As most of you know, I spend a lot of my time talking to fund traders and large money-managers trying to pick their brain. With another year of big gains in equities and only 12-trading days until year-end, most of the big payers seem to be looking for ways lock in profits, hedge against “unknown” price-risk and decoupling. The crazy uncertainty now surrounding crude oil and the energy sector has a lot of guys spooked and is obviously pushing “fund-money” in several unexpected directions. A few clear and obvious beneficiaries as of late have been corn, soybeans and wheat. This might be a tough bridge for some to cross, but for others it appears much more logical, especially when you consider we are rolling into what could be more extreme winter weather, continuing turmoil between Ukraine and Russia, an election in Japan, Fed divergence from the rest of the central banks, a newly controlled Republican Congress, Greece and parts of the EU once again moving towards unstable ground. Not to mention the amount of debt the oil companies had on their books 5-years back was only around $200 billion, while now it’s all of a sudden up around $3 TRILLION. In other words there could be secondary derivative impacts the investment world hasn’t even thought about yet that players are now trying to reposition and protect against. Remember, we have now seen over 80 straight days of declining prices at the pump. Also remember, this is traditionally a “thin” period of time where moves can become extremely over-exaggerated! In other words, when you get major “headline-risk” like we are seeing in the energy markets, coupled with lower than normal trade volume, all bets are off in regard to traditional fundamental rhyme and reason. Like Bill Gross said this past weekend, “The sharp decline in the price of oil has disoriented markets and changed the perception of the creditworthiness of companies and countries. When levered money moves and tries to seek a safe haven, basically you have violent price movements across the board.”
CALPERS (California Public Employees’ Retirement System) has decided to completely pull out of hedge funds, announcing they’ll be divesting all $4 billion they have invested because they are too complicated and their fees are too high. A few months ago, they cut hedge fund investments by 40% for the same reasons and saying they were looking to get back to basics. That was in July, so this decision to cut the other 60% of their hedge fund program so soon afterward is kind of unexpected. CALPERS is the largest pension fund in the US and the fifth largest in the WORLD with nearly $300 billion in assets. They currently have investments in 24 different hedge funds and six fund-of-funds, in which they earned returns of 7.1% in their fiscal year that ended on June 30. In turn, they paid a total of $135 million in fees to those funds. CALPERS aims to average a fiscal return of 7.5% and says that for hedge fund investments to have a material impact, they would have to increase fund holdings to at least 10% of their portfolio, which they say isn’t possible when considering their complexity and cost. CALPERS certainly isn’t the first to express concern over how high hedge fund fees are, which usually operate on a “2 and 20” model, meaning they charge 2% of of total assets and 20% of profits. These fees seem even more unreasonable in light of recent hedge fund performance, which returned on average just 9.1% in 2013, compared to the S&P 500 which increased 32.4%. CALPERS originally turned to hedge funds back in 2002 after the global financial crisis erased more than one third of their value. Returns at the time helped them meet the costs of retiree benefits. Over the last ten years though, their annual hedge fund investments have only returned an average of 4.8%. The hedge fund industry has already started weighing in to defend itself, putting the blame squarely on the shoulder of CALPERS, saying they just didn’t pick good funds. One hedge fund manager told Business Insider, “They got what they paid for since they only invested in managers who would cut fees. So the best funds wouldn’t do that, so they had a mediocre portfolio.” Some managers also argue that those who are critical of hedge fund performance aren’t taking into account their ability to manage assets during down market cycles. While CALPERS $4 billion withdrawal is just a drop in a bucket to the total $2.8 trillion in assets that hedge funds currently have under management, the bigger worry is that other pension funds might follow. Considering CALPERS sheer size, it is only natural that other pension funds look to them for direction, which could be a very bad thing for hedge funds in this case.
There continues to be reports of several large investment banks and money-managers advising clients to be buyers of wheat and or corn as a “portfolio hedge” against the geopolitical tail-risk associated with crisis in Ukraine. I don’t need to remind anyone that many political analyst say we are witnessing the most important set of geopolitical events since 9/11 or perhaps even the Cold War. The “hype” has certainly escalated the hedge interest amongst the larger players. I continue to caution those who try to swim further out “against the tide.” If your a “fundamental” bear I still believe the safest place, at least for the time being, remains on the sideline. As the money is “rotated” the waves can become extremely dangerous. I continue to belive we are in a major transitionary phase, those money-managers and investors who made the jump to “distressed debt investing” back in 2008 are now those creating the “event driven” crowd. Be careful thinking your brains can win against their brawn. In the end, yes, but initially the bigger, faster and stronger almost always win out.
The Australian Bureau of Meteorology is saying six of seven weather models are showing Pacific ocean sea surface temps could exceed El Niño thresholds within the next 90-days. If history is any indication, an El Niño weather phenomena can trigger extreme weather patterns around the world, particularly droughts in South East Asia and Australia along with potential heavy flooding in parts of South America. Interesting to see commodity giant SocGen releasing research that shows nickel has been the best performer in past El Niño conditions, with zinc, coffee, cocoa, cotton and soybeans ALL displaying large price spikes during these periods. Bottom-line, the funds might try to make timing allocation adjustments into commodities that are most sensitive to El Niño weather patterns. Several sources suspect commodities coming out of Australia and Southeast Asia would be their first play, with commodities being affected by flood damage in South America not really becoming a major play until late 2014 or perhaps even early 2015. Keep in mind most El Niño’s don’t reach their full-strength until the Dec-Feb time period. Also keep in mind most El Niño summers here in the Midwest tend to be slightly cooler than normal with above average precipitation. In other words, here in the US it’s the La Niña years that present the most difficult growing conditions, whereas El Niño years have produced some of the best crops. South American production is an entirely different story and can be extremely hampered during El Niño weather patterns as can production in parts of Asia, Australia and India.