Hedge Fund Flows

Bloomberg – Hedge Funds Have Already Bled $55.9 Billion This Year – Oliver Telling 8/21/19

Investors yanked $8.4 billion in July, bringing net outflows this year to $55.9 billion, according to an eVestment report on Thursday. That’s up from $37.2 billion for all of last year.

Investors’ frustration with hedge funds continues to mount, driving down management and performance fees to well below the “two and 20” fee model once considered standard, according to Eurekahedge. More hedge funds have shut than started in each of the last three years, and those that do launch are far smaller than they were before the financial crisis.

The pain for hedge funds isn’t spread evenly, with 37% of funds posting net inflows this year. So-called event-driven funds have fared the best, with inflows of $10.3 billion through July, eVestment data show. These funds try to cash in when events such as mergers, takeovers and bankruptcies lead to a temporary mispricing of a company’s shares.

Long/short equity funds are having the hardest time, with net outflows this year of $25.5 billion, according to the report.

FT – Investors pull money from hedge funds at fastest pace since 2016 – Lindsay Fortado 8/22/19

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Household Debt in China has become a Thing

WSJ – The Trouble With Rate Cuts in China – Mike Bird 8/21/19

This week, the People’s Bank of China revealed a long-anticipated change to how commercial bank interest rates will be calculated. Revealingly, PBOC officials were at pains to stress that while the move might lower interest rates for corporate lending, mortgage interest rates wouldn’t fall.

Eighteen banks now have to show the PBOC the best interest rates they offer to their clients, based on rates set by the central bank’s medium-term lending facility, a source of credit for the banks themselves.

The change has two objectives. One is to lower rates, at least for some loans.

The other is to improve the transmission mechanism for monetary policy: The PBOC wants banks to do a better job of passing changes in policy on to their customers.

The most interesting aspect of the new approach is the deliberate exclusion of real estate. This is likely because Chinese households went on a borrowing spree after the PBOC’s 2015 round of benchmark rate cuts. In 2016, household debt rose by 6.2 trillion yuan ($878.11 billion)—compared with an increase of around 3 trillion yuan a year on average for the previous five years—and only accelerated subsequently.

Which segues nicely to another Mike Bird article.

WSJ – China’s Floundering Crackdown On Household Debt – Mike Bird 8/16/19

Beijing is wisely wary of the decade-long boom in China’s housing market, the consequent build-up in borrowing and what it means for the country’s development model. But in the data there is no sign of a crackdown.

Last week, in its annual Article IV assessment of the Chinese economy, the International Monetary Fund raised its forecasts for Chinese household debt by several percentage points. The IMF expects household debt to rise to 56.2% of GDP this year, and as high as 67.9% of GDP in 2024. The latter figure would be well above current levels in Japan and the eurozone.

In the past 12 months, developers have booked a record 11.7 trillion yuan ($1.66 trillion) in pre-sales—sales of homes due to be completed in the years ahead. Assuming that buyers put down a deposit of around 30%, that is north of 8 trillion yuan in mortgage debt not yet fully on the shoulders of the household sector.

In comparison, Chinese household debt rose by 7.3 trillion yuan between the end of 2017 and the end of 2018, according to data from the Bank for International Settlements. 

The government has good reasons to want to stop the buildup. Many emerging markets have struggled to regain high levels of growth after generating considerable property-related debt, particularly in Asia.

But there is no sign that household debt is even plateauing, let alone declining. Beijing’s stated preference is for an end to speculative household borrowing, but it is proving to be a difficult habit to kick.

Where to find yield in this world and in Venezuela tienen hambre

Bloomberg – BoAML: US % of Global Investment-Grade Yield – John Authers 8/19/19

Bloomberg – BoAML: US & Non-US Investment-Grade Fixed-Income Yield – John Authers 8/19/19

FT – Fears grow of Venezuela malnutrition time-bomb – Michael Stott and Gideon Long 8/20/19

“Six to eight million people are living in a state of undernourishment,” said Susana Raffalli, a veteran Venezuelan humanitarian adviser who has worked across the world with the Red Cross and Unicef, the UN agency for children. 

In a recent report on global food security, the FAO estimates that between 2016 and 2018, about 21.2% of the Venezuelan population was undernourished. When Mr Maduro came to power in 2013 the figure was 6.4%, it says.

In a June report, Unicef estimated that 3.2m children in Venezuela were “in need of assistance”.

Mr Maduro (President Nicolas Maduro) blames a US-orchestrated economic war for the problems with food supplies. The US has imposed an increasing array of sanctions on Venezuela in an effort to force the president from office.

The White House and Venezuelan opposition say the principal culprit is an economy ruined by years of mismanagement whose collapse began years before the first significant US sanctions in 2017. In a statement, the US state department described Venezuela as “one of the worst man-made humanitarian disasters in the modern world”.

Mr Maduro has repeatedly denied there is widespread hunger in his country. He told the BBC earlier this year: “Venezuela has the highest levels of nutrients, has extremely high levels of access to food, and that stereotype, that stigma [of hunger] that they have tried to put on us, has only one objective: to present a humanitarian crisis that does not exist.”

But hunger is one of the main reasons for the mass exodus from the country in recent years, according to diplomats and aid workers. More than 4m Venezuelans have fled abroad, and for those who remain, the food situation is increasingly perilous.

Venezuela will face long-term consequences from chronic undernourishment, especially of children, humanitarian organizations warn. NGO data seen by the FT show the weight and height of Venezuelan children have fallen significantly below the average for comparable populations.

Bees Dying in Brazil

Bloomberg – Bees Are Dropping Dead in Brazil and Sending a Message to Humans – Bruce Douglas and Tatiana Freitas 8/19/19

Around half a billion bees died in four of Brazil’s southern states in the year’s first months. The die-off highlighted questions about the ocean of pesticides used in the country’s agriculture and whether chemicals are washing through the human food supply — even as the government considers permitting more. Most dead bees showed traces of Fipronil, an insecticide proscribed in the European Union and classified as a possible human carcinogen by the U.S. Environmental Protection Agency.

Since President Jair Bolsonaro took office in January, Brazil has permitted sales of a record 290 pesticides, up 27% over the same period last year, and a bill in Congress would relax standards even further.

The fertile nation is awash in chemicals. Brazil’s pesticide use increased 770% from 1990 to 2016, according to the Food and Agriculture Organization of the United Nations. 

Still, in its latest food-safety report, Brazil’s health watchdog Anvisa found that 20% of samples contained pesticide residues above permitted levels or contained unauthorized pesticides. It didn’t even test for glyphosate, Brazil’s best-selling pesticide, which is banned in most countries.

Hunting for Yield

FT – Negative yields force investors to plunge into riskier debt – Robin Wigglesworth 8/15/19

Two decades ago, well over half of the global bond market boasted yields of at least 5%, according to ICE Data Indices. The post-crisis splurge of central bank bond buying and rate cuts lowered this to under 16% a decade ago, but investors could still find plenty of higher yielding debt. Today, a mere 3% of the global bond market yields more than 5% — the lowest share on record.

Indeed, truly high-yielding debt is now almost an endangered species. Bonds with yields of more than 10% amount to just 0.4% of the global fixed income universe, according to ICE.

Negative interest rates in Japan and the eurozone, and mounting expectations that the US Federal Reserve will follow last month’s rate cut with several more this year, have expanded the pool of bonds with sub-zero yields to more than $16tn — or around 27% of the global bond market.

This is primarily a European phenomenon. While US bonds account for just under half the $55tn global investment-grade bond market, they pay out 88% of all yield, according to Bank of America. 

There are, broadly speaking, two main ways for investors to counteract the global yield drought: buying longer maturity or riskier debt. But hunger for long-term bonds from investors such as pension funds and insurers means that the yield pick-up one would normally expect to receive through buying bonds maturing decades into the future, has also fallen sharply.

That leaves many investors pushed towards the only other option: venturing into the riskier corners of the bond market, such as fragile countries, heavily indebted companies and exotic, financially engineered instruments. 

Negative Yielding Debt Make-up & Negative Corporate Bonds

In case you’re wondering where all this negative debt is…

WSJ – Daily Shot: Deutsche Bank – Distribution of Negative Yielding Debt 8/14/19

Negative yields are spreading into Corporate debt.

WSJ – Daily Shot: Deutsche Bank – Negative Yielding Corporate Bonds 8/14/19

WSJ – Daily Shot: Deutsche Bank – Percentage of Govt Bonds Trading at Negative Yields 8/14/19

The Bell Curve of Daily Stock Market Movements, E&P Multiples, and Large Pharmaceutical Charities

WSJ – Daily Shot: Chartr – US Stock Market Daily Movements (Last 10yrs) 8/13/19

Bloomberg – Energy’s Dumb Money May Be Wising Up – Liam Denning 8/13/19

Traditionally, these swung low when oil prices were very high, in anticipation of an inevitable cyclical downswing, and rose when prices fell, pricing in the next recovery. In this latest cycle, however, that relationship has changed. When oil prices fell sharply in 2015 and 2016, valuation multiples soared (and equity issuance spiked). But when oil dropped in late 2018 and this summer, multiples fell alongside it.

The higher risks around energy earnings and damaged trust means investors demand more to buy into them – meaning a higher cost of capital expressed in lower valuations.

Economist – Why America’s biggest charities are owned by pharmaceutical companies 8/13/19

When patients in need of medicines in America go to fill their prescription the price they have to pay can vary wildly. For generic off-patent drugs prices are usually low for the uninsured and free for those with insurance. But for newer patent-protected therapies prices can be as high as several thousand dollars per month. Those without insurance might end up facing these lofty list prices. Even those with coverage will often have to fork out some of the cost, called a co-payment, while their insurance covers the rest.

These co-payments, which for the most expensive drugs can themselves be prohibitively high, can act as a deterrent to filling a prescription. Into this gap a new type of charity has emerged: one that offers to pay co-payments for patients. There are two main types of such charities. There are independent ones, like the Bill and Melinda Gates foundation, America’s largest charity, which spent $3.4bn on co-payments in 2014.

There are also co-pay charities owned by drug makers themselves. According to public tax filings for 2016, the last year for which data are available, total spending across 13 of the largest pharmaceutical companies operating in America was $7.4bn. The co-pay charity run by AbbVie, a drug maker that manufactures humira, a widely taken immunosuppressant, is the third largest charity in America. Its competitors are not far behind. Bristol-Myers Squibb, which makes cancer drugs, runs the fourth largest. Johnson and Johnson, an American health conglomerate, runs the fifth largest. Half of America’s top 20 largest charities are co-pay charities owned by pharmaceutical companies.

The impact of these charities is large and growing. Most of them are less than 20 years old. In 2001 just five drug makers operated co-pay charities, spending a total of $370m. That had risen 20-fold to $7.4bn by 2016. According to Ronny Gal, an analyst at Bernstein, a research firm, the co-payment on the price of a drug is usually just 10% of the cost the pharmaceutical company ultimately charges to the insurance provider. This would mean that $7.4bn spent on copayments could earn drug makers $74bn in revenues, which would account for nearly a quarter of total drug spending in America. Add in spending by the Gates Foundation and this share rises to a third.

Pharmaceutical companies will often claim that helping patients with their co-payments is one way of making expensive drugs more accessible. But it has the fortunate consequence of making their customers price insensitive, because insurance companies will often use high co-payments to nudge their customers into opting for generics over costlier branded drugs: no co-pay, no incentive to save money.

Using co-pay charities to support high prices is good for business, but charitable contributions foster healthy profits in another way too: they are tax deductible. The corporate tax codes of most countries allow companies to deduct the cost of any charitable giving from pre-tax profits. But in America the system is more generous, says Jason Factor, a tax lawyer at Cleary Gottlieb Steen and Hamilton. Companies that give products for the benefit of the “needy or ill” can deduct up to twice the cost of gifted goods.

Tech Companies Crushing It and Those 100-Year Bonds have been very Fruitful

Economist – Silicon Valley’s giants look more entrenched than ever before 8/10/19

FT – Bond buyers playing the long game notch up huge gains – Tommy Stubbington 8/11/19

When Austria sold a €3.5bn 100-year bond two years ago at a yield of just 2.1%, a few eyebrows were raised. Today, buyers who had handed over cash in that sale could be forgiven for feeling a bit smug.

The bond is among the best performing assets in the world this year, notching up a total return of nearly 66% since the end of 2018. Nearly half of the gains have come since June, when Vienna raised a further €1bn in a follow-up sale of the same bond at an even stingier yield of 1.2%.

Debt markets around the world have rallied in 2019. However, it is longer-dated bonds that have been the outstanding performers. That is a function of their high duration — a measure of the sensitivity of bond prices to moves in interest rates. For ultra-long bonds, even a small dip in yields means massive price gains that dwarf income from coupon payments.

German 30-year bonds, which have recently seen their yields turn negative, have returned 28% this year. Holders of UK 50-year bonds are sitting on a 22% gain.

Not all countries issue ultra-long-dated debt. The longest bonds sold by the US and Germany are their 30-year benchmarks. Within the eurozone, Austria, Belgium, France, Ireland, Italy and Spain have all in the past five years capitalized on investors’ thirst for yield by selling bonds maturing in more than three decades.

Generally, demand for these bonds is dominated by pension funds and insurers that need long-dated assets to match their long-dated liabilities — and are typically less concerned with yield levels than other investors.

But Austria’s century bond was an exception, with asset managers accounting for nearly two-thirds of orders, suggesting that many buyers were using the bond to take an outsize bet on lower rates.

I.O.U.s – As Good As Real Money

NYT – Circulating in China’s Financial System: More Than $200 Billion in I.O.U.s – Alexandra Stevenson and Cao Li 8/6/19

China’s trade war with the United States has escalated in recent days, posing a growing threat to an already slowing economy. 

China is not running out of money. But Chinese banks are reluctant to lend to private businesses because they consider big, state-owned enterprises more reliable in paying off their debts. Alternative sources of money have dried up as regulators have cracked down in recent years on China’s shadowy world of unofficial lending.

So a growing number of companies are issuing i.o.u.s to their suppliers. Some suppliers turn around and use the notes to pay another supplier. And then — in a sign of how desperate some Chinese companies have become for money — they sell the notes for less cash than they are worth.

Commercial acceptance bills are not legal tender. Rather, they are pieces of paper promising payment in the future. Companies owed some $211 billion in these informal notes as of February, the most recent government data available, an increase of more than one-third from the previous year.

More debt may be floating around China’s corporate world and goes untracked if the notes are being traded for less than their face value. A market has formed around commercial acceptance bills, in which companies buy and sell them based on the prospects for being paid back. The bigger and better known the company, the more secure the bill is considered.

A pillar of China’s economy, the property sector, is feeling the squeeze particularly hard. Sales have been slowing since late 2017, making it hard to pay for new projects. At the same time, the government is clamping down on other ways that property companies raise money, like through the shadow banking system.

Property companies have adapted by effectively turning the commercial acceptance bills into a currency, according to interviews and filings from dozens of property developers and suppliers like steel companies, design and construction firms.

Xu Jiang of Zhubo Design, an architecture and urban planning company in the southern city of Shenzhen, said customers had started to pay with commercial acceptance bills two years ago. The customers, which include some of the country’s biggest developers, local governments and state-owned firms, now use these notes more frequently than paying cash, he said.

Today, one of the biggest issuers of i.o.u.s is China’s largest and best known property company, Evergrande ($36bn market cap)By the end of last year it had issued nearly $20 billion worth of i.o.u.s to its suppliers. With a towering $100 billion debt pile and a penchant for raising bonds to pay off the interest, it appears to have turned to commercial acceptance bills to help cover costs.

Bauing Construction Holding Group, a big supplier of design and materials to China’s biggest property developers, has disclosed that it is owed $96.4 million in these i.o.u.s from Evergrande.

Another company that owes Bauing money is the state-owned firm China State Construction Engineering. China State said it had owed $490 million in i.o.u.s to all of its suppliers at the end of last year.

Another major property developer, Greenland Holding, which was founded by the Shanghai government and has property developments in dozens of cities across China, had $550 million worth of unpaid notes out to suppliers by the end of last year, according to its annual report. The company said that was 10 times the amount it had outstanding in 2017.

African Swine Fever is likely to make your Bacon more Scarce

Economist – African swine fever threatens 200m pigs in China – Daily Chart 8/6/19

African swine fever, a highly contagious virus, has spread to every province in China. The country is the world’s biggest pork producer, and home to half the pigs on the planet. In the last year it has reported 149 outbreaks. Some 1.2m pigs have been culled, according to official statistics. Unofficial reports suggest far bigger losses. Rabobank, a Dutch bank, reckons that by year-end, as many as 200m pigs could be lost to disease or slaughter, leading to a 30% drop in pork production.

Although African swine fever is not harmful to humans, it kills up to 90% of pigs. Infected animals stop eating, hemorrhage and die, often within a week. There is no vaccine or cure. Before 2007 the disease had been eliminated from most of the world, with the exception of Africa. It reemerged in Georgia in early 2007 and spread to Russia, Ukraine, Belarus and Lithuania.

The disease was probably introduced to China via its northern neighbor, with which it shares a 4,300km (2,670-mile) border, or through infected pork products imported from Europe. 

China’s first outbreak was reported on August 3rd 2018 in Liaoning, a coastal province in the north-east of the country. Chinese authorities scrambled to contain the disease, culling tens of thousands of pigs and banning transport of the animals into and out of affected areas. It did not work. The virus spread to every part of the country. It eventually crossed into neighboring Vietnam, Cambodia and Laos.

With pork prices in the country expected to jump by 70% year-on-year in the second half of 2019, China’s favorite meat may soon be off many dinner tables.