The Hedge Funds industry, which has been touted as offering additional diversification through a absolute return strategy, too has been somewhat of a disappointment. The general Hedge Funds industry has failed to achieve absolute return this year, although it has generally dropped less than the market. The following graph illustrates the performance of Hedge Funds, Managed Futures and MSCI World Index from End Dec 1999 to End Nov 2008. All index has been re-based to 100.

As we can see, in absolute terms, Hedge Funds has provided superior returns compared to MSCI World since year 2000. However, over the last year, Hedge Funds have not been spared in the worldwide sell-down, which was not seen during the recent-past crisis like the Dot.com bust, 9-11 Terror Attack, Iraqi War and Sars period. The Eurekahedge Hedge Fund Index has returned  -12.28% (up to Nov) over the preceding 12 months compared to the -44% for MSCI World over the same period.

A class of Alternative Investment in the form of Managed Futures have stood out amidst this global rout. The Eurekahedge CTA/Managed Future Hedge Fund Index has return 18% (up to Nov) over the preceding 12 months, a respectable return even in bull markets, not to mention that it was achieved during the ‘unprecedented’ situation now.

Contrary to the strategies of Hedge Funds, which can be Equities Long/Short, Fixed Income Arbitrage, Macro Events etc, Managed Futures are usually computer driven funds that invests in the financial and/or commodities Futures market.

It would be interesting to know the kind of performance from Managed Futures Funds in 2009.

During the initial design phase, the ID would offer his views and advice. Some ID can be very opinionated and claim that certain design is the only way to achieve your dream home. At the same time, certain well-known IDs may appear on magazines, newspapers, TV programs or their own website. They too may preach certain methods and disregard the rest, claiming that other IDs are profiting on their client’s expense. These personalities may advocate using certain kinds of build-in household electronic in the kitchen, for example a electronic oven that will produces much healthier food. And the best part is, it cost around the same as traditional ovens! The other IDs who recommend traditional ovens are ripping their clients off. Often, their views would be controversial to attract readership, which fits nicely into the medias’ goal. Controversy attracts readership.

Are the advice from such personalities the only way of achieving your dream home? In my opinion: No.

Different methods or styles are suitable for different people. Simply said: Different folks, different strokes. No single method is applicable to all. Advisers, like IDs, should highlight the pros and cons of each method and recommend the most appropriate 1, taking into account the personality of the client if possible.

In the above example of the electronic oven, the ID have to explain that the oven needs additional periodical maintenance or else the food may not be any healthier or tastier. Worse, the food may become more unhealthy. Also, the client must not panic if the oven create sparks and smoke once in awhile.

Following the ID’s advice blindly may produce undesirable results. However, the layman, who is no expert in the area, rely alot on the ID. This is the tricky part whereby there is no easy solution.

Relying totally on the ID can still produce a dream home - the ID’s dream home, not yours…

By saying we should look for advisers who are ‘worthy of us’, we say it without any hint of arrogance. We are just looking for advisers who do the right things and do not tarnish our reputation and what we stand for. Having seen some of the things that go around in the industry, attracting top producers who achieve great sales through unscrupulous methods is the last thing we want.

The current financial crisis has been dubbed ‘unprecedented’ by many. People and organizations from all walks of life ranging from individual to institutional investors, town councils to Sovereign Wealth Funds, employee to business owners, have been impacted to a different extent. Great challenges have arisen in terms of Wealth Preservation and Distribution.

After spending so much time and effort in accumulating Wealth, it would certainly make sense planning for Wealth Preservation and Distribution. The acts of creating and leaving a legacy for your love ones or organization of choice, be it a welfare organization or place of worship, is heartwarming and many a times, a form of justification of the sweat and tears of wealth building.

However, the current situation whereby major assets classes have tumbled in tandem highlights the potential bind spot that exist in Wealth Preservation and Distribution. Liquidating assets in situations like now would greatly reduce the potential benefits for your beneficiaries. Imagine leaving just 50% of an investment portfolio in the event of a forced liquidation during the probate process! In addition, business owners also face the additional liability arising out of business exposure. Creditors may lay their hands onto the very assets meant for your love ones and strip them of the entitlement.

Fortunately, there are methods and platforms available to help avoid such dreaded situations. It would be comforting knowing that extra efforts have been taken to help protect and preserve what’s meant for the intended recipients.

Generally speaking, the US 10 Year Treasury Note yield has  tracked the FED interest rate for the past 20 years. This is can be seen from the graph below which shows the performance of the MSCI World versus the US Treasury Yield and FED interest rate. Click on the graph for a clearer view.

However, the correlation seem to have disappeared starting around 2002 to the not too distant past. The interest rate were low relative to historical standards. A possible explanation for the vanishing correlation could be the popularity of Collateral Debt Obligations (CDO) due to the search of higher yield.

CDOs were first introduced in 1987 and quickly gained popularity. A valuation methodology which allowed the rapid pricing of CDOs was introduced in 2001. The thirst for higher yield can thus be met using CDOs which can now be priced rapidly.

As the financial tsunami swept through the world with the collapse of Lehman Brothers and the subsequent fallout of the CDO market, investors suddenly find themselves with nowhere to hide. All major asset classes have dropped in tandem, the only difference being the magnitude of fall. The only safe haven now seem to be in government bonds. As investors pile-in in the flight to quality and safety, the yield have dropped to record low levels.

The following graph illustrates the same comparison for the past year. As can be seen, there was a drop in the yield starting around November. On the hand, the MSCI World started to rebound around mid-November after the sell-off from the Lehman bankruptcy and AIG crisis. The MSCI World has managed to recover 20% from the low in mid-November. However, the US Treasury yields have continue to drop and have dropped 44% from starting of November or 29% from the corresponding low of the MSCI World index.

Why the drop in US Treasury yield while the market is ‘recovering’? It could be that the market is buying US Treasuries in anticipation of the FED rate cut. Or could there really be window dressing? Fund mangers are looking for protection in US Treasuries while pumping the market for a better looking portfolio during the year end. If there is a sell-down in the new year, the US Treasuries will offer protection to the downside.

This US$50 Billion fraud scheme will send great repercussions through the world of hedge funds and alternative investments. Many of these investment schemes operate under a veil of secrecy which is under threat of being removed amid calls for greater regulation, thereby killing their efficacy and their existence. This scenario may play out in the short to mid term. In the immediate aftermath of this is the lost of trust in the strategies, which could trigger another round of sell-down.

The October sell-down was said to be the result of massive hedge funds selling to meet redemptions. With the lost of trust comes the redemption by the institutions and the rich. The funds could deal with the redemptions in 2 ways:

1. Sell off the assets, even when it means doing it in a fire-sale kind of way. Many hedge funds and alternative investments hold illiquid assets which may have to be fire-sold to raise cash fast
2. Suspend the redemptions. We are already seeing some funds doing this to protect the interest of other investors and avoid a fire-sale. Doing this enmass would trigger more panic and would most likely  just delay the inevitable

A wave of selling can be expected next year when the new redemption period starts. On what scale will it be remains to be seen.

Calling this Madoff ‘incident’ as ‘Madoff Cocktail’ is certainly an understatement considering that a Molotove Cocktail is easy to prepare and the inflicted damage limited. The exact opposite is more appropriate and likely result.

GE GreatlinkChoice is basically a Synthetic CDO. Refer to the previous post Termination of Swaps for Lehman Minibond to understand how a Synthetic CDO work. This post can be taken a continuation of the Synthetic CDO explanation. The figure below illustrates how the Synthetic CDO work. Click on the figure for a clearer view.

The investors are actually buying into different tranches of the CDO with different seniority as represented by the red square above. The senior tranches have the highest credit rating in the sense that the first defaults will be taken by the more junior or subordinated tranches. The figure below shows the breakdown of the tranches.

The Key Terms to Know:

1. Attachment Point/Subordination/Loss Protetion - The level whereby the tranche will start to lose its principal
2. Detachment Point - The level whereby the tranche will lose ALL of the principal
3. Tranche Size - The difference between Detachment Point and Attachment Point
4. Recovery Rate - The rate in percentage at which creditors are able to recover from the defaulted bond

Now for a bit of Math. Assumption:

• The CDO portfolio: 100 Reference Entities with equal weighting (ie, 1% each)
• Recovery Rate: 50%
• Attachment point/Subordination/Loss Protection: 10%
• Detachment Point: 12%
• Tranche Size = 12%-10% = 2%

Loss per Credit Event = 1% X (1 - Recovery Rate) = 1% (1- 50%) = 0.5%

No. of Sustainable defaults = Subordination/Loss per Credit Event
= 10%/0.5% = 20
Meaning to say, this particular tranche can take up to 20 Credit Events before the Attachment Point is triggered.

Number of additional Credit Event before complete loss = Tranche Size/Loss per Credit Event = 2%/0.5% = 4
This means that from the tranche will lose everything on the 24th Credit event

Loss per additional Credit Event = 100%/4 = 25%
The tranche will lose 25% from each subsequent Credit Event from the 21st to the 24th

The above calculation is illustrative as the portfolio weightage, Recovery Rate, Tranche Size etc may vary from CDO to CDO. It is unlikely to have such nice looking whole numbers.

How is GE Greatlink Choice funds different from the Lehman-linked Structured Notes?
1. GE GreatLink Choice is a fund under a Single Premium Investment-Linked-Product (ILP) sold by an insurance company where the Lehman-linked notes are structured notes sold by banks and other financial institutions.
2. Lehman-linked structured notes have a First-to-Default clause which will trigger unwinding if just 1 of the Reference Entities have a Credit Event. As explained above, there must be a certain number of Credit Events to trigger a partial or total loss for Greatlink Choice.
3. The Lehman-linked notes have Synthetic CDO embedded in a CDO whereas the Greatlink Choice funds are just Synthetic CDO.

Will the Greatlink Choice have a partial of complete loss?
It may or it may not. There are already some Credit Events (1 for Sept and Oct 2010 fund, 4 for Oct 2012 and Aug 2013 and 5 for Dec 2013) and more Credit Events may cause partial or total loss depending on the individual fund’s structure. Note that the defaulting of the Swap Counterparty may also cause a loss.

I was attracted to the graph which shows the historical  Fuel Oil Price (S$/bbl) vs Low Tension Tariff. Shown below is the graph in the ad.

What’s your first impression of the graph? Let’s see if we have the same thoughts. 

• Electricity tariff is very low compared to the Fuel Oil Price (Even the graph title is Fuel Oil Price vs Low Tension Tariff)
• The electricity tariff seems to be very stable
• The volatile oil price has not translated into volatile tariffs. Even with the recent huge movements in oil price, the tariffs has a much smaller corresponding movement

But hey, wait a min… Didn’t the tariffs just increased by 21.5% for the Oct to Dec 08 period and decreased by 24.7% for the Jan to March 09 period? How come there was just a slight movement in the graph for that period?

The answer lies in the scale used.

Although the scale used for the Fuel Oil Price and LT Tariff is in (S$/bll) and (¢/kWh) respectively, both have used the same numeric scale from 0 to 180. By drawing the graph in this way, the tariff would appear to be much smoother than actual. Below is the graph I redrew by using a more appropriate numeric scale of 0 to 35 for the LT Tariff.

Would such a graph make you see the situation differently?

In the course of your own financial planning, be it in insurance or investment, it is not difficult to come across all sorts of historical performance or non-guaranteed future projections. The numbers or figures may look very attractive, even too good to be true. But take note, you may not be getting the ‘correct picture’.

The advert describled the uncertainity in the job market, high inflation rate, typical spending pattern, a vague investment portfolio and the low interest rate environment. These are stuffs that remind the reader of the ‘advantages’ of the ‘high’ SA interest.

A caveat can be found on the right hand side of the ad informing of the irreversible transfer and concerns on using OA for housing purposes. A good sign that such important info are mentioned. However, nothing was mentioned on the 2 years limit on the min floor rate of 4%, the new floor rate of 2.5% thereafter and the pegging of interest rate to the 10 Year Singapore Government Securities (10YSGS) yield.

I find some conflicting information on the ad. But disclaimer first, I have nothing against Mr Jason Kuek or CPF Board. Just some personal questions I have…

1. Mr Jason Kuek mentioned that “I am looking to hold them (shares) for the long term, and its a very good time to invest in Singapore blue chips because price is very low”. At the same time, he puts half his monthly salary into a savings account “even thought he reckons that “interest rates are so low right now that putting money in the bank is as good as doing nothing with it“”. To give the ad the benefit of the doubt, Mr Kuek could be building up more emergency funds to cope with the job uncertainty or he could be a high income earner and even after putting away half his salary and using the bulk of his expenditure on his car and insurance, he still has enough for investments.
2. As with point 1, Mr Kuek mentioned that “Basically, at this point, if I have the opportunity to increase my funds (SA), I will.” Why transfer to SA now when there are much more investment opportunities in OA at a “…good time to invest…”?
3. Mr Kuek’s long term goal is to buy an apartment of his own eventually. Now, transferring OA to SA is irreversible. OA can be used to pay for housing. Hmmm… OK, maybe he is able to pay for his future home using cash, bank savings or his investment returns…

Sometimes, I really wonder why is CPF Board spending so much money on such advertisements to persuade people to lock up their money and not be able to use it for anything until retirement. I am not suggesting that locking up money is necessary bad for everyone. This could be a ‘lesser evil’ to protect you from yourself.

And, by the way, the ad mentioned a Jason Kuek while the photo shows a Jason Ho….  Are they the same guy?…

Well, one of the easiest way to discredit yourself is to predict the direction of the market. Many experts have voiced their opinions over the course of investing history, only to be proven wrong. Any onewho have ’predicted’ the start of a bear or bull market would become a market guru instantly. Journalists would constantly remind the reader of the guru’s ‘achievements’, even if he or she might have ‘hit the jackpot’ out of pure luck. Its much easier to call for market bottom now as the drop has been down for a year. Now, I will try to become a guru. There will be no fancy graphs to support my predictions. Just vibes from the ground. With some luck and hopefully some journalist out there reading, I too will become ‘the one who rightly saw the continuation of the market drop’. Quite a mouthfull…

The market rallied in the last week of November even though economic numbers were disappointing. The official reason was that the market was cheering the rescue of Citibank by FED. Some experts have said that the markets are bottoming or even have bottomed while others have warned that this could be a bear trap.

My take is that there may be window dressing by the fund managers. Window dressing is the ‘artificial’ creation of a healthy looking portfolio by fund managers through the selling of the weak stocks and buying of the stronger ones near the end of quarter or year. Also. we are entering the festive season. The fund managers will go on holiday as well. On this backdrop, the market may be in a upward or sideway movement. Come 2009, there may be more downside as the full effects of the global downturn starts to filter in. It is extremely difficult to price in how the companies’ balance sheet will be affected in this global slowdown.

From my conversations with my friends and clients, the worse (economy wise, not market) is yet to come. More retrenchments are definite on the way. The lucky employees of a company got their retrenchments delayed so as to qualify for their AWS. A large semi-con company is cutting pay. Their major rival has no loadings. The recent good results from an US MNC was due to the sales of inventories and not new productions and they are not buying components. Used plastics is going for free at Hong Kong’s seaport to save on port charges as demand disappeared. Many Americans are staying in house with a ‘For Sale’ sign outside. This was drowned out by all the noise from the Presidential election.

Will the markets go according to my ‘predication’? It can just go the opposite way… Then I have to try harder to become a guru next time.