes. In fact, when you look at the asset allocations, it is different from some traditional allocation benchmarks. From the WSJ:

"U.S. equities constitute 12% of the portfolio; developed foreign equities are 12% and emerging market equities are 10%. Total foreign equities account for 22% of the portfolio, up from 19% in 2007, compared with 12% domestic. Real assets, including commodities, are 33%, up from 31%. Fixed income dropped to 9% from 13%."

Can the average investor duplicate the returns of the Harvard endowment? The author of the WSJ article, James B. Steward, believes so - to some degree. Individual investors can duplicate most categories with individual stocks, sector mutual funds, and ETFs. Foreign equities and real assets are also able to be purchased, and are currently cheaper than just a few months ago, as are energy and commodity stocks and funds. The most difficult areas to duplicate are private equity and hedge fund returns. New long-short ETFs, and various hedge fund replication strategies are being considered, but making such investments is not currently as easy as in the other asset classes. Private equity is particularly troublesome. Nonetheless, and as mentioned by the author, given the current returns of private equity and hedge funds in general, lower weighting in these assets class may not be such a bad thing in the short-term - even if they did juice past returns. Maybe new products will become available before everyone jumps back on the alternative investment train.

Ospraie Management is closing its largest hedge fund after it has been down 38.6 percent this year as a result of bad bets on commodity stocks (see Bloomberg article, CNBC article). The fund got hammered in August, falling 26.7 percent after a sell-off in energy, mining, and commodity stocks. The closing leaves Ospraie Management with three funds that manage more than $4 billion of assets. Amazing, the $4 billion figure is down from $9 billion in March. Talk about the dog-days of summer. Lehman Brothers, with its own problems (see posts here and here) bought a 20 percent take in Ospraie Management in 2005 - yet another unfortunate turn-of-events for Lehman. Of interest is the quote from Dwight Anderson, manager of Ospraie Management:

"The fact that I had a horrible quarter is a statistical probability, and we had always told people there is that possibility. We do everything that we can to manage the risk, and I think we're better at it today than we were a year ago.''

In fact, they managed risk so good that they lost over half their assets in less than six months and are closing their flagship fund. Some times you just have to tell it like it is. People are forgiving, even when you lose lots of money. Just ask Brian Hunter.

The Financial Times is reporting how individual retail investment in U.S. equities has fallen to record lows (see article). This recent data highlights not only the nervousness of retail investors, but also illustrates the growing importance of institutional investors. By the end of 2006, retail investors owned 34 percent of all shares and 24 percent of the stock of the top 1,000 companies. These record low numbers are in contrast to when retail investors owned 94 percent of all stocks in 1950 and 63 percent in 1980. As comparison, institutions owned 76 percent of the shares in the biggest 1,000 companies in 2006, up from 61 percent in 2000.

Of course, one way to have the overall level of retail invest be down is for the large and rich retail investors to bail out of the market. A recent HSBC report (see Yahoo article) finds that the world's wealthiest people are moving their money out of stocks and bonds and into cash. As mentioned by Peter Braunwalder, chief executive of HSBC Private Bank:

"The first half of 2008 has seen a notable change in client expectations and investment choices. Faced with inflation worries, volatile asset prices and sudden changes in exchange rates, a majority of investors have reduced their transaction volumes in equities, bonds, and structured products."

Apparently, such movement into cash is greatest for clients from Asia, where their tolerance for derivatives and structure vehicles has decreased significantly as counterparty risks and volatility has increased. Given recent moves by the Fed and other central banks to increase liquidity in the wake of the credit crisis, some worry how this liquidity will eventually be removed from the market, and worry that interest rates will rise as a result.

Apparently, even large sovereign wealth funds may also be having second thoughts, or are at least re-evaluating how they deploy their ever increasing capital. An article from Asian Investor discusses how sovereign wealth funds, with their own mixed investment results allocating capital to struggling financial institutions, may now be looking for broad diversification, which will ultimately increase the amount of passive investments they make.

None of this really seems to be good news for the banks or the exchanges. As evidence of further weakening, derivative trades on the exchanges fell 13% in the second quarter (see Bloomberg article). This weakening comes as more exchanges enter the fray, causing the London Stock Exchange to cut fees as it deals with new competitors (see Financial Times article). The IPO market has also suffered recently (see Wall Street Journal article, Financial Times article). Only 25 companies priced their stock IPOs somewhere in the world in August, the lowest number of deals since Dealogic began tracking them in 1995.

Maybe even more troublesome than the reduced number of IPOs is the increased numbers of delistings that are also putting pressure on the exchanges. Year-to-date more companies have been delisted from the Nasdaq Stock Market than a year ago (see Financial Week article). To a lesser extent, NYSE listing are also up as companies fail to meet minimum listing requirements. So far, more Nasdaq-listed companies have been delisted for non-compliance this year than in the previous two years. As of August 7, 54 stocks were delisted. As comparison, only 48 total companies were delisted last year, with 52 delistings in 2006. For the NYSE, 11 companies were delisted as of July 1 of this year. This compares to 21 last year and 14 in 2006.

Along with a lower number of IPOs, the lower number of listings are affecting the profitability of the exchanges which derive up to 15% of their overall revenue from listing fees. While there have been more delistings on the Nasdaq, in part since smaller companies are more vulnerable during difficult times, companies pay much less to be on the Nasdaq (around $27,500 a year), so the loss of listing fees is not as severe. On the other hand, the NYSE will lose around $878,000 in annual revenue from IndyBank and Bear Stearns alone. When looking at the stock performance, the NYSE Euronext (NYX) stock has suffered over the last year and is right around its 52 week low near $40 per share. The CME Group (CME) has bounced slightly from 52 week lows near $300 a share to move near $340 a share, but is still struggling. On the other hand, the Nasdaq OMX Group (NDAQ) has recover to $32 a share after bottoming out around $24 a share in early July. The exchanges certainly have more issues to worry about than just delistings, and their stocks reflect this, but the continued fallout of the credit crisis is certainly continuing to find its way into more areas than the obvious players.

The news with Lehman Brothers just keeps coming. In a yesterday's post I highlighted some recent articles that discussed the value of Lehman Brothers Headquarters (article), potential private equity investment and/or purchase of Neuberger Berman (article), and plans for Lehman to cut 1,500 jobs (article). Now it appear that even as plans for reducing the work force are being put into place, Lehman Brothers is looking to hire at various B-schools (see DealBreaker article). While the move is not unprecedented (companies often hire cheap college grads to replace expensive long-timers), the timing and focus are interesting. Not only does news of the job ads come less than a week after the news of lay-offs (granted, it may have been in the works for a long-time), but Lehman is apparently looking for an "Investment Banking Full Time Associate." Of interest in the job description is the following:

"The division provides comprehensive financial advisory and capital raising services. This includes advice relating to mergers and acquisitions, privatizations, and debt and equity financings and restructuring."

No doubt that capital raising and private equity experience would certainly be useful at Lehman right now. Then again, a potential drawback is that "the program begins with four weeks of training in New York." The company could look very different in one month. As mentioned in the DealBreaker article, new hires better "act now, before they go under." Yes, I know. This is too easy to make fun of, and real people are losing real jobs. Nonetheless, given Lehman's recent moves, in particular its desire to have both a quick and sensible sale of their mortgage-related assets, at some point reality will need to step in. To see just how silly things have gotten, check out a recent Here In The City News article regarding a funny spoof email making the rounds on Wall Street. Who ever thought Lehman Brothers, the Tooth Fairy, and Tinkerbell would be in the same article. As with most good humor, there is often a little bit of truth hidden in the satire.

Of course, all of this has the contrarian in me wanting to poke around a little in the stock. I mean, how much worse can it get? Bear Stearns II cannot happen again, can it? Recent valuations certainly seem to be pricing the possibility. The moves have also been extreme enough that the technicals don't provide much help. Some support exists around $13.50, and even near the current price around $16, but both are weak. Downward trend line resistance is near $20. Investors could wait until this trend is broken, but one would have to give up four points and over 25 percent while waiting for confirmation. Traders, acting a little quicker could capture the moves, but as we saw with Bear Stearns, even nimble traders sometimes don't have enough time to act. In the mean time I will probably just sit on the sidelines and enjoy the show. There are just too many other stocks with better risk-reward ratios for investing and trading, even if they are not quite as entertaining.

It is never a good sign when your company is in financial trouble to find out that reporters, analysts, and private equity investors are suddenly interested in the value of the building that houses your headquarters. As reported in a Here Is The City News article, apparently this is exactly what some at the Financial Times and elsewhere are doing. The Lehman Brothers Times Square headquarters building is estimated to be worth $1.3 billion, or about twice what Lehman paid for the building in 2001. When you add its worth to that of asset manager Neuberger Berman, which may be valued anywhere from $6.5 to $13 billion, the sum of the two could dwarf the current market cap of Lehman, currently around $9 billion. This of course opens up the possibility of value for investors, or more likely, private equity investment (see a recent Bloomberg article on the private equity companies interested in Neuberger Berman).

This week it was also reported in a MarketWatch article and elsewhere that Lehman is planning to cut 1,500 jobs, and is also developing plans to off-load some of its real-estate loans (see the WSJ article). The company has $40 billion in commercial real estate assets and another $24.9 billion in residential assets. Lehman is desperately looking for ways to unload the mortgage-related assets for more than the 22 cents on the dollar that Merrill Lynch received (which was even worse when you considering the financing deal Merrill offered Long Star). The sale of these toxic assets may eventually make it easier to value Lehman Brothers, moving them from a "bad bank" to a "good bank" (see an interesting article by Roger Ehrenberg on the importance of separating such assets). By getting the hard to value assets off the balance sheet, Lehman should go a long way towards allowing investors to see the real value in the company, and in the process hopefully reverse the trend of their decreasing market cap. Unfortunately, it may take a fire sale of their good assets to keep them afloat long enough to see it happen. Another reason why a quick and sensible sale of their mortgage-related assets is so critical.

Brazil's Petroleo Brasileiro and Potash Crop. (POT) have been added to Goldman Sachs list of the most popular stocks purchased by hedge fund managers. The Goldman Sachs VIP list (Very Important Positions list) includes the 50 largest holdings in hedge fund portfolios. The VIP list as a group has done better than the S&P 500 during the past year, losing 6 percent during the recent market downturn at a time when the S&P 500 has fallen 9.2 percent. The inclusion of Petrobras is no doubt due in part to the increased interest in the company by George Soros (see previous post). A few more details on the VIP list can be found in a 2007 post at the All About Alpha blog.

It turns out that as a result of surging oil profits and decreased violence in Iraq, the $2.7 billion of 5.8 percent Iraq bonds due in 2028 gained 45 percent since August 2007 (see Bloomberg article). Last year investors were pricing the debt at 7.26 percentage points higher than Treasuries. Now that yield spread is down to 4.84 percentage points. Currently, the spread is actually narrower than the higher yielding notes of KeyCorp and National City banks out of Ohio. High crude oil prices and the global credit crunch are continuing to shake-up the entire global landscape, forcing portfolio managers to reconsider nearly everything in their portfolio.

The global infrastructure play continues to receive capital investment. According to an Asian Investor article, $18 billion is being raised globally by a number of firms for investments into infrastructure funds, with India receiving the most investment. JPMorgan and Macquarie Funds Management are raising $2 billion, while private equity investor Actis is raising $1 billion. Of interest is that various India-based organizations, whether private equity or venture capital-based, are are also investing $1+ billion sums. The combination of infrastructure needs in India and throughout Asia, along with various funds looking to diversity into this growing sector, appear to be driving the need to raise and deploy capital toward infrastructure investment. Recently, new infrastructure indexes were being developed to track infrastructure companies and allow easier investment in index-based ETFs (see previous post). Counter to this trend was the recent divesting of some infrastructure assets as a result of the credit crunch (see previous post), but this action seems to be isolated to Australia for now.

Jerry Webman of Oppenheimer Funds discusses bond market pricing and value. No specific names, but mentions that some individual mortgage-backed tranches offer value if you can find securities that are tied to financial companies with strong balance sheets, or at least companies that have the ability to repair their balance sheets. You need to be a long-term holder, but at least you are getting paid to wait (hopefully).

Bloomberg ClipSyndicate

A recent Financial Times article highlights some research it has done on the impact of the housing and credit crisis on Merrill Lynch. We all know of the problems and losses with Merrill and others, but when you add up the numbers the FT finds that in the past 18 months the losses have amounted to roughly one-fourth of the profits the company has made over its 36 years as a public company. The recent credit problems have caused Merrill to report after-tax losses of more than $14 billion during a time when the company took nearly $52 billion in write-down on its balance sheet. Looking at historical data, the FT calculates that the company's total inflation-adjusted profits between 1971 and 2006 were close to $56 billion. More near-term, the $14 billion in losses also amounts to half of Merrill's profits since 2000. Amazing. If this is not an advertisement for better risk management, I am not sure what is. Securitization and leveraged loans have certainly seen better days. To add insult to injury, it also turns out that Merrill Lynch had the highest ratio of credit related losses to historical profits when compared against ten large U.S. and European financial institutions. UBS had the dubious honor of having the second highest ratio.

Pimco's is working to raise money for a $5 billion fund to purchase tranches of depressed mortgage-backed debt (see London Telegraph Telegraph article and Bloomberg Bloomberg article). Pimco managers are meeting investors to gain commitments for the new fund, called the Distressed Senior Credit Opportunities Fund (already dubbed Disco). The fund will invest in senior and super-senior securities backed by commercial and residential mortgages. Of interest is that while the fund will look for securities backed by traditional home equity, credit cards, and auto loans, the focus of the fund will be more international. Given the senior nature of the debt, the fund will be less risky than some other debt funds. Subordinated debt, selling at even more distressed levels, is still raising concerns. The current move appears more opportunistic than an indication that the credit issues are behind us. As seen recently with other similar investments by John Paulson and Goldman Sachs, those with the capital can often name their price and define their terms. Just a new spin on the golden rule: "Those with the gold make the rules."

The Swiss funds-of-funds firm Gottex Fund Management is launching a new fund that will emulate the investments and strategies of some of the larger U.S. academic endowment funds, such as those at Harvard and Princeton (see the HedgeFund.net article). The new Gottex fund will also allocate around 65% of the fund to alternative investments. Why 65%? When preparing the fund, the Gottex group found that a 65% exposure to alternative investments, when combined with traditional investments, did the best over the long-term. No indication if that means risk-adjusted or not. As for the alternative investments, everything from hedge funds, private equity, long-only equity, commodities, fixed income, real estate, and other real assets will be utilized. Given the current environment, the timing could prove advantageous. As mentioned by fund manager William Landes, "For the short-term the challenging environment for alternative products like private equity and hedge funds was where the opportunities lie. If I put my investor hat on, I would say that if I have a six to nine-month tactical horizon, global equity markets and some alternative markets are actually where I want to be.” Given the move by many academic endowments towards greater exposure to real assets, commodities, private equity, and international equities, any new fund emulating the likes of the Harvard fund may offer no other choice.

There is an interesting article in the Time Online (London). Apparently, Japan's powerful yakuza organised crime syndicates are moving away from old-fashion crimes of drugs and prostitution and are increasingly launching an assault on Japan's financial markets. Studies estimate that there are already hundreds of listed companies that may have some mob connections. Using "front companies," organization have become active traders in listed Japanese shares and in some cases own large positions. Of interest in the article is the feeling that "the new activities of the nation's largest crime syndicates have effectively turned the mob into the biggest private equity firm in Japan." Things have gotten so bad that some observers believe that the problem may have gotten to the point where it is now beyond control. The problem continues to grow exponentially as the groups hire newly unemployed traders who have been laid-off as a result of the credit crunch. In fact, the current mixture between legitimate and illegal activities is making it nearly impossible to discern the difference between the funds that flow through the Japanese markets. Some organizations even operate their own stock trading floors.

All of this reminds me of the attributed quote by the famous bank robber Willie Sutton, although the story may be an urban legend. As the story goes, Sutton was ask by a report why he robbed banks. Sutton is quoted as replying: "Because that is where the money is." It should really be no surprise that criminals will search out the financial markets for profit. After all, that is where the money is.

The Inspector General for the Commodity Futures Trading Commission (CFTF) has begun to investigate an earlier report on the commodity markets (see Reuters article). At question is the CFTC's role in an inter-agency task force report that came to the conclusion that supply-and-demand and not speculation was responsible for the increase in energy prices. Since the report came to a conclusion that some in Congress did not like, and came at a time that was a few days ahead of a Senate vote on the bill, various senators, including some on the Energy and Natural Resources Committee, allege that: "the CFTC knowingly included "seriously flawed" data and the timing was "suspicious." Interesting. The Senate is debating an important issue, a major regulator provides a report and data in a timely manner, and yet the reaction is to question the timing of the report because it came to a conclusion that did not support their initial assertions. Of course, none of this is surprising, and the report may in fact be flawed, but you have to wonder whether if they had come to another conclusion if an investigation would be occurring. Of course, usually when action is finally taken, it often is too late. Maybe this is just another indication that crude oil prices have indeed peaked, Gustav notwithstanding.

As reported at MarketWatch, Japan is considering lowering capital gains and dividend taxes as a way to encourage savers to move funds from lower yielding investments back into the stock market. The plan would cut dividend and capital gains taxes, potentially for up to 10 years. The proposal would temporarily exempt dividend payments of up to 1 million yen ($9,100) from taxes. An earlier plan that was passed in 2003 and cut capital gains by 50% and dividends to 10% is scheduled to expire early next year. It is hoped that the move will help spur the stock market, which has languished for over a decade. Given the level of fear in the U.S. markets, cutting capital gains by 50% and reducing dividend taxes to 10% would certainly give the U.S. markets a nice jolt. Hopefully it will not take over 10 years of poor market returns to see the need and potential benefits of such a cut. Just as the U.S. is considering higher taxes, this is yet another example of how countries around the globe are looking to reduce corporate, capital gains, and dividend taxes. Hopefully we will get the message.

There is an interesting article in the Financial Times regarding the rush by some Australian infrastructure funds to divest assets. Just within the last month or so infrastructure has been receiving increased attention, some of which helped to trigger the creation of new infrastructure indexes (see previous post). Now, credit problems and the general global credit crunch are causing some infrastructure funds to look for ways to reduce their weighted average cost of capital, such as by cutting net debt, paying distributions only from operating cash flows, or even selling assets that are currently at high valuations. What a difference a month or two makes.

Money markets are signaling that recent credit problem may be long from over, with possibly the worst yet to come (see Bloomberg article). As with the end of 2007, interest-rate derivative are showing hesitation from the markets over fear that credit losses will continue to increase. The premium banks charge for lending short-term cash is near 77 basis points over what traders predict the Federal Reserve's daily effected federal fund rate will average over the next three months - approaching the record levels set last year and near recent high levels (see recent posts here and here). The spread is up from 24 bps earlier in the year. The spread effectively measures the difference between the three-month Libor and the overnight indexed swap rate and is often used to tell whether or not the markets have returned to normal. Often a narrowing of 25 bps or less in the Libor-OIS spread is considered positive. Unfortunately, the forward markets do not indicate this happening for nearly two years, around June 2010. Of course, the reliability of Libor has also been in question recently (see previous posts here and here). Nonetheless, the size of the spread still shows a level of fear in the credit markets that may take a while to correct itself as investors wait for the next shoe to drop in the financial stocks.