JPM Prime Brokerage Global Hedge Fund Trends September 2013
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JPM Prime Brokerage Global Hedge Fund Trends September 2013

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JPM Prime Brokerage Global Hedge Fund Trends September 2013

JPM Prime Brokerage Global Hedge Fund Trends September 2013

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JPM Prime Brokerage Global Hedge Fund Trends September 2013 JPM Prime Brokerage Global Hedge Fund Trends September 2013 Document Transcript

  • J.P. Morgan Prime Brokerage Global Hedge Fund Trends 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 August 2013 unless otherwise stated. September 16, 2013 Executive Summary Risk assets1 sold off broadly in August, which was characterized by a renewed focus on macro issues, with weakness widespread across equities, fixed income and credit. Hedge funds posted an aggregate loss of -0.73%2 with event driven strategies posting the narrowest decline (-0.04%) and global macro managers suffering most acutely (-1.20%). Equity long short funds posted an aggregate monthly decline of -0.69%. Leverage For all accounts in the Prime Brokerage portfolio, gross leverage3 fell from 1.84 to 1.82 (-0.84%) in August. For equity-biased strategies, net exposure4 declined from 0.78 to 0.74 (-5.62%). Net leverage also declined, falling from 0.66 to 0.63 (-4.92%) and is just below its 52-week average of 0.64. Securities Lending Even with the decline in equity markets, conviction levels on the short side were low in August. Clients added shorts via ETFs while single name equities ended the month flat. The U.S. Prime Brokerage portfolio ended August net shorted for only the second time in the last six months. Merger arbitrage and special situations trading was active in Europe. Flows were light in Asia. Institutional Investor Sentiment Equity long short and equity-biased event driven remain the strategies of most interest among institutional allocators. Several endowments are in the process of shifting their exposures from hedge funds to long only strategies as they seek to isolate the alpha generation from such managers. Market Perspectives There are fissures emanating from Europe that could lead to heightened volatility, including (1) the German Constitutional Court’s impending ruling on the Outright Monetary Transactions (OMT), (2) the upcoming parliamentary elections in Germany and (3) the destabilizing effect from the tax fraud conviction of former Italian PM Silvio Berlusconi on the Italian government. 1 Assets other than cash and government fixed income securities. 2 Hedge fund strategy returns are based on data supplied by Hedge Fund Research. 3 Gross leverage is the total market value of long and short positions divided by clients' equity in J.P. Morgan’s Prime Brokerage portfolio. 4 Calculated for Equity Long Short and Market Neutral funds on J.P. Morgan’s Prime Brokerage platform only. Net leverage is defined as the market value of long positions (LMV) minus the market value of short positions (SMV), divided by clients’ equity (Eq). Net exposure is defined as the ratio of LMV and SMV, minus one. Figure 1: August 2013 performance HFRI and Market Indices. Monthly Returns Source: Bloomberg, Hedge Fund Research Table 1: Performance of hedge fund strategies and asset classes HFRI and Market Indices5 Aug-13 Year-to-Date HF Index -0.73% 3.87% Equity LS -0.69% 6.72% Event Driven -0.04% 6.88% Macro -1.20% -2.28% Relative Value -0.46% 3.13% S&P 500 -2.90% 16.15% Fixed Income -0.33% -5.03% CMDTY 2.88% 1.62% USD 0.78% 2.91% Credit -0.62% -2.76% Source: Bloomberg, Hedge Fund Research Figure 2: Hedge fund beta to equities Rolling 21-day beta of HFRX equal-weighted index returns to the S&P 500 Total Return Index Source: Bloomberg, Hedge Fund Research 5 Market indices from Bloomberg are as follows: S&P 500 (SPTR Index), Fixed Income (JPMGGLBL Index), CMDTY (SPGSCI Index), USD (DXY Index), and Credit (JULIR Index). -3.0% -2.0% -1.0% 0.0% 1.0% 2.0% 3.0% HF IndexEquity LS Event Driven Macro Rel Value S&P 500 Fixed Income CMDTY USD Credit 2,300 2,400 2,500 2,600 2,700 2,800 2,900 3,000 3,100 0.01 0.03 0.05 0.07 0.09 0.11 0.13 0.15 0.17 0.19 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Equity Beta (LHS) S&P 500 Total Return Index (RHS)
  • Prime Brokerage Global Hedge Fund Trends – Performance, Leverage, and Risk Exposures 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 August 2013 unless otherwise stated. This section presents a summary of the changes that we have observed in leverage and sector exposures across the range of hedge funds that we work with. The confidentiality of our clients’ positions is important to us and as such this information has been aggregated and displayed in an anonymous manner in an effort to mitigate the risk of revealing or alluding to any one fund’s exposures. Information may be excluded due to the perceived risk of revealing sensitive information. The information discussed is specific to activities on J.P. Morgan’s books, and may not represent total client activity. These numbers should only be viewed as representative observations. Market Overview6 In contrast to the July rally, risk assets sold off during August. The month was characterized by a renewed focus on macro issues, including tensions in the Middle East centered on Egypt and Syria, heightened volatility in emerging markets, continued uncertainty over the prospect and timing of Federal Reserve tapering, the choice of Ben Bernanke’s successor and upcoming federal elections in Germany slated for September 22. These factors helped drive uncertainty in markets. Partly as a consequence, equity markets sold off both in the U.S. and internationally. The S&P 500 Index7 fell -3.13% on the month with weakness across key sectors and notable underperformance in the Financial (-5.22%) and Utilities (-5.52%) sectors. August therefore marked the worst month-over-month performance for the S&P 500 all year. The picture was no brighter for equities internationally. The MSCI World Index dropped -2.1% in August with losses across sectors save for Materials (+1.3%), which was the sole bright spot. The Nikkei was off -2.04%, the Hang Seng declined -0.7% and the MSCI Europe Index also fell -0.9%. Losses were not confined to equities. Most fixed income assets posted negative returns as yields continued to back up. For example, the 10-Year Treasury was down -1.21% month- over-month with the yield now hovering just below 3.0%. Conditions also continued to weaken for credit in August. High yield fell -0.7%8 and investment grade credit was down -0.62%.9 Along with the overall choppiness in markets, volatility once again began to rise in August across all asset classes (See Figure 3). Implied volatility for front month S&P 500 notched up to 15% (compared to 8.7% in July) and front month implied volatility for EM equities (as measured by the MSCI EM Index), at 25%,10 is now close to a year-to-date high of 28%. 6 Hedge fund strategy returns are based on data supplied by Hedge Fund Research. 7 Reference is to the SPX Index, not the SPTR Index, as in Table 1. 8 Source: US Corp HY. 9 Source: JULIR Index. 10 As of September 26, 2013. Figure 3: Average implied volatility across five asset classes Average of five asset classes (equities, FX, commodities, credit and rates) Source: CFTC, J.P. Morgan Global Asset Allocation Composite Hedge Fund Performance While the S&P 500 declined -3.13%, hedge funds suffered an aggregate decline of -0.73%. August marks only the second month of negative performance over the preceding ten months. While all of the major hedge fund strategies suffered negative performance in August, global macro (-1.20%) was most adversely impacted. Event Driven Event driven strategies delivered a narrow aggregate loss in August (-0.04%). Despite broader market declines, corporate transaction and event activity continued apace. As a result, event driven managers’ losses were small relative to other strategies. Event driven managers have delivered positive aggregate performance in thirteen of the last fifteen months with a year-to-date return of +6.88%. Merger arbitrage managers were down -0.11%. By contrast, distressed debt managers posted a narrow overall gain of +0.08%. Relative Value Relative value managers posted a month-over-month aggregate decline of -0.46%. Structured credit managers delivered aggregate gains of +0.15%, aided by the continued U.S. housing recovery and declining loan severities. Convertible arbitrage managers were up +0.22%. However, relative value multi-strategy funds declined (-0.54%). August saw continued widening in credit spreads along with 10 15 20 25 30 35 40 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Apr-12 Jan-13
  • Prime Brokerage Global Hedge Fund Trends – Performance, Leverage, and Risk Exposures 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 August 2013 unless otherwise stated. weakening conditions for positions with interest rate sensitivity. Equity Hedge Equity long short and market neutral strategies were down -0.69% in August. Although short biased (+0.58%), Technology/Healthcare-focused (+0.29%) and Energy/Basic Materials-specific (+0.26%) funds posted gains, every major sector, both defensive and cyclical, experienced declines as shown in Figure 4 below. Globally, however, Materials outperformed, with the MSCI World Materials Index up +1.3% on the month. (All other sectors in the MSCI World ended August in negative territory.) Figure 4: Sector performance (S&P 500 Index), August 2013 Source: Bloomberg, Standard & Poor’s Global Macro Global macro strategies suffered the steepest monthly decline (-1.20%) among the main hedge fund strategies. Losses were acute for managers with emerging markets exposure in August. The HFRI Emerging Markets Index fell -0.77%, with losses across regions. Declines were most acute among managers with Latin America, Middle East and India exposure. Systematic managers – particularly medium-term trend followers – experienced significant aggregate losses on the month (-1.84%) partly as a result of pronounced intra- month currency fluctuations (See Figure 5). More specifically, emerging markets currencies tumbled against the U.S. Dollar. The pressure was heaviest on currencies that have been dependent on inflows resulting from developed market central bank easing (and which are therefore most vulnerable as rates back up). The Indian Rupee and the Indonesian Rupiah both fell over -8.0% in August compared to 11% and 5% over the preceding three months, respectively (See Figure 6). The Dollar also strengthened considerably against currencies in Latin America. Countries with large internal and external imbalances such as Brazil suffered most. As the Dollar rose sharply against such currencies, managers with short Dollar trades were hurt. August also saw wide dispersions among developed market currencies. For instance, both the Canadian and Australian dollars drifted lower against the U.S. Dollar while the Euro gained. Such dispersions also contributed to systematic managers’ losses. Figure 5: Rolling 3-month EM currency volatility Average 3-month rolling realized volatility of EM Asia (Indian Rupee, Indonesian Rupiah, Malaysian Ringgit) and Latin America (Brazilian Real, Mexican Peso, Peruvian Nuevo Sol) currencies based on daily returns against the U.S. Dollar Source: Bloomberg, J.P. Morgan Figure 6: Year-to-date EM currency performance Year-to-date performance of EM Asia (Indian Rupee, Indonesian Rupiah, Malaysian Ringgit) and Latin America (Brazilian Real, Mexican Peso, Peruvian Nuevo Sol) currencies against the U.S. Dollar Source: Bloomberg, J.P. Morgan -0.19% -0.84% -2.08% -2.76% -3.00% -3.63% -4.14% -4.54% -5.22% -5.52% -6.0% -5.0% -4.0% -3.0% -2.0% -1.0% 0.0% 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Asian Currencies Latin America Currencies 70 75 80 85 90 95 100 105 110 115 120 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 INR IDR BRL
  • Prime Brokerage Global Hedge Fund Trends – Performance, Leverage, and Risk Exposures 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 August 2013 unless otherwise stated. Leverage and Risk Exposures Gross Leverage Gross leverage for all accounts in the Prime Brokerage portfolio fell from 1.84 to 1.82 (-0.84%) (See Figure 7). Gross leverage of levered accounts in the Prime Brokerage portfolio declined from 2.54 to 2.47 (-2.89%) (See Figure 8). The decreasing leverage levels were partly the result of an uptick in volatility – and thus less risk appetite – fueled by declining emerging markets, escalating tensions in the Middle East and concerns around monetary policy. Figure 7: Daily gross leverage and the S&P 500 Index Source: Bloomberg, J.P. Morgan Prime Brokerage Figure 8: Gross leverage (levered accounts) 5-day moving average and the S&P 500 Index Source: Bloomberg, J.P. Morgan Prime Brokerage Figure 9: 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 mean Source: Bloomberg, J.P. Morgan Prime Brokerage Gross Leverage by Strategy High Grade Fixed Income and Multi-Strategy saw increases in gross leverage month-over-month, rising +15.90% and +2.35%, respectively. All other strategies experienced a decrease in gross leverage in August. All strategies except for High Grade Fixed Income are running gross leverage above their two-year averages. Figure 10: Gross leverage by strategy Source: J.P. Morgan Prime Brokerage 1.75 1.80 1.85 1.90 1.95 1,300 1,350 1,400 1,450 1,500 1,550 1,600 1,650 1,700 1,750 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 S&P 500 Index (LHS) Gross Leverage (RHS) 2.4 2.5 2.6 2.7 1,300 1,350 1,400 1,450 1,500 1,550 1,600 1,650 1,700 1,750 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 S&P 500 Index (LHS) Gross Leverage (Levered Account s - RHS) -2.0 -1.5 -1.0 -0.5 0.0 0.5 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Difference between gross leverage and S&P 500 Index Z-scores 3.89 1.96 1.77 3.72 2.22 1.42 0 1 2 3 4 5 Market Neutral Equity Long Short Multi-Strategy Convertible Arbitrage High Grade Fixed Income High Yield Fixed Income Jun-13 Jul-13 Aug-13
  • Prime Brokerage Global Hedge Fund Trends – Performance, Leverage, and Risk Exposures 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 August 2013 unless otherwise stated. Table 2: Gross leverage by strategy Average and first quartile calculated for the period of August 2011 to August 2013 Source: J.P. Morgan Prime Brokerage Net Exposure and Net Leverage Net exposure for equity-biased funds fell in August, declining from 0.78 to 0.74 (-5.62%), the second consecutive monthly decrease. Net leverage also declined, falling from 0.66 to 0.63 (-4.92%). The month-over-month decrease in net leverage coincided with the -3.13% decrease in the S&P 500 while the decline in net exposure was driven largely by a pullback in clients’ long exposures. Short exposures also fell on the month but by far less than longs. Figure 11: Net exposure and net leverage Equity Long Short and Market Neutral funds on the Prime Brokerage platform only. LMV: Market value of long positions. SMV: Market value of short positions. Eq: Equity in the clients’ accounts Source: J.P. Morgan Prime Brokerage Sector Exposures The largest month-over-month increases in the long Prime Brokerage portfolio were in the Communications (+0.3%) and Technology (+0.3%) sectors. The largest decline was in the Financial sector (-1.1%). The largest increase in the Prime Brokerage short portfolio was in the Financial (+0.4%) sector. The most substantial decreases in short exposure occurred in Non sector-specific ETFs (-0.5%) – though short macro hedges remain elevated – and the Energy (-0.4%) sector. The Prime Brokerage portfolio may have become more bullish on the Communications Energy and Technology sectors, which experienced month-over-month increases in long exposure and decreases in short exposure. By contrast, the Prime Brokerage portfolio may have become less bullish on the Financial sector, which saw a month-over-month decline in long exposure and an uptick in short exposure. Table 3: Long and short exposures by sector Long (Short) exposure by sector as a percentage of total client long (short) exposure in Prime Brokerage portfolio Long exposure Short exposure Aug-12 Jul-13 Aug-13 Aug-12 Jul-13 Aug-13 Basic Materials 5.1% 4.4% 4.4% 5.3% 5.4% 5.3% Communications 12.3% 13.7% 14.0% 7.3% 5.8% 5.7% Consumer, Cyclical 10.8% 11.7% 11.7% 8.7% 8.1% 8.0% Consumer, Non- cyclical 15.6% 16.5% 16.6% 10.5% 11.0% 11.0% Diversified 0.3% 0.4% 0.3% 0.1% 0.0% 0.1% Energy 8.1% 8.2% 8.3% 6.5% 6.9% 6.5% Non sector-specific ETF 3.9% 1.9% 1.9% 17.4% 19.4% 18.9% Financial 18.8% 18.1% 17.0% 11.3% 9.0% 9.4% Industrial 6.0% 6.6% 6.5% 5.9% 7.3% 7.2% Technology 5.5% 4.9% 5.2% 5.2% 6.7% 6.6% Utilities 1.8% 1.3% 1.2% 1.3% 1.6% 1.6% Government 5.4% 7.2% 7.7% 10.1% 6.8% 6.8% Other 6.2% 5.1% 5.1% 10.3% 12.1% 12.9% Source: J.P. Morgan Prime Brokerage Jun-13 Jul-13 Aug-13 Average First Quartile % Change Market Neut 4.08 4.15 3.89 3.80 3.54 -6.3% Equity Long 1.97 1.99 1.96 1.83 1.72 -1.7% Multi-Strateg 1.72 1.73 1.77 1.76 1.73 2.3% Convertible A 3.62 3.81 3.72 3.69 3.50 -2.6% High Grade F 2.08 1.92 2.22 2.46 2.22 15.9% High Yield F 1.41 1.48 1.42 1.25 1.16 -4.4% PB Portfolio 2.41 2.54 2.47 2.51 2.47 -2.9% 0.4 0.7 1.0 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Apr-13 Aug-13 Net Exposure (LMV/SMV)-1 Net Leverage (LMV-SMV)/Eq
  • Prime Brokerage Global Hedge Fund Trends – Securities Lending 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 August 2013 unless otherwise stated. North America Securities Lending Equities The U.S. Prime Brokerage book ended August net shorted for only the second time during the last six months. However, conviction levels appeared to be low, as short exposure was added via ETFs while single name equity activity ended the month flat. Gross volume in August was lower than the 2013 monthly average amidst overall thin trading volumes during the summer season. From a sector perspective, shorting was most concentrated in Communications, Technology and Industrials, while covering was most pronounced in Basic Materials and Financials. ETFs ETFs were net short in August and drove the overall U.S. short book. Fixed income ETFs were particularly active with new shorts in HYG (iShares iBoxx High Yield Corp Bond ETF) and TLT (iShares 20+ Year Treasury Bond ETF). Additionally, sector ETFs XLE (Energy Select Sector SPDR ETF), XLP (Consumer Staples Select Sector SPDR ETF) and XLI (Industrial Select Sector SPDR Fund) saw notable shorting. Moving against the trend, EEM (iShares MSCI Emerging Markets Index ETF), IWM (iShares Russell 2000 ETF) and XOP (SPDR S&P Oil & Gas Exploration & Production ETF) saw the largest covering in August. Although relatively unreported, SPY (SPDR S&P 500 ETF Trust) experienced a large drop in shares outstanding with approximately $14 billion leaving the fund, a sign that investors are scaling back long exposure to the S&P. Event Driven • Perrigo Company (PRGO) and Elan Corporation, plc (ELN) announced an agreement pursuant to which Elan will be acquired. Elan shareholders will receive $6.25 in cash and 0.07636 shares of new Perrigo stock for each Elan share held. The purchase price represents an approximate 10.5% premium for Elan shareholders. The proposed transaction has been approved by both boards and is expected to close by the end of 2013. We have seen moderate demand for Perrigo borrow since the merger announcement, but shares remain easy to borrow. • Community Health Systems, Inc. (CYH) announced it will acquire Health Management Associates, Inc. (HMA) for a mix of stock and cash. Health Management shareholders will receive $10.50 in cash, 0.06942 shares of Community Health Systems, and one contingent value right for each Health Management share held. The contingent right could yield up to an additional $1.00 per share based upon the outcome of previously disclosed legal proceedings on the part of Health Management. The merger is expected to close by the end of Q1 2014, and is subject to the approval of 70% of Health Management stockholders. Demand for Community Health Systems has been relatively light and borrow remains at GC levels. Fixed Income The Prime Brokerage fixed income book ended August net covered. This represents the sixth month of net covering in the past eight months, exceptions being January and July. Despite the overall trend, the Basic Materials, Diversified, Industrial and Financial sectors all saw market value increases on the short side. Similarly, U.S. Treasuries experienced a continued increase in activity and in net shorts. Names that saw significant activity throughout the month included Cliffs Natural Resources Inc. (CLF), Dell Inc. (DELL), Fortescue Metals Group Limited (FMG) and Walter Energy, Inc. (WLT). Convertible bonds mirrored the overall trend of net covering with Archer Daniels (ADM 0.875% 02/15/14) and Priceline.com, Inc. (PCLN 1% 03/15/18) in the lead. International Game Technology (IGT 3.25% 05/01/14), Intel Corp. (INTC 2.95% 12/15/2035), Lam Research Corp. (LRCX 1.25% 05/15/18) and Newmont Mining Corp. (NEM 1.625% 07/15/17) were exceptions to the trend of net covering and remain active with continued interest in new shorts.
  • Prime Brokerage Global Hedge Fund Trends – 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 August 2013 unless otherwise stated. Figure 12: Cumulative net activity Market value change of activity across equities, ETFs, and fixed income Source: J.P. Morgan Securities Lending Figure 13: Rolling 1-month daily short flow Daily Activity Relative to 30-Day Average (LHS) and S&P 500 Index (RHS) Source: Bloomberg, J.P. Morgan Securities Lending Table 4: U.S. securities lending trends by sector For the month of August 2013 5 Day 30 Day 90 Day Price Change Position Change (shares) Price Change Position Change (shares) Price Change Position Change (shares) Consumer, Non-cyclical (1.4%) 0.3% (3.0%) 0.3% 3.8% (0.6%) Financial (2.0%) (0.2%) (5.5%) (3.0%) (2.3%) (10.3%) Technology (0.4%) 2.0% (1.3%) 3.0% 0.6% 4.5% Energy (0.1%) 0.6% (2.3%) 1.0% (1.4%) 3.6% Communications (1.1%) (1.0%) (2.4%) 3.6% 3.9% 7.0% Industrial (2.3%) (0.1%) (3.3%) 0.5% (1.7%) 5.9% Consumer, Cyclical (1.3%) (2.1%) (3.5%) (4.2%) 0.3% (0.1%) Basic Materials (2.7%) (2.1%) 1.6% (8.6%) (3.3%) (1.7%) Utilities (1.7%) (4.7%) (7.4%) (4.7%) (6.6%) 15.8% Source: J.P. Morgan Securities Lending Table 5: U.S. securities lending trends by ETFs For the month of August 2013 5 Day 30 Day 90 Day Price Change Position Change (shares) Price Change Position Change (shares) Price Change Position Change (shares) SPDR S&P 500 ETF TRUST (0.9%) 0.5% (3.6%) 24.0% (0.8%) 31.3% ISHARES RUSSELL 2000 (2.0%) (0.4%) (3.7%) 1.0% 2.2% 10.0% ENERGY SELECT SECTOR SPDR 0.7% (12.1%) (1.8%) (4.3%) 0.3% (14.9%) SPDR S&P RETAIL ETF (0.6%) 43.0% (5.6%) 104.1% 1.0% 295.0% ISHRES US REAL ESTATE ETF (2.2%) 4.0% (6.7%) 37.5% (11.3%) (16.3%) ISHARES MSCI BRAZIL CAPPED (EWZ) (0.3%) 6.0% (2.4%) 20.6% (18.9%) 138.8% ISHARES MSCI EMERGING MARKETS ETF 0.1% 0.2% (2.7%) (43.3%) (8.7%) 22.3% POWERSHARES QQQ TRUST, SERIES 1 (ETF) (1.3%) 4.8% (0.8%) 28.7% 2.7% 57.7% FINANCIAL SELECT SECTOR SPDR (1.9%) (2.3%) (6.1%) (7.3%) (2.8%) 29.0% ISHARES IBOXX HIGH YIELD CREDIT ETF (1.2%) (17.9%) (1.3%) 24.0% (3.9%) 12.6% Source: J.P. Morgan Securities Lending -$18.0 -$16.0 -$14.0 -$12.0 -$10.0 -$8.0 -$6.0 -$4.0 -$2.0 $0.0 $2.0 $4.0 4-Sep 4-Oct 3-Nov 3-Dec 2-Jan 1-Feb 3-Mar 2-Apr 2-May 1-Jun 1-Jul 31-Jul 30-Aug Equity ETF FixedIncome Net Activity 1,550 1,575 1,600 1,625 1,650 1,675 1,700 1,725 1,750 -150% -100% -50% 0% 50% 100% 150% 200% 250% 300% 350% 400% 02-Aug 09-Aug 16-Aug 23-Aug 30-Aug Net Cover Activity (LHS) Net Short Activity (LHS) S&P 500 Index (RHS)
  • Prime Brokerage Global Hedge Fund Trends – Securities Lending 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 August 2013 unless otherwise stated. International Securities Lending EMEA Merger arbitrage and special situations trading was particularly active across our client base in August as a result of deal flow. Further to Vodafone Group plc’s (VOD) bid for Kabel Deutschland Holding AG (KD8 GR) in June, hedge funds continued to increase positions in the German cable operator as the September tender deadline approached. Koninklijke KPN NV (KPN EN) was very active, with hedge funds trading in and out of the name on the back of America Movil’s (AMX) takeover bid. Convertible bond issuance was limited in August. Renewable Energy Group, Inc. (REGI) issued $110 million of 2018 convertibles replacing an existing 2014 issue. Convertible arbitrage managers continued to trade around Alcatel Lucent (ALU FP), Nokia Corp. (NOK), and Emaar MGF Land Limited (EMAAR) convertible paper. Borrow liquidity increased and costs fell for both Nokia and Alcatel Lucent as directional managers began to close short positions. Directional trading across equity long short funds was mixed, with net selling in Insurance, Consumers and Chemicals versus net buying in Financials, Industrials and Telecoms. Among the most crowded shorts, borrow in K+S AG (SDF) tightened following news that competitor Uralkali OJSC (URKA) was exiting the market. Short positions continued to build in Banca Monte Dei Paschi Siena (BMPS MI) and New World Resources (NWR LN) but borrow liquidity remained limited. The Prime Brokerage short interest radar illustrated a significant rise in Kone OYJ (KNEBV FH), with the short base doubling throughout the month. Italian equities saw reduced overall volumes as investors considered the economic implications of the Financial Transaction Charges on derivatives. Asia Pacific Ex-Japan Taiwan HTC Corp. (2498 TT HTC) short interest regained traction in August with funds adding to existing short positions. Onshore borrow became available after the dividend recalls. MediaTek Inc. (2454 TT) also saw renewed demand after it was announced that MediaTek’s acquisition of MStar Semiconductor Inc. (3697 TT) would be approved. Borrow for MediaTek has ebbed and flowed over the last year though the recent news sparked renewed demand. Hong Kong Although volumes were light as is typical in August, to the extent there was demand it was driven by recently announced results. Geely Automobile Holdings Ltd. (175 HK) saw large shorting into month-end although results beat expectations. However, there has been minimal covering and borrow remains liquid. Guangzhou R&F Properties Co. Ltd. (2777 HK) results were announced mid-month and the stock slumped 3.4% post announcement as shorting rose. Maanshan Iron & Steel (323 HK) experienced a rise in demand although supply is likely to be unsustainable. This name has been active for the past year as has its competitor, Angang Steel Co. Ltd. (347 HK). Both names remain difficult to locate in size. Korea Flows were light in August. One name of note was Celltrion Inc. (068270 KO), which experienced heightened demand after reports that it may be purchased by AstraZeneca. The stock fell nearly 30% during the month. August also saw interest in Doosan Heavy Industries & Construction Co. Ltd. (034020 KO) after the company announced it is considering a global depository receipt. Japan August witnessed a marked drop in momentum in the Japanese market as the impact of Abenomics softened. Although flows were down, borrow interest increased in Gree, Inc. (3632 JP), Dena Co. Ltd. (2432 JP), and GungHo Online Entertainment Inc. (3765 JP). There was also scattered borrow activity in the retail broker names, with locates in SBI Holdings (8473 JP), Monex Group, Inc. (8698 JP), and kabu.com Securities Co. Ltd. (8703 JP). Australia Covering was the trend in August as shorts declined by 56%. The Consumer, Discretionary, Financial and Materials sectors benefitted most throughout the reporting season. Longstanding shorts in electrical retailers JB Hi-Fi Ltd (JBH AU) and Harvey Norman Holdings Ltd. (HVN AU) reported sizeable covering with shorts coming in by 46% and 23%, respectively. The market’s most popular short, Flight Centre Ltd. (FLT AU), also saw 35% of its shorts covered. Banks and mining companies such as Australia & New Zealand Banking Group Ltd (ANZ AU), Westpac Banking Corp. (WBC AU), Commonwealth Bank of Australia (CBA AU), BHP Billiton Ltd. (BHP AU) and Rio Tinto Ltd. (RIO AU) also experienced covering.
  • Prime Brokerage Global Hedge Fund Trends – Institutional Investor Sentiment 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 August 2013 unless otherwise stated. Institutional Investor Sentiment North America As the doldrums of August set in, last month was relatively quiet in terms of institutional investor activity. The Capital Introduction Group (CIG) met with several funds and allocators in Chicago this month. Activity among the family office and endowment/foundation segments is minimal. By contrast, the consultants and funds of hedge funds (FoF) are quite active in their due diligence efforts. To the extent that FoF investors are experiencing demand, it is with respect to customized products and solutions, not co-mingled vehicles. Certain of those FoFs are interested in new launches and will consider “Day 1” investments, albeit through founders share classes or similarly beneficial economic arrangements. With respect to specific strategies, equity long short and equity-biased event driven are of most interest among allocators in North America. FoFs with exposure to structured credit are beginning to take profits selectively from such managers. Certain of those FoFs are replacing their structured credit allocations with equity-focused strategies. A number of multi-strategy managers also have started to benefit from the rotation away from structured credit. In keeping with the overall trend, a number of endowments are in the process of shifting their exposures to equity strategies, including long-only. Consequently, certain hedge fund managers either have or are considering long-only offerings in order to exploit the growing demand for such products. EMEA During August, CIG met with a number of UK pensions that are undergoing personnel changes and restricting their portfolios. Certain of those pensions are disappointed with performance in the hedge funds with which they are invested. As a result, the pensions are concentrating their hedge fund portfolios with higher conviction managers. In some instances, the pensions are simply redeeming from certain strategies that have failed to meet expectations. Additionally, fee pressure remains an ongoing trend among UK-based pensions. European investors remain most interested in equity-focused strategies. There has also been a slight uptick in interest in discretionary global macro. Interest in CTAs and convertible arbitrage remains low. Asia Pacific August was a quiet month in the APAC region, with little change month-over-month. Consequently, Asia Pacific-based investors are still showing the most interest in equity long short. As in July, Asian investors continue to rotate out of credit- biased strategies, particularly structured credit, in favor of equities and event driven managers. Demand for strategies with de minimis correlation remains stable. Table 6: Investor strategies of interest by region11 North America EMEA Asia Pacific Direction of Interest Level of Interest Direction of Interest Level of Interest Direction of Interest Level of Interest Convertible Arbitrage Neutral Neutral Neutral Corporate Credit Neutral Neutral Neutral Equity Long Short Neutral Neutral Increasing Event Driven Neutral Increasing Increasing Macro Neutral Increasing Decreasing CTA Decreasing Neutral Neutral Market Neutral Neutral Neutral Increasing Structured Credit Decreasing Neutral Decreasing Legend Low Interest Medium Interest High Interest Source: J.P. Morgan Capital Introduction Group 11 This information comes from CIG conference calls and meetings with global hedge fund managers and institutional investors. This table represents views of the CIG team and may not be completely exhaustive.
  • Prime Brokerage Global Hedge Fund Trends – Market Perspectives 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 August 2013 unless otherwise stated. August Commentary At this time last year, Europe was viewed as a significant source of macroeconomic event risk, as a Greek exit from the European Monetary Union (EMU) seemed not only plausible but potentially imminent. Then, in September 2012, Mario Draghi announced the Outright Monetary Transactions (OMT), the European Central Bank’s plan for unlimited purchases of Eurozone government bonds. With the announcement, Draghi mitigated the tail risk from a potential dissolution of the Euro and the implosion of the EMU. One year later, in terms of potential event risk, all eyes have been focused on the prospect and timing of Federal Reserve “tapering” and, more recently, Syria. Once again, however, there are fissures emanating from Europe that, while mild at the moment, have serious implications and could cause a pronounced spike in volatility. The risks stem from (1) the German Constitutional Court’s impending ruling on the OMT, (2) the upcoming parliamentary elections in Germany and (3) the destabilizing effect from the tax fraud conviction of former Italian PM Silvio Berlusconi on the Italian government. The German Constitutional Court will soon issue a ruling on whether the OMT compromised Germany’s ability to control its own public finances. If the Court imposes extensive limitations on the OMT, the program’s future effectiveness in improving Euro area financial market conditions and making it resilient to shocks could be hampered. Draghi’s rhetorical bulwark from one year ago, when he pledged to do “whatever it takes” to keep the EMU intact, could thus lose its resonance. Therefore, as the decision draws near, the extent of the Court’s ruling will likely become an increasing concern for investors. Germany’s federal election on September 22 will also be a key event. Chancellor Angela Merkel still enjoys widespread approval for her management of the Eurozone crisis. Accordingly, the most likely electoral outcome is a “grand coalition” of Merkel’s ruling Christian Democratic Union with the opposition Social Democrats. The process of forming a new government will not be easy and could cause uncertainty, as prior governments have taken upwards of three weeks to take shape. Markets, like politics, abhor a vacuum. Finally, on August 1, Italy’s Court of Cassation upheld a tax fraud conviction against Silvio Berlusconi, which will make it harder for the fractious coalition government, comprised in part of Berlusconi’s PDL party, to remain intact. Increasing divisions within the government could lead to policy paralysis and derail structural reforms. Markets have shrugged off this development so far. That could change as tensions within the coalition government increase, with the potential effect of rising yields on Italian government bonds. How these events unfold could thus have a material impact on financial markets in the weeks to come. The following sections are excerpts from J.P. Morgan Research publications. The full publications can be accessed via the sources provided in the footnotes below. The 2016 problem 12 The Fed faces an interesting situation at the September FOMC meeting. At that meeting they will introduce their 2016 interest rate forecasts for the first time. The problem is that at the end of 2016 their economic forecasts may well show an economy that is close to full employment and price stability. Normally in that situation one would expect the fed funds rate to be close to neutral—which is somewhere close to 4%. However, their end-of-2015 forecasts have a funds rate forecast centered around 1%. An end-of-2016 funds rate of 4%, which implies 300bp of tightening over the course of 2016, is well in excess of what the market is pricing in. If the FOMC were to produce such a forecast, and if the market were to take its cue from that forecast, then the ensuing tightening in financial conditions would undo much of the hard work the Fed has done in getting rates low enough to support the recovery. In some ways the Fed is at risk of being a victim of its own success. After a few fits and starts, the Fed has finally convinced the market it will keep rates low for a very long time. However, the Fed’s ever-expanding embrace of transparency means it now has to quantify how its verbal attachment to accommodative policy translates into economic and policy rate forecasts. For someone like Michael Woodford, whose paper at last year's Jackson Hole conference arguably had a meaningful impact on the policy debate, such forecasts shouldn't have much of an influence on financial conditions: after all, it is well known that the Fed doesn’t have much of an advantage over the private sector in forecasting accuracy. 12 J.P. Morgan North America Economic Research, The 2016 problem, August 14, 2013, https://jpmm.com/research/content/GPS-1191154-0.
  • Prime Brokerage Global Hedge Fund Trends – Market Perspectives 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 August 2013 unless otherwise stated. That being said, we do think the forecasts convey a policy message, as they indicate how the Fed will react to a given economic outcome. In particular, the 2015 forecasts are already well below what most Taylor rules would prescribe. We expect a similar gap for the 2016 forecasts, which would leave the mid-point of those forecasts around 2.25%, or perhaps a shade above. This would be somewhat above where the market is now pricing the Fed, but not nearly as much as if the funds rate went back to neutral. Such a forecast, well below a Taylor rule, would continue to signal that the Fed will remain “highly accommodative…even after the economic recovery strengthens.” A risk to this outlook is that not enough of the Committee “gets the memo,” so to speak, and pencils in forecasts that are at odds with what the leadership would probably like to see. European High Yield Update13 Slowly but surely the three core strands of our 2013 Outlook appear to be falling into place. Volatility has moderated, as investors recalibrate to a new interest rate environment, default rates remain subdued and, at last, Europe is lifting out of recession. Regarding the latter, it’s hard to portray economic recovery right now as more than a fading of drags from fiscal tightening, inflation, and inventories. Still, improvements are visible across a broad set of data, evident right across the region, rather than confined to the Core. The Euro area composite PMI crossed 50, with a 2.5-point bounce in manufacturing; economic sentiment rose sharply in Italy and Spain in July and Euro area unemployment declined in June for the first time in two years. The return to growth has so far come about without the contribution from improved financial market conditions within the Periphery that our economists had hoped for. There are tentative signs that credit conditions are starting to ease, although the main potential catalyst for further loosening – the EBA’s Asset Quality Review and subsequent stress tests – remains some time away. Despite the pick-up in growth, we no longer see interest rates as the greatest near term risk factor for credit markets. There has already been a sizeable upward move in yields since May, and the Fed has so far been successful in guiding the market through the exit process and timeframe. In Europe, both the ECB and the BoE have sought to limit the spill-over 13 J.P. Morgan Europe Credit Research, European High Yield Update, August 9, 2013, https://jpmm.com/research/content/GPS-1187720-0. from the US with forward rate guidance. This has resulted in European credit outperforming the US, both in spread and total return terms, as we have been calling for.
  • Important Information and Disclaimers 12 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 August 2013 unless otherwise stated. This material (“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. This Material includes data and viewpoints from various departments and businesses within JPMorgan Chase & Co., as well as from third parties unaffiliated with JPMorgan Chase & Co. and its subsidiaries. The generalized hedge fund and institutional investor information presented in this Material, including trends referred to herein, are not intended to be representative of the hedge fund and institutional investor communities at large. 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