AsianInvestor picks its 2011 winners

AsianInvestor is currently announcing its 2011 award-winners over a period of four days.  

Awards with a global theme include:  

Distributor of the year, commercial bank
HSBC

Global fixed income, hedged
Credit Suisse Asset Management

Global fixed income, unhedged
Amundi

Global equity
Schroder Investment Management

Real-estate investment trusts, global
LaSalle Investment Management Securities

There are regional and country awards too.  Find out who all the winners are at AsianInvestor. 

India opening up to Sovereign Wealth Funds

From  SWF Institute

Historically, investment access to India’s equity markets has created several problematic issues and headaches for sovereign wealth funds. Currently, sovereign wealth funds are grouped under the category foreign institutional investor or FII defined by the Securities and Exchange Board of India (SEBI).

A few current sovereign-entity FIIs registered include:

• Abu Dhabi Investment Authority
• Abu Dhabi Investment Council
• Australian Future Fund
• Provincial Government of Alberta (AIMCo)
• China’s National Social Security Fund
• Fullerton Fund Management Company LTD (SWE of Temasek Holdings)
• Kuwait Investment Authority
• New Zealand Superannuation Fund
• Norges Bank
• Queensland Investment Corporation
• Singapore’s GIC

Sovereign entities can also invest as a Foreign Venture Capital Investor. FII’s are under strict regulation and cannot hold large positions in listed Indian companies. Times have changed, India wants to increase foreign investment in companies and attract foreign capital. There is a heavily-debated plan underway to create a new defined class of investor for sovereign funds which will be fundamentally different from the FII classification. This new class for sovereign funds would allow them to hold a much larger stake within a publicly traded Indian firm. The plan must be approved by SEBI and receive permission from the Reserve Bank of India. India’s fear was that foreign governments could create numerous sovereign entities to bypass the 10% rule and thus effectively control the company for geopolitical reasons.

Recently, the Government of Singapore Investment Corporation opened up an investment office in Mumbai. This was after India and Singapore signed an economic agreement. The Indian Government would also treat Temasek Holdings and GIC as separate investors, not acting in concert in potential large stake undertakings. Sovereign wealth funds are warming to investing in the Indian equity markets as the Government of India begins to warm up to foreign investments.

How to survive stock market crashes without getting screwed

By Mark Hebner, President, Index Fund Advisors. 

It happens every time.

Toward the end of long bull markets, when stocks finally begin to feel safe and everyone’s making money, folks that are nervous about investing in the stock market finally begin to relax. They put their money in the market and, lo and behold, for a little while, they do well. They tell themselves they’re in it for the long haul. They promise themselves that they won’t be scared off by the inevitable “dip.”

Then the “dip” finally comes. And they lose 10%-15% of their money. They don’t feel great about that, and stocks don’t seem like such a good idea anymore, but they hang in there. Stocks for the long run! But then the dip becomes a “bear market” — down 20%. And then it becomes a bad bear market — down 30%. And then it becomes a once-in-a-generation bear market — down 40%. And suddenly everyone is saying that stocks are going to fall another 50% from there because the world’s headed to hell in a handbasket.

And, eventually, the folks who put their money in the market near the top can’t take it anymore. So they yank their money out. Better to save what little they have left, they think, than to see all of their hard-earned savings get flushed down the drain.

For a few weeks or months, they feel vindicated: The stock market drops some more. But then it turns around and rallies, and a year later, disgusted, they note that if they had only hung in there, they’d be back to even. And they vow never to invest in stocks again.

This, unfortunately, happens to lots of casual investors. It happens, in part, because investors get bad investment advice. It also happens because investors haven’t learned the history of the stock market and prepared themselves for its gut-wrenching volatility.

But the good news is, it doesn’t have to happen. As long as investors understand how the market behaves and have a concrete plan for dealing with this volatility, they can actually benefit from market crashes rather than get destroyed by them.

In this video, I talk with advisor Mark Hebner of Index Funds Advisors about how IFA has handled the past decade. Like other disciplined asset managers, IFA constructs portfolios designed to match the risk-tolerance of each individual investor and then uses portfolio rebalancing to keep this risk constant, regardless of what the market is doing.

IFA’s funds have done very well over the past decade, despite the S&P 500 having been down over the period. Because IFA prepared its clients for the market volatility, they did not freak out and sell everything at the bottom.

Source: http://finance.yahoo.com/blogs/daily-ticker/survive-stock-market-crashes-without-getting-screwed-according-143507867.html#more-id


Sovereign Investor:   With the rise of dynamic asset allocation, will sovereign/institutional investors really be any better off, or will they and up (supported by weighty presentations and recommendations from asset advisors) behaving like the individuals described in this article as they try to pick market trends?  To what extent is the dynamic asset allocation approach funadamentally in conflict with developing and sticking to a long-term strategy supported by periodic rebalancing? 

Diversification by omission

From Fama/French Forum

Can investors build a better portfolio by combining asset classes that have low correlations? It is possible, explains Ken French, but not in the way that most investors attempt it. Some think they can enhance diversification by eliminating mid caps and concentrating on only large and small cap stocks because these asset classes are less correlated. Ken explains that portfolio variance is determined not only by correlation, but also by variance of the individual asset classes and, critically, by their weighting in the portfolio. He emphasizes that throwing out mid caps is equivalent to doubling up on the risk of large and small caps, which is the opposite of diversification.

 (View the video)

IMF echoes ETF concerns

From Global Pensions:

The International Monetary Fund has become the latest financial body to express concerns about the growth of the ETF industry.

The IMF's warnings, made in its latest Global Financial Stability paper, centred on the risks involved with synthetic replication and securities lending. They echo similar concerns expressed recently by the Financial Stability Board and the FSA.

The report acknowledges these "enhancements" reduce costs, but increase counterparty and liquidity risks. ETFs are as yet a relatively small market in Europe in comparison with the US. However, despite this there are strong signs that pension funds, hedge funds and other investors are beginning to embrace these products.(Global Pensions: 08 December 2010)

Part of the IMF's unease stems from the growing size of the synthetic ETF market in Europe, which it argues increases the potential for contagion.

The report says: "The gross exposures of these funds raises some concerns on whether current restrictions on derivative contracts are sufficient to curtail counterparty risks from becoming systemic under stressed market conditions."

The IMF also alleges that investors are unhappy with current regulation that requires ETF providers to be able to recall lent securities and provide collateralisation.

It reveals: "Participants claim this process currently lacks transparency and that the cash reinvestment guidelines have not been clearly laid out by regulators."

The report also calls into question the ability of ETF issuers to maintain normal creation and redemption mechanisms at times of market stress, and reiterates concerns that heavy ETF trading could disrupt prices in small markets and commodities.

Sovereign Investor:   Exchange Traded Funds (ETF) are used by transition managers, amongst others, to obtain market exposure as part of a cost-efficient transition strategy.  In light of regulator and IMF concerns, is this approach wise?  What is your experience?  The IMF paper (10.50 MB) can be downloaded here.  Annex 1.7 (page 69) is the place to find a useful discussion on ETFs.  The introduction to the Annex reads,

Exchange-traded funds (ETFs) have become increasingly popular over the past few years.  They give investors increased access to emerging market assets while also offering flexibility and leverage to specialized investors. Traditionally, ETFs have physically held underlying assets, but a new breed of ETFs have emerged in Europe that use synthetic replication techniques and derivatives to reduce costs and thereby boost returns.  A small percentage of these funds also use leverage to cater to the hedging needs and speculative positions of their nonretail client base. While these enhancements have reduced costs, they add a layer of complexity and increase counterparty and liquidity risks. The disproportionately large size of some ETFs compared with the market capitalization of the underlying reference indices poses a risk of disruptions in some markets from heavy ETF trading. This annex surveys the growth and mechanics of ETFs and highlights some of the key risks pertaining to synthetic replication and the use of leverage and derivatives in ETFs.

Complexity?  The following diagram from the report provides some hints

 Risk?  The report describes the following menu, for those so inclined:

• Counterparty and mark-to-market risk for the ETF provider
• Leverage risk for investors
• Liquidity risk
• Market disruptions
• Legal and policy risks

Graham's 50-year study -- foolproof?

Extracted from The Graham Investor.

In 1976, Hartman L. Butler spent an hour with Benjamin Graham and the interview is recorded within a fine study of Graham’s life published by The Financial Analysts Research Foundation. During the interview, Graham describes buying groups of stocks that meet some simple criterion for being undervalued, regardless of the industry and without detailed investigation of the individual company. This was anathema to his earlier method – as described in Security Analysis – of going through each stock with a fine-tooth analytical comb.
In the interview Graham mentions an article on three simple methods applied to selecting common stocks which was published in a 1975 seminar proceedings. In connection with this statement, he also mentions a 50 year study he had just completed:

“I am just finishing a 50-year study–the application of these simple methods to groups of stocks, actually, to all the stocks in the Moody’s Industrial Stock Group. I found the results were very good for 50 years. They certainly did twice as well as the Dow Jones. And so my enthusiasm has been transferred from the selective to the group approach.”

… “Imagine–there seems to be practically a foolproof way of getting good results out of common stock investment with a minimum of work. It seems too good to be true. But all I can tell you after 60 years of experience, it seems to stand up under any of the tests that I would make up. I would try to get other people to criticize it.”

Basically the three simple methods (tested separately) were:

1. Look for stocks with Earnings Yield, i.e. E/P twice the prevailing AAA Corporate Bond interest yield (albeit limiting P/E no greater than 10, and no lower than 7, regardless of the bond rate).
2. Look for stocks making a low around 50% of their two year high.
3. Price at two-thirds of book value.

In the article, Graham tabulates the results for all three methods; each method beats the index by a considerable margin, with the P/E method being the best, the 2-year low being second-best.

I found it interesting to read about the 2-year high/low study, because I have previously mentioned the need to pick stocks from the screen that are well off their previous highs – so we know there is sufficient upside potential to make a serious profit. In other words, if a stock on the screen is at $2, but only ever got as high as $2.50 in its history, it would not apparently have as much upside potential as a similarly-priced stock that once hit $10. It would seem from reading these studies that Graham himself also found this to be true and allowed himself room for at least a 50% return.

It’s also important to remember that in this study, Graham was advising the purchase of a basket of around 30 stocks matching any one criteria of undervaluation, e.g. 2/3 of book. He even went so far as to say “You can’t lose when you do that.” His experience proved that buying a stock at such a criteria was a dependable indication of group undervaluation.

Sovereign Investor:  A normal institutional or SWF wouldn't restrict itself to such a portfolio, but the underlying drivers may nonetheless of interest to investors seeking exposure to the value factor. The original article at The Graham Investor has sparked off a lively discussion.

US should "give up on the dollar"

The push to replace the U.S. dollar as the world's reserve currency has been gaining steam, with one expert arguing that America "must give up on the dollar."

In a Financial Times op-ed, Michael Pettis, a finance professor at Peking University, said U.S. policymakers should lead the charge to create a more diverse reserve system, "in which the dollar is simply first among equals."

The dollar has been the dominant reserve currency for decades, with central banks and other institutions around the world amassing vast reserves.

Pettis argues that this has resulted in dangerous trade imbalances that threaten to destabilize the global economy. He contends that countries such as China have been able to "game the system" by stockpiling dollars, which has allowed them to grab a larger share of global demand for goods and services.

Read the rest of this article at CNN Money.

Sovereign Investor:   Is it really doom and disaster for the US dollar?  If so, how are you gearing up for the inevitable changes the fall of the world's reserve currency would bring?  If not, what makes you so convinced?  Here's a graph of exchange rates over the past decade (Source:  IMF World Economic Outlook, April 2011):

Santiago Compliance Index - 2011 Update

Ashby Monk, from the Oxford SWF project, reports that Sven Behrendt has released the second edition of his “Santiago Compliance Index” for 2011. Ashby notes that this year’s edition is definitely a provocative read. For example, it shows that some of the SWF signatories still have not managed to implement any of the Santiago Principles (i.e., zero percent compliance).

Click graphic for bigger view

Download the Santiago Compliance Index here.

Sovereign Investor:  The management of public funds should be transparent.  After all, it's money managed on behalf of your stakeholders, and they have a right to know what you're doing with it.  Do you agree?  Where does your SWF fit on this scale?  What steps can you take to make it more transparent?  Share your views, even if you feel there are good reasons why the Santiago Principles go too far.

The Evolving Role of Technology in Financial Services

State Street has published a report, "The Evolving Role of Technology in Financial Services".

Technology has long been an essential behind-the-scenes partner in the financial services industry, providing the innovative incremental advances necessary for the industry to upgrade and expand its services. Improvements in storage capacity and processing speed, for example, have had a profound impact on data management and transactional capabilities, with accompanying reductions in cost. Yet despite these and other advances, the industry has struggled to fully leverage the power and promise of technology,with market participants eager for solutions that are not only faster and cheaper, but that also offer greater security and efficiency.

Click here to download the full report

Source: Top1000Funds.com

Sovereign Investor:   Technology makes the world of investing go around.  Imagine if we had to go back to a world of sailing ships and exchanges of letters under seal.  But how prepared are you if the power goes off for a week or two, or a tsunami bursts through your front door?  Do you even have a DRP?  Even if so, would it really work, or has its author simply filled it with comforting phrases? 

Global equities: Dealing with currency volatility

By James Wood-Collins, from Pensions & Investments.

Whether they represent developed or emerging economies, currencies can create a substantial element of volatility in a global equity portfolio. This may not be apparent when international stocks represent, say a third of the total but, as that share rises, so does the potential for currency-induced volatility. More alarmingly, sudden currency shocks — such as the dramatic rise in the yen that followed Japan's disastrous earthquake — can leave investors highly exposed.
Currency management: time for a change?

Techniques for handling currency exposure such as hedging through forward contracts have been available to investors for many years. The traditional approach uses a symmetrical offsetting portfolio of forward contracts — a passive form of hedging — that does reduce volatility over time. Even this established approach should be implemented in the light of currency management best practices. These practices apply to four key areas:

Pricing or best execution.

Any pension fund engaged in currency hedging should ask the institution responsible what safeguards are in place to ensure best execution. Elsewhere, in the U.K. for example, passive currency programs have often been handed off to the plan custodian but recent lawsuits by several state pension plans in the U.S. alleging that custodian banks overcharged in routine foreign exchange transactions have raised serious doubts as to whether custodians should be entrusted with hedging mandates.

Counterparty diversification.

The most efficient and most liquid instrument for hedging currency exposure is the forward contract, traded over the counter. Assuming that forward contracts continue to trade in this way (provisions in the Dodd-Frank Act may subject them to centralized counterparty clearing, raising the cost of hedging), pension funds need to know who their counterparties are and how many they have. If the fund has a mark-to-market currency loss in dollar terms offset by hedges that are “in the money,” it needs to be sure the hedges are widely diversified, minimizing counterparty credit exposure.

Program design and efficiency.

Hedging is intended to act as a proportional offset to the underlying currencies, typically representing between 50% and 75% of total exposure (the “hedge ratio”). Only very rarely does it approach 100% because there is no linear decrease in volatility as the hedge is increased. To illustrate a traditional program, take a situation where the U.S. dollar is weakening: a U.S. pension plan will have a mark-to-market currency gain but it also has forward contracts that mature with an offsetting cost. The market gain is unrealized but cash payments on the contracts have to be met.

Cash flow management.

These payments may be relatively small, year to year, and they may be offset by contracts realizing a gain. However, as indicated earlier, very large currency movements can occur that might necessitate payments reaching 10% to 15% of the total equity program covered, according to research by Record Currency Management. This carries more serious implications for the fund's cash management. Because pension plans typically do not hold large cash balances, securities might have to be sold. While this discrepancy cannot be eliminated in a passive program, the program can be designed to minimize the burden placed on the plan.

Consider a more dynamic approach

There is an alternative to the traditional hedging technique, one that is asymmetric in nature and executed in an active manner rather than passively. Active, or dynamic, hedging is any hedging activity that involves discretion to deviate from the benchmark hedge ratio. Specialist currency managers who take on dynamic hedging mandates almost always have a formal investment process, and operate more or less systematic techniques designed to exploit inefficiencies — such as momentum, or mean reversion — which they have identified in the market. These strategies permit payments to a pension plan through hedging when foreign currencies weaken but reduce the hedging program when these currencies strengthen, allowing the plan to benefit without meeting large forward contract costs. This approach is analogous to insurance, offering U.S. investors the benefit from foreign currencies strengthening against the U.S. dollar while maintaining some protection against periods of weakness.

As U.S. pension plans continue to expand their horizons away from home and pursue opportunities in global equity markets, the issue of effective currency management becomes ever more critical. This is especially true now that investor appetite for emerging market equities has added a wide range of underlying currencies to the mix. In this climate, plan sponsors need as much thought and flexibility in their hedging programs as they can possibly muster.

James Wood-Collins is CEO of Record Currency Management, a specialist currency management firm based in the U.K.

Read more: http://www.pionline.com/article/20110413/REG/110419974#ixzz1JjL8XJIb

Sovereign Investor:   The old adage is that there isn't value to be had from trying to manage currency exposures in a global portfolio.  Agree? Disagree?  Is there evidence that custodian banks overcharge for routine FX services?  How can this be controlled?

Institutional Investment Managers Anticipate Inflation Risk

Approximately 70% of institutional investment managers believe that the risk of inflation will increase over the next six months, according to a quarterly survey conducted by Northern Trust.

In addition, a majority of managers (62%) expect market volatility, as measured by the VIX Index, to increase over the next six months. Responses on both questions were at their highest points since the Northern Trust survey began in the third quarter of 2008, according to a press release.

Read the full report at PlanSponsor.

Sovereign Investor:  Is inflation going to take off or not?  Someone got a coin?

Regulatory Requirements Top Concern for Investment Managers

A poll released by SEI reveals that meeting new regulatory requirements remains the top challenge among investment managers.

One in three respondents (33%) identified this as the most significant challenge to the industry over the next 12-18 months. Participants were split on the effect of new financial regulation; half of those polled believe new regulations will have a significant effect on the profitability of their firms while 41% of participants expect insignificant impact.

According to a press release, managers were not split, however, on the top channels for growth for the next 12-18 months, as nearly half of respondents (46%) ranked the institutional channel as the greatest opportunity for asset growth among client segments and distribution channels. Other respondents named RIAs/IFAs (20%), retirement plans (18%), and sovereign wealth funds (11%) as top growth opportunities.

A summary of the poll is available for download at http://www.seic.com/managerpoll.

This article is extracted from a report at PlanSponsor.

Sovereign Investor:  Are asset managers to be trusted if we don't have strict regulations?  If you're a sovereign/institutional investor, to what extent are you prepared for that 11% of the industry that's out to win your  mandate? Will managers in more highly regulated markets be more or less likely to get your business, or is it not an issue?  Is regulatory compliance an important factor in your evaluation process?

What is a Strategic Development SWF?

Extracted from Sovereign Wealth Fund Institute, 14 April 2011

Strategic Development Sovereign Wealth Fund (SDSWF) – It is a sovereign wealth fund that can be utilized to promote national economic or development goals.
 
It is commonly accepted that most sovereign funds have a commercial objective which is to earn a positive risk-adjusted return on their pool of assets. There are some SWFs known to promote national economic or development goals.

Common Scenarios (SDSWF)

Domestic Stabilizer Scenario

SWF invests in domestic asset(s) or domestic firm(s) to stabilize aggregate asset pricing, create domestic jobs, and/or prevent entity insolvency.

Industry Job Creator Scenario

SWF acquires a direct stake or total control of Firm A. Firm A owns proprietary technology, controls a unique process, or has access to materials. Firm A opens a factory, sets up an operation, creates a subsidiary or JV, or research facility in SWF home country. This enables strategic knowledge transfer to the SWF home country, while providing potential employment opportunities for the SWF home population.

Country – Corporate Alliance Scenario

SWF signs a memorandum of understanding (MoU) with Country A. Select companies domiciled in Country A receive direct investment from SWF, while those companies sell to the SWF home country government. Those companies may also set up operations in the SWF home country.

Resource Transfer Scenario

SWF acquires a direct stake or total control of Firm A. Firm A controls resources in which SWF home country needs for economic or development purposes.

Buy now, pay later

Extracted from The Economist, 14 April 2011

PUBLIC finance can seem a dry, abstract subject until the point when it becomes all too real. Portugal and Greece managed for years with budget deficits, high public debt and low growth (Ireland, with the failure of its outsize banking sector, is a rather different case). Now they have been forced into painful restructuring by bond markets.

On the other side of the Atlantic, America faces its most serious budget crisis for decades. America's economy is so large, and foreign appetite for greenbacks so voracious, that it seems inconceivable that it could suffer a fate similar to that of Portugal or Greece. The IMF's World Economic Outlook (WEO), published this week, aims to shatter such complacency.

America, its authors write, lacks a credible strategy for dealing with its growing public debt, and is expanding its budget deficit at a time when it should be shrinking. The chart below, drawn from the WEO, illustrates the size of the problem America faces.

Three Proxy Advisors assist CalPERS

Three proxy advisors have endorsed a proposal by the California Public Employees’ Retirement System (CalPERS) requesting Graco Inc. to adopt a majority vote standard for unopposed Board candidates.

ISS Proxy Advisory Services, Glass Lewis & Co., and Egan-Jones Proxy Services have advised shareowners to vote for Proposal 5 on the proxy card at the April 21, 2011 annual meeting of the Minneapolis, Minnesota, industrial equipment manufacturer.

Read CalPERS press release here.