2012: A year of potential excessive returns

As we come to the end of 2011 there appears to be ample of opportunities for 2012 to be a great year for large returns. I say this from a macro perspective. Many hedge fund managers have struggled in 2011 trying certain obvious trades that have not worked. Probably the most popular trade that has not worked is to short the Euro verses commodity based currencies (i.e. Australian and Canadian dollar). I have tracked my hedge fund compatriots throughout 2011 on their endeavors to make money from this fundamentally sound trade. Many have failed as they have tried too aggressively to enter this trade, only to have cover their short position on excessive daily volatility. The largest problem with this trade was the simple technical factor that the trade was crowded, i.e. everyone shorting together. In fact I credit the fact that I have avoided crowded trades in 2011 as one of the main reasons I have outperformed my peers.  As 2011 comes to the end I sense most portfolio managers are giving up on this trade. This is exactly why I have started to build a position and thankfully it has started to show positive signs. It might be thought this trade is exploiting the demise of the Euro. Even though this is true and it would benefit, it is actually Euro survival neutral. If the European politicians do come with an answer to restore market confidence, that answer must include a lower Euro. Why? Simply it is twofold: Europe has to export it way out of a potential recession and to solve the credit issues it must print more Euros. The problem is the rest of the world including the US also has the same tactic. In order for Europe to compete it must have a lower value of the Euro to remain price competitive. I believe by the time most market participants will regain the belief in this trade, a canny investor can already be holding a position with a large return. This is just but one of the apparent opportunities developing which is making 2012 look like a great year from a return potential.

Power to the People

When a company has difficulties it takes creative thinking by its managers to cut costs and increase productivity to ensure survivorship. Running a country is no different. That is why we need to think about radical policies at the national level to help the western world out of its predicament. To me one solution that has not been thought of is to reinvigorate the consumer i.e general public. A radical way to achieve this would be, instead of writing down national debt, to write down private individuals debt. If a nation wanted a direct policy to increase consumer power they could invest money in writing off a percentage of consumer debt. Governments would repay lenders, which are predominately banks, a percentage of private consumer debt. This would overnight effect the mentality of individual consumers who would immediately become wealthy. Austerity taxes  could remain for a period, these would be less of an issue on individuals, who have reduced debt levels, and would allow governments to reclaim this investment in realistic time frame. From a philosophical and sociological standpoint some may argue that this would be incorrect. However given a world where the average tax payer is paying for mistakes of their own doing as well as companies, banks and governments mistakes, I believe it is actually a positive action from a sociological and philosophical level. Society would feel less aggrieved with the financial system and the institutions that are its constituents. Then appropriate controls could be placed to prevent the same over-extension of credit ever taking place again. I have even thought of how to implement this in a nation like the UK. Yes this is radical, yes it is a solution that could contain some negative behavioral effects but what it amounts to is putting faith and responsibility back to ordinary people. If governments can trust their public by giving them this responsibility to act in the new world in a disciplined manner, I am sure the public would show the politicians that trusting the people is far more efficient than trusting other politicians and bankers. Power to the people is not activism but a road to a happier and prosperous society.

Making Money - Its all about Risk Management

As we come up to the end 2011 I always like to reflect on how I have done in terms of my trading. One thing for sure the markets have been a tough challenge in 2011 due to their volatility but lack of direction. So as I analyze my performance ,which thankfully is +20% for the year, I like to identify what has and has not worked. Surprisingly to some I am not that happy with personal performance. I have spent time this year being out of step with the markets rhythm and other times dancing like late and great Michael Jackson to the music of the markets. The main factor why I have produced a positive number is due to to my risk management. Its all about my average payout ratio, i.e. my average win amount compared to loss amount. it averages just below 3:1. This means on average I have made 3 times more on my winning trades than my losing trades. This style of trading means you have to at times take a number of small losses. Most portfolio managers are not able to do this as psychologically they can not handle being incorrect over 50% of the time. However this form of risk management allows me to have a year like 2011 where I have been wrong numerous times, on occasion dancing like a hippopotamus to sound of the markets, and still produce a double digit percentage return. You see its all about risk management. You must respect the markets. Setting the right stop levels with the right size positions is the key. That is why I can be critical of myself but still outperform for my clients.

The Shift of Power

When this crisis first started the immediate analysis by main investors was that there will be a shift in global power to China, other parts of Asia and certain other emerging markets at the cost of the US. As I look at this 4 years later I believe the emerging market rise has started to become true. However it has not necessarily been at the expense of US but Europe. European politicians handling of the debt crisis has managed to create such global stress due to their inability to make firm decisions that other regions view of Europe leadership has declined. China in particular has changed their view from Europe being the most important western global partner to a much lesser standing. In fact China has recently indicated that they have become much comfortable with an economic relationship with the US rather than Europe. China's way of showing this has not been by words but by actions. Rather than continue to increasingly buy European debt that have started to increase their percentage of buying US debt at the expense of Europe. This could well be a response to European politicians playing a hard line with China over special conditions for buying their debt. These conditions were ultimately aimed at China requesting more power at the international economic stage, especially within organizations like the IMF.  Europe have decided not to bow down to China. Lets hope they do need to renegotiate for China will be even more demanding next time.

Euro: A failing friendship

As we witnessed today in the bond market, France is now starting to be hit with the European contagion as they sold debt at historical highs since the creation of the Euro. Demand for these bonds also fell as measured by the bid to cover ratio. Political comments coming out of France is again putting on the agenda the ECB role as a lender of last resort. Within 30 minutes of this statement Germany responded via Merkel clearly stating that Germany does not believe ECB is mandated to do this. It is understandable why this point will lead to a strain on the German-French relationship. France and Sarkozy need a quick remedy. With elections around the corner Sarkozy's winning ticket is how he has handled the debt crisis in Europe. If France is beginning to struggle to refinance its debt this will devalue this argument. Germany as the biggest shareholder in the ECB and therefore as the biggest monetary contributer is reluctant to give an increased balance sheet to the ECB without the proper infrastructure in place to monitor and manage borrowing countries. Germany also suffers from the fact that the governments mandate to act on European issues is weaker as they have never allowed the German people a proper vote on their position in Europe. This is ultimately causing a strain on the friendship. Another way to view it is as a business. When the two most powerful executives in a company in trouble disagree it tends to start as tension that eventually leads to the company suffering and sometimes not surviving. It is essential for market psychology that somehow France and German resolve their issues and unite.

The key to trading this market: trade structure

There is no doubt that November is providing ample opportunity in many asset classes to profit. However most managers I speak to are not making the most of it. Why? Simple its all to do with trade structure. The markets intraday volatility at present is extremely high. This means that in order to profit by get your direction right an investor must have time their entry to a trade extremely well or set a stop loss that allows enough room to handle this daily noise. The real key is to structure trades that minimizes this noise or in other words avoid the over crowded obvious trade. Let me give you a simple example. Lets say your analysis is that the euro should weaken against sterling. Putting on a short EUR/GBP trade would be entering a market where the daily volatility is high due to the amount of professional market practitioners trying the same trade. However due to the Swiss National Banks policy of pegging CHF to the Euro, a less crowded way to exploit this view and have the Swiss National Bank on your side is to go long GBPCHF. This methodology of lateral thinking in trade structure can be applied to all markets and asset classes.

EURO: The death of democracy

My father use to tell me that desperate men are capable of doing desperate things and lose all sense of their worth. Its shame my father never had the chance to give this lesson to Ms Merkel and Mr Sarkozy. Both these leaders of Europe have encouraged democratic elected governments to be replaced by unelected "technocratic"governments. "Technocratic" can be translated as they will do what the ECB, IMF, Germany and France tell them to . The leaders of Europe have decided that democracy in Europe was the problem of the debt crisis so they would choose who should run certain nations for this extraordinary period. While Merkel keeps stating she is fully committed to the European project what she actual has done is start the process of the destruction of the Union not just the Euro currency. Simply the European Union main rationale for forming was to avoid another European World War, i.e. to consolidate defenses. Also free trade was a main founding block to bring European nations together. The actions in actively removing two democratic leaders are completely inconsistent with these founding principles. I doubt if other European leaders inside the Euro rejoiced at last weeks events. Not only has trust disappeared but now the door is definitely wide open in the up and coming national elections for a far right or left government to take the anti-European card. The Chinese must find this amusing. I think Germany and France have lost any credibility in using freedom of individual rights argument with the Chinese. At least the Chinese have enough honor to admit they have a dictatorship. And what makes it even worse is that the problem with the Euro has nothing do with what government or individual is leading the country but has all to do with an inadequate infrastructure. There needs to be a centralized European lender of last resort, there needs to be greater tax harmonization, there needs to be more centralized power. Treaties need to be changed but also the people of countries need to vote on this. The fact that the German people were never allowed to vote originally on the Euro probably infers that there is more historical anti-Europe feeling within the key nation for Europe's survival than an outsider might suspect. Can the Euro be rescued? Yes, but not by ignoring the mass populaton. The public must be properly informed about the advantages of a united Europe and what sovereignty they need to give up for it to work and then be left to democratically vote. Anything else will eventually lead to revolution. I can only explain European leaders actions as those of desperate men, which tells you just how bad the situation is. Maybe in Merkel's case it can simply be explained as the love and infatuation for her mentor, the ex-Chancellor Kohl, and defending his creation. As a hedge fund manager I see opportunity. Every action has a reaction...

OK Lets talk about the Euro

I could not have a picked a better day to explain how a hedge fund manager thinks, rightly or wrongly, about the Euro and the opportunities to make some potential gains. Yesterday we saw Euro sell off over 2% as finally the realities of the European single currency in the wake of a debt problem became apparent. The interesting thing is I don't think many managers made money yesterday. Most traders have tried all year to sell the Euro but unsuccessfully. As ever this move came just as most people I talk to have said that they were giving up trying to sell it. It was for exactly this reason that I had last friday sold some.  Today we are seeing the Euro gain ground and now the rest of the investment community, those who missed the boat yesterday, have to decide whether they want join in the selling at a decent level or believe the politicians can come up with a quick solution to restore market confidence. Obviously given my actions last friday I believe the Euro must devalue. Here is my rationale: this is not about blaming Greece or Italy, even though the one thing they do have in common is an inability to collect taxes from the ultra rich. This is about the poor foundation the Euro was originally built upon. Firstly there was never enough sovereignty given from the members of the single currency to allow it to survive in stressful times. A central powerful institution who is a true lender of last resort is required. Also the existing legislation is inadequate to allow for the flexibility that is needed.  Secondly lets presume that this can be addressed now comes the biggest problem: what would be the correct monetary an fiscal policies to employ given the vast cultural and economic cyclical positions of each individual country. Ok let me explain because that sentence sounded like I was an academic or worse an economists. Lets look at two different countries Germany and Greece. Germany economy is doing OK in hard times, it has benefitted from exporting to Asia as well as within the Eurozone. Germany biggest fear is inflation. Historically many blame inflation as the catalyst that eventually led to Nazi Germany. Greece on the other hand is going through a depression with decreasing growth and rising unemployment, now approximately 18%. Greece's biggest industry is tourism and that is the key to reviving the Greek economy. Therefore Greece needs a lower Euro so holiday makers will choose it as a location over non euro destinations. However the policies that are needed to consciously reduce the Euro in value would be seen in Germany  as inflationary. Question: what would an independent central all powerful European financial institution do? Who knows...So given that the task would be hard enough with the right political will backed by appropriate European treaties conferring sovereign power what chance does the Euro have without this? So how do we analyze todays market movement as Euro is up over 0.6%. Easy..its human nature. After yesterdays sell off it is only natural that today many market participants believe the move was "overdone". These participants tend to be short-term traders who sometimes miss the greater picture. This combined with other human attribute that it is a lot easier to believe the world is fine, that central banks are in control, rather than believe the world is completely economically messed up and market forces are greater than any political will makes it logical why today should be a positive day for the Euro.  What today does provide, and maybe the positive feeling extends for a few days, is a chance to sell the Euro again. For someone like myself who already has sold the Euro and is profitable it gives a greater chance to add to a position. This is how markets work. Its a combination of fundamental, technical and market psychology that provide for money making opportunities. At anytime one these three elements dominates but never do they dominate for ever. The key is either work out which one is prevalent or to work out which one suits you better and risk manage accordingly.

Independent Hedge Fund Directors: Bravo to Mike Powell of USS

One of the biggest concerns in investing in a hedge fund is the risk the manager does not keep to his mandate in investing and maintain operational infrastructures to prevent fraud. These concerns should be mitigated by the independent hedge fund directors. Mike Powell of USS has been highlighting this point recently in publications and articles. He is absolutely correct in his sentiment and his rationale conclusion that the quality of independent directors needs to improve. Practically this means an independent director must be experienced enough to analysis the strategy the manager of the hedge fund executes in order to assess whether they have kept to their mandate and have maintained sufficient controls to safe guard investors. On the latter issue I would suggest that valuation of investments is the most complex area that needs to be monitored. Unfortunately there are few independent directors that have the required knowledge to execute their duty of care. Independent directors are a closed club of individuals who either are just looking for a retirement salary or who only care about their fee and so take on far too many independent directorships. To this end a transparent register, as Mike Powell has suggested, will mitigate the over loaded director.  Independent directors tend to be recommended by administrators who lack the knowledge to assess whether the independent director is capable to execute his responsibilities. This role, which so many investors and managers alike seem to devalue, is key in building an industry that can be trusted and limit the amount of frauds like Madoff and Weavering Capital the industry has to experience. Hedge fund managers must embrace this role, make sure that the independent directors on the board of their fund are capable to challenge them. The result will only be a positive to their fund. It is for hedge fund mangers to drive this change as well as institutional investors. If you are new hedge fund manager or an established manager launching a new fund I challenge you to ensure the quality of your independent directors. If you do not know how to source these individuals contact me and I help.

Introduction

Hi and welcome to my blog. This blog intends to give its audience an inside perspective into the issues within the hedge fund industry, a managers perspective and the chance for anyone to respond. Its purpose is to engage its readers into the topics that confront the industry, read the truth on the thoughts and actions on how the industry is responding to these topics and to hear from others what they think. I never wanted to be a blogger but I feel that there are so many misconceptions about investing in hedge funds that from all parties concerned a forum is needed that is completely honest and transparent. Sometimes the blog will be opinionated. That I believe is natural given that as a hedge fund manager I am paid to be opinionated. I am also paid to change my mind when I am incorrect and reverse my initial view. So I look forward to being challenged....

P.S. Will there be information regarding investments? Yes, some discussion will be based on investments ideas but never in specific details. The clients of my firm will be the only people that benefit from my specific investment actions. However general investment themes can easily be discussed. These discussions will probably not lead directly to profit without the skill of knowing when to buy, when to sell and in what quantity. These are the elements of skill of hedge fund managers that can make them an extremely profitable investment.