Friday, August 17, 2007
The New Investing Paradigm
I still think that the subprime thing is just a small thing, however the blowout due to the repercussions of subprime give rise to many fresh lessons in the continually evolving investment paradigm. You can call it the globalisation effects. Unless you still have walls around your stock markets like China, you are no longer immune to seemingly unrelated hiccups 10,000 miles away.
Put it another way - almost every asset class or sectors or country effects will have an effect on your stock portfolio, whether you like it or not, whether you have even heard of them in the first place is immaterial. Hence you can be safely buying and keeping Public Bank and UMW and IJM, but something could have happened to cause wild gyrations in gold futures due to a no-export and no-gold trade rule put up by Russia, leading to a 25% jump in gold prices. Now, nothing PB, UMW or IJM does is in any way related to gold or even something as far away as Russia. But the thing is NOTHING is unrelated anymore. By virtue of the leveraged hedge funds seeking out investments in every nook and corner of the world, all investments are related, whether you like it or not!
Imagine a US$2 billion hedge fund, they gear up by borrowing an additional 100% in Kiwi-carry trade, and then gear up another 100% doing a yen-carry trade. Now the fund has US$6 billion in investible funds. The US$2 billion borrowed on Kiwi dollars is used to invest in Singapore REITs which are yielding 5.5% in Sing dollars - the bet being the Sing dollar will appreciate at least 4% against the Kiwi dollar over the next 12 months, and the REIT yields give a good buffer. Then with the other US$2 billion in yen carry trade, borrowed at a ridiculous rate of 1.0%, the fund invests in hot markets such as Malaysia, HK, Singapore and Vietnam shares. Again the rationale being the stocks there are hot and the currency outlook all looks better than the yen. The remaining US$2 billion is invested in American instruments. Now somebody in the firm decides to sell US$500m in gold futures as a hedged bet against oil as the volatility indicates a spread play. They get caught in the 25% gold price correction, investors got wind of the US$500m losses from the gold exposure gone bad. Hedge fund put up no-redemption as each US$1m redemption will require them to dump US$3m in actual stocks. They sell stocks where they could get liquidity fast.
This kind of scenarios will play out more often in the future. As long as leveraged hedge funds' portfolio have 10 different assets exposure, each of the 10 asset class will be related whether you like it or not. As investors, its not enough to study capital flows, yield differentials, economic growth rates and inflationary rates. You have to open your eyes to Colombian stocks and maybe even English football clubs because certain hedge funds have bought heavily in them, etc... you get the drift. Hence its time for more regulations to have all hedge funds reveal their asset class exposure so that this information is known to all. Money supply growth figures have been compounding in most countries leading to high liquidity in the financial systems. Unfortunately a disproportionate amount has found its way to pump up private equity and hedge funds. The sheer size and the ability to leverage easily makes the hedgies the probable root cause of this new investing paradigm shift. The sheer size of many of these hedge funds forced them to bet big stakes in order to obtain alpha returns - these big bets can only be in certain instruments, and many of these quants think alike, thus ending up making similar bets: when there is even a little wobble in these instruments, the whole chain reaction gets magnified along the way.
Its the new investing paradigm, get used to it. On the flip side, we can also benefit from the new paradigm - when they are throwing out the baby with the bathwater, you know they are being irrational, and you can easily spot stocks that have been battered for nonsensical reasons.