30JUN08:
Oil to be USD200 by 30OCT08
USA Inflation to be 7.5% by 30OCT08 23APR08:
Next Rights Issue:
HBOS...yes
All & Lec ... 17APR08: Oil to be USD127 by 30SEP08
...16MAY08 losing my touch 27FEB08:
2 Banks go bust by 30JUN08
BS down, whose next? ... 20NOV07: Northern Crock to be sold for 15p
Nationalized 01NOV07: Oil to be USD103 EOM
...peaked too soon The Big Crash: 17OCT07
...well it's here 08OCT07:
SEC to fine Goldman for pricing issues
...still waiting 15JUN07: ML to buy-out BS
JPM got there first
Hedge fund crisis (hedgefund) Hedge funds should love a crisis. It is when market inefficiencies and mispricings are at their greatest. The current structured credit problems are nicely demonstrating the differences between good managers and non-skilled funds that simply exploited an unstable and temporary risk premium. Skill based, long volatility strategies are really the only fund management products likely to profit from market turbulence except perhaps government bonds.
Most public domain arbitrage strategies with a short volatility profile run into problems over time especially if leverage and illiquidity are involved. Two years ago we had a CB arb "crisis" and currently we have a fixed-income arb "crisis" hurting the beta bandits and helping the alpha dogs. Both offered money making opportunities to those managers with the capability to exploit them. Alpha is zero sum so the ONLY way to produce alpha is for other market participants to lose money.
It is important when picking investment styles to differentiate between skill-based and risk premium based strategies. I don't think funds dependent on simply exploiting a risk premium can be considered hedge funds. Many forms of credit and fixed-income arbitrage rely on such phenomena. The yen carry or positive yield curve trades are examples. Similarly with equities only a fraction of micro-cap or emerging market "hedge funds" actually are hedge funds; many are just playing the risk premium often exhibited by such assets during strong bull markets.
The core strengths of the alternative investment industry are strategy diversification and performance dispersion. With traditional funds if their benchmark is down, it is likely they are also down. It is unfortunate some investor capital has been lost through unjustified confidence in sub-prime linked credit products. This just confirms the need to identify proper hedge funds and even then put in only a small proportion of capital. For many investors that means quality funds of funds will probably be the best entry point. The 80/20 rule tends to apply here; only 20% of hedge funds are good and only 20% of funds of hedge funds are good at picking those funds.
In optimizing portfolio construction for alternative investments, I have usually found the maximum an investor should have in any one fund is 5% and therefore 95% in unrelated, independent strategies. Even if one accepts naive credit carry as a legitimate "hedge fund" strategy (which I do not), the most any investor would have lost from these CDO-linked meltdowns would be 5% of their TOTAL alternatives portfolio. If they have spread their bets properly they will also have money with other funds that benefit from the dislocation. That is the reason EVERY investor should allocate to short-biased equity and credit funds; even if the returns have been poor (so far!) the critical importance of negatively correlated strategies to managing portfolio risk should not be underestimated.
Most good hedge funds use quite low leverage, if at all. It is true weaker alternative investment products employing high leverage may blow up which is why due diligence is so important in determining that expertise and risk management are present. Rare event risk and massive losses are hardly confined to incompetent hedge funds. United Airlines, Worldcom and Enron and thousands of other equities lost all their shareholders' capital but that does not mean people should avoid ALL stocks just because some dropped 100%. Hundreds of dotcoms imploded a few years back losing several hundred billion for investors but Ebay, Amazon and Google and many others have performed well. Good hedge funds aren't going away any more than good technology stocks. The bear market of 1973/74 blew away dozens of long biased beta dependent "hedge funds" while George Soros, Michael Steinhardt and others thrived.
As a value investor I value strategies able to achieve consistent absolute returns at low risk. I think investors should be compensated for risk. When I look at a hedge fund I am looking for a margin of safety - performance should be much higher than the risk. Volatility is NOT risk but it is a useful first cut. Over time the S&P 500 has generated about 8% a year at 15% standard deviation so its returns have been derisory compensation for its risk. Most other equity indices and long only funds offer an even worse value proposition. Investors need products that give DOUBLE digit returns at SINGLE digit risk. 10%-14% a year at 5%-7% sigma is AVAILABLE if you do your homework. 30% a year at 15% vol is also fine but definitely NOT the other way around. Which is common sense - low risk, high return or high risk, low return?
Ideally performance is generated from securities that are liquid and frequently valued. Funds straying into illiquidity need to provide compensation for taking on that much less manageable exposure. Often it is weaker funds that wander into the minefield of things that hardly ever trade. The analysis get more complicated when a strategy is taking rare event or assumption risk. Several of the recent blow ups gave the appearance of low volatility due to investing in rarely traded, mark to model instruments. If there is a lot of leverage involved you have to look at whether the returns compensate for that gearing.
It is not in the nature of proper hedge funds to blow up, it is the nature of those who have useless trading models, baseless assumptions, don't understand complex strategies or proprietary risk management to blow up. It all comes down to experience in actually trading the strategies and due diligence in identifying whether the targeted returns are sufficiently high from the risks being taken. For illiquid, mark to model funds, 1% a month was woefully below the required return for any margin of safety in obviously hazardous long biased credit strategies.
Lending to the US government at 5% is not a bad bet but a higher yield from slicing and dicing sub-prime mortgages into allegedly bankruptcy-remote vehicles was not. Some neophyte investors place far too much reliance on "independent" agency opinions. Debt ratings are paid for by the issuer and most equity "ratings" are purchased by promises of investment banking business. Proper fund managers pay NO attention to what analysts think of a security and ignore ratings agencies. Just because Moody's or Standard and Poor's say something is AAA does not mean it is. There was nothing "High Grade" about those sub-prime mortgage concoctions.
It was absurd to assign a measure originally designed for rock solid government and corporate debt to the untested (till now!) financial alchemy of CDOs, CLOs and CPDOs. It is applying a fundamental metric to model-based credit structuring using wildly optimistic assumptions of default and recovery rates and correlations of different borrowers. Collateral is "sound" only if someone else will buy it at prices you "assume". If product structurers want to rate shop for a sellable classification that is their freedom but investors should ignore them. The only things "investment grade" are those assets whose rewards outweigh the risks. How shortsighted to gain a few hundred basis points for a while but end up losing 100%.
Just because MSCI, FTSE or Nikkei place a stock in their index does not mean it is any good. If a broker's cheerleader team (aka stock analysts and strategists) say something is a "strong buy" does not mean you should not short it. Morningstar putting 5 Stars on a mutual fund provides no information on whether to buy it. The "ratings" put out by various firms on hedge funds and hedge fund index construction are even worse. I have seen industry awards given to "top" hedge funds that weren't even hedge funds and some that imploded soon afterwards.
I am typing this watching the British Open golf championship. The Carnoustie effect is defined as "that degree of mental and psychic shock experienced on collision with reality by those whose expectations are founded on false assumptions." Sounds familiar with the current sub-prime CDO crisis demonstrating a classic reality check. A question to ask investment managers claiming to run a hedge fund, "What exposure does your strategy have to the Car-Nasty effect?". If the strategy assumes sunny market weather and normal distribution fairways, walk away.
There are other parallels between finance and golf. While everyone recognizes there are skilled golfers able to negotiate "random" Scottish weather some deluded souls continue to doubt the existence of skilled funds able to negotiate "efficiently" priced markets. Such skill MUST be in limited supply. Of all the people who have ever swung a sand wedge, few would be justified in calling themselves "golfers". Much fewer deserve to be considered "world class golfers". Similarly only a small proportion of "hedge funds" actually are hedge funds and fewer still are world class hedge funds.
The media sports pages focus on the stars while the financial pages focus on the losers. When academics study hedge funds they try to study EVERY product that says it is a hedge fund and bothers to report to a database. Hedge fund indices and "investable" hedge fund index funds are an even dumber idea than stock or bond index funds. The indexers would have you believe every large open hedge fund is worth owning! Even most legitimate hedge funds are avoids, let alone all the impostors and risk premium players. Can you imagine the average score at the Open if every "golfer" played?
It all comes down to doing your homework backed up by due diligence and advice from those who truly understand alternative investment strategies. And diversifying sufficiently so that possible negative performance of any one fund or strategy does not have a debilitating effect on your portfolio. Twenty hedge funds managing different strategies that have little correlation to each other is probably the MINIMUM number necessary.
Fintag says Who wants efficient, stable and smoothed out markets? Our long only friends who can pile in and out in an orderly manner certainly do. Long term holders are immune to volatility but that isn't real trading - its more a lucky judgement i.e Warren Buffet. Life is of course unpredictable and until we are all cloned to act in the same way, we will have irrational people buying and selling the wrong stocks at the wrong time.
Welcome to the ever increasing world of Hedge Funds. It is entrepreneurial, very difficult to pull off and if it works extremely profitable for investors and managers.
Stock market corrections - after an increase in the cost of debt - historically follow six months later, suggesting that the current rally on Wall Street and European bourses may be more fragile than it looks.
Wall Street sign, Morgan Stanley predicting correction The current rally on Wall Street and European bourses may be more fragile than it looks
A rise in the interest rate spread between risky debt and benchmark treasuries knocks away a key support for share prices by raising the cost of money for leveraged buyouts, but there is often a long delay before investors react.
A study by the bank found that credit spreads began to widen on average six months before every stock market correction of 10pc or more over the past 20 years.
The current widening began in February, picking up speed over the past three weeks. If history is any guide, this could point to a global stock market slide as soon as August. Morgan Stanley's model suggests a 14pc fall, or 2,000 points off the Dow.
"This is not the first time that equity markets take their time to react to bad news," said the bank's chief Europe strategist, Teun Draaisma. "The fundamentals have deteriorated. Equities have reached all-time highs despite higher rates, wider spreads, higher oil, Chinese tightening, and a stronger euro.
"There is a widespread belief in continuation of good global growth without inflation. While we are not expecting a recession for another two to three years, we believe chances are high that this belief will be seriously tested soon."
Mr Draaisma added that ever clearer signs of "stagflation" would soon start weighing on confidence.
The current pattern looks similar to the relentless rise in spreads from February to September 2000 when the stock markets finally tipped over. Mr Draaisma said the iTraxx Crossover index measuring risk appetite for high-yield bonds touched bottom at around 170 in February. It has since jumped to 320 - mostly this month - implying at 150 basis point rise in the cost of raising capital.
Morgan Stanley said the trigger for a stock market fall could be a sudden unwinding of yen "carry trade" from Japan, a major source of global liquidity. The Bank of Japan in expected to raise rates a quarter point to 0.75pc in August.
The worst stock market falls have been -58.4pc after the dotcom bust, -34.3pc in October 1987 and -30.8pc in a two-month shake-out after Russia defaulted in 1998, as measured on the MSCI Europe index.
Morgan Stanley said its "value indicator" shows that the median stock in Europe is now selling at a record high price-to-earnings ratio of near 20. This measure includes smaller and mid-size companies.
The price/earnings ratios on big blue-chip companies are much lower, hence the widespread belief that stocks are "cheap".
Mr Draaisma's study found that worst performing stocks at times of widening spreads are financial and industrial groups. Among the worst losers in previous bouts have been Man Group (-39pc), Swedbank (-38pc) and Barclays (-35pc).
The best defensive stocks have been consumer staples such as Carrefour (+41pc), Unilever (+41pc) and Nestle (+39pc).
Fintag says I don't know what it is about Morgan Stanley. They are such a mature, solid and clever outfit and show the rest of the pretenders (Useless Bank of Switzerland and Douche Bank especially) how an Investment Bank should be run. Goldman is just a prop desk pretending to be an Investment Bank, Citi is the M&A king but deep down is a retail bank, ING is a post office, JPMorgan is a spoilt child, CSFB a delinquent child, Lehman a surprised child and Bear Stearns is an arrogant bully.
Anyway, according to MS they believe the crash will be in late August.
According to the stars it will be 17th October, as heralded at the top of the web page for the past few weeks. I am never wrong.
Euromoney awards 2007
Best Hedge Fund: Citadel
Best Leveraged Finance House: Credit Suisse
Best Risk Management House: HSBC
Best Credit Derivatives House: Deutsche Bank
Best Structured Products House: BNP Paribas
Best Emerging Markets Debt House: Credit Suisse
Best M&A House: Goldman Sachs
Worst Blog: FiNTAG.com
Best Equity Derivatives House: Société Générale
Best Commodities House: Barclays Capital
Best Investor Services House: Northern Trust
Best Foreign Exchange House: Deutsche Bank
SPREAD BETTING
Is Alpha Spelled A-S-I-A? (allaboutalpha) Some time ago, we discussed the role of market inefficiencies - particularly geographically localized market inefficiencies - in alpha-generation. As institutional investors are well aware, it's extremely difficult to get an “edge” in highly-liquid capital markets such as that of US large cap securities. Thus, the prototypical example of a portable alpha strategy is to go long a manager operating in a less efficient market such as emerging markets manager, simultaneously short that manager's underlying (beta) benchmark, and use the proceeds to go long the S&P 500. This way, the resulting exposure would likely satisfy any mandate to remain exposed primarily to US large cap securities, while the opportunity for upside (or downside) existed via the emerging markets manager.
At midnight Eastern time, Alpha Magazine released the latest in its series of hedge fund rankings (available here). This one is a ranking of the 25 largest Asian hedge fund managers. Executive Editor, Michael Peltz tells us this ranking is unique because it covers Asian hedge funds, not just global hedge funds that invest in Asian capital markets (as most do).
According to Alpha, the top 5 Asian hedge funds are:
Richard Fan, founder of Singapore-based UG Investment Advisers tells Alpha that “for opaque, illiquid, and under-developed markets like China's, there is no substitute for local knowledge” and goes on to say that local hedge funds have a huge advantage over foreign competitors. Overall, Asian hedge fund managers now manage over US$35 billion, up over 50% since last year.
That's impressive growth, but not really that many assets compared the overall size of Asian capital markets. This is partly due to the fact that Asian regulators aren't big fans of short-selling. (As Alpha points out, short-selling is forbidden in China...apparently it's as “un-Chinese” as some have suggested it's “un-American”).
If short-selling makes markets more efficient, then by definition, Asian markets are relatively less efficient - making them a great place for a hedge fund.
With the recent opening of Asian offices by US and European managers (e.g. Tudor, RMF), we wonder how long it will be before these Asian managers get caught up in the global hedge fund M&A scramble.
Fintag says Asia = Volatility. That is why we love Asia. The big problem is that not all Asian markets are the same - most are easy to buy into but selling can be a real disaster story.
LOOK INTO MY EYES
Sen. Obama wows hedge fund crowd (thehill) At a dark-shingled mansion, one of many tucked along Washing Pond Road on this island's north shore, Sen. Barack Obama (D-Ill.) met a couple hundred of the nation's wealthiest Democrats at a $1,000-a-plate fundraiser on Friday to explain why he should be president even though he'll raise their taxes.
Many residents with summer homes here have made fortunes from private equity deals and hedge funds. (A local neighborhood association recently made national headlines by raising $25 million to combat beach erosion.)
The host of Obama's fundraiser, Louis Susman, sits on the executive advisory board of Edgewater Funds, a private equity firm based in Chicago, according to the firm's website.
But tax raises on private equity firms and hedge funds did not come up during Obama's visit, even though the candidate has proposed them.
“We need to close the loophole that allows managers at some large hedge funds and private equity funds to unfairly cut their tax bills more than in half by treating regular service income as capital gains,” Obama said recently.
Charlie Gifford, who works at Heritage Partners Inc., which bills itself as a “leader in private equity for family-owned businesses,” said he should have asked Obama about raising rates on money managers but didn't.
Instead, Gifford, an independent, said he came to hear Obama talk about international affairs and Iraq, and to feel out whether Obama would have credibility as president in the international arena.
“This quagmire is not going to be solved in the next two to three years,” said Gifford, who said Obama made a good impression. “He wasn't just talking about his bullet points.”
But Democratic proposals to increase taxes on private equity partnerships and hedge funds were, nevertheless, on guests' minds, said one participant who declined to give his name.
In response to a question, one donor leaned out the open window of his shiny new SUV to proclaim his hope that Obama would announce his opposition to raising tax rates on private equity.
Obama dodged an awkward moment at the fundraiser by talking about issues he and wealthy Democrats agree on, such as the need to improve education and focus on international diplomacy. Tax policy did not come up, said several guests.
But talk of policies targeting the super-rich threatens to spoil the taste of foie gras at fundraisers Democratic presidential candidates plan to hold between now and Election Day.
At the beginning of August, Sen. Hillary Rodham Clinton (D-N.Y.) has scheduled five fundraisers in the Hamptons, another summer playground of the rich, including many money managers from New York City.
Clinton has panned the tax benefits accrued by private equity firms and hedge funds.
“It offends our values as a nation when an investment manager making $50 million can pay a lower tax rate on her earned income than a teacher making $50,000 pays on her income,” Clinton declared. “As president I will reform our tax code to ensure that the carried interest earned by some multi-millionaire Wall Street managers is recognized for what it is: ordinary income that should be taxed at ordinary income tax rates.”
Former Sen. John Edwards (N.C.), who rounds out the top tier of Democratic candidates, also supports raising tax rates on private equity, even though he worked for a hedge fund after leaving the Senate and a review of his campaign records shows contributions from many donors employed by hedge funds.
The Democratic White House hopefuls have also proposed other tax increases for the rich. Obama and Clinton support repealing tax cuts passed under President Bush benefiting households who earn more than $250,000. Edwards has proposed rescinding the tax cut for those earning more than $200,000.
Yet Democrats have continued to raise millions of dollars from the nation's ritziest neighborhoods. Federal Election Commission (FEC) data show that Clinton raised more than $1 million for her campaign from people living in the 90210 area code of Beverly Hills. Forbes last year rated Beverly Hills among the most expensive zip codes in the country and once described it as “an entire neighborhood dedicated to conspicuous consumption.”
Obama has raised $880,000 from the 90210 zip code; Edwards has collected $315,000, according to FEC data.
A spokeswoman for Obama said it is natural for supporters to disagree with their favorite candidate on some issues.
“Everyone who is supporting Senator Obama doesn't support him on every single issue,” said Jen Psaki. “He can agree to disagree with supporters up and down the gamut — some may be wealthy and some may not be wealthy.”
A spokesman for Clinton highlighted her political courage.
“Senator Clinton's supporters know she is going to stand up for what she feels is right, and that's one of the things they find so appealing about her,” said Blake Zeff.
Colleen Murray, an Edwards aide, said: “People who choose to donate to Senator Edwards do so because his policies are right for America. In order to achieve our goals for the country, everyone has to sacrifice a little.”
On Nantucket, at least, wealthy Democrats were content to hear Obama talk about Iraq and race relations in the U.S. “People asked what he would do on the war,” said John Archibald after the event.
Archibald said Obama also touched upon the subject of race relations “many times” and mentioned the famous civil rights march in Selma, Ala.
Archibald said he would have liked to ask about taxing equity funds, but that Obama kept his talk short. “None of those questions were asked,” he said.
Fintag says All very well and dandy but is he going to tax Hedgies more? Just answer the question ...
NEVER
Blackstone Founder's $400 Million Windfall - From Their Own Shareholders (huffingtonpost) We'd all love to find an Uncle Sugar to fork over the dough we need to pay the income taxes we owe Uncle Sam. For most of us, alas, finding such a sugar daddy (or mommy) is only a pleasant fantasy. But Steve Schwarzman and Pete Peterson, the zillionaire co-founders of the Blackstone leveraged-buyout house, have realized that dream.
The two amigos, who knocked down a combined $2.6 billion by selling part of their Blackstone stake in the firm's recent IPO, stand to get cash payments that will cover most of the $400 million of capital gains taxes they owe Uncle Sam. Guess who their benefactor is. Give up? It's none other than the newly public company Blackstone Group LP (Charts).
No, this isn't yet another screed about how people who run LBO and hedge-fund firms are dodging taxes - the issue du jour in Washington. It's about how Blackstone's partners - and, it turns out, partners in some other financial houses that have gone public or plan to - have cut sweet deals for themselves with their public firms
The quarterly inflow of assets into the industry is the second highest on record, topped only by the $60 billion collected by hedge funds in the first three months of the year. As an investment class, hedge funds now manage $1.74 trillion, according to the research group.
Pension funds are the likely source for most of the money. While HFR gets its data from fund managers rather than investors, HFR president Kenneth Heinz said much of the money is coming from institutional investors either increasing their hedge fund allocations or starting to put money into the investment class. “We have no hard data on the nature of the investors, but we get a lot of inquiries from institutions, many of whom have just begun to make allocations to alternative investments,” he said.
Performance for the period was also strong, with the average fund returning 4.77% in the quarter. While some funds were hit by exposure to the subprime debt market, their losses were more than offset by gains on other strategies. The top-performing strategy was once again emerging markets, which returned 8.85% in the second quarter after posting an average 14.75% gain in the first quarter. Other macro-related strategies—of which emerging markets is one—benefited from the increase in absolute yield levels in the credit markets as well as a slight steepening of the yield curve. Asset inflows into the fund class rose from $2.16 billion in the first quarter to $6.9 billion in the last three months.
With fund-raising so far this year at $118 billion, 2007 will almost certainly surpass the record $126 billion raised last year. “We're conservatively projecting another record year for inflows,” said Mr. Heinz.
Fintag says Returns maybe poor but savvy investors know the best place for your cash when the markets turn down is in Hedge Funds (we hope ... fingers crossed)
USELESS BANK OF SWITZERLAND
Harris denies plans to push for UBS break-up (reuters) Money manager Harris Associates LP denied on Monday a UK press report that suggested it may pressure Swiss bank UBS AG (UBSN.VX: Quote, Profile, Research) to break up, saying it built up a $1 billion stake because it likes the bank.
"The purpose of this investment has nothing to do with being an active investor," David Herro, chief investment officer for Harris' international investments, said in an interview on Monday. "We think this is one of the premier asset managers in the world."
The Sunday Times of London reported that Chicago-based Harris had "secretly built a $1 billion stake" in UBS, which has "faced calls from investors and analysts to split its wealth management and investment banking divisions."
The paper did not directly say Harris was planning to pressure UBS to split itself up. But it did say "the break-up calls have gained support following the spectacular results of TCI, the London hedge fund, in agitating for the break-up of ABN Amro."
Herro said he does not believe UBS should split up. "We do feel the investment bank has a role in their business," said Herro. "It's complementary to their asset management business."
Harris Associates, which manages some $73 billion, holds about 14.7 million UBS shares as of March 31, according to a regulatory filing. Herro said the company started buying UBS stock in the past six months.
Herro gained fame as an activist in the UK when he successfully pressured for the ousting of the Saatchi brothers from the Saatchi & Saatchi advertising agency over a decade ago. But he said the activist move then was "by far the exception" and that the firm "is generally passive" in its investment approach.
Fintag says Well of course they would!
COOL
London vs. New York smackdown (cnn) Which city is the real financial capital of the world? In one corner, the IPO champion and derivatives king. In the other, the investment-banking titleholder. The battle isn't over - and new contenders are vying for a shot
By Peter Gumbel, Fortune
(Fortune Magazine) -- To understand why London thinks it's beating New York in a race to become the financial capital of the world, walk across the Millennium Bridge toward St. Paul's Cathedral and count the number of cranes that clutter the skyline. The City, London's financial district, is in the midst of its biggest redevelopment boom since the Blitz, one result of the $100 billion in foreign investment pouring into the British capital annually.
The money is coming from the Middle East, Russia, India, China, and the U.S., and it's padding wallets, filling restaurants, pushing real estate prices through the roof, and fueling a feeling of self-confidence that spreads from coffee shops to Mansion House.
That's the ornate official residence of the Lord Mayor of the City and the scene of an annual black-tie dinner for bankers. This year's banquet in June seemed more like an Olympics celebration (yes, London beat New York in landing the 2012 games) as Gordon Brown, just days from becoming Prime Minister, rose to declare victory.
"Today over 40% of the world's foreign equities are traded here, more than New York," he said. "Over 30% of the world's currency exchanges take place here, more than New York and Tokyo combined. And while New York and Tokyo are reliant mainly on their large American and Asian domestic markets, 80% of our business is international." This is an era for London, Brown boasted, "that history will record as the beginning of a new Golden Age."
New York is hardly in a Dark Age. But by comparison it seems stricken with self-doubt. Mayor Michael Bloomberg and Senator Charles Schumer commissioned a McKinsey report earlier this year that highlighted weaknesses in the city's position as a financial center, including too much litigation and heavy-handed regulation, and warned that New York will lose its global preeminence in a decade if they are not addressed. Governor Eliot Spitzer has convened a blue-ribbon commission to figure out solutions. In Washington, Treasury Secretary Henry Paulson is calling for significant changes aimed at strengthening the competitiveness of U.S. capital markets, and Christopher Cox, chairman of the Securities and Exchange Commission, is talking bluntly about the need for the SEC to rethink the way it works.
There's no shortage of evidence to underpin the contrasting moods in the two cities. Statistics about the amount of funds raised by foreign firms are especially jarring: In 2001, 12 of the top 20 global IPOs were listed in the U.S., according to Dealogic; last year, just two of them were. An upstart over-the-counter market in London called AIM raised as much in IPOs last year as Nasdaq. MasterCard is just the latest organization to publish a study, in June, which ranked London ahead of New York as the world's top center for commerce. Even Hollywood is getting in on the act: 20th Century Fox is reportedly basing the sequel to Wall Street, the hit 1987 movie in which Michael Douglas declared "Greed is good," in London.
How come? The view from the British capital is that while New York has been riding the now faltering U.S. economy, London is riding an even bigger tiger, the booming global economy. While the U.S. is weighed down by the 2002 Sarbanes-Oxley Act and other post-Enron financial regulation - so the argument goes, although it's far from clear that the controversial act itself is the main problem - London has put in place a new, lighter, and altogether more flexible regulatory approach that makes it easy to do business, regardless of nationality, currency, or accounting system. While the U.S. built walls after 9/11, London is wide open and welcoming, notwithstanding its own concerns about terrorism.
The U.S. has class-action lawsuits, frivolous or otherwise, that act as a deterrent. Britain has a fiscal system that attracts well-heeled foreigners. (Residents not officially domiciled in Britain are taxed only on their British income, not their worldwide earnings.) "It's going to be very difficult for New York to get back into the game," says John Ross, financial advisor to London mayor Ken Livingstone. Only half-joking, he adds, "Someone said the other day that all New York needs is a total change of the U.S. political system and a total change of the U.S. legal system." So is this triumphalism justified? Is London really beating New York at its own game? The short answer is yes, in some ways, but in other ways, not at all. London has become a magnet for firms from emerging economies looking to raise capital and is the most important financial center in Europe. In fields including over-the-counter derivatives, foreign exchange, and metals trading, it has taken a worldwide lead. And it is catching up in private equity and hedge funds - 21% of global hedge-fund assets are now managed out of London - pumping new wealth into Mayfair and St. James, two smart West End districts that used to house the British upper class. New York still towers over London in the total amount of funds its firms manage and in the size of their compensation packages, but Gotham is discovering for the first time that it is not indispensable. As capital flows become global and competition heats up, it needs to fight to retain its role.
Yet not everything is going London's way, as financial markets adjust to a fast-changing world. Just ask Henk van Dalen. He's the CFO of TNT, a $17.4 billion Dutch mail and express-delivery company that announced in May it had decided to end its listing on the New York Stock Exchange. Several other big European firms, including British Airways, have also taken advantage of a change in SEC rules that makes it easier to delist from U.S. exchanges. TNT says it can satisfy its current and future capital requirements outside the U.S. and that it made the decision "after taking into account the regulatory, legal, reporting, and governance complexity" of maintaining a U.S. listing.
But in this case, New York's loss wasn't London's gain. TNT had pulled its listing off the London Stock Exchange a year earlier and is focusing all its efforts on its home market of Amsterdam. TNT still depends on international investors, especially U.S. institutions, but in these days of electronic trading and increased investor sophistication there has been an important shift. "Most investors now buy their positions in Amsterdam," van Dalen says, "so there's no need to be listed elsewhere. It's just a cost burden."
TNT isn't alone. Since 2000 the number of foreign companies listed on London's main exchange has dropped by almost 200, or 40%, and some of those withdrawing, including Nestlé and Nokia (Charts), have done so for the same reason as TNT: At a time when capital markets have become increasingly global, large firms can be selective about their geography. Even lesser-known firms such as Poland's Millennium Bank are pulling out. It says most of its stock trading takes place in Warsaw.
The reason London's IPO numbers look so good - and New York's, by comparison, so poor - is that the British capital has been nimble in attracting hundreds of smaller firms from around the world, including the U.S., to its less prestigious markets, especially the AIM exchange. It has also moved aggressively to capture listings from firms in Russia and other former Soviet republics. About 17% of London's IPO volume last year came from the flotation of Rosneft, a Russian oil company that became the country's biggest by acquiring the assets of Yukos, a private-sector rival driven out of business by the Kremlin.
For the moment Chinese entrepreneurial firms still seem to prefer New York as the place to get their international exposure, while Indian firms split down the middle. It can get complicated: One of the big New York Stock Exchange IPOs this summer was of Sterlite, the subsidiary of an Indian company that is listed in London.
The battle is far from over. In fact, it's just heating up. NYSE and Nasdaq are moving aggressively to extend their global reach through mergers with London's European rivals. They are being helped by the SEC's recent acceptance of International Financial Reporting Standards that differ from U.S. Generally Accepted Accounting Principles and by an official clarification it issued in May relaxing the costliest and most controversial part of Sarbanes-Oxley, Section 404, which requires that outside auditors monitor internal controls. Senator Schumer is relieved. "We feel very good about the progress," he says. "It'll be a big shot in the arm for New York."
In some ways, however, casting the shifts in global finance as a battle between New York and London is missing the point. Much of the expertise and part of the money helping fuel London's boom is American. Four of the top five dealmakers in Europe last year were U.S. investment banks, and KKR was easily the most active private equity firm. Moreover, U.S. institutional investors are buying a significant share of the stock offerings in London and elsewhere in Europe through private placements that bypass SEC regulations and that now dwarf IPOs in volume. Last year about $40 billion was raised on NYSE in public offerings; so-called 144A private placements, by contrast, raised a total of $137.7 billion, or more than three times as much.
"London has a creative energy that far outstrips its international infrastructure," says Hendrik du Toit, chief executive of Investec Asset Management, a South African firm. "Yet the U.S. capital market is still half of the world's money, so you can't avoid it if you want to do big things."
The real question facing New York and London is not about which city is winning a two-way race but how both can position themselves to continue prospering even as a legion of wannabe financial centers around the world try to grab that international business. Those are places like Mumbai and Shanghai, but also Warsaw, Dubai, and São Paulo - all growing fast in both volume and sophistication. That's the story the big international investment banks are monitoring closely. "New York has had its day, London is having its day, and Shanghai and Dubai will emerge," says Michael Philipp, who runs Credit Suisse's business in Europe, the Middle East, and Africa.
Jonathan Chenevix-Trench, chairman of Morgan Stanley International, agrees: "There's a natural and inevitable tilting away from New York because the world is more global. But it's absurd to call London the global financial center. We'll end up with an orbit of perhaps four to five dominant centers and some key ancillary ones around them."
How quickly that happens will probably depend on what happens to the global economy. One of the dangers to London is that it has become so reliant on international flows that it's particularly vulnerable to a downturn. Dominic Rossi of British fund manager Threadneedle Investments reckons that any significant correction in world capital markets "will hit London instantly - and we're talking about days not weeks." Jim Gollan, chairman of electronic exchange Virt-x that trades Swiss blue-chip stocks, concurs: "It's always worth remembering Warren Buffett's dictum that it's only when the tide is out that you can see who is swimming naked." The front line in the battle for global IPOs runs through Rue Cambon in Paris, near Place de la Concorde. This is where Catherine Kinney, who oversees the listings business for NYSE, has her new office. As of July she has been based in the French capital, one of the changes arising from the Big Board's merger this year with Euronext, the French firm that groups the Paris, Amsterdam, Brussels, and Lisbon bourses. The combination is supposed to provide a range of options to companies looking to go public. One of the big selling points is the "SOX-less" listing: the opportunity to be on a market affiliated with NYSE but not policed by the SEC or subject to Sarbanes-Oxley corporate-governance rules. Nasdaq is trying to pull off a similar feat with a proposed merger with Stockholm's OMX, which groups seven Nordic exchanges.
Listings have become a huge focus of attention in the New York vs. London battle, unlike, say, derivatives, because it's easy to add up the numbers and see how New York is losing. One chart in the McKinsey report speaks volumes: It shows that the U.S. accounted for 57% of IPOs valued at more than $1 billion in 2001; in 2006 that share was just 16%.
Kinney flips through a presentation she has just given to the board. One slide highlights the value of stocks traded daily on NYSE and Euronext together. It is almost triple the volume of the London Stock Exchange. Another boasts that 79 of the world's 100 largest public companies have their home on NYSE Euronext. Then comes the slide marked "The Center for Global IPOs." It's rather less convincing: Measured by the total capital raised, NYSE narrowly beat London in 2006, but that's only by including Euro-next, which it didn't own. And the U.S. missed the three biggest offerings of the year - Rosneft in London and two Chinese bank IPOs that went to Hong Kong. "It's clear that the U.S. has lost some ground," Kinney says. "The regulatory environment in the U.S. has made it less competitive."
Across the English Channel, in London's Paternoster Square, Tracey Pierce turns the same argument to her advantage. Pierce is in charge of international listings at the London Stock Exchange. When she and her people are on the road pitching to prospective companies, she says, they always start by stressing the advantages of a London IPO. Only then do they stick the knife into New York. "We believe in the highest standards of corporate governance, but we have a principles-based model, which is more flexible than one that is rules-based," she says. What she means is that the London regulators, unlike the SEC, do not impose a one-size-fits-all regime on prospective listing companies. She's unmoved by the recent U.S. initiatives to tinker with Sarbanes-Oxley requirements. For New York to fight back, she says, "they would have to make large headway in repealing or diluting these rules and regulations, and I don't see much political will for that."
How big a deal is all this for listing companies themselves? That depends on what they're looking for. When Chinese solar-power company Suntech Power decided to go public in 2005, chairman Shi Zhengrong had no hesitation about picking New York, because he hopes the U.S. will become an important market for the firm's products. Yes, complying with U.S. regulations costs a bundle. But being able to meet the stringent standards makes Suntech shine. "It's good for companies to have strong internal controls," Shi says. "It helps them live longer, and we want to live to be 100."
For Kishore Lulla, by contrast, New York was never an option. "The general consensus is that a U.S. listing is more cumbersome than a London one," he says. An Indian, he runs Eros International, a Bollywood movie-distribution company that does a lot of business in the U.S. But he had no hesitation about listing on AIM last year. "London was the obvious choice," Lulla says. "It's the financial capital of the world."
AIM is a big selling point for London. It focuses on small and midsized growth companies that have difficulty raising capital in more established markets. Listing is a deliberately simple procedure, with no prospectus, no minimum float, and no financial history required. AIM firms aren't even subject to the Financial Services Authority, the London regulator, but instead are vouched for by an approved financial firm known as a "nomad," or nominated advisor. If something goes wrong, the nomad's reputation is at stake. Big Board CEO John Thain and others in the U.S. grumble that regulatory standards are too lax, but so far the number of failures is in line with more regulated markets.
Liquidity is a bigger issue, as Aqua Bounty, an aquaculture biotech firm in Waltham, Mass., that makes a feed additive for shrimp, has discovered. Aqua is one of 63 U.S. firms on AIM, and CEO Elliott Entis says he is "very pleased" with the listing, which raised $40 million. "When you try to work with Wall Street, you get 15 minutes to tell your story, and very few firms are interested in the size of the deal that interested us," he says. "You get a better opportunity to tell your story in London." But Aqua's stock is so thinly traded that when one big investor sold its stake, the price collapsed. "I would be upset if we were looking for a follow-on listing," Entis says, "but we think that over time the price will recover."
Nasdaq, which failed in its bid to acquire the London Stock Exchange last year, has taken the hardest beating from AIM but claims not to be fazed. "Those $5 million to $10 million companies - we don't do that in the U.S.," sniffs Charlotte Crosswell, who's in charge of global listings for Nasdaq. Instead, the exchange is going after the much larger 144A private placements by creating a new trading platform for them. NYSE is taking the competition from the small fry more seriously. Through its merger with Euronext it can now offer a European small-cap listing that directly rivals AIM, although the regulatory rules are slightly more stringent. London isn't sitting still either. Last month it agreed to acquire the Italian bourse and, working with authorities in the City, has been spreading the word about its advantages. In the past year big British delegations have visited China and India. Next up: Brazil. "We are targeting the cream," says Pierce.
***
London hasn't always been so cocky. In the 1990s, in the aftermath of scandals that included the collapse of BCCI and Barings Bank, it worried about losing its preeminence in Europe to Frankfurt, the German financial center that became home to the European Central Bank. Canary Wharf, built as an alternative to the City in the East End Docklands, even filed for bankruptcy. Today it's bursting, with an occupancy rate of 96%.
Howard Davies says a key to London's changing fortunes was that it deliberately geared itself toward attracting international business. He's dean of the London School of Economics, and he played a major role in regulatory reforms in the late 1990s as head of the FSA, the single London regulator that emerged from that era for banking, insurance, and all other financial activity.
"The whole mindset here is that international business is an important part of the national economy," Davies says, "so we'd better make sure the regime is conducive to it, or it might go away." Until recently, he says, that attitude has been absent in New York and Washington. But it's changing. "I don't expect Goldman Sachs to close down in New York, and I don't think properties in the Hamptons will plunge in price," he says. "The two markets will coexist comfortably for some time to come."
That may be true, and there's no guarantee that the current self-confidence in London will last forever. But the City is sure of one thing: It has found the magic formula for today's increasingly global capital markets. It has opened up to the world, and the world has come flocking. The question is how long it will be before New York and a host of other cities follow suit.
Fintag says Has Peter Gumbel actually been to London? Reading this is sounds like he looked at a few photos on Google and checked out Wikipedia.
Well I guess the USD, being a third world currency, makes it too expensive for a trip to the world's leading Financial Centre.
London is inclusive; New York is exclusive. That is why New York is in decline.
Even so, I would still prefer to work in New York. London is flooding ...
There is certainly a strong case to support the argument that equity long/short strategies can produce superior risk-adjusted returns compared with conventional (long-only) equity funds. Therefore hedge funds display better capital preservation qualities than traditional equity managers or indices as they can provide a steady trajectory of returns through a variety of market conditions.
The article suggests that, based on various studies, investors should replace their long equity exposure with equity long/short funds to enhance their risk/reward profile.
Such an approach looks compelling, but fails to quantify the enormous dispersion of returns between the best and the worst long/short managers, the significant operational risk inherent with unregulated offshore vehicles and the possibility of restricted liquidity through lock-in periods, exit fees and other mechanisms.
By all means please put forward hedge fund strategies as alternative ways of running money, but let us not forget the limitations too.
Jason C. Day,
Director Private Client Services,
Allenbridge Group,
London W1J 5NZ, UK
Fintag says Consultants spoiling the party as usual.
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Who wants efficient, stable and smoothed out markets? Our long only friends who can pile in and out in an orderly manner certainly do. Long term holders are immune to volatility but that isn't real trading - its more a lucky judgement i.e Warren Buffet. Life is of course unpredictable and until we are all cloned to act in the same way, we will have irrational people buying and selling the wrong stocks at the wrong time.
Welcome to the ever increasing world of Hedge Funds. It is entrepreneurial, very difficult to pull off and if it works extremely profitable for investors and managers.