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.


ikanair said...

Subprime a small thing?

Nope, i think subprime is not the real problem, it is just the symptom of easy credit, idiotic borrowers and downright evil bankers.

And the cure for all this, is quite simple really. Just remove the easy credit and the evil bankers. (Only thing is, doing so will cause some really bad hiccups).

Current market conditions are purely collateral damage.

As for CHINA's stock market, well, common sense shall prevail.
(any way you put, when retirees start to invest in share marker, run as fast as you can)
It's going down, and it will be hard, but, the worse part, we will be the collateral damage again.

Liquidate, sit tight and watch the show.
It's ain't over until Shanghai crashes.

solomon said...

Dear Ikanair,

This is a society of free market, willing borrowers and lenders. Don't blame them, but the greedy fellows.

You can remove all the parties in a transaction, but not sensible. No trades, no growth unless you go back to Barter system. Not a bad idea too.

You are right on collateral damage. The key word is reputation risks which involve counterparty risk and credit risk.

The only rescue package I can see is TIME. Whether this will come in favour or not, history will tell. At least, this round it will record in the academic books on whatsoever names.

Or a more idiotic idea is to ask the TOP100 richesmen in the World to tell the market they are spending now. Publish a few statements with concrete spendings evidence. It might work.

On the other hand, I prefer not to watch the show, but to eat, sport and have a good nap. This is more constructive to one's health rather than cheering on other investors' misery.

The Great Game said...

Talking abt the collaterals, heard that few banks are now revaluing the value of these structured finance products as collateral.

If say the banks really revalue these assets value, most hedge funds would be sandwiched bet. the redemption of the investors and the collateral crunch from the banks.

... which either ways means the doomsday for the market, at least in the short term...

classic prisoners dilemma faced by all instituational investors and bankers now, which we know their cover- your- ass mentality would only result in the sub-optimal (or subprime) outcome.

Wow.. it's already 1148.. another 30 points we'd be back at 03 Jan 07 level...

TK said...

Thanks Dali,

I get some picture how the hedge funds works.

Thanks for all the recent write ups on the subprime issue too.


TK said...

Thanks Dali,

I have got some picture how the hedge funds works now.

Thanks for all the recent write ups on the subprime issue too.


lsblmllms said...

The wealth of the world took a quantum leap: when agriculture first began, the wheel was invented, Renaissance, steam engine, I T (telephony communication) and the U S really took off when it made the move to its west coast by the massive investments in building railways and telegraph @ telephone lines network and later roads to the west coast.

The move to the next level of wealth is always initiated by investments (fiscal spending, here to include private spending too). The 9mp at home will therefore play to stabilize the volatility effect of world macro on M’sia, even if it is to be poorly implemented. The wealth of the world is poised for the next leap by the massive infrastructure investments in China (airport, ports, railways, roads, industrial zones, housing etc), India, Middle East etc. I am an optimist on the world as a whole in the long haul.

For M’sia, the problem is its feudalism in Malay politics in reality, with the Royalty, UMMO leaders each with its own fiefdom. The governance system is neither efficient nor intended (not by choice but by history and legacy of British intention) to be effective. We are a lucky country with abundant wealth to feed the inefficiency and still have decent growth.

Kiwi $ is at historical high, this is for the currency dealers.

ikanair said...

Dear Solomon,

The current evil bankers, by providing easy credit to those who are least able to pay, is in the same rank as my neighbourhood loan shark, so can be said of the drug lords.

The only thing is, there are no laws to punish these evil bankers.

TIME???, nah... this is not the answer, just look at the addicts(drug, gambling, or easy credit), the only answer is the removal of the addiction.
What we have is just the withdrawal symptom, with it, pain, lies and denial.

TIME only fogs up the memory, so people forgets, and this will happen again.

The world ain't short of suckers.


mak said...

Great idea for a blog. Keep it up!! :-)


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hellthy correction said...

we saw it happened (the panic) in 1997 and now 2007 it happened again. Dejavu! Where do u go from here? perhaps its about time the world look away from US and gradually end its influence as economic power of the world....just like the once mighty roman empire, the center of commerce then.

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