ALTERNATIVE INVESTMENTS

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Sybil Lindsey
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Page 02 FIXED INCOME Theme 2 Low interest rates are locked in, and A glance at the markets and current issues government bond

1 Market Overview April 2019 MARKET OVERVIEW Theme 1 Spring is in the air: the volatility index reaches a new low, while US equities receive a further boost. Page 02 FIXED INCOME Theme 2 Low interest rates are locked in, and A glance at the markets and current issues government bond yields are languishing. Page 03 ALTERNATIVE INVESTMENTS Theme 3 The capital guarantee offered by hedge funds with first-loss structures means there is no risk of losses an advantage for both investors and portfolio managers. Page 04

2 Market overview: first green shoots of spring While the global economy is cooling slightly but does not look likely to dip into recession and political risks remain high everywhere, the volatility index is trading at its lowest level since March Have investors worries evaporated? Is hope once again on the rise? In economic terms at least, we have already seen the first green shoots of spring. Both the Organisation for Economic Co-operation and Development s (OECD) economists and their colleagues at the European Central Bank (ECB) lowered their growth and inflation forecasts considerably in recent weeks, and trade and manufacturing production may be under pressure although some sectors are doing well. However, in numerous countries including the United States, the UK, Germany and Japan unemployment rates are at, or near, their lowest levels in decades, and economic fundamentals remain sound. As already mentioned, the political risks Trump s trade war, a hard Brexit and other political accidents such as in France and Italy should not be overlooked, though. Spring also reaches US equities Nevertheless, there is still a great deal of uncertainty. We are still sat in the waiting room awaiting news of further developments. The longer the uncertainty persists, the greater the risk that the demand for construction machinery, industrial equipment or construction material, for example, will fall. Insofar as Brexit is an issue primarily affecting the UK and the European Union (EU), and the ongoing trade dispute is a matter mainly for the US and China, the resulting uncertainty could also have an indirect impact on other countries. That is also the reason why global growth is weakening. Equities continue to recover In recent days, the positive signals emanating from the tariff dispute between the US and China have further buoyed both Wall Street and the Swiss stock market. But, after the strongest start to the year in four decades, US equities are running up against key lines of resistance. Nonetheless, stock market trends continue to point upwards. The US advance/decline line has reached a new all-time high, underscoring that the upswing has a broad base in the US market and is not restricted solely to a handful of equities, like the technology shares that have increased again recently. That is a very good sign. Given technical resistance, however, the indices are rather unlikely to keep scaling new heights. The best chance of that occurring is in late spring, especially if Trump and US Federal Reserve (Fed) Chair Jerome Powell do not make any grave errors. 02/09

3 Fixed income: low interest rates locked in While the ECB left its key interest rates unchanged, it did lower its guidance for both inflation and economic growth. Interest rates are now likely to remain unchanged until at least the end of The ECB also announced the issue of new targeted, longer-term refinancing instruments for banks (TLTRO-III), which will commence in September 2019 and run until March Each instrument will have a term of two years. TLTRO-III is the ECB s response to its own lower forecasts for growth and inflation. Investors responded to this package of measures with a sell-off of risk investments, pushing yields on government bonds down and probably locking in low interest rates. The periphery will benefit most from this trend, with the spread between Italian Buoni del Tesoro Poliannuali (BTP) and German Bunds narrowing to 240 basis points. The Italian political landscape should not be overlooked when it comes to the trend in BTP. It is doubtful, however, whether the periphery will continue to outperform to this extent. If growth weakens substantially, the focus will probably again shift to the long-term sustainability of the debt burden, even though the low absolute yields are a source of strong fiscal relief for the periphery. Standard & Poor s (S&P) left Italy s rating unchanged this month, but raised Portugal s one notch to BBB, citing the gradual improvement in the country s fiscal situation, among other reasons. The move to a higher rating came relatively quickly, given that S&P Global had attested Portugal a positive outlook only on 14 September Downward revision at the Fed as well At its monthly meeting, the Fed underscored its dovish (accommodative) monetary policy. It expects to see a prolonged period without interest rate hikes. None are currently expected this year, though one increase is a possibility in The Fed also took the opportunity earlier than expected to specify its plans to slow the normalisation of its balance sheet. What is more, it lowered its forecast for inflation in 2019 from 1.9% to 1.8%. GDP growth for 2019 was also revised downwards, from 2.3% to 2.1%. Languishing yields on government bonds Government bond yields fell to historic lows at the end of the month. The ECB s recent announcements strengthened market participants assumptions that there will be no notable increases in key interest rates during the current economic cycle. Any countermovement and steeper yield curve would require growth to accelerate enough to push up inflation. Similarly, there would have to be a lasting abatement in the uncertainty surrounding global trade conflicts and Brexit in order to reverse the flight to low-risk asset classes. German Bunds, which are viewed as a safe haven, profited additionally from the slight rise in uncertainty. Otherwise, economic data did not provide any substantial impetus. That is why the yields on 10-year German Bunds are unlikely to rise until later in the year. In a constellation like this, we would expect to see a smaller 03/09

4 increase in yields on long-term German and Swiss government bonds. Given the concerns about economic growth, cyclical corporate bonds will probably continue to lag behind the broader bond market. First-loss structures: hedge funds with a capital guarantee Hedge funds differ from traditional forms of investment in various aspects: a more flexible strategy, for instance, the way in which risk is managed, or the fee model designed to ensure a better alignment of investors and managers interests. As regards the latter, hedge funds often speak of 2 and 20, i.e. the manager receives a flat annual management fee (2% of the assets under management) plus variable compensation (20% of the annual profit). Whereas this fee model with differing percentages is still very common in the marketplace, hedge fund investors have a whole array of alternative, innovative forms of compensation to choose from. First-loss structures are one example. A deposit to cover losses On the face of it, first-loss structures function in the same way as a fund of funds or multistrategy fund. The first-loss manager looks for promising (external) portfolio managers or existing funds, and puts together a portfolio. However, the big, decisive difference compared to a conventional fund-of-funds strategy is the form of compensation paid for these external allocations: a portfolio manager (or fund) that receives an investment from a first-loss manager undertakes to bear in full the first 10% of any potential loss attributable to their strategy (first loss). In return, the portfolio manager (or fund) gets a higher percentage of any potential gain than the otherwise customary 20%. In practice, a typical structure looks like this: A first-loss manager allocates an external portfolio manager USD 10 million (typically referred to as the sum of all long and short positions ). By way of collateral for this allocation, and to cover any future losses, the external portfolio manager sets aside a sort of deposit of USD 1 million (10%), which only the first-loss manager can access. If the external portfolio manager s strategy generates losses, these are covered in full by the deposit and neither the investor nor the firstloss manager have to bear any losses. In return, the external portfolio manager receives 50% of any gains achieved with their strategy, but no flat management fee. In order to ensure smooth risk management and prevent any losses for the first-loss manager and the investor, structures of this kind always include a stop-loss component: if losses reduce the original deposit by more than 50% (i.e. generating a 5% loss for the strategy), the external portfolio manager has to top it up again by a certain amount using their own funds. Otherwise, the allocation to that strategy is liquidated in full. 04/09

5 Only gains for investors Given adequate management and monitoring, this structure offers investors a highly attractive proposition that is slanted in their favour. For a small fee (the management fees for first-loss managers are significantly lower than those for conventional hedge fund managers), investors participate solely in the gains made by the underlying strategies, but never in their losses, as the individual portfolio managers bear the latter in full. In this way, first-loss structures eliminate netting (i.e. variable compensation is paid on gains, and the remaining amount is used to cover part of the losses generated by other strategies), which is practised by traditional fund-of-funds investments and is often very expensive for investors. Although the higher variable compensation payable to the portfolio manager means the upside potential is somewhat lower than with traditional investments, it is achieved without the risk of investment losses. Portfolio managers benefit too First-loss structures offer advantages not only to investors, but also to the individual portfolio managers. While they have to forgo a flat management fee, they can pocket a higher share of any gains. Consequently, structures of this kind are of particular interest to portfolio managers that do not (yet) have the resources to find a large number of external investors, but still want to be able to boast a good track record and a certain asset base. But first-loss allocations are even an interesting option for established funds offering scalable and/or high Sharpe ratio strategies, as they do not incur them any additional costs and the risk of own losses is limited. 05/09

6 Equity markets % March % YTD MSCI AC World SMI SPI DAX EuroStoxx EuroStoxx 600 Price Index FTSE DOW Transportation S&P NASDAQ Shenzen-Shanghai CSI Emerging Market Nikkei Volatilität Commodities % March % YTD WTI-CrudeOil Brent Oil ThomReuters /JefferiesCRB Gold LIBOR % March % YTD Libor 6M CHF Euribor 6M Libor 6M USD Alternative Investments % March % YTD S&P Leveraged Loan TR Index Swiss RE Cat Bond TR Index HFRX Global Hedge Fund Index /09

7 Currencies % March % YTD EUR/USD USD/CHF USD/JPY EUR/CHF GBP/CHF CAD/CHF AUD/CHF JPY/CHF BRL/CHF CNY/CHF INR/CHF RUB/CHF TRY/CHF ZAR/CHF Countries / GDP %Q3 18 % Q4 18 % Q1 19 % Q2 19 % Q3 19 % Q4 19 % 2018 % 2019 % 2020 USA Euro Area Japan China Schweiz Countries / CPI %Q3 18 % Q4 18 % Q1 19 % Q2 19 % Q3 19 % Q4 19 % 2018 % 2019 % 2020 USA Euro Zone Japan China Schweiz /09

8 Rates in bps March in bps YTD 10j. USD (Swap) j. EUR (Swap) j. UK (Swap) j. CHF (Swap) Bonds in bps March in bps YTD US Govt 10Y GER Govt 10Y Swiss Govt 10Y UK Govt 10Y IT Govt 10Y ESP Govt 10Y Generic itraxx in bps March in bps YTD Europe Main Finl Sen Finl Sub X-Over Disclaimer This document was produced by Tellco Ltd (hereinafter referred to as Tellco ) to the best of its knowledge and belief. However, Tellco gives no warranty as to the contents or completeness of this document and accepts no liability for any losses that may arise through use of the information contained in this document. The statements made by Tellco in this monthly report may be amended at any time without notification. Barring any notice to the contrary, all amounts and disclosures in this document are unaudited. This publication is for information purposes only. It is not intended as a recommendation to invest or investment advice, nor as a recommendation to buy or sell financial instruments or banking services, and is no substitute for the requisite expert advice from a qualified professional prior to making any purchase decision, particularly with regard to the risks such a decision entails. This document may not be reproduced in part or in full without the express written consent of Tellco. In particular, this document is not intended for persons whose nationality or place of residence prohibits access to such information on legal grounds. 08/09

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Canada's equity market lagging world markets

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