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Hedge Funds in Asia

Thursday, May 20, 2010

Coming Soon: The Biggest Institutional Investor in the World - Japan Post

"What counts is not necessarily the size of the dog in the fight - it's the size of the fight in the dog"

Dwight D. Eisenhower (1890 -1969)

The wheels are in motion, and in Japan and elsewhere people are looking and expressing concern. Why? The reason is as follows: Japan Post (a Japanese state entity) will become a "private" operation called Japan Post Bank Company .

Already the single largest deposit taker in the world it is looking to double those assets, eating away at the competition, before moving (inevitably) into the lending business. Japan Post Bank Co. currently weighs in with a massive $3.3 trillion in assets comprising approximately $2.1 trillion in savings accounts and $1.2 trillion in life insurance policies.

Critics of this "supertanker deposit bank" include onshore Japanese banks, city banks, regionals and brokers. Surely this interloper with cheaper deposit base would be in a great position to "steal" away business especially as their assets were built up at subsidized borrowing costs.

Overseas, the U.S. and Europeans have already made noises at the WTO as they too are worried that this new operation will easily move into any financial market it wants and effectively beat out the JP Morgan Chase and Citis of the world, that are currently under attack from their own domestic regulators.

The battle lines are being drawn. Of course, this organization already is (secretly) a massive players in the fixed income markets effectively backstopping the lousy returns of the JGBs. It has also been a big player in the U.S. treasury market and less of a player in equities due to the excessive volatility and risk of principal loss.

However, that might change especially as the vast amount of assets Japan Post Bank controls is effectively the savings of their rapidly aging population. Once there is greater clarity as to the type of market-based operation and strategy it will pursue (no clues as yet from a vague and politically correct website www.jp-bank.japanpost.jp/en_index.html) what we might see is the beginnings of a new and substantially powerful quasi-SWF force out of Japan, one that will inevitably be a big player in the passive equity investments , fixed income and alternatives including hedge funds.

Whether Japan Post Co. can suceed will depend on its independence as well as the quality of its management. Hopefully, Japan Inc. will not make the mistake of manning it with "old timers" or Oji-Sans whose primary skill is in playing politics and taking favors and not building sensible businesses with rationale investment decisions based on positive NPV project analysis. A rare opportunity is approaching.

According to a recent communication between Japan Post Bank Co. and the BIS (http://www.bis.org/publ/bcbs165/japanpostbank.pdf) the fact that the former invests very heavily in Japanese Government fixed income instruments which it considers risk-free means that it has (so far) side-stepped any issues related to leverage on those investments.

A logical suspicion is that Japan Post Bank Co. has a lot of its balance sheet invested in leveraged JGB products. Unfortunately, in light of the recent issues related to international sovereign debt exposure and bank balance sheets, this may become a very real short-term problem as the latter may soon be forced to look for alternative risk-free asset investments if BIS rules on banks start to redefine more clearly how much these investments can be leveraged and what that means for capital requirements going forward. U.S. Treasury securities here we come? Mahalo.

Friday, May 14, 2010

Dollar Carry Not Yen Carry - The Most Important Trade of 2010

"You can avoid reality, but you cannot avoid the consequences of avoiding reality".

Ayn Rand (1905-1982)

In the midst of a sudden burst of volatility across a number of asset classes over the last four weeks, one is reminded of comments made back in January 2010 by the Deputy Governor of the Bank of China.

He said, in what may be fast becoming a trading reality for a number of hedge funds, prop shops and SWFs, that the biggest risk to the global financial system was the unwinding of a dollar carry trade.

The scale of this unwind (rumored to be in the order of $1,500 billion) would manifest itself in a sell-off in so-called risky assets like emerging market currencies, equities as well as commodities (like copper) and more recently the euro and yen. The fundamental basis for this unwind purports that the U.S. would lead a global tightening in interest rates and that this would turn the U.S. currency into an investment as opposed to a funding currency.

The problem with this thesis is that the Federal Reserve has stated that the Fed Funds rate will remain low for an extended period. In the meantime, other central banks have tightened, namely: China, India and the RBA. So what we have now have is the dollar being bid-up as a safe haven in the face of geopolitical and sovereign debt risks with investors again being sucked into the U.S. Treasuries as the only "riskless asset in town".


However you cut it, the U.S. dollar is likely to continue its medium term assault higher sucking in global portfolio flows away from potentially more attractive NPV projects in the BRICs and emerging markets in general. Confirming this, recent Treasury statistics for March 2010 showed that overseas investors (including the Chinese) have increased their appetite for U.S. stocks and bonds by a combined $140 billion. This was a massive $93.4 billion over February. The bulk of these flows have headed to "riskless" U.S. Treasuries, to a lesser extent stocks and even back to illiquid U.S. real estate projects.

In the long run though, a shortage of available global riskless assets is a BIG weakness in the global financial system, and may warn that the market turnaround in rates will make the inevitable outflows all the more vicious and destablizing.

With trends now clear and present across a number of asset classes expect macro, multi-strategy funds and managed futures hedge funds to enjoy a period of solid, albeit volatile returns, while the outlook for long/short equity managers may be a little more difficult as equities zig-zag lower as the global "w-shaped recovery" takes shape and sluggish growth and persistently high unemployment takes root.

A supplementary point to the above observation, is that the U.S. Treasury bond market which is benefiting greatly from the current rush of safe-haven capital, is likely to snap higher once the deteriorating state of the fundamentals take shape. Maybe the dollar moving higher will choke off some of the market share that large U.S. multi-nationals had been making recently in overseas markets, including in Asia. It is all worth watching with volatile, bated breath. Mahalo.