HSBC Absolute Return Strategy Investment Update

Transcription

1 HSBC Absolute Return Strategy Investment Update December 2008 Background The severe falls in global markets has affected all asset classes. Our diversified strategy normally offsets rising assets with falling assets in order to deliver steady returns with lower volatility. However the extreme selling pressure that has materialised since the Lehman Brothers failure has caused all assets to become highly correlated. The high degree of diversification has not delivered the level of capital preservation that would normally have been expected. However, despite the severe falls in the value of the portfolio, we have good reason to believe that the underlying assets are of high quality and will recover very strongly over the medium term. This update will clarify our current positioning and then discuss the outlook. Key points Dollar portfolios are worst affected due to dollar strength overdone? Indiscriminate selling of all assets driven by forced sellers High correlation of assets severely reduced the effectiveness of diversification No meaningful winners to offset other losses Convertible and high yield bond market suffered from forced selling Hedge fund performance was poor minor factor Hedge funds dropped to significant discounts to net asset value major factor Assets are of high quality and we believe they are likely to see a strong recovery Markets offer considerable value to investors Asset Allocation The portfolio can be broken down into three areas: Just under a third in low risk assets such as cash or government bonds A third in non directional risk which are typically hedge funds Just over a third in diversified risk The low risk component has been unaffected by the financial crisis and continues to benefit from falling interest rates and the flight to quality. We have recently increased the duration (longer dated bonds) of our government bonds to seek higher yields as short dated bonds now pay little or no yield. Investors have sought higher risk free returns and therefore stepped out along the yield curve. Many people fear that yields will rise as governments are issuing vast amounts of bonds over the next few years. However, the market disagrees since yields continue to fall as wealth destruction from falling asset prices exceeds this supply. We expect long term interest rates to continue to fall over the coming year. The non directional risk portion has fallen in small part due to the weakness in hedge funds but in large part due to the mark to market of the closed ended funds which are now priced at significant discounts to their net asset value (NAV). The HFR hedge fund index is down 22% so far in 2008 but the hedge funds held in Absolute performed better than that with the average fund down approximately 5.1%. However, the share prices of the closed ended funds have fallen 35% meaning that on average, our hedge funds trade at a 23% discount to their net asset value.

2 Many of the hedge funds held are listed on the stock market where the price normally trades close to NAV. In recent years a 5% discount (or even premium) has been considered wide in the closed ended hedge fund sector which has consistently traded much closer to NAV than other closed ended funds such as those that invest in property, private equity or equities. In fact the average close ended company (across all asset groups) now trades on average at a 42% discount to NAV having been 8% in recent years, a situation that arose since the Lehman Brothers failure. Furthermore, the combined monetary discount spread across all closed ended funds is estimated to be over $64 billion according to a specialist fund arbitrage manager we recently spoke to. The distressed pricing in closed ended funds is no different from the dislocation seen elsewhere in the market. Hedge funds, real estate, commodities or even convertibles bonds have also suffered; it is just more visible and easier to understand and visualise discounts to NAV than mark downs in other areas. Unlike most closed ended funds, the closed ended hedge funds were designed with a discount control mechanism in case this ever happened. A typical structure enables investors to call for the board to hold a continuation vote should the discount exceed 5% on average over a 12 month period. Some of these companies have already breached these terms and many more are sure to do so unless they manage this issue with urgency. To take no action will ultimately lead to the companies being shut down and the proceeds returned to investors at NAV (less costs). This would indeed be a shame as there is every likelihood that hedge fund performance will pick up strongly over the next few months as the investment opportunities are so widespread precisely at a time when they will face less competition. Quite apart from higher asset prices, any normalisation in the workings of financial markets will go a long way to address this point. Indeed, two of our funds have already taken aggressive action. Marshall Wace has allowed all investors to exit at NAV whilst Dexion Absolute has announced it will allow sellers to exit via an auction process. This will mean that Dexion will continue to be viable but will hopefully flush out the forced sellers, thereby enabling more normalised pricing thereafter. If this does not work, they will have to continue their buy back program until it does. We expect the other funds to follow this lead, as if they don t, they will be forced out of business by their shareholders. The directional risk portion of the portfolio is diversified across equities, gold, high yield bonds, convertible bonds, emerging market currencies and emerging market inflation linked bonds. All of these assets have fallen to varying degrees, in all cases by materially more than what would have been reasonably expected in a normal recession. There is little point repeating what was stated in the recent Q3 quarterly review, except for the key point that throughout 2008, the portfolio has moved from growth to value. That means the equity exposure was radically reduced, commodity exposure was reduced to zero and developed market inflation linked bonds were sold. By the time the stock market had fallen 20%, we believed the outlook for markets had improved since a recession had already been priced in. After all, the problems in the financial sector were already well known and many emerging stock markets had already fallen significantly. However, since there were considerable risks that lay ahead, it was unlikely to be a smooth recovery and so we kept equity exposure at low levels. Instead we invested into value assets that were expected to perform throughout a period of greater uncertainty. Typically, these value assets deliver returns by paying high yields as opposed to reliance on capital growth. In the case of convertible bonds, should share prices rise, the bonds would follow, albeit at a slower pace, whereas should share prices fall, the convertibles become bonds and pay a yield. So whilst they theoretically offer capital preservation, as things stand today, they trade at prices that are irrational. The Threadneedle High Yield Bond Fund (Sterling and Euro portfolios) yields 20% and the Goldman Sachs High Yield Bond Fund (Dollar portfolios) is very similar. For a more detailed explanation on some of these funds, please visit our website and read the interviews with the manager of the Salar Convertible Bond Fund or the chief investment officer at Ashmore; we have two more of these on the way and they will provide much more information should that be of interest to you. We want our investors to try to understand that whilst the falls in asset prices have been unprecedented, the funds that we hold are exceptionally well managed and the assets held are of high quality that will recover in time. Finally, we have a little over 13% in equities and it is clear that even this low number has appeared to be high. In order to maintain our preference for high quality assets, we have screened our equity fund for companies with strong balance sheets to ensure we do not have material exposure to companies that may need refinancing over the next two years. History tells us that bear market rallies are much stronger than people expect and we believe the market is setting itself up for a significant move. Already we are seeing the market shrug off bad news and financials are stabilising as evidenced by Citigroup which has rallied 142% over the past few trading days from its low point. In fact, as we write, the market has just had its strongest four day rally since 1933, a year when the market went on to rally 117% in just four months. Over the medium term, the market strength indicators have readings commensurate with major low points and compare favourably to the 1987 crash, LTCM, 9/11 and the Enron crisis. Furthermore, market breadth indicators (number of shares rising versus falling) have made higher lows from the most distressed readings in a generation. The leadership is likely to be the commodity stocks, especially oil, but defensive companies such as pharmaceuticals are very crowded, so we don t expect them to participate. The pieces are falling into place for this rally to begin and it should last until the early spring. The fund is now well positioned for recovery having recently increased exposure towards Asia and energy. Until recently, trading actively has been light during these incredibly volatile markets for the simple reason that when correlations are very high, little purpose is served by swapping one asset for another when they behave in a similar way. However, we have recently been active in the government bond market and also added a small position in gold bullion as the price correction appears to be complete. As conditions return to normality, we look forward to taking advantage of the considerable opportunities that lie ahead. Given the extreme level of value across the board, it is wholly reasonable to say that returns over the next five years will be comfortably ahead of those over the last five. Charlie Morris Will Bartleet November 2008 Please visit our website at in order to keep in touch with portfolio changes, fund manager interviews, factsheets and other announcements.

3 ABSOLUTE RETURN SERVICE STERLING 27/11/2008 SECURITY NAME WEIGHT % DESCRIPT ION LOW RISK 27.8 Cash 7.9 Cash Gilt 4.5% Government Bond Gilt 4.75% Government Bond Gilt 5% Government Bond DIRECTIONAL RISK 38.2 Gold 3.0 Physical commodity Ashmore Local Currency Debt Fund 4.5 Emerging market government bond fund Sinopia Inflation Linked Bond Fund 2.9 Emerging market government bond fund T hreadneedle High Yield Bond Fund 4.4 Corporate high yield bond fund Salar Fund 3.7 Convertible bond fund Aviva Convertible Fund 3.5 Convertible bond fund JP Morgan Small Cap Fund 1.8 Equity - Japan Imara African Opportunities 1.0 Equity - Africa HSBC Global T rend Fund 10.8 Equity - Global Ashmore Global Opportunities Fund 2.6 Emerg in g market multi strategy NON DIRECTIONAL RISK 34.0 Mellon Global Evolution Currency Options Fund 3.5 Currency fund Sinopia Alternative Fund Hedge fund - fixed income trading Acencia Debt Strategies 2.1 Hedge fund - credit fund of funds FRM Credit Strategies 2.3 Hedge fund - credit fund of funds HSBC Technology Alpha 1.8 Hedge fund - equity long / short Marshall Wace Tops 2.3 Hedge fund - equity long / short Polar Capital UK Fund 3.4 Hedge fund - equity long / short Third Point Offshore 0.9 Hedge fund - equity long / short Alternative Investment Strategies 1.3 Hedge fund - fund of fund s Dexion Absolute 1.8 Hedge fund - fund of fund s Brevan Howard G lobal 2.1 Hedge fund - multi strategy HSBC Trading Advantedge 4.4 Hedge fund - CT A fund of funds HSBC Partners G roup Private Equity 4.8 Private Equity Total Closed ended funds 13.1

4 ABSOLUTE RETURN SERVICE US DOLLAR 27/11/2008 SECURITY NAME WEIGHT % DESCRIPT ION LOW RISK 30.4 Cash 8.3 Cash Gilt 3.125% Government Bond Gilt 4.25% Government Bond Gilt 6.25% Government Bond DIRECTIONAL RISK 35.5 Gold 3.0 Physical commodity Ashmore Local Currency Debt Fund 3.8 Emerging market government bond fund Sinopia Inflation Linked Bond Fund 2.5 Emerging market government bond fund Goldman Sachs High Yield Bond Fund 4.3 Corporate high yield bond fund Salar Fund 3.8 Convertible bond fund Aviva Convertible Fund 3.6 Convertible bond fund JP Morgan Small Cap Fund 1.4 Equity - Japan Imara African Opportunities 1.2 Equity - Africa HSBC Global T rend Fund 9.1 Equity - Global Ashmore Global Opportunities Fund 2.7 Emerg in g market multi strategy NON DIRECTIONAL RISK 34.2 Mellon Global Evolution Currency Options Fund 3.5 Currency fund Sinopia Alternative Fund Hedge fund - fixed income trading FRM Credit Strategies 2.4 Hedge fund - credit fund of funds HSBC Technology Alpha 1.9 Hedge fund - equity long / short Marshall Wace Tops 2.7 Hedge fund - equity long / short Polar Capital UK Fund 3.6 Hedge fund - equity long / short Third Point Offshore 1.1 Hedge fund - equity long / short HSBC GH Fund 5.2 Hedge fund - fund of funds Brevan Howard G lobal 2.1 Hedge fund - multi strategy HSBC Trading Advantedge 4.4 Hedge fund - CT A fund of funds HSBC Partners G roup Private Equity 4.0 Private Equity Total Closed ended funds 8.5

5 ABSOLUTE RETURN SERVICE EURO 27/11/2008 SECURITY NAME WEIGHT % DESCRIPT ION LOW RISK 28.0 Cash 5.0 Cash Bund 3.5% Government Bond OAT 4.25% Government Bond Bund 6.25% Government Bond DIRECTIONAL RISK 35.4 Gold 3.0 Physical commodity Ashmore Local Currency Debt Fund 3.8 Emerging market government bond fund Sinopia Inflation Linked Bond Fund 2.7 Emerging market government bond fund T hreadneedle High Yield Bond Fund 4.6 Corporate high yield bond fund Salar Fund 3.7 Convertible bond fund Aviva Convertible Fund 3.4 Convertible bond fund JP Morgan Small Cap Fund 1.6 Equity - Japan Imara African Opportunities 0.9 Equity - Africa HSBC Global T rend Fund 9.0 Equity - Global Ashmore Global Opportunities Fund 2.8 Emerg in g market multi strategy NON DIRECTIONAL RISK 36.6 Mellon Global Evolution Currency Options Fund 3.6 Currency fund Sinopia Alternative Fund Hedge fund - fixed income trading FRM Credit Strategies 2.3 Hedge fund - credit fund of funds HSBC Technology Alpha 1.8 Hedge fund - equity long / short Marshall Wace Tops 2.9 Hedge fund - equity long / short Polar Capital UK Fund 3.7 Hedge fund - equity long / short Third Point Offshore 1.1 Hedge fund - equity long / short HSBC GH Fund 7.1 Hedge fund - fund of funds Brevan Howard G lobal 2.1 Hedge fund - multi strategy HSBC Trading Advantedge 4.4 Hedge fund - CT A fund of funds HSBC Partners G roup Private Equity 4.1 Private Equity Total Closed ended funds 8.8

6 Important Information The material contained in this presentation is for information only and does not constitute investment advice or a recommendation to any reading this material to buy or sell investments. HSBC Global Asset Management (UK) Limited has based this presentation on information obtained from sources it believes to be reliable but which it has not dependently verified. HSBC Global Asset Management (UK) Limited and HSBC Group accept no responsibility as to its accuracy or completeness. This document is intended for information only and shall not be capable of creating any contractual or other legal obligations on the part of HSBC Global Asset Management (UK) Limited or any other HSBC Group company. Care has been taken to ensure the accuracy of this presentation but HSBC Global Asset Management (UK) Limited accepts no responsibility for any errors or omissions contained therein. Investments in emerging markets are by their nature higher risk and potentially more volatile than those inherent in established markets. Emerging markets are generally, but not exclusively, those that are not within the United States, Canada, Switzerland and members of the European Economic area, Japan, Australia and New Zealand. Please note Hedge Funds often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. They can also be highly illiquid, are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing information Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management (UK) Limited accepts no liability for any failure to meet such forecast, projection or target. The value of investments and any income from them can go down as well as up. Where overseas investments are held the rate of exchange may cause the value of such investments to go down as well as up. Stockmarket investments should be viewed as a medium to long term investment and should be held for at least five years /1108 FP