Long time readers may know my fascination with the evolution of portfolio construction and the exploration of "new" asset classes and market segments. It is worth noting that more time is spent on the exploration than actual implementation but I view a big part of the task as being research and study in the hopes of adding value in the future even if the study simply tells you what not to do. It is truly fascinating.
Embedded in the topic is seeking different ways to construct a portfolio to account for short term events or bigger picture changes in the world and whether the current situation is a short term event or a change in the big picture.
This brings us to the latest recap of the Absolute Macro Fund run by Hugh Hendry from Ececlectica via Market Folly. Hendry is a deflationist these days. I don't necessarily agree with everything he says or run out to copy his trades but he is very insightful and the positions he puts on can convey several messages. Per the Market Folly post Hendry was up 31% in 2008 and down 8% in 2009.
Only the fund's top ten holdings were disclosed. The largest by far is 19.8% of the fund in EUR-LVL. He is short the Latvian lat (LVL) against the euro. LVL is pegged against the euro and the peg is causing all sorts of problems for Latvia as the government won't give up the peg. At some point you would think it would have to be depegged or otherwise adjusted and apparently Hendry thinks the same thing. I first mentioned Latvia's troubles three years ago.
In theory, let me say that again, in theory the trade can't lose other than carrying costs or other slippage. It would seem he is content to wait for the depeg to happen. There is probably something to learn from that even if there is no easy way to access LVL.
The fund has 7.4% and 7.1% respectively in Australian ten year sovereigns and 30 year German sovereigns. Going out that far is a good trade if deflation really happens and both countries are obviously on relatively firm footing. Also featured in the top ten are five different tobacco stocks adding up to about 10% of the fund. I guess that no matter how bad things get people will still smoke, maybe some will start to smoke--clearly this is a bet on stock prices going down.
The top ten add up to 52% and the fund's "gross invested position is 75.5%" which I take to mean there is 24.5% in cash. Only 25% of the fund was in long equities and we know at least 10% was in tobacco stocks. The letter talks about high yielding pharma and utility stocks as well but those were not disclosed. Also mentioned in the commentary were currency positions in USD-HUF (Hungarian forint) and GBP-NZD and a recently added position in USD-ZAR (South African rand). These positions seem to point to betting on risk aversion which also seems consistent with the deflation bet.
The fund is obviously an absolute return vehicle and the literature notes there is no benchmark. It is clear from this post and even more so if you click through and read the report that the fund will go anywhere to seek its result. A 31% return in a year like 2008 is evidence of a great call, no question about that, but not what I would expect from any sort of absolute vehicle. Either "absolute" is not the most accurate description or maybe my interpretation is too narrow.
Reading about these vehicles and then pondering whether or not this is the way to go is intellectually interesting but I would not expect 30% in a year very often, never actually and you will get a couple of those in your lifetime from a normal equity portfolio which would be a big chunk of your lifetime return. Anyone thinking they want to give that up probably needs to plan on saving a whole lot more money.
That said there is room for a little absolute exposure in a diversified portfolio and much to learn from gameplans like Hendry's.
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11 comments:
fwiw, Bill Gross at Pimco was also out not long ago talking about loading up on German Bunds. Just prior to that, Gross wrote in December on the attractive yield of Utility stocks in comparison to skinny Fixed-Income yields.
The tobacco bet is not unlike a bet on XLP (Consumer Staples) or KXI (Global Staples). A developing world needs more toothpaste and household items apparently.
image to see this in recent months/years:
www.tinyurl.com/yco4rx9
Hendry is one of my favorites. Unfortunately while he is one of the most insightful people I know he gets his timing wrong IMO.
This explains his being down 9% in 2009. Overall still better than most.
SEG
8% in 2009
fat fingers
Out of ignorance, what is a sovereign in the context of finance? From what I can gather it is debt issued by a government, much like a U.S. treasury note or bond.
Too bad I'm dumbing down the group here.
you have it right, debt issued by a government
Thanks Roger. That was my understanding, debt issued by a government in somebody else's currency.
How is that a new asset class? It seems to me a position in a sovereign is speculation in both interest rates and currency flucuation at the same time. For someone hedging, it seems like you would want a position in one or the other, but not both. I would assume debt and currency can move independently of each other.
for longer dated paper interest rate moves can effect bond prices but shorter term not really--same as US paper.
so hendry has longer term stuff because he believes rates will come down which would be the case, as mentioned if he is correct about deflation
The Economist seems to think Latvia is doing okay, or at least better than Greece -- http://tinyurl.com/yelau9o (do I hear the sound of one hand clapping?) -- but with 22% unemployment and a 17.5% drop in GDP that display of disciplineTM may result in an outcome even an Austrian economist might consider mixed.
Still, Latvia is a good example of the tradeoff that no country can completely escape during a contraction and The Economist article states it clearly even if the author appears to neither appreciate its impact on larger trends nor consider it an actual policy choice viz "Latvia seems to have achieved something many thought impossible: an internal devaluation. This meant regaining competitiveness not by currency depreciation but by deep cuts in wages and public spending."
IOW deflation but not sure why anyone would think it "impossible:" Maintaining the currency's value was a policy choice and if the populace remains willing to accept the pain that involves then the policy can stand.
OTOH as the article notes there is an ongoing emigration of skilled labor, greater disparity between wealthy and poor, distrust of elites and growing political influence from Moscow which suggests that, if Hugh Hendry can afford the carry and opportunity cost, his trade may yet pay off even though it was early (a situation I can easily sympathize with IAC).
The thought occurs to me that Hendry could already be profiting from Latvian bonds independently of the currency issue; e.g., in a deflation long debt becomes more valuable so, depending on how he has set the play up, he could already be making money and may actually be depending on the stubbornness of the government to keep it that way for awhile. Or he may not really care since a sudden depreciation would push interest rates up lessening the value of his bonds but then the currency trade would add profit on the other side due to increase in the Euro against the Latvian currency. Nice.
maybe somewhere with Latvia is the trade from the Russia Forum that he mentioned but did not disclose; was it 75% upside no downside, is that how he described it?
Well initiative, carry on........
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