JPM Prime Brokerage Global Hedge Fund Trends March 2013
J.P. Morgan Prime Brokerage Global Hedge Fund TrendsMarch 12, 2013 Figure 1: February 2013 performance HFRI and Market Indices. Monthly ReturnsExecutive Summary 3.5%There was a slight pullback in risk assets1 during February. All 2.5%of the major hedge fund strategies posted gains except forGlobal Macro, which fell -0.67%. The HFRI Global Hedge 1.5%Fund Index inched up +0.14%, with Relative Value (+0.66%)being the top performer among the key hedge fund strategies 0.5%for February. The HFRI Equity Hedge Index increased -0.5% HF Index Equity LS Event Macro Rel Value S&P 500 Fixed CMDTY USD Credit Driven Income+0.50% and Event Driven rose +0.06%. -1.5%Leverage -2.5%For all accounts in the Prime Brokerage portfolio, grossleverage2 fell from 1.91 to 1.88 (-1.5%) in February as market -3.5%participants slightly reduced exposure and leverage in light of -4.5%increased market volatility. Net exposure3 for equity-focused Source: Bloomberg, Hedge Fund Researchstrategies fell from 0.78 to 0.70 (-9.6%). Net leverage forequity-biased strategies declined from 0.69 to 0.64 (-7.2%) Table 1: Performance of hedge fund strategies and asset classesdue largely to a decrease in long exposure. HFRI and Market Indices4 Feb-13 Year-to-DateSecurities Lending HF Index 0.14% 2.67%As the Dow Jones Industrials and S&P 500 indices Equity LS 0.50% 3.84%approached all-times highs in February, clients were reluctant Event Driven 0.06% 2.38%to add short exposure. The U.S. Prime Brokerage short book Macro -0.67% 0.98% Relative Value 0.66% 2.40%was therefore net covered in February, offsetting January’s S&P 500 1.36% 6.61%increase in short activity. In Europe, new deal activity was Fixed Income -1.08% -2.56%light, with new trading flows stemming primarily from capital CMDTY -4.02% 0.25%raising events. Flows were also light across Asia. USD 3.46% 2.73% Credit 0.76% 0.04%Institutional Investor Sentiment Source: Bloomberg, Hedge Fund ResearchFewer new allocations are going to structured credit from U.S.investors. At the same time, U.S. allocators are showing Figure 2: Hedge fund beta to equities Rolling 21-day beta of HFRX equal-weighted index returns to the S&P 500 Total Returnheightened appetite for directional strategies. European Indexallocators continue to upgrade portfolios while Asian investors 0.16 2,800are pulling back from longer-biased credit exposure. 0.14 2,700 0.12 2,600Market PerspectivesTightening measures in China, disappointing data from 0.10 2,500Europe and the perpetual impasse in Washington were 0.08 2,400sufficient to cause only a pause in the 2013 rally. The U.S. 0.06 2,300continues to lead the global recovery. However, it may be 0.04 2,200infeasible for the U.S. economy – and in turn the globalrecovery – to attain “escape velocity” absent longer-term 0.02 2,100 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13clarity with respect to fiscal policy in Washington, including Equity Beta (LHS) S&P 500 Total Return Index (RHS)the pace with which, and the extent to which, federal spending Source: Bloomberg, Hedge Fund Researchwill be pared back.1 Assets other than cash and government fixed income securities. 2 Gross leverage is the total market value of long and short positions divided by clientsequity in J.P. Morgan’s Prime Brokerage portfolio.3 Calculated for Equity Long Short and Market Neutral funds on J.P. Morgan’s Prime 4Brokerage platform only. Net leverage is defined as the market value of long positions Market indices from Bloomberg are as follows: S&P 500 (SPTR Index), Fixed Income(LMV) minus the market value of short positions (SMV), divided by clients’ equity (Eq). (JPMGGLBL Index), CMDTY (SPGSCI Index), USD (DXY Index), and Credit (JULIRNet exposure is defined as the ratio of LMV and SMV, minus one. Index). 1 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.
Prime Brokerage Global Hedge Fund Trends – Performance, Leverage, and Risk ExposuresThis section presents a summary of the changes that we have observed in leverage and sector exposures across the range of hedge funds that wework with. The confidentiality of our clients’ positions is important to us and as such this information has been aggregated and displayed in ananonymous manner in an effort to mitigate the risk of revealing or alluding to any one fund’s exposures. Information may be excluded due to theperceived risk of revealing sensitive information. The information discussed is specific to activities on J.P. Morgan’s books, and may not representtotal client activity. These numbers should only be viewed as representative observations.Market Overview Equity HedgeThere was a slight pullback in risk assets during February. Equity Hedge strategies returned +0.50% in FebruaryAlthough the S&P 500 Index increased +1.1%,5 the MSCI according to the HFRI Equity Hedge Index. Overall,AC World Index declined -0.2%. European markets exerted a defensives led other sectors. The MSCI World Consumerdrag, with the Euro Stoxx Index down -6.2%. Emerging Staples Index was up +2.4% in February compared to +0.5%markets equities also underperformed, with the MSCI EM for the MSCI World Consumer Discretionary Index and aIndex falling -1.3% through month-end. Year to date, decline of -2.9% for the MSCI Market Materials Index.however, equities continue to rally. The S&P 500 is up Market neutral managers benefitted from small cap and pair+6.46% and the Russell 2000 has risen +7.70%. Additionally, trading strategies while fundamental growth strategiesthe S&P 500 / 10-Year Treasury return differential stands at capitalized on gains in the U.S. Small Cap, Cyclical and+6.54%. Alongside February’s slight pullback in risk assets, Financial sectors.the HFRI Global Hedge Fund Index inched up +0.14%. Allof the major hedge fund strategies posted gains except for Event DrivenMacro, which reversed two consecutive months of positive The HFRI Event Driven Index was largely flat in February,performance. inching up +0.06% month-over-month amidst robust strategic, financial and distressed M&A activity. LBOOn the macro economic front, inconclusive election results in activity was particularly strong in February, accounting forItaly captured news headlines but the impact was primarily $51 billion out of $200 billion in total M&A globallylocalized, as demonstrated by declining yields on Spanish according to J.P. Morgan Global Asset Allocation. Februaryand Portugese debt (though Italian yields rose). The Yen thus marked the strongest month for LBO activity since Julycontinued to weaken in February pursuant to “Abenomics,” 2007, when volumes reached $55 billion (See Figure 3).further bolstering Japanese equities. Year to date, the Nikkei February’s heightened LBO activity was spurred by lowremains one of the world’s strongest markets, having surged yields, record levels of cash on corporate balance sheets and+11.65%. High expectations surrounding new leadership for robust demand for high yield loans, as evidenced, forthe Bank of Japan have helped drive yields on 10-year JGBs example, by record new issuance of loans and high yieldto a decade-long nadir. bonds in February (See Figure 4).Relative Value Figure 3: LBO transactions as a percentage of total M&ARelative Value was the best performer among the major 40%hedge fund strategies in February, with the HFRI RelativeValue Index increasing +0.66%. Multi-strategy relative value 35%managers profited from active commodity spread trading. 30%Gains among multi-strategy fixed income arbitrage and 25%convertible arbitrage strategies also contributed to February’spositive returns. Multi-strategy fixed income arbitrage 20%managers benefitted from global credit exposures as the 15%HFRI Relative Value Multi-Strategy Index rose +1.49%. 10%Convertible arbitrage funds with directional exposures toAsia Pacific convertible securities performed well, with the 5%HFRI Fixed Income-Convertible Arbitrage Index up +0.45% 0%month-over-month. Jan-00 Apr-02 Jul-04 Oct-06 Jan-09 Apr-11 Source: J.P. Morgan Global Asset Allocation5 References are to SPX Index vs. SPTR Index as in Table 1. 2 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.
Prime Brokerage Global Hedge Fund Trends – Performance, Leverage, and Risk ExposuresFigure 4: Loan and HY bond new issuance ($ billions) USD. Several factors underpinned this trend, including a 140 Institutional loans further decline in the Yen (-0.9%) due to anticipated easing High‐yield bonds measures by the Bank of Japan, Moody’s UK downgrade, 120 and renewed pressure on the Euro (-3.8%) as a result of 100 113 disappointing fourth quarter GDP. 80 60 38 34 52 32 44 27 50 19 24 30 33 40 7 14 22 26 14 18 16 10 6 20 46 40 42 13 47 43 48 33 34 27 8 24 32 31 31 30 22 20 17 8 6 10 26 22 19 13 23 0 1 7 10 4 May‐… May‐… Mar‐… Mar‐… Nov‐… Nov‐… Jul‐11 Oct‐11 Jul‐12 Oct‐12 Jan‐11 Dec‐11 Jan‐12 Dec‐12 Jan‐13 Apr‐11 Apr‐12 Feb‐11 Aug‐11 Feb‐12 Aug‐12 Feb‐13 Jun‐11 Sep‐11 Jun‐12 Sep‐12Source: J.P. Morgan High Yield and Leveraged Loan ResearchWhile the HFRI Event Driven Index was more or less flat inFebruary, managers with exposures to active targetcompanies in pending mergers have benefitted from robustyear to date corporate activity (See Figure 5). If conditionssuch as low interest rates and high levels of cash on corporatebalance sheets persist, the auspicious M&A climate is likelyto continue, especially as companies seek to grow throughacquisition rather than organically. Merger arbitragemanagers should in turn benefit, assuming that completionrates follow the same trajectory.Figure 5: S&P Long-Only Merger Arbitrage Index year to dateperformance 1910 1900 1890 1880 1870 1860 1850 1840 2-Jan 9-Jan 16-Jan 23-Jan 30-Jan 6-Feb 13-Feb 20-Feb 27-Feb S&P Long-Only Merger Arbitrage IndexSource: BloombergGlobal MacroGlobal Macro strategies declined in February, blunting thegains of the prior two months. The HFRI Macro Index fell –0.67% as negative performance among systematic CTAs(-1.11%)6 partially offset gains among currency and fixedincome discretionary managers.Discretionary managers with long USD and short JPYexposures posted gains as most currencies sold off against the6 HFRI Macro: Systematic Diversified Index, February 2013. 3 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.
Prime Brokerage Global Hedge Fund Trends – Performance, Leverage, and Risk ExposuresLeverage and Risk Exposures Figure 8: Z-score of gross leverage and the S&P 500 Index The Z-score measures how many standard deviations an observation is above or below the meanGross LeverageGross leverage and net exposure for clients in the Prime 1.3Brokerage Portfolio were stable in the first half of Februarybut trailed off towards month-end as market participantsreduced exposure and leverage slightly because of increasedmarket volatility. For all accounts in the Prime Brokerage 0.0portfolio, gross leverage fell from 1.91 to 1.88 (-1.5%) (SeeFigure 6). By contrast, gross leverage of levered accounts inthe Prime Brokerage portfolio increased from 2.50 to 2.59(+3.8%) (See Figure 7). This dichotomy was a reversal from -1.3the pattern in January. As fewer clients deployed leverage in Feb-11 Aug-11 Feb-12 Aug-12 Feb-13February, gross leverage among levered accounts was Difference between gross leverage and S&P 500 Index Z-scoresskewed higher since clients that retained debits did so athigher levels. Month-over-month, leverage in the Prime Source: Bloomberg, J.P. Morgan Prime BrokerageBrokerage portfolio was subdued relative to the gain in the Gross Leverage by StrategyS&P 500 (See Figure 8). Gross leverage rose for High Yield Fixed Income from 1.26Figure 6: Daily gross leverage and the S&P 500 Index to 1.42 (+12.4%). Gross leverage for Market Neutral also increased in February from 4.26 to 4.47 (+4.9%). By 1,550 1.95 contrast, gross leverage fell for High Grade Fixed Income, 1,500 which declined from 2.41 to 2.06 (-14.3%). All strategies are 1.90 running leverage above their average 2-year levels except for 1,450 High Grade Fixed Income. 1,400 1.85 Figure 9: Gross leverage by strategy 1,350 1.80 5 1,300 4 1,250 1.75 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 S&P 500 Index (LHS) Gross Leverage (RHS) 3Source: Bloomberg, J.P. Morgan Prime Brokerage 2Figure 7: Gross leverage (levered accounts) 5-day movingaverage and the S&P 500 Index 1 1,550 2.7 1,500 0 Market Neutral Equity Long Multi-Strategy Convertible High Grade High Yield Short Arbitrage Fixed Income Fixed Income 1,450 2.6 Dec-12 Jan-13 Feb-13 1,400 Source: J.P. Morgan Prime Brokerage 1,350 2.5 1,300 1,250 2.4 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 S&P 500 Index (LHS) Gross Leverage (Levered Accounts - RHS)Source: Bloomberg, J.P. Morgan Prime Brokerage 4 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.
Prime Brokerage Global Hedge Fund Trends – Performance, Leverage, and Risk ExposuresTable 2: Gross leverage by strategy Table 3: Long and short exposures by sectorAverage and first quartile calculated for the period of February 2011 to February 2013 Long (Short) exposure by sector as a percentage of total client long (short) exposure in Prime Brokerage portfolio First Dec-12 Jan-13 Feb-13 Average % Change Quartile Long exposure Short exposure M arket Neutral 4.36 4.26 4.47 3.84 3.54 4.9% Feb-12 Jan-13 Feb-13 Feb-12 Jan-13 Feb-13 Equity Long Short 1.86 1.97 1.94 1.83 1.72 -1.0% M ulti-Strategy 1.76 1.77 1.79 1.77 1.74 1.2% Basic Materials 6.2% 5.6% 5.4% 4.2% 5.2% 4.8% Convertible Arbitrage 3.65 4.17 4.29 3.61 3.44 2.7% Communications 11.6% 13.5% 14.4% 6.5% 6.6% 7.2% High Grade Fixed Income 2.39 2.41 2.06 2.61 2.38 -14.3% Consumer, Cyclical 11.3% 11.0% 11.0% 8.5% 8.6% 7.9% High Yield Fixed Income 1.17 1.26 1.42 1.21 1.16 12.4% Consumer, Non- 14.2% 15.1% 14.9% 10.2% 11.8% 10.8% PB Portfolio (Levered Accounts) 2.54 2.50 2.59 2.53 2.48 3.8% cyclical Diversified 0.3% 0.3% 0.3% 0.0% 0.0% 0.0%Source: J.P. Morgan Prime Brokerage Energy 8.7% 8.6% 8.7% 7.5% 5.9% 6.2% Non sector-specific 3.3% 4.1% 4.2% 14.9% 16.0% 18.4%Net Exposure and Net Leverage ETFNet exposure for equity-biased funds fell from 0.78 to 0.70 (- Financial 20.4% 18.1% 17.9% 11.6% 11.8% 10.8%9.6%) in February and net leverage declined from 0.69 to Industrial 6.3% 5.9% 5.8% 6.2% 6.7% 6.7%0.64 (-7.2%). These decreases reflected the overall pullback Technology 5.2% 4.0% 4.1% 5.4% 7.1% 6.6%in February as managers reduced their net long exposure. Utilities 1.9% 1.3% 1.1% 1.9% 1.9% 1.9% Other 5.5% 6.3% 6.1% 9.2% 10.1% 11.8%Figure 10: Net exposure and net leverageEquity Long Short and Market Neutral funds on the Prime Brokerage platform only. Source: J.P. Morgan Prime BrokerageLMV: Market value of long positions. SMV: Market value of short positions.Eq: Equity in the clients’ accounts 1.3 1.0 0.7 0.4 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Net Exposure (LMV/SMV)-1 Net Leverage (LMV-SMV)/EqSource: J.P. Morgan Prime BrokerageSector ExposuresThe most sizeable increase in the long Prime Brokerageportfolio month-over-month once again was in theCommunications sector (+0.9%). The largest declinesoccurred in the Basic Materials, Consumer, Non-cyclical,Financial and Utilities sectors, each of which fell -0.2%.The largest increases in the Prime Brokerage short portfoliowere in the Non sector-specific ETF (+2.4%) andCommunications (+0.6%) sectors. (The increase in long andshort exposure for the Communications sector wasattributable largely to heightened M&A activity.) The mostsubstantial decreases in short exposure occurred with respectto the Financial (-1.0%) and Consumer, Non-cyclical (-1.0%)sectors. 5 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.
Prime Brokerage Global Hedge Fund Trends – Securities LendingU.S. Securities Lending Liberty Global agreed to acquire Virgin Media (VMED) in a stock and cash deal valued at over $23 billion.Equities Shareholders of VMED will receive a combination ofAs the equities market approached all-time highs in February, cash and shares of Liberty series A & C shares. Libertyclients were reluctant to add short exposure, with the U.S. expects to realize synergies from the scale of theshort book net covered for the month. As of month-end, the combined business once the acquisition is completed byshort sale/buy to cover ratio by market value for 2013 was mid-year. LBTYA and LBTYK borrows remain liquidflat, with shorting in ETFs offset by single name covering. despite increased demand.Most sectors were net covered in February led by Consumer,Non-cyclical, Consumer, Cyclical and Technology. The lone LinnCo. LLC (LNCO) announced its acquisition of all ofoutlier was the Communications sector, which was net the Berry Petroleum (BRY) shares in an all-stockshorted. That anomaly resulted from heightened demand for transaction. The transaction represents the firstLiberty Global shares (LBTYA and LBTYK), which spiked acquisition of a publicly held company by an upstreamafter the planned acquisition of Virgin Media (VMED) was LLC/MLP. The transaction has already been approvedannounced. by the boards of directors of each of Linn EnergyETFs (LinnCo.’s parent), LinnCo, and Berry, and is expectedFebruary was the second consecutive month during which to close in the second quarter. Arbitrage funds have notETFs were net shorted. SPY (SPDR S&P 500 ETF Trust), been very active with this transaction due to scarceIYR (iShares Dow Jones US Real Estate) and HYG (iShares borrow in LNCO.iBoxx High Yield Corp Bond) were the key drivers. Clients OfficeMax (OMX) and Office Depot (ODP) announcedincreased short exposure in other broad based ETFs such as an all-stock merger, which has already been approved byQQQ (PowerShares QQQ Trust) and MDY (SPDR S&P the board of both companies. OMX stockholders willMidcap 400 ETF). There was reduced exposure to small-cap receive 2.69 shares of ODP for every share held, and theETFs led by IWM (iShares Russell 2000). transaction is expected to close by year-end. Borrow forHYG was the most active ETF in February from a stock loan ODP remains liquid despite increased demand.standpoint. Creating to lend HYG is unattractive and PPG Industries (PPG) completed the spinoff of itsexpensive due to the difference between the creation basket chemicals and commodities business to Axiall Corpand the high-yield index that it tracks. When demand (AXLL – formerly Georgia Gulf (GGC)). Overall, justincreases, as it did in February, borrow cost spikes and the under 15% of PPG shareholders elected to take part inETF trades like a hard-to-borrow security. FXI (iShares the voluntary exchange offer.FTSE XinhuaChina 25 Index) also was active in February,skewed towards buys-to-cover. The fund saw large outflows Fixed Incomeas demand decreased, in turn causing the cost to borrow to There was a marked decrease in fixed income shorting forease. both investment grade and high yield corporate debt in February. Financials and technology were the only sectorsEvent Driven for which there were net increases in shorts. Basic Materials,M&A activity was again robust in February, continuing thetrend that commenced in January: Communications, Consumer, Non-cyclical and Utilities were the leading sectors for short covering. February witnessed Kinder Morgan Energy Partners (KMP) agreed to strong flows in the following names, partly in response to acquire Copano Energy (CPNO) in a transaction valued potential LBO activity: Dell, Inc., (DELL), HJ Heinz Co. at approximately $5 billion. Owners of CPNO will (HNZ) and JC Penny (JCP). receive 0.4563 shares of KMP for each Copano share they own. The transaction is expected to close in the In contrast to February’s corporate debt activity, there was a third quarter of this year subject to regulatory and net increase in short balances with respect to convertible shareholder approvals. We are approving limited bonds. Several issues experienced a sudden tightening of quantities of KMP. However, supply across the street liquidity along with headline-driven rate volatility. The U.S. remains constrained. Prime Brokerage book continues to see heavy flows around 6 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.
Prime Brokerage Global Hedge Fund Trends – Securities LendingLam Research (LAM), Newmont Mining (NEM), Peabody Table 4: U.S. securities lending trends by sector For the month of February 2013(BTU), Priceline (PCLN) and RadioShack (RSH). 5 Day 30 Day 90 DayFigure 11: Cumulative net activity Position Position PositionMarket value change of activity across equities, ETFs, and fixed income Price Change Price Change Price Change $4.0 Change (shares) Change (shares) Change (shares) Consumer, Non-cyclical 1.2% -2.4% 1.6% -4.9% 9.0% 1.0% $2.0 Financial 0.8% -1.8% 1.2% -3.5% 12.1% -3.8% Technology 0.9% 0.0% -2.0% -3.2% 14.0% -11.5% $0.0 Energy 0.5% -3.4% 1.6% 2.8% 10.4% -4.0% Communications 1.5% -0.3% -0.1% 7.0% 14.1% 3.4% ‐$2.0 Industrial 1.3% 0.3% 0.9% -1.3% 14.7% -6.2% ‐$4.0 Consumer, Cyclical 0.7% -0.5% -0.4% -1.6% 9.8% -7.2% Basic Materials 0.7% 2.6% -6.0% 0.7% 1.8% 24.4% ‐$6.0 Utilities 1.2% -0.1% 2.0% -0.8% 9.8% 11.3% ‐$8.0 Source: J.P. Morgan Securities Lending Equity ETF Fixed Income Net Activity ‐$10.0 3-Jan 17-Feb 2-Apr 17-May 1-Jul 15-Aug 29-Sep 13-Nov 28-Dec 11-Feb Table 5: U.S. securities lending trends by ETFsSource: J.P. Morgan Securities Lending For the month of February 2013 5 Day 30 Day 90 DayFigure 12: Rolling 1-month daily short flow Position Position PositionDaily Activity Relative to 30-Day Average (LHS) and S&P 500 Index (RHS) Price Change Price Change Price Change Change (shares) Change (shares) Change (shares) 350% 1,550 SPDR S&P 500 ETF TRUST 0.9% 32.6% 1.1% 34.7% 8.9% 27.1% ISHARES RUSSELL 2000 0.6% -1.8% 0.5% -4.4% 13.5% 3.7% 250% SPDR S&P MIDCAP 400 ETF 0.7% 0.0% 0.6% 17.0% 12.0% -11.2% 150% ENERGY SELECT SECTOR 1,500 0.8% 12.0% 1.3% -8.0% 10.0% -25.9% SPDR ISHARES IBOXX H/Y CORP 50% 0.7% 14.4% -0.8% 41.3% 2.2% 81.9% BOND POWERSHARES QQQ 0.9% 9.3% 0.0% 37.4% 5.0% -15.0% -50% NASDAQ 100 INDUSTRIAL SELECT 1.2% -2.9% 1.5% 47.0% 12.3% 23.2% 1,450 SECTOR SPDR -150% MATERIALS SELECT 1.9% 25.9% -2.4% 57.4% 7.2% 89.7% SECTOR SPDR SPDR BARCLAYS HIGH -250% 0.3% -15.3% -1.6% 87.4% 1.6% 46.8% YIELD BOND ETF CONSUMER STAPLES 0.1% -21.4% 3.5% -15.7% 8.3% -8.4% -350% 1,400 SPDR 01-Feb 08-Feb 15-Feb 22-Feb Source: J.P. Morgan Securities Lending Net Cover Activity (LHS) Net Short Activity (LHS) S&P 500 Index (RHS)Source: Bloomberg, J.P. Morgan Securities Lending 7 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.
Prime Brokerage Global Hedge Fund Trends – Securities LendingInternational Securities Lending general meetings in March. There was heavy activity around MediaTek Inc. (2454 TW) as market participants trimmedEuropeNew deal activity was light in February with most of the long positions and put on new shorts in anticipation oftrading flows stemming from capital raising events. antitrust approval for the company’s merger with MStarKoninklijke KPN N.V., Citycon OYJ and Royal Imtech N.V. Semiconductor, Inc. (3697 YW).each announced rights issues. Borrow demand was mostsubstantial for Koninklijke KPN as funds sought shares prior Hong Kongto the general shareholders meeting in March. Borrow for As in January, fees on Evergrande (3333 HK) and ZoomlionCitycon was limited, with aggressive bidding by arbitrage (1157 HK) declined during February as liquidity for thosefunds. Utilization of Royal Imtech borrow was high in names increased. Demand was heavy for company namesadvance of its rights issue announcement. The only other that are under review as a result of the MSCI’s rebalancing.trade of note was Exor S.p.A., which is planning a mandatory Japanconversion of preferred shares. Although the Nikkei was up +3.8% in February, activity was generally light as was the case in the rest of the region.Directional trades remained a primary focus for many hedge Hedge funds sought locates in names such as Gree Inc. (3632funds in February. Nokia, which has been heavily shorted JP), Dena Co. Ltd. (2432 JP) and Start Today Co Ltd (3092over the last 12 months, experienced heightened demand in JP). The Prime Brokerage book experienced recalls for Bicadvance of its deletion from the Euro Stoxx 50. Index tracker Camera, Inc. (3048 JP) in anticipation of the company’sfunds re-balanced, which in turn catalyzed recalls. Demand is record date.still robust for Banca Monte dei Paschi, with many fundsincreasing short positions. The borrow level for Alcatel- AustraliaLucent continued to ease as a number of funds covered short February was earnings season in Australia. There was strongpositions. February saw heightened recalls on PagesJaunes demand for borrow in Monadelphous Group Limited (MNDGroupe, for which utilization is still heavy. AU), as investors remain bearish on the mining services sector. Borrow for Tatts Group Ltd. (TTS AU) also was inIn Spain, the Prime Brokerage book continued to see strong demand ahead of the company’s earnings statement. Tattsdemand from directionally-oriented hedge funds for Bankia, Group continues to trade at expensive multiples relative to itsCaixabank, Banco Popular and Fomento de Construc Y peers, a fact that also helped spur demand. Additionally, thereContra, with recall pressure in Bankia pushing borrow rates was increased short interest in Ansell Ltd. (ANN AU) on theto 70%. heels of disappointing net profits.With respect to the Glencore/Xstrata merger, the completiondate moved to mid-April. Risk arbitrage funds thereforeadded to their positions, which created upward pressure onborrow costs.Asia ex-JapanKoreaOverall, flows were light in February. Brokers used theopportunity to refinance existing shorts. Activity declined forOCI Co. Ltd. (010060 KS), which has been a popular nameamong short sellers. Demand remains strong for LGElectronics (056670 KS).TaiwanFlows were generally muted in February, with activity drivenlargely by investors exercising calls in anticipation of annual 8 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.
Prime Brokerage Global Hedge Fund Trends – Institutional Investor SentimentInstitutional Investor Sentiment Asia Asian investors are pulling back from long-biased creditAmericas exposure and instead are showing renewed interest in lowWe are approaching an inflection point in the market for directional, relative value and long short credit. Amonginstitutional investor capital, as flows into structured credit investors who do not already have exposure to structuredare slowing while allocators are showing heightened appetite credit, there is strong interest in the strategy. As ever, “good”for directional strategies with higher betas. Given the strong discretionary macro managers are in demand but Asianreturns and corresponding inflows that structured credit investors are generally disillusioned with underperformancegenerated from 2009 through 2012 – a period during which among macro funds. However, there has been a slight uptickthe HFRX Fixed Income-Asset Backed Index averaged in interest in emerging markets macro.+19.63% annually – fewer investors are making newallocations since (1) the strategy now comprises part of many Equity long short remains a “bread and butter” strategyU.S. investors’ portfolios and (2) some investors who have among Asian investors and there is renewed interest in thenot yet made allocations are concerned about the current region in capturing risk-on equity upside. However, onlyopportunity set. There has been a palpable uptick in interest investors who are currently underweight equities are makingin equity long short and event driven managers. Interest in such allocations. Asian investors are generally saturated withsystematic strategies and CTAs remains muted. New respect to multi-strategy funds, as most of the major multi-launches continue to garner interest. strategy managers already account for core allocations inThe Capital Introduction Group (CIG) spent time with investors’ portfolios. Finally, interest in CTAs has waned.institutional investors in and around Boston in February. Only groups that view CTAs as a tail to their portfoliosFund of hedge funds (FoFs) continue to grow their advisory remain committed to the strategy.and customized businesses while their comingled vehicles Table 6: Investor strategies of interest by region7contract. Notably, Boston-area consultants were interested inlearning about new launches, which have not been a Americas Europe Asia Direction of Level of Direction of Level of Direction of Level oftraditional focus for them. Interest Interest Interest Interest Interest Interest ConvertibleCIG also hosted a heavily attended event on convertible Neutral Neutral Neutral Arbitragearbitrage managers in February. While it is too early to say Distressed Neutral Neutral Neutralthat a trend is underway, we have seen an uptick in interest inconvertible arbitrage, especially given heavy 2013 issuance. Equity Long Increasing Increasing Neutral ShortEurope Event Increasing Neutral Neutral DrivenTo the extent that any clear themes have emerged amongEuropean allocators, it is the continual upgrading of Macro Neutral Neutral Decreasingportfolios as investors rotate away from managers who have CTA Neutral Neutral Decreasingunderperformed. As in the U.S., there is interest amongEuropean investors in new managers across the strategy Market Neutral Neutral Increasing Neutralspectrum. Structured Neutral Neutral Increasing CreditCIG met with an array of investors in Switzerland. Zurich-based family offices continue to reduce their hedge fund Legend Low Interestholdings, with private equity and direct market investments Medium Interestbenefitting from this reallocation. Swiss corporate pensionscontinue to disintermediate FoFs in lieu of direct High Interestinvestments, albeit not without the services of consultants. Source: J.P. Morgan Capital Introduction GroupOverall, there is rising interest in directional equity long shortstrategies and, in a few instances, long-only equity asinvestors try to increase the volatility in their portfolios. 7Institutional investors in Switzerland also expressed interest This information comes from CIG conference calls and meetings with global hedge fund managers and institutional investors. This table represents views of the CIG teamin global macro and European structured credit. and may not be completely exhaustive. 9 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.
Prime Brokerage Global Hedge Fund Trends – Market PerspectivesFebruary Commentary The following sections are excerpts from J.P. Morgan Research publications. The full publications can beThe rally that commenced with vigor in January took a pause accessed via the sources provided in the footnotes below.in February. Headwinds emerged as a result of tighteningmeasures in China, disappointing data from Europe and the Bernanke Stays the Course on Asset Purchases 8perpetual impasse among Washington policymakers over thefederal budget. As expected, Fed Chair Bernankes semiannual monetary policy testimony sounded a little more dovish than the mostThose obstacles, however, were sufficient only to cause a recent FOMC minutes. In particular, while noting the costs topause in, rather than a reversal of, the global recovery, which balance sheet expansion, he concluded that these costs werecontinued in February but at a lower pace. The J.P. Morgan either small or nonexistent, and more than easily offset by theGlobal Manufacturing PMI was 50.8 in February, still in beneficial effects of asset purchases. These benefits wereexpansion territory but down from 51.4 in January. characterized as "clear" whereas the "potential" costs wereSignificantly, data from China also blunted momentum as the methodically discussed and minimized. We believe todayscountry’s manufacturing PMI declined from 50.4 in January testimony supports the view that the Fed remains comfortableto 50.1 last month. February was therefore the fifth continuing with its asset purchase program.consecutive month during which China’s PMI signaled The first cost that the Chairman dismissed was worries thatexpansion. However, the month-over-month decline is the eventual exit would un-anchor inflation expectations. Toindicative of a decrease in the rate of that expansion. this he noted that measures of inflation expectations remain low and that the Committee was "confident" in their exitThe U.S., by contrast, continues to be a key driver behind the tools. The second cost was excessive risk-taking, in the formglobal recovery. Even as across-the-board federal spending of, for example, reach-for-yield behavior. Bernanke observedcuts took hold, the U.S. PMI rose to 54.2 in February from that some risk-taking, such as that by entrepreneurs, is part of53.1 in January, the highest reading since June 2011. a healthy recovery. He also echoed Governor Steins pointAdditionally, the U.S. economy added 236,000 jobs in that low rates encourage longer-term funding, which shouldFebruary as unemployment fell to 7.7%, the lowest level reduce systemic risk. He concluded that the Feds regulatorysince December 2008. Furthermore, new factory orders – a tools should help to head off brewing financial imbalances.key leading indicator – climbed to 57.8 in February from Finally, on the topic of potential losses on the Fed balanceJanuary’s 53.3, the largest such increase since March 2010. sheet, he made that the point that on a through-the-cycleAccordingly, the U.S. expansion continues to gain steam in basis, any future decline in remittances should be more thanspite of the ongoing paralysis in Washington. offset by the outsized remittances that the Fed has paid to Treasury over the past few years. In sum, Bernanke brushedExpiration of the continuing resolution for the federal budget off the costs and risks attending to asset purchase, whileand the debt ceiling loom next on the horizon. Yet markets noting that the benefit has been an important support to thenow appear to view a refusal by Congress to renew its recovery.continuing resolution on March 27, or to lift the debt limit inMay, as low probability outcomes. Bernankes remarks on the economy were quite limited and focused on the labor market and the costs of high andSuch resilience notwithstanding, the pullback in federal extended unemployment. His testimony also commented onspending, even if incremental, is likely to extract a toll. U.S. fiscal policy, repeating the usual advice to put in place long-GDP slowed from 3.1% in the third quarter to 0.1% in the run reforms in lieu of short-run fiscal austerity. The Monetaryfourth quarter partly as a consequence of declining federal Policy Report did not add too much to the discussion, otheroutlays, which fell at an annualized rate of 14.8% over that than to more thoroughly examine the benefits of assetperiod. It may therefore be infeasible for the U.S. economy – purchases, to which "a balanced reading of the evidenceand in turn the global recovery – to attain “escape velocity” supports the conclusion that LSAPs have provided aabsent longer-term clarity with respect to fiscal policy,including the pace at which, and the extent to which, U.S.federal spending will be pared back. 8 J.P. Morgan Chase North America Economic Research, Bernanke Stays the Course on Asset Purchases, February 26, 2013, J.P. Morgan Markets, https://na- markets.jpmorgan.com/research/content/GPS-1062584-0. 10 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.
Prime Brokerage Global Hedge Fund Trends – Market Perspectivesmeaningful support to the economic recovery while across households, banks, and sovereigns. In the event, themitigating deflationary risks." rebound in spending on durables was modest overall and focused on machinery, transport equipment, and autos. TheThe Next Wiggle is a Weaker US Consumer9 recovery relied heavily on the ending of an inventory adjustment and the recovery of global trade. The regionGlobal activity indicators lifted as we turned into the New moved back into recession in late 2011, as these exceptionalYear with the latest three-month gains in global industrial supports faded, financial stress increased, and the regionproduction and retail sales volumes each tracking close to a turned to substantial fiscal consolidation.4% pace of increase. We believe that this news points to abroad positive turn in global growth, but we recognize that As we look to the coming few quarters, we expect the regionthe underlying pace of global growth is not as rapid as the to exit recession and start growing again. The initial impulselatest activity readings suggest. Drags that weighed heavily for growth is coming from a return of confidence in theon global growth early last quarter—notably the Japan-China integrity of the Euro area, a fading of fiscal austerity, and andispute, Hurricane Sandy, and a temporary drop in global improvement in the global backdrop. But, for growth in theauto production—have faded, boosting industrial activity region to be sustained, cyclical forces need to be at work. Thearound year-end. Meanwhile, household spending was lifted scope for a cyclical recovery, as seen in 2009-10, is clearlylast quarter by falling inflation. In the coming months, this there: cash balances are high, levels of spending on durablesboost will be replaced by large headwinds concentrated in the are low, and monetary policy remains very easy. But, on theUS, resulting from rising energy prices and a tax hike. other hand, inventory positions are less lean than in 2009, global trade will not be bouncing back from depressed levels,We have sent a message that there is upside risk to our and the same deleveraging headwinds remain in place. Thus,current quarter 2.4% global GDP forecast because the lift in the recovery over the coming 18 months is unlikely to be asglobal activity into the New Year has proved stronger than solid as during the period from the middle of 2009 to theanticipated. However, the stage is now set for moderation in middle of 2011.the monthly data flow. Global retail sales volumes areexpected to flatten during February and March as USspending contracts. Meanwhile, global production gains areexpected to slow to a roughly 2.5% annualized pace over thenext three months. If we are right, this softening will provetemporary and a rebound into midyear will leave 2Q13 globalgrowth roughly in line with this quarter’s outcome.Cyclical Lift in the Euro Area: Let’s Have Another Go10In our view, the Euro area is moving toward exiting recessionand will start to grow again from the second quarter. The lasttime the region made a transition from recession to expansionwas in the middle of 2009. After a 5.6% drop in the level ofGDP from early 2008 to the spring of 2009, the economybegan to expand again from the third quarter of 2009 andenjoyed eight quarters of growth averaging 2% ar.Despite very depressed levels of spending on durables, lowinventory positions, and very low interest rates, it was alwaysclear that the recovery from the 2008-09 recession was goingto be hard work. There was significant pressure to delever9 J.P. Morgan Economic Research, Global Data Watch: The Next Wiggle is a WeakerUS Consumer, February 22, 2013, J.P. Morgan Markets, https://na-markets.jpmorgan.com/research/content/GPS-1060551-0.10 J.P. Morgan Economic Research, Economic Research Note: Cyclical Lift in the EuroArea: Let’s Have Another Go, February 22, 2013, J.P. Morgan Markets, https://na-markets.jpmorgan.com/research/content/GPS-1060083-0. 11 This material is provided by J.P. Morgan’s Prime Brokerage business for informational purposes only. It is not a product of J.P. Morgan’s Research Departments. For Institutional Investors only. For the intended recipient only. The reference period for this publication is February 2013 unless otherwise stated.