On 22 June 2007 Bear Sterns announced that they pledged loans to the value of USD3.2 billion to bail out two hedge funds hit by subprime losses and investor redemptions, but that did not prevent the funds eventually filing for bankruptcy on the 1st of August the same year. The first weekend in August this year saw the two year anniversary of BNP Paribas’ suspension of three investment funds, also due to sub prime exposure. Since those early credit crisis shocks there have been periodic liquidity injections by central banks across the globe. Most recently the Bank of England (BoE) announced that it will pump an extra 50 billion pounds into the economy in a move that has caught a number of economists off guard, raising fears that this could be in anticipation of further financial instability. The chart below shows the performance of a range of equity, bond and property indices from August 2007 to date, with bonds (government, investment grade corporate and high yield) all in positive territory, and riskier assets such as equities and property still lagging.


In the shorter term global equities added 8.5% in July 2009, which surprised many market participants. Emerging equity markets raced ahead with another strong month as the MSCI World Emerging Market Index gained 11.5%. In local currency terms the Japanese market was not quite as buoyant as its’ Western counterparts, only adding a little over 2%. With Japan, France and Germany now officially out of their respective recessions (albeit with sub 1% growth rates) market movement may depend very much on participants’ views of the sustainability in economic growth.

Bonds did not quite sell off as much as one would expect when equity markets rally so much supporting the view that there may still be a drag on the recovery in spite of share markets fairly optimistic view of future economic developments. Government bonds in the US (+0.4%) and Europe (+1.8%) were slightly stronger with the UK (-0.8%) and Japan (-0.2%) selling off slightly when measured in local currency. Credit rewarded its investors for the extra risk it contains when compared to government bonds, and investment grade bonds across the globe had a strong month with decent gains. High yield bonds continued to do particularly well and ended the month up in the US (+6.0%) and in Europe (+8.4%). On the back of the rally in equity and credit markets global convertible bonds posted a solid return of 6.8% for the month. Viewpoint continues to favour this asset class as a more defensive exposure to equity like returns.

August will see a number of US Treasury bond auctions, as the US Treasury plans to raise around USD2 trillion in bonds for the year. Investors’ appetite for these bonds may provide a broad indication of the sentiment in markets for the period to the end of the year. Interest from non-US investors will also be watched closely as this will be a barometer for the US Government’s (perhaps more particularly the US Dollar’s) role as a safe haven in times of financial turmoil. In recent months the greenback sold off when equity markets rallied, and an increase in demand for US treasuries could have a negative effect on the performance of risky assets. Once again global property securities performed in line with equity markets with the regional FTSE EPRA/NAREIT indices advancing between 8% and 11% in local currency terms during July. Many property funds still hold impaired properties and with occupation rates still falling around the world fund managers will have their work cut out to bring these assets back to their former stable and income generating attributes again. We believe that the residential property cycle is long and suspect that we could be in for a lengthy period of “bottoming out” in the market with little upside potential for some time. The commercial property market has also fallen dramatically and is not yet showing signs of a recovery. As with residential property, the commercial property cycle is very long. It might be some time before a meaningful recovery starts, given the oversupply of property and the fall in occupier demand as the recession in across the globe runs its course. However the pace of the falls and the growing attraction in the yields are leading to some “dipping the toe in the water” from cash rich investors.

On the back of strengthening equity markets the US Dollar was slightly weaker against most other developed currencies. More notably the Dollar has had mixed fortunes against developing market currencies for the year to date (see table alongside). Viewpoint is still of the opinion that a well diversified basket of emerging market currencies could hold up well against the euro, Yen, US Dollar and Pound Sterling.

On the commodity front markets were quiet in July compared to the gains that we have seen for the year to date; broad commodities (+2.4%), agricultural commodities (+1.1%) and gold (+0.5%) were up with oil futures ending the month slightly lower (-3.0%).

Looking towards the rest of the year Viewpoint expects less clear direction in equity markets than has been the case up to the end of July, and remains cautious with regards to equity exposure in our balanced mandates.

Source: RMB Asset Management / Bloomberg / Lipper Hindsight. August 2009

Source: Lipper Hindsight.  Auguste 2009

FOCUS

In the first of a two part series we take a look at exchange traded funds (ETFs), and their application in portfolio construction.

What is an ETF?

An ETF is a collective investment scheme that invests in an underlying portfolio of securities on an investor’s behalf. This is similar to the multitude of mutual funds available globally which also give unit holders fractional ownership of the underlying investment portfolio in the fund. Like most mutual funds, ETFs are also open ended vehicles meaning that the underlying pool of capital may swell and contract with new investments and divestments. Unlike most mutual funds, however, ETFs are free to float on stock exchanges, a feature which is usually the preserve of closed-end investment trusts. It is these combinations of features that make ETFs attractive to investors and their fund managers alike. These characteristics also provide a unique set of structural requirements that make ETFs stand out against their open and closed ended counterparts.

The advent of ETFs and the size of the universe

The fund which is considered to be the first ETF, the SPDR Trust, was listed in 1993. Since SPDR, ETFs have been launched to allow investors access to a plethora of investment strategies including broad indices, sectors, emerging markets, commodities and even geared and active strategies. At the end of May 2009 the global ETF industry had 1,660 ETFs with assets under management of USD774.8 billion. It is a testament to the continued popularity of this corner of the industry that there are presently plans to launch 767 new ETFs. The rapid growth of the industry has been impressive and reflects the versatility of these instruments. According to a recent survey , 67% of investment professionals canvassed identified ETFs as the most innovative investment vehicle of the last two decades. Furthermore, 60% reported that ETFs have fundamentally changed the way they construct investment portfolios. Evidence such as this suggests that ETFs should be better understood by investors, even if only to better understand their strengths and limitations.

Trading ETFs

For the majority of ETF traders the buying or selling process will be identical to trading equity on an exchange. Investors will instruct a trade with their broker who will provide a bid and offer spread. The investor can choose to buy at the offer (higher) price or sell at bid (the lower price). The broker will probably also take a commission and there are often other small costs such as exchange fees which may apply. This differs from a normal mutual fund in the sense that an investor can trade an ETF in the secondary market at any time during the exchange’s trading hours. Normal mutual fund investors will have to wait until the Net Asset Value (NAV) of the fund they want to buy is published before being able to buy units. For mutual funds that are priced daily, the NAV will be determined at the end of the trading day, whereas for funds that have longer periods between the publishing of the NAV, access to the mutual fund, will be less frequent.

A result of ETFs floating is that their price is determined on the exchange by supply and demand. As market forces can affect the price of an ETF independently of its NAV, there is no guarantee that the ETF will always trade with a mid price (the mid-point between bid and offer) at NAV. There is, however, a system in place that will tend to prevent an ETF’s market price from deviating too far from the NAV. This is the ability of larger institutional clients to participate in creation and redemption unit transactions.

Rather than trade through the secondary market, institutional investors may use what is effectively a primary market for the ETF shares. The ‘creation (and redemption) units’ are tool which allow an ETF to maintain an open-ended structure, whilst being listed on an exchange as if an equity. The creation unit process is depicted graphically below, but the process is relatively straightforward. The reason that this procedure remains the preserve of institutional participants is that there is a minimum trade size requirement which drags the function out of reach for most non-institutional investors and also the complexity in creating the in specie stock basket which must match the composition of the ETFs underlying holdings. These Authorised Participants are able to, therefore, effectively buy and sell units directly from the Fund.

In figure a. the independent investment manager invests a portfolio of cash to have the same proportions of underlying investments as the ETF. The Mirror Portfolio is then transferred to the ETF manager in specie and the Mirror Portfolio is subsumed into the ETF portfolio. In figure b., the ETF portfolio’s NAV increases by the value of the Mirror Portfolio’s NAV, and the independent investment manager is granted creation units in the ETF that reflect the value of the contribution to the ETF. The above process may be reversed in order to exercise a redemption from the ETF’s pool of assets.

How ‘Creation Units’ help ETF pricing

It has been mentioned above that ETF’s prices may deviate from NAV and also the mechanism through which institutions may trade with the ETF has been summarised. This is not the case for open ended mutual funds as access to them is only possible once the NAV has been struck. This is a clear difference between ETFs and mutual funds, emphasising the equity-like characteristics of ETFs. Unlike stock, however, ETFs do not have a designated market maker. The function of the market maker in normal equity markets is to provide a degree of liquidity and keep the bid-offer spread of a stock within a reasonable band of its mid price. As a result, if the demand or supply fundamentals for any particular ETF became extremely imbalanced, the result may be impaired liquidity or at least an unattractive bid-offer spread. In the equity markets, this is where the market maker would step in to redress the imbalance. In the ETF universe there is no designated institution tasked with maintenance of liquidity and reasonable market prices. Instead it is left up to institutional investors to seek to profit from pricing anomalies to bring the market price to within a reasonable level of the NAV and by doing so promote liquidity.

The ability of authorised participants to create and redeem units in the ETF via an in specie transfer on any trading day, reduces the likelihood that the market price of the ETF deviates far from its quoted NAV. This is due to the ability of the authorised participant to use the creation / redemption mechanism to make an arbitrage (or ‘riskless’) profit from pricing anomalies. If the ETF is trading in excess of its NAV, the independent institution could seek to profit by creating extra units in the ETF at the cost of the underlying shares and sell the ETF in the secondary market at its prevailing market price. This increased sell side pressure for the ETF is likely to pull the market price down if the volumes involved are adequate.

The opposite is also possible. If an ETF is trading in the market below its NAV the institution will buy the ETF in the market, redeem the units in specie and then sell the component parts off at a profit.

Next month we will look at the advantages and disadvantages of ETF’s, as well as some innovation in this new investment field.

IGNIS ASSET MANAGMENT

Chris Ralph has left Ignis Asset Management, where he was a MultiManager, following the termination of Ignis, joint venture with Maia Capital. Jason Collins has left Ignis Asset Management, where he was a MultiManager, following the termination of Ignis, joint venture with Maia Capital.

LV = ASSET MANAGEMENT

Dan Ford has moved to LV = Asset Management as a Product Manager. He will focus on regulatory issues and managing the firm’s products through different market conditions. He was formerly a Product Manager at New Star Asset Management.

UNIVERSITIES SUPERANNUATION SCHEME

Luke Dixon has moved to the Universities Superannuation Scheme as a Hedge Fund Manager. He was formerly Executive Director, responsible for Global Hedge Fund due diligence on EMEA structured products at JP Morgan

ADELANTE ASSET MANAGEMENT

Edward Cowen has moved to Adelante Asset Management as a Partner. He was formerly Head of Emerging Market Credit Trading at Nomura Asset Management.

HENDERSON GLOBAL INVESTORS

Elissa Johnson has moved to Henderson Global Investors as Leveraged Loans Director. Elissa was formerly a Principal at Apollo Asset Management.

Nicolas Ware-Fredriksson has moved to Henderson Global Investors as Director. Nicolas was formerly a Senior Portfolio Advisor at Highland Capital Management Europe.

Stef Abelli has moved to Henderson Global Investors as Leveraged Loans Director. Stef was formerly a Director of Acquisition and Leverage Finance at BayernLB.

HEWITT ASSOCIATES

Anne Swift has moved to Hewitt Associates as Chief Investment Officer within its UK Defined contribution team. She was formerly a Director and an Investment officer at BlackRock Investment Management

MERCER

Katherine Photiou has moved to Mercer as a Principal in its strategic benefits consulting and delivering team. She was formerly a UK Corporate Strategy Manager at Friends Provident Life & Pensions.

RATHBONE INVESTMENT MANAGEMENT

Tracey Peters has moved to Rathbone Unit Trust Management as a Sales Executive for the South Wes, Midlands and the North. She was formerly Sales Director at F&C Asset Management.

THREADNEEDLE INVESTMENTS

Agnes Balaisch, has moved to Threadneedle Investments as an Emerging Markets Strategist. She was formerly at International Monetary Fund where she was responsible for monitoring emerging markets economies.

UBS GLOBAL ASSET MANAGMENT

Jerry Rivera, has moved to UBS Global Asset Management as an Equity Fund Manager. He was formerly Equity Fund Manager at SAC Capital.

Konstantin Stoev has moved to UBS Global Asset Management as an Equity Fund Manager. He was formerly at Swiss Re.

Michael Reznikas has moved UBS Global Asset Management as an Equity Analyst. He was formerly at Fidelity Investments.

ALADDIN CAPITAL MANAGEMENT

Mark Atmore has moved to Aladdin Capital as Managing Director in Credit sales. He will specialise in selling asset backed securities and collateralised debt obligations. He was formerly at Nomura.

AVIVA INVESTORS

Roger Webb has left Aviva Investors where he was Head of Credit. He will be leaving the Group for personal reasons and would be exploring other opportunities.

BROOKS MACDONALD ASSET MANAGEMENT

Daniel Minett has moved to Brooks Macdonald Asset Management as a Private Client Fund Manager. Daniel was formerly at Cavendish Wealth.

Howard Crossen has moved to Brooks Macdonald Asset Management as a Private Client Fund Manager. Howard was formerly a Fixed Income Fund Manager at Premier Asset Management.

Julian Holden has moved to Brooks Macdonald Asset Management as Intermediary Sales Manager for the Manchester office. He was formerly at New Star Asset Management where he was responsible for promoting retail funds and managing strategic alliances with life companies and platforms.

CARDANO

Adelaide de Casson has moved to Cardano as an Investment Manager based in London. He was formerly a Risk Manager at Lehman.

Darran Specter has moved to Cardano as an Investment Manager. He was formerly a Member of Research and Investment Committees at Schroeder Investment Management.

C-VIEW

Adrian Schmidt has moved to C-View as Head of Research and Strategy on the currency investment management team. He was formerly a Senior FX Strategist at RBS Global Markets.

GAM

Nicki Martin has moved to Liontrust Asset Management as an Equity Analyst. Nikki is currently an Equity Analyst at GAM.

Rob Cornish has moved to Liontrust Asset Management as an Analyst. Rob is currently a Quant Analyst at GAM.

Tom Ayres has moved to Liontrust Asset Management as an Equity Analyst. Rob is currently a UK and European Equity Analyst at GAM.

Industry news; Godliman Press Digest, Investment Week, Financial News, Investment Adviser, Financial Times, Beeley.  June 2009

Important Notes

Disclaimer:
This document does not constitute an offer or solicitation to any person in any jurisdiction in which it is not authorised or permitted, or to anyone who would be an unlawful recipient, and is only intended for use by original recipients and addressees. The original recipient is solely responsible for any actions in further distributing this document, and should be satisfied in doing so that there is no breach of local legislation or regulation.  The information is intended solely for use by our clients or prospective clients, and should not be reproduced or distributed except via original recipients acting as professional intermediaries.  This document is not for distribution in the United States.

Prospective investors should inform themselves and if need be take appropriate advice regarding applicable legal, taxation and exchange control regulations in countries of their citizenship, residence or domicile which may be relevant to the acquisition, holding, transfer, redemption or disposal of any investments herein solicited.

Any opinions expressed herein are those at the date this material is issued. Data, models and other statistics are sourced from our own records, unless otherwise stated herein. We believe that the information contained is from reliable sources, but we do not guarantee the relevance, accuracy or completeness thereof.  Unless otherwise provided under UK law, Wealth management Group Ltd does not accept liability for irrelevant, inaccurate or incomplete information contained, or for the correctness of opinions expressed.

We caution that the value of investments in discretionary accounts, and the income derived, may fluctuate and it is possible that an investor may incur losses, including a loss of the principal invested.  Past performance is not generally indicative of future performance. Investors whose reference currency differs from that in which the underlying assets are invested may be subject to exchange rate movements that alter the value of their investments.

Our investment mandates in alternative strategies and hedge funds permit us to invest in unregulated funds that may be highly volatile.  Although alternative strategies funds will seek to follow a wide diversification policy, these funds may be subject to sudden and/or large falls in value.  The illiquid nature of the underlying funds is such that alternative strategies funds deal infrequently and require longer notice periods for redemptions.  These Investments are therefore not readily realisable. If an alternative strategies fund fails to perform, it may not be possible to realise the investment without further loss in value. These unregulated funds may engage in the short selling of securities or may use a greater degree of gearing than is permitted for regulated funds (including the ability to borrow for a leverage strategy). A relatively small price movement may result in a disproportionately large movement in the investment value. The purpose of gearing is to achieve higher returns associated with larger investment exposures, but has concomitant exposure to loss if positive performance is not achieved. Reliable information about the value of an investment in an alternative strategies fund may not be available (other than at the funds infrequent valuation points). 

Under our multi-management arrangements, we selectively appoint underlying sub-investment managers and funds to actively manage underlying asset holdings in the pursuit of achieving mandated performance objectives. Annual investment management fees are payable both to the multimanager and the manager of the underlying assets at rates contained in the offering documents of the relevant portfolios (and may involve performance fees where expressly indicated therein).

Wealth Management Group is licensed with the Hong Kong SFC for Type 9 regulated activity, Asset Management (ANM279)
Wealth Management Group PTE is registered with the Monetary Authority of Singapore (MAS) as Exempt Fund Managers
Wealth Management Group 2009