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

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. DISCLAIMER
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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. Portfolio Hedging Strategies
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ABSTRACT
- for confidentiality
reasons

4. Portfolio Hedging Strategies
How DoWe Define Hedging at Fasanara?
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 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)

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 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?

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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

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 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

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 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

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 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' .

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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

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 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

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 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

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 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

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 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

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 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

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 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

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 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)

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 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