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Abstract from MARCH 2012 fasanara 'fat tail risk hedging programs' FTRHPs

Abstract from MARCH 2012 fasanara 'fat tail risk hedging programs' FTRHPs

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Abstract from MARCH 2012 fasanara 'fat tail risk hedging programs' FTRHPs

  1. 1. Investment Outlook, Special Sits & Fat Tail Risk Hedging Programs (FTRHPs) STRICTLY PRIVATE & CONFIDENTIAL Authorized and Regulated by the Financial Services Authority Strictly Confidential | Not for Distribution March 2012 ABSTRACT ONLY - for confidentiality reasons
  2. 2. DISCLAIMER 2 This document is a strictly confidential communication to and solely for the use of the recipient and may not be reproduced or circulated without Fasanara Capital Ltd.’s prior written consent. If you are not the intended recipient, you may not disclose or use the information in this documentation in any way. The information is not intended as an offer or solicitation with respect to the purchase or sale of any security. The information in this documentation has been prepared from sources believed to be reliable but Fasanara Capital Ltd. does not represent it as accurate or complete.
  3. 3. Portfolio Hedging Strategies 3 ABSTRACT - for confidentiality reasons
  4. 4. Portfolio Hedging Strategies How DoWe Define Hedging at Fasanara? 4  At Fasanara we breakdown Hedging Strategies into three major categories o Security-Specific Hedging: built to adjust the portfolio long exposure to specific names and / or sectors whenever appropriate or cost efficient o Macro Overlay Portfolio Hedging: designed to adjust the overall portfolio exposure to specific Risk Factors / Macro Scenarios o Fat Tail Risk Hedging Programs (FTRHPs): engineered to position the portfolio against pre-identified, low- probability / high-impact events. Such hedging are achieved mainly thorough asymmetric profiles and cheap optionality (Select Shorts and Cheap Options), but also through Dislocation Hedges whenever feasible  The following slides aim to provide a clear guide to the process of hedging tail risk across asset types and describe examples of our proprietary FatTail Risk Hedging Programs (‘FTRHPs)
  5. 5. Strictly Confidential | Not for Distribution 5  We start with clarifying the instrument NOT to be used (although it is conventionally believed to represent the most standard way of hedging), as it is too expensive in the current markets: Put Options on the Equity and Bond markets  The embedded cost of using Puts (as measured by Skew-ness) has rose to unbearable levels. Therefore it is paramount to identify and implement smarter Hedging and implement alternative ways to achieve an hedging / protective strategy Why the Use of Put Options Is Not Advisable?
  6. 6. Strictly Confidential | Not for Distribution 6 EURUSD Currency Basis OIS-Libor Spread USD 2yr Swap Spreads EUR 2yr Swap Spreads FatTail Hedging vs Renewed Credit Crunch CreditTightness in Interbank Market Reminds of Lehman’s
  7. 7. Strictly Confidential | Not for Distribution 7  In Japan technicals are good for a short / hedge  Surge in overseas acquisitions by Japanese companies, spurred by the yen’s appreciation, helped reverse a two-year decline in bank lending that has been a legacy of the nation’s battle with deflation.  Japanese companies spent $88.7 billion in 2011 to buy businesses abroad, the most since 2000  Also spurring loan demand are reconstruction projects since Japan’s record earthquake in March FatTail Hedging vs. Default Scenario (cont’d) FatTail Hedge Example: Short Japan FX
  8. 8. Strictly Confidential | Not for Distribution 8  The strength of the Yen during the second half of 2011 was driven by the EU crisis, with the currency being viewed as a "safe haven". Now, without having to intervene, the Yen weakened as a result of the Greek / Eurozone accord  This weakening of the Yen will create other problems for Japan. Reliance on nuclear power for so many years has backfired recently as the aging and damaged nuclear power facilities become decommissioned FatTail Hedging vs. Default Scenario (cont’d) FatTail Hedge Example: Short Japan FX Japan's trade balance
  9. 9. Strictly Confidential | Not for Distribution 9  The recent news flow from Japan is also important. The current account surplus turned negative in January (first negative reading since 2009) marking decisively higher fuel imports, and making a tricky macro set there even more delicate.  Japan could serve in hedging some of European malaises and negative scenarios, as similarities between the two economies are marked, especially on monetary grounds and debt metrics, and right there on monetary outcomes Japan may well be leading the way ahead of Europe FatTail Hedging vs. Default Scenario (cont’d) FatTail Hedge Example: Short Japan FX  The absolute basis (purple line) between CDS and JGBs remains notably above any of its peers reflecting more of the possibility of a hyperinflationary or devaluation 'event' .
  10. 10. Strictly Confidential | Not for Distribution 10 Baltic Dry Index China’s Imports Dry Bulk Company Disconnect with the Equity Markets FatTail Hedging vs. Default Scenario (cont’d) FatTail Hedge Example: Short Shipping
  11. 11. Strictly Confidential | Not for Distribution 11  China’s Imports will have an impact on the industry  China is rebalancing its economy by moving away from export and infrastructure economy toward domestic demand, with a focus on household consumption. China’s demand for commodities is therefore set to decline  From 2000 to 2010, China’s imports (in value terms) of iron-ore surged by 42.5 times, thermal coal 248 times and copper 16.2 times  In 2011, it took 71 million tones of steel for one percentage point of GDP growth – that is unheard of in the world’s modern history. The ratio should moderate going forward FatTail Hedging vs. Default Scenario (cont’d) FatTail Hedge Example: Short Shipping
  12. 12. Strictly Confidential | Not for Distribution 12  Shipping Distress and collapse in BDI rates: what is the driver of its setback? What will stop the bleeding?  So at what level does one predict scrapping for 2012? The answer lies with those that have both old and modern tonnage — it is in their interest to remove their older vessels to help revive the supply/demand balance to help lift rates to more profitable levels for their newer vessels  Operators with older unleveraged assets (paid off in full) can now afford to charter vessels at extremely low rates (even negative), whilst those operators who have newly acquired (leveraged) stock are restricted to charging rates that ensure a break- even rate on their financing costs FatTail Hedging vs. Default Scenario (cont’d) FatTail Hedge Example: Short Shipping
  13. 13. Strictly Confidential | Not for Distribution 13  Swiss Franc has depreciated against the Euro after SNB intervention  Market does not trust moral suasion, and challenges SNB’s resolve  The Floor provided for by the Central Banks implies much lower pricing for hedging options  Such hedging options would then become cheap hedges against EUR disintegration FatTail Hedging vs. EU Break-Up Scenario FatTail Hedge Example: Swiss Franc
  14. 14. Strictly Confidential | Not for Distribution 14  CHF option against EUR disintegration 10x payoff 1.05 1.20 FatTail Hedging vs. EU Break-Up Scenario (cont’d) FatTail Hedge Example: Swiss Franc
  15. 15. Strictly Confidential | Not for Distribution 15  DKK option against EU Break-Up risk  Denmark’s status as a safe haven has triggered markedly stronger demand for DKK. This has been exploited by the central bank to bolster the currency reserves to a record-high level as a safeguard against the unrest in financial markets (DKK 490bn as a safeguard against potential future turmoil affecting the DKK)  The combination of lower imports and higher exports has pushed Denmark’s trade balance to a historically high level. Over the past 12 months the surplus has reached DKK 117bn, making a significant contribution to Denmark’s safe haven status FatTail Hedging vs. EU Break-Up Scenario (cont’d) FatTail Hedge Example: Danish Krone 100x payoff 7.436.00
  16. 16. Strictly Confidential | Not for Distribution 16  Japan failed to stimulate growth despite massive credit expansion  Monetary policy transmission system failed to transfer into bank lending – collapse of money multiplier  But now the BoJ said it would increase the size of this year’s asset purchases by Y10tn ($123bn), Quantitative Easing to combat Deflation. . Now that deleveraging has abated, the central bank should have the power to change inflation expectations FatTail Hedging vs. Inflation Scenario FatTail Hedge Example: Short Japan Rates
  17. 17. Strictly Confidential | Not for Distribution 17  Gold: new paradigm at play FatTail Hedging vs. Inflation Scenario (cont’d) FatTail Hedge Example: Gold  Current gold reserves are a drop in the bucket compared to outstanding debt of most Sovereigns. Italy's $130bn worth of gold is 6% of their total debt outstanding (which is actually higher than it is for the US)
  18. 18. Strictly Confidential | Not for Distribution 18  A key indicator of China's economic conditions is the "excess export growth". The idea is to see by how much the rate of export growth exceeds the GDP growth. Historically exports grew at a much faster pace than the GDP  During the 08-09 recession however, the GDP rate significantly outpaced exports. Rather than the output growth being fuelled by exports, it was financed via the injection of government stimulus  The figures from January of this year show that China's excess export growth is once again in the negative territory not seen since 2009  Other signs of economic growth stability in China had been iron ore prices and coal imports, both of which moved lower recently. Once the seasonal distortions of the early Lunar New Year holiday have passed, the level of this slowdown will become clear FatTail Hedging vs. China Hard Landing Example of Hedging Strategy

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