Hedge Fund Titans - The Good, the Bad and the Ugly...

Ok I am biased.  I have been associated with the hedge fund industry since the early 90's. In the early days I was a complete believer in true active portfolio management verses long only asset managers who were glorified benchmark huggers. I was proud to work for a hedge fund manager, trying our best to make money for our clients. We were driven by passion of investing in an unconstrained manner. I guess we were too successful; as our returns compounded investors money verses the equity market more money flowed into the industry and more institutional clients came. This growth led to our industry developing a breed of hedge fund titans, most were great investors or traders and their fortune and fame started getting public attention. Their firms grew exponentially in line with their wealth and unfortunately media attention. So today as I assess the last few month news in the hedge fund industry I feel the need to both to defend and attack these investment gurus. Lets start with the Ugly. It is not so much a person but a situation that is developing. SEC's relentless assault on Steve Cohen and SAC is an ugly situation. It is a data point that should worry the whole industry but especially large firms. Their is a clear message: the regulator is worried about the power of large hedge funds. Do not get me wrong, I am not saying that some form of insider trading did not happen at SAC or that the firm should not be fined and improve their internal systems but their attack on Steve Cohen is bordering on vindictiveness. There is no doubt SAC is a competitive environment but do you really believe this firm is any worse than the likes of Deutsche Bank, JP Morgan or Goldmans. Did the regulator play such hard ball with JP Morgan when there CIO office racked up immense losses that hit shareholders that include pension funds. Or did the regulator really go after Goldmans when they breached the principals of fair treatment of clients when they were selling structured credit products to insurance companies and then helping Paulson structure short credit products with exactly the same positions in them. So the message is simple, beware big hedge funds the SEC is after you. If I were Izzy Englander at Millenium I would be nervous. His smoothed returns on the back of Millenium's variable expenses could be on their radar screen. Now for the bad. You see money is a funny thing, it can lead you to take yourself too seriously. Once that happens and your ego inflates you can be a victim of your own propaganda. Paul Tudor Jones is a great investor. Hi style is one I admire as a fellow macro trader. But his comments about women, which are completely inaccurate statically anyway,  show a ego that only a man who believes he is verging on immortality would make. He also made comments about the lack of hedge fund talent. Here I would tend to agree with him but Tudor as a firm is as guilty as anyone. You see I would not be offered a job at Tudor as a macro manager, even though I have outperformed over the last 15 years. Why? Because I am not educated in the Ivy league, I do not have a mathematics or science degree. I learnt to trade the old fashioned way, by losing money and then working out how to make money. This takes hubris which many graduates who get a job at hedge funds do not have. They are as egotistic as Paul Tudor Jones but without the trading skills or experience. So Mr Jones if you really want to find hedge fund talent, employ me and I build a desk for you the old fashioned way: more about the individual's passion for trading, willingness to learn than their school. I finally and rightly so the good. You see the hedge fund industry still has a lot of good in it. Ray Dallio and his firm Bridgewater is an example as the largest hedge fund manager. His strong moral code, his unique investment philosophy, has led to great returns and he has developed a firm with a great working environment. Likewise Daniel Loeb. Sometimes confrontational but never for the sake of it. In Europe Michael Hintze of CQS is a role model for any investor, hard but fair, intelligent and has built internal procedures that not even the SEC with an itch could fault. Thankfully these hedge fund titans still prove the industry has a lot to offer.

It Is All About Risk Management

I am not one that usually likes to gloat, it tends to always be a precursor to losing money, but at times I feel for the sake of common good one must express their views in the most powerful way. Here is the reality, since 2005 I have not had a negative returning year. I am a macro investor, who has the fortunate position of being able to invest in a variety of liquid asset classes. Given I do not consider myself an expert economists or a quantitative genius, the question should be asked why I can do this when banks and other hedge funds could not. The only answer I can come up with, by analyzing myself as an investor, is I use a mixture of common sense and risk management. If we presume that common sense, given it is common, is not something that makes me special, it leads to the conclusion that what distinguishes me from the so called elite in the financial industry is risk management. Here I am referring not just too Chief Investment Officers, Portfolio Managers, Traders, Risk Managers but also Regulators. In fact the problem the world finds itself in economically is due to poor risk management from global regulators. Simply they did not set the appropriate risk capital boundaries for financial institutions. So lets focus on the way regulators view risk, which by the way is effecting how all institutions view risk. They believe an appropriate calculation of risk can be done by looking at a model that comes up with a number representing what an institution could lose over a given time for a certain probability. This is known as Value at Risk. One of the most important components of this calculation is a correlation matrix. In layman terms this number defines the so called relationship between 2 asset classes or positions. The simplest way to think about this is the old adage when equities go up bonds go down. In this case the two assets are negatively correlated. If we hold the same amount of these two and they move in exactly the same amounts with same velocity then they would be perfectly negatively correlated. In my view, this belief and reliance on this relationship is where regulators go wrong in setting the boundaries. You see asset classes, like bonds and equities are like people, they are influenced by many things and at different times what influences them changes in priority. Therefore you can not average or assume how they act over history, all you can do is make a best assumption for today. In fact if we look at the history of Value at Risk this exactly the view of the academics who first brought this model to the general public's attention. I suggest anyone interested should read Markowitz original paper on the subject. In fact the original way of using this model by a regulator was probably the best, known as the SEC model, it just asked bank to calculate how much they could lose over a given time for each asset class and then totaled the risk rather than using a correlation calculation. However this method was hijacked and developed to include a correlation matrix, and the SFA in the UK were the main proponents of this. As ever in life much of this was due to personalities. The SFA regulatory model team was led by an academic and practitioner called Dr Andrew Street. An extremely intelligent, yet arrogant individual. The team he headed were populated ultra intelligent indivduals yet none with any trading or market experience. A recipe for disaster.  SFA's development in using this correlation matrix resulted in lower capital charges for banks. Basle in Europe adopted this and hence when Basle II  rules, which codified this form of calculation of risk, came into print the US regulators had no option but follow or lose a considerable amount of trading in New York.  The story in reality has a few more sub-plots, which include JP Morgan's development of the model, known as RiskMetrics. I am more than happy to provide the details for private requests, however for the purpose of this article lets focus on the regulator.  So now Value at Risk, as promoted by global regulators, with its correlation matrix now becomes the standard for risk management in the finance industry. And yes was also the base for calculating structured credit risk. This leads into 2007 when of course the model proves complete ineffective to prevent the credit crisis. So what do I do that so different from a risk management perspective that has allowed to make money in all market environments. Well it starts with philosophy. I do not just view risk management as a way of assessing how much money I could lose. I view it from perspective how much money could I lose and what money do I have left after this calculated loss to make the loss back. You see by adding the latter to risk I also take into account how much money I need in the future. Common sense, no? Then in calculating this loss amount I do not use a correlation matrix but a causation matrix. Basically I use common sense to work out the relationship between asset classes. I analysis historical relationships only as a reference and then consider what is different in todays world. You see risk management should not be driven by quantitative individuals. It needs to be executed by individuals who are sensitive to the way humans behave. As much as I enjoy their company, and have a great deal of respect for them, quantitative individuals are generally not people persons. I think they are better to focus trying to make money especially in light of how ultra high frequency trading is increasing. Risk management is better left to individuals that question from a more qualitative fashion. This is exactly what I do and if global regulators came my way the financial world would be a safer place be. But not only safer but better equipped to make profit in the future. You see it is all about risk management. Risk management is about survival and recovery.

Hedge Fund Insider: Germany: You Should Know Better !

Hedge Fund Insider: Germany: You Should Know Better !: March has been an extremely interesting month as far as analyzing the psychology of world markets. I do not normally like to get politically...

Germany: You Should Know Better !

March has been an extremely interesting month as far as analyzing the psychology of world markets. I do not normally like to get politically or sensational in writing commentary but what has developed in Cyprus, I believe, needs to be analyzed and assessed. German politicians and central bankers need to study history. Their actions are all to similar to a time in history that eventually led to the rise of the Nazi party. There are so many lessons from the boom of 1920's and the great depression of 1929 to 1931 and the then sociological implications of  1931 to 1937 (when the markets crashed again) and the following change in sentiment in the world, especially in Germany. Germany's and Europe's attempt to tax savers in Cyprus is a direct analogy on the fiscal constraints the world put on Germany post World War I. Germany as a country should understand better than any other country that policies that cause unemployment and distress amongst the vast majority of the public while only benefitting the elite are socially a catalyst for the rise of extreme political opinion and parties. By ignoring or not caring about other European countries social implications of austerity they providing a foundation for the rise of a extreme revolution in Europe. Grillo's success in Italy should not be ignored. Any country where the unemployment rate is over 20% for people under 24 years of age is a social problem and one that must be addressed. This is exactly what was not done in the world after 1929 and eventually led to the rise of the Nazi party. This time it will not be in Germany, but extreme politics could give rise in any South European country where the average person is being hurt by austerity, where unemployment is rising, where the wealth gap between the top 1% of rich people and the rest of the population is rising. What this means for the markets is that volatility, uncertainty, and eventually capitulation will occur if the European politicians and central bankers continue on this course. Merkel and Draghi will be remembered in history as the individuals that built the foundations of a social disaster in Europe. The best strategy I believe in dealing with this environment is to be short-term in trading. The world's economies are in a unstable state, political actions today will have ramifications on countries social environments for the next two decades. The more detached politicians and bankers become from the public the unstable the world will be.

Where has all the Talent Gone ?

I started in the hedge fund industry in the early 90's, I was, and still am a supporter of the industry, so what I am about to write is not something that puts a smile on my face. However investors need to know the reality in order for the industry to survive.  We have a quality problem in the next generation of hedge fund managers. Why this is, and how it happened I will explain. Starting my career as a hedge fund manager in the early 90s we were a fringe industry, controlling enough AUM (assets under management) that could make you wealthy by performance but not by earning a management fee. This meant that only the most dedicated of individuals would work in the industry. Our backgrounds were extremely varied, some from investment banks, some from prop trading companies, some from trading their own monies. We enjoyed running portfolios were we had freedom to execute strategies not governed by the long only asset management industry. We were secretly wealthy, never quoted in the press, never mentioned on the the front page of a newspaper. The markets were dominated by large tradition asset management firms that were governed by benchmarks. Investment banks conducted prop trading but due to their capital rules they were not a dominate force in the markets, mostly concentrated on market-making. However life changed as institutional investors started allocating funds to hedge funds, regulators relaxed rules on investment banks. Suddenly the traditional managers with their long-term investment styles became ordinary clients, hedge funds volumes exploded, investment banks became warehouses of risk. This led to a change in the hedge fund model. Management fee became the biggest driver of hedge funds income. At an average of 2% management fee of assets many of us were now becoming insanely rich just by surviving, suddenly performance fee was no longer the driver of our income. Institutional investors had a twofold effect: not only did their money mean due to our larger status we had to change our style but they were less demanding of absolute performance, more interested in returns compared to volatility. We as passionate managers of the 80s and 90s, were smart enough at first to balance the increased assets with still above average performance. We became even richer, our size of position meant now market commentary included our actions.  This extra publicity was not confined to market commentary as we started to find ourselves on Rich Lists, society pages and being investment minded individuals we even managed to gain publicity as we started to invest in other alternative assets like art. Suddenly everyone wanted to work for us. First we employed the senior traders from investment banks. What this meant was the relatively inexperienced traders left were promoted. Suddenly investment banks had lost their intellectual property and experience in proprietary trading. They did not care as other  business areas expanded in importance like product development, sales trading, market making, prime brokerage that directly benefitted from hedge fund volumes. This was the main factor in the demise of the schooling of traders at investment banks. They were no wise heads left to direct the young, raw arrogant talent. This was never really appreciated in a bull market as even the youngsters could produce profit.  However from 2007 -2012 it has became blatantly transparent, and explains why the investment banks are more than happy to quickly close down their prop trading in all asset classes.  So if the investment banks were not cultivating the trading talent then you think surely the hedge funds were but this was not the case. The main hedge fund managers now owning their own firms were talented traders and investors.  We had started working as hedge fund managers because we were passionate about trading. This passion translated to dedication to our work which did not make us the best teachers. This dedication to be the best was also lacking in our new employees. They really wanted to work for us just for the money.  They are smart, academically brillant but lacked the market savvy to deal with a changing market environment. This can clearly be seen when you look at hedge fund returns at the end of 2012. Firms where the experienced hedge fund managers who dominates risk taking at heir firms have outperformed. Take Dan Loeb at Third Point. Here is a manager that is a perfect example to show the passion of the old school hedge fund manager. Even though many criticize his style, he is a hands on leader, so when you invest in Third Point, you pay your management fee for one of the best researchers and portfolio managers around. However be aware not all old school managers are like that. Some firms really show the weaknesses where the founder has stepped aside to let others run their business. Izzy Englander's Millennium are a prime example of this. Izzy set up Millennium to be a quasi fund of hedge funds. Thankfully he does not charge a management fee but makes money from volume rebates and performance. Izzy was great at spotting trading talent and then putting a sensible risk structure around this talent. However Izzy is not hands on any more and his senior staff who run business lack the talent, knowledge and hubris to spot talent. If fact if ever there was example of how arrogance hides incompetency, the Millennium senior staff are that. This is an international problem: both New York and London have the same attributes (in fact in my analysis I think the London office is worse, where the head of finding new trading talent is so inept I think the only place he could survive is Millennium which thankfully still has a common sense risk management infrastructure that Izzy originally developed).  However if a Millennium, whose business is spotting new talent, cannot even staff itself with quality at a senior level, then this obviously reflects on the talent in the whole industry. Another key factor in finding the next generation of hedge fund manager is background. Unfortunately there seems to be belief that Physics or Mathematics from a top university means that an individual will be a great trader because of new technology of electronic execution. In fact the investment banks are partially to blame, but maybe this was there only choice given the lack of senior trading experience. While these individuals are extremely smart they unfortunately tend to have similar academic foundations. This is why the Flash Crash of 2010 and the quant problem driven by Goldman's hedge fund products of August 2007 exist, basically the models trade the same. One of my most successful trading hires in the last few years was a gentleman that was educated at the best university, did not get the highest mark, but the was someone through university traded his own account to make some money. He was passionate about the markets and became a great employee and trader. However as he often said to me, he would have never been considered as a trader in an investment bank or as trader with another hedge fund. If he ever has a desire to set up his own hedge fund I would back him. Of course I have not told him that but he does have that passion for trading, he is not just trading to earn lots of money, he enjoys it and he is dedicated. So there is hope. Unfortunately though finding him is like finding a needle in a haystack.

Sorry - we are greedy but we are stupid...

I apologize. I apologize on behalf of all top hedge fund managers and private equity managers. Even if most would probably would not want me to apologize for them or even feel they owe anyone an apology. Personally I do not care. When the latest fiscal cliff deal was signed, once again my industry ended up paying less tax than teachers, doctors, nurses firemen. For those who are knowledgeable on tax law, I am referring to the carried interest tax rule that both Democrats or Republicans guard with the same passion and intensity. This rule is not only anti-social, it is actually offensive given how much tax-payers money has been spent on bailing out the financial industry. The fact is that even some of the most intelligent investment professionals, leaders of their industry, blessed with a great ability to see into the future,  can be absolutely blind and stupid when they have to confront their own emotion of greed. You see these great men can not see that their happiness is not just created by accumulating wealth for themselves and their families but also involves the happiness of the environment they live in, beyond their front door and street. The wealth gap between the middle class and ultra rich has widened to an enormous level over the last 10 years. What is even more worrying is that this rate has increased since the financial crisis. Basically as the world had to did deep in their  pockets, the elite few made sure they were not digging as deep. Prima facie you might think this to be smart. But it is not true. They can not see they are building a level of resentment amongst the masses. This resentment is justified. It is not driven by pure envy, it driven by anger. And this anger is well founded, the super-rich in the financial industry are not paying their fair share, especially after benefitting so much in the good times. The resentment if not addressed will escalate and ultimately it will be the super-riches next generation that suffer. The problem is power and greed are dangerous drugs, highly addictive and as a hedge fund manager for over 20 years one that I confront on a daily basis. But the reality is true wealth is not having isolated power, its enjoying life amongst others who are also enjoying life, so they don't even notice you. The financial industry owes it to everyone including themselves to readdress this issue now. All we have to do is pay our fair amount. It does not mean that the tax rate needs to be so stringent that it strangles growth and investment, but we should contribute to the general welfare state to ensure the foundations of the next growth period (which there will be one) are built as quick as possible. I ask all hedge fund managers, private equity managers to contact me and maybe as a combined force we can beat this greed. However I doubt I will receive one contact. The problem is it just to easy. the elite control. The present system of party donations means there is no end to this selfishness. All I can do is apologize to the rest of you..

SAC - The Real Issue

Apologies its been too long but these markets have been tricky and I had to prioritize my investors. Thankfully this paid off and I pleased to have delivered nearly a 20% return for them in these markets. Ok lets talk insider trading and hedge funds. Of course as SAC and Steve Cohen come under scrutiny its worth thinking about exactly what the hedge fund industry has become. I started as a hedge fund manager at a similar time to Steve Cohen. He was one of the most gifted equity traders there was. He could have a positive view on a company and yet on a daily basis be short that company make money  and then go back to being long. But SAC today is a billion dollar hedge fund and Steve's style cannot run that size money. So he had to bring in other managers and traders. as SAC success grew so did their asset base and Steve became a smaller percentage of the capital. He made a conscious decision to build SAC into a large asset management firm and by doing this he made the decision to focus on management fee and not performance fee. I took a different route, always running a small amount of money for a select group of investors but my income is driven my income performance. Is Steve more wealthy than me? In pure money terms yes. We occasionally cross paths in the art world and he has more buying power than myself for sure ( I believe he is in the top 3 art buyers in the world. An unregulated market where insider trading, and cornering a market is legal!). But wealth is not just measured by money. I provide a service where my investors are my friends (this probably has a lot to do with the fact I make them money rather than my personality). I do not employ anyone else and have no operational headaches focussing on investing. Steve has to run his firm, which involves a lot personnel issues and ultimately has led him to getting the negative press he is receiving. Do I think Steve is an insider trader..No. He was always looked after by the street (Wall Street), was one of the first calls on breaking news but this is all legal and he had the knack to take advantage of it.  However this skill is only privy to a few and the vast majority of Steve's employees are no where near as good as him. This then leads them to the temptation to cheat. Unfortunately SAC only crime may well be that they did not have the infrastructure operationally to identify and prevent this. It basically comes down to a simple fact: hedge funds should not be that big. I often think how I would create a large hedge fund and I have come up with one solution. Get together a small group of experienced and talented managers and create a super hedge fund. I thought of calling up Bruce Kovener, Louis Bacon, Paul Tudor Jones and Steve Cohen and suggesting it to them. But I would imagine that ego might be a preventive factor and in truth we all are in control of own lives so why? I would do it as a showcase, to show there is still trading talent in the hedge fund world. However this talent sits with a few. I feel sorry for all those institutional investors: pension funds, insurance companies etc who believe large hedge funds provide them alpha. Let me tell you they don't, they can not, they are far to big not to be Beta. Anyway I guess that is human nature..Alfred Winslow Jones created a great vehicle, for approximately 50 years it delivered excessive returns but now greed has destroyed this product. I hope Steve Cohen does not suffer too much from this, he is someone to respect. He probably needs a good succession plan at SAC but that a discussion for another time....

Happy Holidays!

As the leaders of countries go on holiday, I wonder just how they will be feeling. Mr Sarkozy will probably go and have a great time, forgetting the troubles both Europe and France face in 2012. No doubt his tremendous self belief, that sometimes crosses the line into blinded arrogance, will allow him to forget the following: France and other major European countries need to refinance and a large amount of debt in 2012, banks need also need to refinance a large amount of debt especially as they start preparing for new regulatory capital rules. French banks in particular hold a large percentage of Greek, Italian, Spanish and Portuguese debt. The rating agencies have France on their negative watch-list for a potential downgrade. Europe need to implement their new treaty quickly to at least give the markets some positive action to be come optimistic to a solution to the European debt problem.  He has elections in April and he basing his campaign on his handling of the economy. No matter of the severity of these problems, Mr Sarkozy will no doubt feel he has handled the situation to date perfectly, even though he has managed to cause friction with the UK, who the rest of Europe need to be amicable in order to quickly implement many of their new measures by using existing European Union infrastructure. Regardless Mr Sakozy will look into the mirror and still remain firmly in love in what he sees. Mrs Merkel will not quite have such a joyous christmas. Her biggest concern is how to convince domestic politicians and the German public that a greater federal Europe is the best for Germany. While economically her arguments are strong and clear, sociologically there are many issues. The greatest is Germany once being perceived as wanting to be the masters of Europe. If austerity leads to a protracted European recession Germany will become once again resented by the rest of Europe. This is something the German public want to avoid at all costs. Mr Cameroon christmas will be a subdued affair with element of exhaustion. While he knows deep down the stand he made regarding Europe was the correct one, he also knows the reaction to this action needs to be managed. Mostly he knows he must keep a coalition government united which has mixed and vastly different views on UK's participation in Europe. He also must balance UK's interest while still appreciating how dependent the UK is on the free trade benefits of being a part of a European union. He might feel a little proud of how he handled himself on the international stage especially compared to the juvenile French leader.  But this warm feeling may dissipate quickly as he remembers the present stress of the global banking industry, which is the main driver of the UK economy. Mr Obama will have a philosophical holiday break. He will be bemused at the process behind the US political system. He will question whether the systems allows for personal gain to prevent consensus cross party politics, which is necessary in times of crisis. He will be preoccupied by the Iranian situation. Somehow he must appease Israel enough not to take military action, and work out how best to diplomatically handle a irrationally Iranian leader. And for the Chinese premier it will be just another day, in a week, in a month, of a long term -cycle that will see China's influence in the world increasing. Happy holidays. 2012 looks set be just as challenging yet full of immense potential as 2011.

Making Money with the Swiss Franc

Most traders, hedge fund managers and portfolio managers I speak to have lost money trying to trade the Swiss Franc this year. I initially find this surprising as trading the Swiss Franc this year has been a very profitable currency for myself. I decided to conduct some research into why this is so. The conclusion to this research may also have some bearing on why I have been profitable in 2011 and to my surprise others have not. The key in 2011 to making money in the Swiss Franc (also I believe this will continue in 2012) is to understand Hildebrand the Head of the Swiss National Bank.  Unlike other Central Bank chiefs he has true market experience in trading. This means when he decides to intervene or use political messages to depreciate the Swiss Franc, this can be, to a certain degree, preempted. It takes a simple trading analysis of what you would do as a trader if you were in his shoes. This study of market psychology is sadly not conducted by the majority of macro and FX dedicated traders. Most short-term traders in FX are purely systematic. I should point that this style of trading, I believe, does have true validity but can go through periods of losing, as 2011 shows. Pure systematic traders therefore ignore the market psychology aspect that I believe is the key to Swiss Franc trading at the moment.

Its Better To Die On Your Feet Than Live On Your Knees

After the UK's decision to step out of the Euro crisis and risk political isolation, the immediate reaction of many market participants has been to consider this a negative move. I am not sure this is the correct perception. It must be not be forgotten that UK's GDP is driven predominately by services, most of which stem from finance. This fact means the greatest risk the UK face from all the proposals of Europe on the table is the financial transaction tax. In fact it was JFK's decision to have a tax regarding Eurobonds that original aided London to become the financial centre in Europe in modern times. It would have been a risk to trust that Germany and France would not have used the new proposed treaty changes to try to take some of this lucrative business away from London to Paris and Frankfurt. In fact the French's Napoleon-like president's reaction was all too clear in showing his disappointment in what might have been his saving political move to win himself another term. France under his leadership is definitely not to be trusted. As for Germany this is rather more of a complex analysis. I fortunately have worked closely with a German bank  and so maybe have a little bit more of an insight into their motives. However a quick review of recent history can be an interesting guide. When German reunification was first proposed, both UK represented by Thatcher and France by Mitterrand opposed the move as they believed this nation would become too powerful within Europe. At present their fears seem to have some validity. Germany now controls Italy and Greece via technocratic governments, as well as France. Germany seems to be making the fatal mistake of ignoring the public feeling of other nations in favor of austerity at all costs. Is this similar to their previous mistakes of dominating Europe? Unfortunately yes. But this is only true of German leaders and politicians. The average German on the street does not want to be in the spotlight. They fear accusations of similarity between them and Nazi Germany. They want their country to do well, be the great industrial power which they are, but not to invade Europe. Unfortunately this rational and sensible view is lost at the political and high ranking German level. Here you find characters who have the fatal cocktail of arrogance and resentment. I never thought Merkel fell in to this category but unfortunately I think I was wrong. For Sarkozy the analysis was straight forward. His ego is  his biggest hindrance combined with his inability to control his feelings. The French must be totally embarrassed at voting such an individual into power? Remember his first speech on US soil after his election win: he told the Americans to get their finances in order! The French have a chance to rectify this situation at the April elections. It will be interesting for me to see just what the French people decide and certainly for an onlooker the result will tell us a lot about the French public. They may also feel that they do not want to be Germany's puppet...will we see. So given this background, the UK's decision may not be perceived that negatively. What I find the most disturbing is that the European Union was set up to prevent war and a dictatorship in Europe by friendly nations sharing defense and trade. It was never about the loss of individual nation's sovereignty.   The UK demands last week were not that unreasonable. Germany and France response was worrying. For me as trader I think the probability of all outcomes, including the most negative for the UK, Cameron's decision was a good trade. I bet many Greeks and Italians must feel they wish their governments have made similar decisions. For surely it is better to die on your feet than live on your knees?

How to Profit from a key week in Euroland

As the markets prepare themselves for another European summit, canny investors will be prepared to take advantage of the weeks events. When they analyze how to implement strategies it is always worth assessing what they know and they do not. What they do know is there will be price movements surrounding the summit as politicians use the press to restore confidence in the European debt markets. Whether the final announcement will induce this confidence or be ignored is an unknown. Therefore a trading plan should incorporate both these outcomes. It is relatively clear how a positive outcome should be played: go long equities, short treasuries, short the dollar and long commodities.  However the key to success will be picking the right way to implement these macro themes. given the expected volatility, it is essential to avoid crowded trades. These crowded trades will have numerous stops placed by traders and therefore will experience excessive volatility on an intraday basis. This means there is a higher probability of a trade held being stopped out. The answer is simple search for uncrowded trade that has the same macro catalyst. Let me give you an example: instead of going long the Euro verses the dollar, an extremely crowded trade, an alternative is to go long Canadian dollar verse Swiss Franc. This latter trade is essentially long risk, just like the Euro position. It also has the characteristic that it may benefit from Euro specific very negative news due Swiss National Bank's policy of pegging to the Euro. This kind of alternative trade can be sort in all asset classes. The next piece of the puzzle is to decide on an entry level, profit target (if used) and stop loss level. Once these have been established the size of the trade in terms of risk can be defined. The same exercise can be done for a negative reaction to the summit. In this way an investor can be armed with definitive plans to quickly react once a direction is established.

Wise Words from Karl Lagerfeld

In order to be a successful investor you must appreciate that good advice can come from many sources. Running a country through a global credit crisis is no different and leaders would do worse than consider a suggestion from this fashion guru: Karl Lagerfeld. I have mentioned before in a previous post that we need leaders to exert creative thinking in order to help their national and also ultimately the world economy. Mr Lagerfeld has suggested an interesting proposal to get rich people to spend their money. So I understand, he has suggested that people who earn over a certain excessive amount should be taxed if they do not spend a certain proportion of it. Obviously the implementation of this suggestion needs to be clarified but I think its actually the kind of creative solution we need. Maybe it could be taken even further and applied retrospectively to the banking industry. This would have a massive positive sociological effect, as many investment bankers who have taken large bonus payments during the last 5 years would be forced to spend money to help their national economies. I guess as a hedge fund manager I have to accept that this also should be applied to all areas of finance, including asset management. Mr Lagerfeld suggestion has real merit from a practical to a psychological perspective. Personally my extra spending may not go to haute couture which will probably will disappoint  Mr Lagerfeld, and believe  me my partner definitely does not need haute couture clothing to look amazing, but could go to investing in the economy through loans to small business and entrepreneurs. Bravo Mr Lagerfeld for your creativity.... but I bet you have heard that before!

Time for a Recap

What an interesting day the last day of November 2011 turned out to be. I congratulate Central Banks on their timing. Not only did it have the surprise element but it also helped year end trading books of banks with a 4% rise in equities. I hope every investor out there had the appropriate risk management discipline to survive such intraday volatility. So lets assess where we are the day after. Is there still a problem Europe? Unfortunately yes even after todays relatively successful French and Spanish auctions. While maybe European banks situation is slightly better with more relative cheap central bank funding available there is a whole plethora of problems facing the banking industry and Europe. The European debt problem remains. Yesterday action did nothing to resolve this except insure the security of a functioning global banking system. Countries around the world still face large debts to repay with falling revenues. Europe has not resolved their unity issues. As I have repeated many times they need fiscal and political harmonization through treaty changes. The grapevine says the draft treaty changes being considered does not have complete backing from all countries. Giving sovereign rights to a central European institution is a tough decision and not one to be rushed. Both US and China are being effected by the European problem. But lets not get too downbeat, there are many great investment opportunities. Liked I mentioned in my previous blog a long commodity short European problem is an interesting trade and one that has already paid dividends in the last few days. If interested I suggest you look at a Euro vs Australian dollar chart. In fact I think they some interesting plays in commodities. If you combine fundamentals with a technical reading of the markets I would suggest look at some long commodity plays. With commodities supply and demand metrics are key, combined with the analysis of the positions of both investors and the industry players. Also equity market provides some interesting investment opportunity.  I have identified some interesting companies that will benefit from an increase in infrastructure investment. Corporate credit should not be overlooked. Strong fundamental analysis of future expected cash flows in a recession environment can provide some great lending opportunities. This a market where hard work pays off. But whatever you decide to invest in discipline in risk management is key. They are many opportunities but there is also a high probability of surprises as well. The key to making money is discipline. It is what separates a great investor who has the potential to benefit from all market environments from a just a lucky investor. This is the key question that many participants in the hedge fund industry should ask, especially hedge fund of funds. I wonder if they have analyzed this about their hedge fund investments, and what category the likes of John Paulson or  Greg Coffey fit into?

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...