14 June 2006

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Business Today

Hedge funds or bust

As Euro changeover day approaches, the controversy deepens amid contrasting views that the Euro will either give us balmy days or raise prices sky high

An aura of fear and uncertainty has settled over global markets, mirroring the intensity of the Iran declarations on enriching uranium and the turbulence that is hitting the oil markets.
Oil prices are edging up and to cap it all US consumers have reduced their spending spree slowing the momentum of internal growth of the world’s biggest economy.
Few investors seem convinced that better times lay ahead for the equity markets. As a prime example we notice the negative impact that hit major tourist resorts around the globe due to higher oil prices and increased alert from terrorist attacks. Travel experts predict that most Mediterranean holidays this summer will be put on hold or switched to other exotic destinations such as the Caribbean. Certainly destinations such as Indonesia and Bali have still not yet recovered from the “tsunami” scare and recent terrorist attacks. No doubt reductions in tourist traffic as a consequence of the fuel hikes also hit in-bound tourism while we may expect to suffer a drop in American tourists on board cruise liners visiting our harbours. The greatest variable in this picture is the price of oil. If pessimists are proved right then it will stabilise at the USD65/70 mark. Of course this is highly unpredictable since uncertainties in Nigeria and Venezuela may still be marred by equally bad news arising from sporadic production cuts. In the US, the current level of security alertness concerning the probability of terrorist strikes is again on a warning level following fresh Al Qaeda threats.
Naturally, this means that corporate travel schedules will be critically affected and conducting of overseas business involving US citizens will suffer.
And what about Europe’s stock markets?
European banks, mutual funds and investors face increasing risks as the Iran dispute looms larger as it adds a plethora of uncertainties.
We are enduring familiar economic risks endemic to capitalism, including speculative bubbles, the erratic business cycle, terrorism, and shifting government policies. What is new?
No one likes risk. Ironically, increased risk is integral to the higher level of performance that all stakeholders – investors, workers and business partners - demand. The obvious question is how can nationwide investors avoid this turbulence and achieve a better return given their omnipresent risk-averse mentality?
Can we avoid drinking this poisoned chalice?
The answer lies in our quest for superior investment strategies, in this column we discuss the rationale of switching from equity investment to hedge-funds.
Within Euroland growth remains particularly low in Germany, but France and Italy (now Italy renamed the sick man of Europe) are equally expected to see growth of less than two per cent this year.
Germany's manufacturing slump continues whereas its industrial production shows slight improvement perhaps coupled with the temporary boost expected ahead of the World Cup tournament. Another sign of weakness is the continued edging up of interest rates and a rally on inflation figures.
Sceptics are spreading widespread fears that Euroland is facing a prolonged period of low economic growth and persistent underperformance .Unlike the US, the EU is further constrained by its adherence to unjustifiably tight fiscal and monetary policies. A typical case is the mechanism called the 'Growth and Stability pact' which imposes onerous restrictions on members forcing them to maintain tight reins on their deficits and inflation rates. This pact was recently revised to accommodate the worsening performance of both German and French economies.
Is there a solution in sight? Governments can assist by promoting incentives to increase savings and monetary policy could be used by increasing interest rates when markets are considered over-priced.
It is not so surprising that the international interest rate scene has changed radically in recent months. As has been the case in Malta fears of a drop in foreign reserves and inflation peaks has pushed the Authorities to raise interest rates.
Malta's recent 3.1% growth in the first quarter may rebuke the pessimists that lament about the underlying sluggishness. The latter contend that growth is artificial and domestic trade is harmed by the recent interest rates increases.
On a European scale, the main problem though is one of changing a mindset that believes that people can amass great wealth by clever investment in equities or bonds. Wider global imbalances, notably the huge US external deficit and the accelerated free fall in the dollar highlight acute policy dilemmas. The European Central Bank has a critical role as it must avoid monetary overkill that would harm growth while raising interest rates at an early stage so as to suppress inflationary pressures Ironically this the price that local investors are suffering from when switching from non-performing equity to high coupon bonds.
It is no surprise that over Lm100m lost in Argentina by Maltese investors that stampeded into higher yield coupons is still reverberating through their minds three years ago.
The backlash has now turned sour and the general feeling among local investors is to shy away from pouring money into listed shares.
Lack of privatisation bonds and the dearth of lucrative opportunities for secure investment have obviously accelerated the thirst for low risk corporate bonds. One can only wonder at the acute yearning shown at the offering by Capital Asset Bonds that were oversubscribed within three hours from time of issue.
Is this because, the coupon rates for local bonds are attractive in relative terms compared with what banks offer to depositors on term deposits. To name some successful and heavily oversubscribed past issues one can mention Corinthia, Eden Finance, Mizzi Finance, Bay Street,Tumas, the Casa Arcati Finance, Intercontinental Hotel project, and Big Bon finance. As a general rule most of the bond issues were used to reschedule bank borrowings.
In the past three years the cost of bank borrowings was higher than the bond rate so raising capital by bond issues helped in debt rescheduling. It also served to create new credit for the promoters.
Sceptics question the financial cost to service local bonds issued at a comparative high coupon rate when the general trend is for Central Bank’s to increase the official bank rate. If this trend continues, such a situation will make servicing costs of bond issues less attractive in the near future. Some financial advisers may challenge this theory as being a hypothetical question yet local bondholders cannot rest on their laurels as there will be precipitating factors.
The global economic prospects appear at best mediocre, as instability in the financial world points towards an escalating level of risk averseness. Could this be part of the justification why on the international scene analysts are lauding hedge funds that are raking hundreds of billions in dollar revenue? The hedge fund boom has sweeping implications not just for the Wall Street traders and a few thousand well-heeled investors, but increasingly for every enterprising European or Japanese pension fund manager. Paradoxically we find that the trend in America is that hundreds of billions of dollars poured into hedge funds originated mostly from rich investors - generally fat cats with USD1 million or more in assets.
Critics point out that the secret to success lies in the clever leverage that hedge fund managers use to invest or borrow to enhance their returns. Certainly these financial vehicles are unsuitable for the feint hearted speculator.
The obvious question to ask is whether hedge funds' superior returns on investment will survive in times of uncertainties such as these. The answer is that nobody can guarantee future returns particularly given that the past three years have been a nerve breaking experience for equity investors. Analysts question whether the medium sized investor ought to pour money into hedge funds at all.
Can hedge funds save our bacon and rid us of the current malaise that is plaguing the global stock markets?
Hedge funds are not a panacea for all our investment woes. They are not the proverbial pot of gold at the end of the rainbow. Certainly they are the flavour of the month and consequently ought not to be overlooked in any well balanced portfolio strategy.

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