The global thirst for yield has spawned a familiar, if alarming, trend in the hedge fund space. In order for banks to better sell Triple A CLO tranches, and for hedge funds to make better returns, the pairing has come up with a new plan. Banks are now lending money to hedge funds so that the money managers can buy Triple A CLO tranches back from the banks. The trade helps hedge funds magnify returns through leverage and helps banks dispose of hard-to-sell assets. Such high quality tranches generally have relatively low yields, which has long kept hedge fund investors out of the space, but with the new ability to add leverage and magnify returns, the segment has become attractive. Many are sceptical of the new trades, saying they are highly risky carry trades that will prove hard to exit and could unwind in several ways. One high ranking banker says that there is way too much supply on the issuance side because of the reach for yield on the buyside, meaning lots of low quality CLOs are being offered.
FINSUM: This sounds like old-fashioned pre-crisis “risk-on” leverage that is buying into complex assets. Hopefully, if rates are raised rationality will return to the market.
After a months-long court battle and a failed appeal to the US Supreme Court, Argentina has officially been ordered by US courts to pay the $1.5 bn in debt it owes to creditors. Argentina had pleaded with the Supreme Court to hear their case on the basis that previous courts had misread their bond agreements and thus violated their sovereign immunity, but the Supreme Court declined to hear the case. That means that Argentina must pay the $1.5 bn before it is allowed to pay money owed to other bondholders. The situation also sets a dangerous precedent for Argentina and other borrowers as it shows that “holdout” creditors can win cases and be paid in full, therefore, potentially lowering the incentive to participate in debt restructurings in the future. 93% of Argentina’s creditors participated in debt restructuring plans, but the remaining 7% will now be repaid in full. Argentina’s next interest payments are due on June 30, so the $1.5 bn will need to be paid before then.
FINSUM: This story does have interesting implications for debt restructuring everywhere, especially in light of Europe still working out its debt issues. Why would one now give-in to restructurings if they have a good chance of being paid in full?
The results of a major ten-year academic study at London’s Cass Business School Pensions Institute have been released and offer some sobering insights into investing. When taking account of fees, just 1 in a hundred managers, or 1.4%, actually beat the performance of their index. The study looked at the performance of 516 funds over ten years, and found that only 1.4% delivered any value to investors. The results mean that investors would have been much better off had they simply parked their money in low cost ETF or tracker funds which simply mirror the benchmark index. Despite the findings, which build on several others released over the past few years, active management, where “star” managers are paid to pick stocks, remains by far the dominant style in the investing landscape. The paper also concluded that large funds tended to underperform smaller ones because of the way that large capital bases boosted asset prices and lowered yields.
FINSUM: Because of previous headlines, it likely surprises no one that active managers get consistently outperformed by their benchmarks, but the degree to which this is true is startling.
Details are slowly emerging about a potentially large credit-related fraud found within China’s metals industry. It has recently emerged that copper and aluminum stored in China’s busiest port, Qingdao, may have been used multiple times, by multiple companies as collateral for shadow bank credit. Warehoused metals are often used as collateral for loans in China, especially since the country tightened it lending rules, but it appears many companies have pledged their metals more than once, meaning there is many times more credit extended than metal in existence. Standard Chartered and Standard Bank are both potentially involved in the practice, and the latter is launching an investigation into the practice. Last year, the collapse of an East China steel trader revealed that the company had pledged its metal multiple times, leading to its bankruptcy. Up to 20,000 tonnes of copper and 100,000 tonnes of Aluminum have allegedly been pledged multiple times.
FINSUM: Depending on how widespread this practice is, it could cause major problems to the shadow banking sector as many of the loans are much more risky than previously thought. This is a story to keep an eye on.
Just as the UK suffered from the Libor-rigging scandal and then worked to regulate the market, UK Chancellor George Osborne has announced that the government is moving to regulate the $5 tn per day foreign exchange market as the price fixing probe goes ever deeper. The UK Treasury is working with the International Financial Stability Board and seeks to “clean up” the market by introducing more transparent pricing and electronic trading, as well as making manipulation of the market a criminal offence. The move has been sparked by the current probe into market manipulation that has already engulfed 40 dealers and investigations in a half dozen countries. London is home to the largest foreign exchange market in the world.
FINSUM: It sounds like the government is set to come down tough on the “wild west” forex market. Banks can likely expect margins to shrink and volumes to diminish alongside regulation.