ISDA Property Index Derivative Transactions and ISDA Documentation
ISDA Symposium: Property Index Derivative Transactions and ISDA Documentation
Thursday, July 12, 2007
Global Financial Markets Conference Center, New York
The application of derivative products to the residential and property market has begun to develop in markets around the globe. The housing and residential real estate market is estimated to be a multi-trillion pound asset class.
Until recently, investors could not effectively participate in this asset class. With the publication of the 2007 ISDA Property Index Derivatives Definitions, investors can achieve portfolio diversification and diversify their exposure to local property markets through industry-developed standardized documentation. The development of various property indices globally has contributed to the development of standardized ISDA documentation to facilitate property index transactions.
At this symposium, traders and attorneys will share their views on end user demand, geographical diversification and continued product innovation in the property derivatives space. A discussion of the different methodologies of leading indices will be offered as well. With regard to the documentation, a comprehensive examination of the ISDA definitions booklet, focusing on key issues such as delays between measuring an index, revisions to that measurement and consequent publications of index values, adjustments such as rebasing and errors in publications, and disruption events affecting indices will be discussed.
The forward and total return swap forms of confirmation will also be discussed. As with other Symposia hosted by ISDA, audience members will be able to engage in a Q&A with panelists and receive the set of ISDA documentation. Property Index Derivative Transactions and ISDA Documentation.
The application of derivative products to the commercial and residential property market has begun to develop in markets around the globe. In the United States alone, the housing and residential real estate market is estimated to be a $21 trillion asset class. Until recently, investors could not effectively participate in this asset class. With the publication of the 2007 ISDA Property Index Derivatives Definitions, investors can achieve portfolio diversification and diversify their exposure to local property markets through industry-developed standardized documentation.
The development of various property indices globally has contributed to the development of standardized ISDA documentation to facilitate property index transactions.
At this symposium, traders and attorneys will share their views on end user demand, geographical diversification and continued product innovation in the property derivatives space. A discussion of the different methodologies of leading indices will be offered as well. With regard to the documentation, a comprehensive examination of the ISDA definitions booklet, focusing on key issues such as delays between measuring an index, revisions to that measurement and consequent publications of index values, adjustments such as rebasing and errors in publications, and disruption events affecting indices will be discussed. The forward and total return swap forms of confirmation will also be discussed. As with other Symposia hosted by ISDA, audience members will be able to engage in a Q&A with panelists and receive the set of ISDA documentation.
Welcoming Remarks: Kimberly A. Summe, General Counsel, ISDA
Panelists: David M. Blitzer, Managing Director and Chairman of the Index Committee, Standard & Poor'sDavid Felsenthal, Partner, Clifford Chance US LLP Rajiv Kamilla, Head of New Products Trading, Structured Products, Goldman SachsTodd Kushman, Managing Director, Bear Stearns
Register for this event.ISDA, real estate, property, real estate securities, mortgaged backed sderivatives, derivatives, real estate derivativesLabels: derivatives, ISDA, mortgaged backed sderivatives, property, real estate, real estate derivatives, real estate securities
Congress could regulate private equity
Congress could regulate private equityUnions said pressure from Congress on private-equity funds could lead to higher pay and more benefits and could spur more unionization. In a May 16 hearing, House Financial Services Committee Chairman Barney Frank, D-Mass., said he was looking at unspecified legislation that would put tighter controls on the funds. "When a small number of individuals benefit from a particular deal in the tens and sometimes hundreds of millions of dollars, and concurrently, workers are laid off, we have a situation which [is] wrong," Frank said.
Congress hints at regulating private equityBy Sara Hansard
May 29, 2007
WASHINGTON — Unions are hoping that pressure from Congress on private-equity funds will lead to better pay and benefits for workers, including more unionization.
“We’re in the early stages of starting a national debate about income inequality in this country, and the special responsibility that private equity has [is] to address greater opportunity for workers in this country,” Stephen Lerner, assistant to the president of the Service Employees International Union in Washington, said in an interview last week. He is the director of the 1.8-million-member union’s private-equity campaign.
House Financial Services Committee Chairman Barney Frank, D-Mass., made clear at a hearing held by his committee May 16 that he is looking at unspecified legislation to regulate private-equity funds more stringently.
“When a small number of individuals benefit from a particular deal in the tens and sometimes hundreds of millions of dollars, and concurrently, workers are laid off, we have a situation which [is] wrong,” he said at the hearing, which dealt with private equity’s effects on workers and firms.
Mr. Frank cited as an example a news report that $19-an-hour union janitors at the Tommy Hilfiger Corp. recently were replaced with $8-an-hour non-union janitors as a consequence of the $1.6 billion buyout of the company last year by private-equity firm Apax Partners Inc.
Both companies are based in New York.
The laid-off workers later were rehired by a different contractor.
Company founder Tommy Hilfiger will receive at least $14 million a year through 2010 from the sale, “while workers in their 40s and 50s have been laid off with one day’s notice,” Mr. Frank said.
“If we have a situation in private equity where enormous values are created, and the workers are either no better off or worse off, then from the public-policy standpoint, that seems to me to be undesirable,” Mr. Frank said.
The committee is focusing on whether there is such a pattern and whether the government should do something about it, he said, adding: “It could have [an] effect on policies involving unionization [and] taxation.”
‘No specifics’
Committee spokesman Steve Adamske said in an interview that “there are no specifics” on what legislation the committee might consider.
But a Republican staff aide, who asked not to be identified, suggested that “one of the issues they might look at is disclosure,” specifically more disclosure required for investors by the Securities and Exchange Commission.
Congress also is looking at changing the way hedge fund and private-equity fund managers are taxed.
At a meeting with reporters in Washington this month, Senate Finance Committee Chairman Max Baucus, D-Mont., said that he and the committee’s ranking minority member, Sen. Charles Grassley, R-Iowa, are looking at such changes.
Blackstone not representative
“The fundamental question is the degree to which income gain is ordinary income or cap gains,” Mr. Baucus said.
The issue that members of the Senate committee are trying to determine, he said, is how performance fees charged by private-equity and hedge fund managers should be taxed.
Currently, they are taxed at lower capital gains rates.
Although large firms such as The Blackstone Group LP of New York have attracted much public attention, “they’re not representative of the typical private-equity firm,” Jeffrey Jay, the managing partner of Great Point Partners LLC of Greenwich, Conn., said in an interview.
“The typical private-equity firm is providing growth capital for businesses, not involved in massive cost-cutting and debt-pay-down-type strategies,” he said. Individual investors and advisers who work with high-net-worth clients and family offices have “always been meaningful players in private equity and venture capital,” Mr. Jay said.
The AFL-CIO in Washington recently asked the SEC to require Blackstone, a private-equity and hedge fund group, to register as a mutual fund in light of the company’s offering its shares as a publicly traded limited partnership. Blackstone’s offering is one of the first major public offerings by a private-equity and hedge fund firm, and the SEC is reviewing it.
“If Blackstone LP can avoid coverage under the Investment Company Act of 1940, it appears to us only a matter of time before other investment companies rely upon the devices used by Blackstone LP to avoid regulation under the act,” AFL-CIO secretary treasurer Richard Trunka wrote in a May 15 letter to Andrew “Buddy” Donohue, director of the SEC’s division of investment management, and John White, director of its division of corporation finance.
Although officials associated with private-equity management firms argue that most of their profits go to institutional investors such as mutual funds and public pension funds, as well as financial advisers who serve wealthy clients, some advisers say that such investments may not be appropriate for investment advisory firms.
“In many of these cases, [advisers who invest in private-equity funds] are breaching their fiduciary duty by using some of these funds, because they are so non-transparent,” said Charles Stanley, a certified financial planner and chartered financial consultant with Capital Financial Advisors LLC of San Diego.
“There’s no way of knowing really what it is that they are doing with clients’ money when they put it into some of these funds,” he said. “That’s very questionable activity to be doing as a fiduciary adviser.”
full articleprivate equity, american regulations, congress, secLabels: american regulations, congress, private equity, SEC
How to handle the MA boom
How to handle the M&A boomBy Mohamed El-Erian
The boom in mergers and acquisitions has underscored the disparity between rising market values and serious economic concerns, writes Harvard Management Company President Mohamed El-Erian in this Financial Times commentary. Meanwhile, equity investors are enjoying benefits as investors looking for markets to "revert to the mean" have been stymied.
The mergers and acquisitions boom rolls on, slowly but surely changing the financial and corporate landscape. Spurred on by a record surge in private equity flows and enormously accommodating debt markets, the momentum of this shift is showing little sign of fading.
The impact is being felt across markets, particularly in the US where several indices have reached record levels.
But the M&A boom has helped to accentuate the contrast between buoyant market valuations and concerns about a US economy facing headwinds on account of a difficult housing market, a subprime mortgage debacle, high energy prices and large consumer debt.
The joy of equity investors, especially leveraged ones, also contrasts vividly with the frustration of others. Investors betting on continued historical aberrations in market trends have continued to benefit so far. In contrast, those looking for markets to "revert to the mean" have been left frustrated.
The latter have continued to observe stark historical inconsistencies in market valuations, volatilities, correlations and liquidity. Yet their attempt to exploit these inconsistencies has been repeatedly disturbed by yet greater market aberrations. The "Theory of Second Best", which dates back to the 1956 work of two economists Kelvin Lancaster and Richard Lipsey, provides a useful framework for thinking about all this.
Essentially, this theory looks at what happens when, in certain circumstances, one of the optimal conditions of a model is not fully met. Intuitively, when this happens, it might be supposed that the second-best solution involves continuing to meet the other optimal conditions of the model. The Theory of Second Best cautions against this. Instead, it suggests that a better outcome may involve deviating from these conditions.
When applied to today's financial markets, the second best theory illustrates one of the ways in which investors have had to adjust their approach to take into account the manner in which emerging economies are allocating their large and increasing reserves.
These economies' large "non-commercial" purchases of US fixed income products have introduced and sustained significant pricing distortions. And, as the Theory of Second Best suggests, the next-best solution for investors has implied betting on additional historical anomalies in other markets.
How has this worked? Large foreign purchases of US bonds have led to an unusual compression in bond yields and credit spreads. The resulting misalignment versus the equity risk premium has encouraged increasingly large leveraged buy-out activities which, in turn, attract even more capital to private equity.
No wonder M&A activity has surged. And, as the corporate landscape changes, companies with large cash holdings have been forced in, with some playing defence and others offence.
How long can this go on? For a while; but not forever. In the short term, the phenomenon has significant momentum that can only be derailed by a series of economic and technical dislocations. A single dislocation will not suffice as illustrated by the temporary setbacks of May-June 2006 and February 2007.
Over the longer term, valuations will be excessively divorced from the underlying economic realities, especially if the US economic slowdown intensifies. In addition, the risk of regulatory and political backlash will rise. Finally, the distortion that lies at the heart of it all – the non-commercial allocation of sovereign wealth funds – will slowly fade as emerging economies face pressure to increase the rate of return on their reserves and to allocate more funds to domestic uses.
Therefore, the basic challenge for investors is an outlook that is inherently fluid and potentially dualistic. The solution may well have three principal components: a strategic asset allocation that emphasises secular themes and a long-term destination; portfolio overlays that recognise the reality of an historically unusual journey; and a risk management process that is sensitive to the nature and evolution of the underlying market distortions.
Mohamed El-Erian is president and chief executive of Harvard Management Company.mergers, acquisitions, M&A, investment banking, private equityLabels: acquisitions, investment banking, MA, mergers, private equity
Instinet algorithm automates human-trading strategies
Instinet algorithm automates human-trading strategiesInstinet has launched Sidewinder, an algorithm that adjusts the rate at which a trading desk buys and sells a stock as its price hits certain benchmarks. The algorithm allows faster reactions to market shifts, enabling traders to quickly make "momentum" trades and take advantage of value strategies.
Instinet automates human trading strategiesMelanie Wold
29 May 2007
Agency brokerage Instinet has taken a traditional trading strategy and turned it into a new algorithm, to enable faster reactions to market forces than a human could achieve.
Instinet’s Sidewinder algorithm dynamically adjusts the rate at which a trading desk buys or sells a stock as its price moves relative to selected benchmarks. Sidewinder can take advantage of so-called "value" strategies, whereby the rate a trader buys shares slows down as the price moves away from his target, and speeds up as it moves closer.
Sidewinder also enables traders to do "momentum" trades automatically, where it buys more as the price goes up and less as it goes down, or vice versa.
The benchmark element means that if a stock is part of an exchange traded fund or index, there is a high correlation that the stock won’t move against movements of the ETF or index. So if it does momentarily get out of line, Sidewinder can take advantage of it.
Mike Plunkett, president of North America for Instinet, said it is difficult to be unique these days in algorithms, so it took a traditional trading strategy and added to it. “Truly useful algorithms mimic what any good trader would do intuitively, while at the same time making the trading process more efficient,” he said.
Sidewinder, available via Instinet’s trading platforms or partner FIX systems, allows clients to customize execution style, benchmarks and participation rates. Sidewinder can also be pegged to the widening or tightening of the spread between two stocks or between a stock and an ETF. Sidewinder uses Instinet’s SmartRouter to seek liquidity in displayed US dark pools.
Plunkett said the feedback from clients testing the algorithm has been positive. The target market for Sidewinder is buyside trading desks and single stock traders, he said.
full articleLabels: algorithmic trading, electronic trading, instinet
State Street Corporation Strategy in Investment Outsourcing
State Street Corporation Strategy in Investment OutsourcingState Street Corporation at Lehman Brothers 10th Annual Financial Services Conference
JASON GOLDBERG, ANALYST, LEHMAN BROTHERS: Moving right along, next up we're very pleased to have State Street. State Street is one of the largest custodians in the world, one of the largest asset managers in the world and very well positioned in higher growth businesses where it is actually outgrowing its peers. It is a name that has put down extraordinary revenue growth over the last decades and more recently a key focus on expenses as well as managing net interest margin, has also helped to double-digit earnings growth, a trend we expect to continue, aided over time by its pending acquisition of Investors Financial. From the Company we're very pleased to have Ron Logue, Chairman and CEO; Ed Resch, Chief Financial Officer and Kelly MacDonald, Director of Investor Relations. With that, we'll turn it over to Ron.
RON LOGUE, CHAIRMAN & CEO, STATE STREET CORPORATION: Jason, thank you. Thank you very much. As Jason said, our CFO Ed Resch, is here as well and Kelly MacDonald in the audience if anybody wanted to direct any questions to Kelly as well. So why is this title called "setting the standard". We think that for the market to continue rewarding us the way they have in the most recent past, that we're going to need to continue to set the standard for our particular industry, and that standard is what I would like to talk about with you this morning.
We believe in four things. I'm going to talk about how we performed against our goals in 2006, how we're going to build on that success in 2007, why it is so important for us for our success to extend our global reach, and then I will summarize and talk about how we continue to deliver that financial performance. Obviously I have to show you this slide again. I am sure you've seen it many times. I have to remind you that I may make forward-looking statements and that actual results may differ materially. So let's talk first about 2006, just recap what happened.
We have three financial goals. We express those goals in terms of ranges, because we realize that we're going to be operating in different economic climates. The first goal is to be a consistent earner. We define that as operating EPS growth of 10% to 15%; in the last year we grew operating EPS almost 23%. If we are going to be considered a growth company we're going to have to grow topline revenue consistently. We have a goal of growing topline revenue 8% to 12%. Last year again exceeded that goal in good markets, growing topline revenue growth 15%.
And our third goal is to be a prudent allocator of capital, defining that in terms of operating return on equity of between 14% and 17%, and again exceeding the high mark of that last year at 17.1%.
So let's review what's happened so far in 2007. At the beginning of the year we announced that our acquisition of Investors Financial, which is a $2.2 trillion trust bank based in Boston. Prior to that announcement, however, we said that we thought we would expect to operate in the top half of what our goals were, hence the 10 to 12% growth in revenue, 12.5 to 15% growth in earnings per share, 15.5 to 17% operating return on equity.
As a result of that acquisition, we adjusted those goals for 2007, and obviously increasing revenue 16 to 18%, reducing growth and operating EPS 8 to 10% and operating return on equity 12 to 15%. We are off to a pretty good start in the first quarter of 2007; revenues were up a little over 11%. Expenses up a little less than 11%, generating 60 basis points of positive operating leverage, the 10th consecutive quarter in a row where we have been able to do that and growing earnings about 11%, return on equity 17%, as well.
In the fourth quarter we made two acquisitions. The first acquisition was the foreign exchange trading platform, a company called Currenex. What Currenex does for us, and you will see in a few minutes why it is also important in terms of some our other acquisitions, it really accelerates our participation in the growing electronic foreign exchange market. It is going to be neutral to earnings in 2007; slightly accretive in 2008. What it really does it provides for us a very high-speed technology solution for very sophisticated traders who truly demand fast execution.
Let me just break that down a little bit. It is very complimentary to a platform that we have -- some of you may know as FX Connect. It serves a very different constituency as you can see here. Between the two we believe that what we will have is the real-time, transparent, streaming price capability that really is going to marry liquidity and technology for tomorrow's foreign exchange world. Why is that important to us? As you will see in a minute, 43% of our revenue comes from outside of the United States. As we acquire a win, large pieces of non US assets this capability becomes an ever-increasing more important capability for us.
We made another acquisition which probably has received much more press than Currenex. The acquisition of Investors Financial. Let me focus on the first three points that you see here. I am going to show -- I am going to drill down a little bit and talk a little detail on what this transaction really does do for us. It truly accelerates our leadership in high growth areas, mutual fund custody, administration, but also hedge funds, offshore funds. Yes, it adds $2.2 trillion in assets under custody, and more than $800 million in revenue, and it truly extends our leadership in this new business that is called middle office outsourcing or investment managing operations outsourcing.
Given us a very good client base. Many customers that we did not have in the past. I said it added $2.2 trillion of assets under custody, and on a pro forma basis that is going to make us the second largest custodian in the world behind the combination of Bank of New York and Mellon once that transaction is consummated, as well. That is nice. That may sell a lot of newspapers, but that's not what really pays the rent. We pay the rent -- on the next three or four slides -- and I'm going to show you. I am going to start with the US mutual fund marketplace.
People have been telling us for years that the US mutual fund marketplace is a mature market.
We don't necessarily believe that's true. As you can see here is the total market about $10.3 trillion of assets under management, and in the last two years it has grown faster than it has previously, [50.5]% versus 11.5%. So if you take a look at the US mutual fund assets that we have about, $4 trillion worth, I show you the pro forma after IFIN and before IFIN. You can see that that is significant more than the -- in terms of assets under custody -- significantly more than the number two player, number two player here being JPMorgan Chase. And you can see the lineup in terms of assets under custody.
The right-hand side of the screen that is for us much more important and very relevant in terms of the acquisition. Of that $3.97 trillion in assets under custody we do the accounting evaluations for the greater majority of those assets. You can see again pro forma after IFIN. And I think what you can see from this screen is how quickly that drops in terms of the accounting and valuation of in essence daily price collective [clones]. Very fragmented, very few number of players and those traditional large custodians that you know of as having trillions of dollars of assets under custody, for the most part really aren't in this business. So I think you can begin to see the relevance of the acquisition of IFIN.
Another business that we haven't talked a lot about in terms of our acquisition of IFIN but the hedge fund administration business today, fastest-growing business or service business anyway is State Street; a $1.4 trillion marketplace. You can see the market's growth over the last three years, 21%; we growing almost twice as fast as that through the acquisition we made almost five years ago now, International Financial Services are doubling (inaudible) base, hedge fund administrative. Again I show you the pro forma numbers here.
After adding IFIN's numbers in their own right a very significant hedge fund administrator, large operations in Dublin, which also will be integrated. Again because of this acquisition we can see us now becoming the number one hedge fund administrator in the world, leapfrogging Citco Fund Services and again you can see the order in terms of who the other competitors are and relative size and scale of those, as well.
Let's talk about another fast-growing market, the offshore funds market, based for the most part Dublin and Luxembourg. $2.7 trillion market. Market growth again, very strong 29%, again our growth extremely strong, very large operations in both Luxembourg and Dublin that we've had for sometime going back to the early 1990s, actually 1990 itself. Again, you can see the acquisition of IFIN extending our already first-place lead in this business again determined by assets under custody, almost $300 billion of assets under custody after the IFIN transaction here as well. Again, you can take a look at the other providers.
The newest business, investment manager outsourcing, taking the investment operations of large global asset managers, rationalizing those operations literally, lifting out many of those employees, the first transaction was and many of you may remember one we did now almost seven years ago with PIMCO. And then after PIMCO the Allianz (inaudible) business that PIMCO took over, at least on the fixed income side. What we are targeting here are the top 500 investment managers worldwide, a very large market here.
The original global demand for this type of product, again if you take a look at the market growth here and our growth, (inaudible) has been the leader for sometime with the number of the mandates that we have won in Europe. Some of the most notable, AXA, ABN Amro asset management, Investec in the United States the most recently. Putnam and the Evergreen funds. IFIN as you know also in its own right a large customer in BGI. So you can see the lead that we have in this business, fast emerging as a growing business, one that truly captures the relationship. This type of business is really the creation of annuity streams, large long-term contracts usually 8 or 7 or 10 years, sometimes 12 year contracts. So a business that really captures the relationship and creates annuity streams of revenue. If you can do it and if you do it well.
So what else have we been doing as well as extending our lead or taking the lead in some of the faster growing product segments? As well as being a market leader in those product segments we also need to be a market leader in the geographies that are growing faster than other geographies. Our global imprint is very important. Let's talk about that just for a second. Let's go back five years, what we had found and had been saying for some time, is our non US business is growing 2 to 2.5 times faster than our US business. If you look at the CAGRs in terms of non US revenue versus company revenue, the absolute numbers 2001 versus 2006. I think what is important however, is the percentage of growth of non US revenue growing from 27% to 43% pre IFIN. After IFIN it will drop to 37% given the fact that a majority of IFIN's assets under custody are US based.
And the other thing that is important in telling the number of employees and the number of non US employees more than doubled. We have 8600 people on the ground outside the United States, twice as much as we had five years ago, 40% of the total staffing. If you take a look at the total staffing it is clear that total staffing is not grown as much as non US staffing. We are extracting productivity out of I guess what you would say some more mature markets and I believe we have begun to bring that down to the bottom line as well.
Let's drill down a little further and talk about peer comparisons. Non US revenue, pre-tax income non US employees. As I said in terms of non US revenue (inaudible) pro forma after IFIN down to 39%. You can take a look at that, I guess what you call the near term competitors, (inaudible) the Morgan trusts, many of you could walk in the Mellons, and again showing here Bank of New York Mellon pro forma after the (inaudible) was consummated in terms percentage of non US revenue versus total revenue. Same thing on pre-tax income, significantly more pre-tax income as I said again in terms of numbers of employees, people on the ground.
So let's take a look at the opportunity and let me first focus on Europe. We target the seven largest markets in Europe, you can see them here. Break it down by collective funds, pensions funds and insurance funds so a $21 trillion opportunity. Offshore market as you can see here, the largest market for collected funds, UK the largest market for pension and insurance funds.
Market grew 12% in the last three years and we've grown almost 30% in that period of time, a lot of that arguably because of the Deutsche Bank acquisition we made about three years ago now. Talk about Asia Pacific a littler over $12 trillion market, again broken down, collected funds, pension funds, what we'll call government related. Again, looking at the seven largest markets I think it is obvious with Japan dominating all of those three segments.
Again here that market growing 14% again as in many cases we almost growing twice as fast as that market as well. So ask the question really is should you invest in a growth company like ourselves positioned where we are in those markets. And I guess what I would say is three things. First of all, what we are really doing is establishing a very strong position in fast-growing markets and trying to grow faster than our competitors; hedge funds, private equity, offshore funds, increasing the non US revenue, twice the US growth. That is what has been fueling our topline growth, I'd say for the last three or four years.
Investment servicing, solidifying our leadership in mutual funds. That is what IFIN does for us. You can tell from that slide I showed you the tremendous need we have in terms of accounting in administration for US mutual funds. Positioning foreign exchange for the change that will take place in that business, going truly to an electronic real-time streaming priced type of function that's going to be necessary, especially if you have as a goal as we have to eventually get 50% of our revenue from outside the United States, a real opportunity foreign exchange as long as you have the capability for today's world markets. And continuing to lead in investment manager operations, outsourcing, creating those annuity streams, those 7, 10, 12 year contracts with large, complex, global investment managers around the world.
We do talk a lot about investment management. But our investment management on global advisors has significantly increased its profitability over the last two or three years growing to 25% of our bottom line contribution, a goal that we gave them just a little over two years ago, growing from somewhere around 13, 14% profit contribution. Have done an extremely good job in terms of extracting more profitability out of that business.
So we have a simple formula for success. What we need to do is strengthen our foundation, our foundation, our franchise was built in the US as you might imagine, it was built on the back of the US mutual fund business in the 1970s, we need to protect that strong franchise. Again, IFIN has a lot to do with that. (inaudible) relationships with our customers; you can measure market share in many ways; the traditional way obviously is assets under custody. I like to measure it in terms of how deep our relationships with those top 500 financial institutions in the world. It goes without saying we have to deliver superior service levels. It is not necessarily a differentiator any more. It is something that you have to do and obviously we need to continue to seek operational efficiencies. If we add to that, building market share, growing in those new markets that are growing faster than others, creating critical mass. If we continue to develop new products and services continue to take the lead, one of the things that we didn't talk about, IFIN is, IFIN gives us the capability we did not have and that is the servicing of private equity funds. Granted a relatively small business today, a business that we were going to invest in. (inaudible) we have to but probably a business that is going to grow pretty quickly. We're going to keep winning competitively. We've got to win our share and obviously add quantitative active management capabilities to our already very large passive asset management capabilities.
We do that, what we're trying to seek is sustainable growth, meeting the benchmarks, making sure our revenue is growing faster than our competitors in strong markets and in not so strong markets. To continue to increase profitability; achieving operating leverage. An annual goal of achieving operating leverage, maybe not every quarter but at least at the end of the year revenue has to grow faster than expenses. We've been able to do it 10 consecutive quarters and it continues to be a very strong goal. (inaudible) discipline has been inculcated in the Company that I think allows us to do that much better than we have in the past and if we do that then we're going to deliver consistent results. Because I think what the market place seeks is that consistency quarter after quarter after quarter, and that is what we're seeking to do. So with that, I'll stop I will stop my formal remarks and be happy to answer any questions that anyone has.
UNIDENTIFIED AUDIENCE MEMBER: What are the major cost opportunities related to the acquisition?
RON LOGUE: I'm sorry, the major what?
UNIDENTIFIED AUDIENCE MEMBER: Cost opportunities, taking out costs.
RON LOGUE: The IFIN acquisition, IFIN is a mirror image of State Street. You can basically say it is a miniature State Street. It is organized, and I mean this literally, exactly the way the State Street servicing organization is organized, it is physically in the same city. The degree of difficulty is nowhere near with the degree of difficulty Deutsche Bank was, which was multijurisdictional. Obviously it is a legal organization itself, so all the corporate staff, US will be eliminated. We've publicly stated reduction of 1700 staff. On Friday we announced the severance of about 550 individuals on the day that we will close. We've actually identified those.
Most importantly we've also identified the key managers that we want to keep. Because the way you retain the business is by retaining the people who service the business. We've also notified those individuals, as well. Happy to report that most of the customer facing management beginning at the Chief Operating Officer are staying. We called on most of those customers already. No one has said they are leaving; as you know as I am sure that you've seen other acquisitions, these things have long tails. It will take some time. We're very confident we're going to be able to get those cost savings. We've known this organization for a long time, and it truly is the mirror image of State Street, just smaller. So we're extremely confident we'll be able to get those kind of cost savings that we publicly stated. Hopefully that answers your question.
UNIDENTIFIED AUDIENCE MEMBER: Ron, you just mentioned at the end there that on a go forward basis you were hoping to win your share of competitive bids. And maybe just a comment about the competition in the states you see and maybe the pro forma Bank New York Mellon but over here who you are up against and who you expect to be competing against.
RON LOGUE: Over here the traditional American banks are obviously but also Hong Kong Shanghai, BNP Paribas, and Societe Generale probably the larger players still here. Obviously as consolidation is going to continue you are going to see that there is going to be some dislocation, there is a differentiation of I don't know how many people appreciate between the consolidation of State Street and IFIN and the consolidation of the Bank of New York and Mellon. The content of customers at Bank of New York Mellon for the most part are US based, defined benefit plans.
The content that IFIN for the most part are US, in this case, (inaudible) mutual fund managers. When we talk about price competition you cannot generalize and say there is price competition in the custody business. There is price competition in segments of the custody business and where there is the most intense price competition is in the pension world, defined benefit defined contribution US and non US. Not so much in the collective fund world. Why? I take you back to that chart. There are not many people who do it, so there aren't many people who compete. All of us custodian banks can compete the defined pension business. For most of us who are custodian banks cannot compete at scale for collective funds business, especially in the United States. And that is, it remains to be seen what happens in consolidation as I said before these things have long tails. We are really not going to know how that is going to work out probably until first and second quarter next year and the telltale sign in my view is going to be topline revenue growth, all other things remaining equal, so we will see.
UNIDENTIFIED AUDIENCE MEMBER: If I could tag onto that just briefly if you can provide a little bit more granularity on the Bank of New York Mellon; do you see any fallout on that side. Is it easy to pick up contracts?
RON LOGUE: It is too early to tell, is the honest answer. It is clear just as all of the other custodian banks went after the Deutsche Bank or bank of trust book of business when we acquired that that we and everyone else is calling on all those customers. It is really going to depend not necessarily so much on price, but although it will to some extent. But how much dislocation is going to take place at in this case Bank of New York Mellon versus if one has to go through that dislocation anyways, is it worth, can you get more value somewhere else? My sense is a lot of those decisions will be made in the third and fourth quarter, probably closer to the fourth quarter of this year. Then you won't be seeing announcements of those things probably until the first quarter of next year. If in fact that happens and probably begin to see some of that reflected, I would think in topline revenue in first, second, third quarter of next year. It just takes a long time for that to happen. I'm sure you will hear from time to time names here or there; personally I don't think it is very constructive to talk about this name or that name. You will hear that from time to time. It may or may not be meaningful. It is really in the aggregate, and it is really usually at least three quarters after a close, at least that has been our experience and that is where you're going to be able to tell. At least that is where I would look to see.
UNIDENTIFIED AUDIENCE MEMBER: Ron, you talked about (inaudible) outsourcing opportunities (inaudible) Europe, and I guess you know a lot of big contracts but I think it is our understanding those are still not I guess converted onto your platform. Can you just talk to (inaudible) on building on your own platform and the process (inaudible).
RON LOGUE: Sure. What is happening with this business -- I have to go back for a minute -- is that the degree of difficulty of processing has continued to escalate. There was a time we were all custodian banks and that is all we did. We settled trades, and then some of us went to do accounting and some of us went to do trusteeship or fund administration, as we call it. And now some of us are trying to increase that degree of difficulty and literally take over the investment operations of large, global asset managers.
The key here is it is not about building a system to do that. It is about finding a way to integrate various functions and we've identified I think it is fourteen different functions that take place within the investment operations. They are small functions but fourteen very important functions; some of which organizations are emotionally attached to, want to do it themselves, some of which they don't care about. And they'll let others do it. It is a question of integrating that and creating a platform. It is not about building a whole new system.
So what we've done is we've taken over those operations as is and over time begun to develop a process that integrates systems that asset managers are using today with some of our systems and mixing and matching. And that is what the investment manager operations outsourcing is about. It is not about waiting for a system to be delivered. So we have something called the enterprise platform. We are at the point where we are installing pieces of that in different non US actually organizations, Investec, Scottish Widows, Axa, ABN Amro asset management. What we've said is that most of that will be done by the middle of 2008, and we will be on our platforms.
Until that time we basically literally take the people, put them on our payroll. That is a good thing, by the way, not a bad thing. A number of people said that is a bad thing. Why is it a good thing? It is a good thing because custodian banks don't necessarily know how to operate in the middle office. That is not what they've done all their life. Acquiring intellectual capital who knows how to do that is very important. And so we've probably acquired some lift outs of maybe over 1000 people who have done that. So today as I am speaking to you there are people who used to and still do work for PIMCO in Newport Beach, California, Citi in Paris, France and Amsterdam; and here in London helping those organizations convert, if you will, or integrate their operations. We have been able to take that intellectual capital and spread it around the world.
So at the end of the day what happens is Axa will do some things themselves, and we will do some things. ABN Amro asset management may do a totally different set of things. They will use the same underlying integrated platform to do that. It is not like you are bringing in a system and you are plugging it in and it's working. And I think that is a something that is not well understood in this newly emerging business.
UNIDENTIFIED AUDIENCE MEMBER: (inaudible -- microphone inaccessible) competition between State Street's own asset management group and what BGI group does. Is that an issue in moving that contract over?
RON LOGUE: No. First of all, it is not BGI business that is here. It is all BGI business that is in the United States currently serviced by IFIN in Sacramento, California. I think there has been more hype about that then reality, honestly. When we look at BGI as any other customer, we have to prove our worth to them. The way we are organized again just the same way IFIN is organized, it is around individual customers. It is not a large factory. So the ring fencing of BGI is the same as the ring fencing that we do for Fidelity. We are in another group we're doing work for Putnam. It is very similar. We are used to that. We've been doing that for years and years and years. When you are looking at that from the outside it looks like it is one large homogenous factory and the things can get intermixed, but that's not the way things work. So that is why we feel pretty good about our ability to do that. We've been working that way literally since the 1970s, with all of those competitors in the US mutual funds business. This is no different.
UNIDENTIFIED AUDIENCE MEMBER: Can you comment on some M&A opportunities in Europe? We seem to have Bisys being acquired by Citi. Any comments that would be useful for the group.
RON LOGUE: Bisys was a book of business that didn't have the same kind of interest, at least not in the US mutual fund side, very small number of customers. The one piece of value that we saw there was the hedge fund piece, a company called Hemisphere that they had purchased. But we already have that now in terms of our own business with IFS and now with IFIN. So I don't see that as a major issue at all. I think there will over time continue to be opportunities here in New York for more consolidation. I don't think it is going to happen in the near future. Things are going pretty well for everybody now. If you go back in time and look at when acquisitions take place, they usually during or just after down economic times when certain organizations no longer want to invest in this business. I would anticipate that at or slightly after the next down economic cycle there will be organizations who will rethink and potentially get out of that business. At that time we, as we have in the past will look long and hard at being able to do that. I think hopefully time will be such that we will be able to finish with the IFIN transaction this year, and if that were to happen in the next one or two years we would be in a position to do something again, and we would very proactively seek to do that.
UNIDENTIFIED PARTICIPANT: Please join me in thanking Ron for the presentation.
Full articleinvestment management, business process outsourcing, state street, hedge fund, mutual fundLabels: business process outsourcing, hedge fund, investment management, state street
Outsourcing Investment Management
Outsourcing of funds could be good for investorsAs hedge fund and mutual fund managers rely on third parties for risk management and other controls, investors may profit with better products, reduced costs and more transparency. About 31% of investment-management firms expect to increase this type of outsourcing over the next few years, found a survey by PricewaterhouseCoopers.
Market or manager?- 29-May-2007
The imminent departure of Anthony Bolton, Fidelity's star fund manager, has rekindled the debate about the relative merits of active management versus passive. Should investors put faith in a manager or an index, asks Adam Lewis"A blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by the experts."
That is the accusation made by Burton Malkiel, an economics professor at Princeton, in his classic work A Random Walk Down Wall Street.
Some fund managers, such as Fidelity's Anthony Bolton, could justifiably object to being compared to primates. But the debate between active and passive fund managers remains central to the investment industry.
Given the performance record of Bolton on the Fidelity Special Situations fund, it was hardly a surprise that the announcement of his successor two weeks ago was covered widely in the media. According to Morningstar, the fund, which was split into two last year, grew 160-fold from its launch in December 1979 to May 14, 2007.
As is well known to most readers, Sanjeev Shah, the former manager of Fidelity's UK Aggressive fund and current manager of the European Aggressive fund, will take on the £3.2bn UK Special Situations portfolio in January next year. His appointment was mostly welcomed by the fund industry. But his relative lack of experience means that advisers and fund of fund managers are looking at alternative funds.
On the week of Bolton's departure, Bestinvest, an IFA firm, recommended no fewer than five potential funds that have similar objectives to Fidelity Special Situations, if investors wanted to switch to "a more proven manager".
These include: the £1bn Artemis UK Special Situations fund run by Derek Stuart; Nigel Thomas's £1.5bn Axa Framlingon UK Select Opportunities fund; and the £729m Merrill Lynch UK Special Situations fund, managed by Richard Plackett. It also suggested that clients look at Mark Hall's £632m Rensburg UK Select Growth fund and the £165m Investec Special Situations fund, run by Alistair Mundy.
Not on the recommended list of Bestinvest, advisers or fund of fund managers, was that investors switch their holdings into an index tracker fund. Hardly a surprise given the difference in styles, but according to several prominent investment professionals, buying a fund that tracks the stockmarket is the only way to properly invest for the long term.
John Bogle, the founder of the Vanguard Group in 1974 and author of The Little Book of Common Sense Investing (reviewed in Fund Strategy, May 7, 2007, page 28) is in the Malkiel camp. At Vanguard, Bogle was responsible for the creation of the world's first index mutual fund (now called the Vanguard 500 Index fund) in 1975.
According to Bogle, out of 355 equity funds launched in America over the past 36 years, only 24 have outpaced the S&P 500 by more than one percentage point a year. Of these, he adds, just three have mounted a record of sustained outperformance: Davis New York Venture; Fidelity Contrafund; and Fidelity Mutual Shares. Meanwhile, the only manager to have outperformed the S&P 500 in the past four decades for 15 consecutive years is Legg Mason's Bill Miller. While Bogle acknowledges Miller's ability, he says the odds of owning a consistently successful equity fund are less than one in a hundred. Indeed, Millar's run of S&P 500 outperformance ended in 2006, when in dollar terms his American-domiciled Value Trust returned 5.85% compared with the index, which grew 15.79% over the calendar year, according to Morningstar.
Bogle also makes the point that in America, over the course of the past 36 years, out of 355 equity funds that existed, 223 have gone out of business. "If your fund doesn't last for the long term, how can you invest for the long term?" he asks.
Another problem with active funds is manager turnover. While Bolton has managed his fund for almost 28 years, according to research statistics in the 2005 UK Fund Industry Review, three-quarters of fund managers in Britain have managed their funds for four or fewer years (see pie chart, above).
The message of Malkiel's book, into its ninth edition since first being published in 1973, is similar to Bogle's. That is, investors are better off buying and holding an index fund than attempting to buy and sell individual stocks and actively managed funds. One of his main arguments is that the developed financial markets, such as America and Britain, price stocks so efficiently that strategies designed to beat it are futile.
Malkiel, who sits on the Vanguard board with Bogle, adds that those mutual fund managers in America who have beaten the market over certain periods have typically underperformed it substantially at times.
This is true of Bolton. Mark Dampier, the head of research at Hargreaves Lansdown, says that between 1988 and 1992, and again in the late 1990s, Bolton's style of investing fell out of favour with the market. The fund underperformed substantially as a result.
James Norton, the director of Evolve Financial Planning (which only offers clients passive funds), notes that if an investor had put money into Bolton's fund in 1989, it would have taken them 11 years for their investment to get back to beating the market, such was the degree of the fund's underperformance.
"There is no doubt that Bolton is a star fund manager," Norton adds, "but investing in him was not without risk. Investors would have had to stick with his fund through thick and thin to have made the returns often quoted."
For Bogle, the main reason for the underperformance of most actively managed funds is that they are hampered by expense costs, poor stock selection and market timing, taxes and inflation. He estimates that management fees, operating expenses, sales charges, the cost of portfolio turnover and broker commissions, can come to as much as 3-3.5% percentage points a year for actively managed funds.
However, Dampier says that while the fees on index tracking funds are much lower, investors who use them are "guaranteeing themselves underperformance". Any fee they charge will mean the return for the investor is less than the index.
This is an argument supported by John Chatfeild-Roberts, the head of the Jupiter independent funds team. He says: "Trackers may be cheaper than active funds, but price does not always represent value for money. Passive index tracking funds are almost guaranteed to underperform the index they track by roughly the amount of their annual charges. That can have a significant effect on the value of an investment over time."
Norton agrees: "If the manager of an index tracking fund does their job properly, an investor will be left with the market return, minus the costs. These costs should be more than 0.5% a year and decent funds charge 0.3%. It remains criminal that Virgin still charges 1% for its passively managed tracker fund.
"If you compare this with research conducted by Lipper Fitzrovia last year, the average total expense ratio of an active UK equity fund was 1.63%. This is a 500% disparity in costs and means the average active managed fund will underperform the index by a larger amount than index funds, as their costs are higher."
Chatfeild-Roberts says the contention for arguing for trackers on the basis that active managers cannot consistently beat the market index is "nonsense". He argues: "Good performance is repeatable if you invest with a talented fund manager. There may only be about 100 of them in the UK market place, and if you do not feel you can identify them, that is your prerogative. However, investors should not be fooled into thinking it cannot be done."
So how does an investor go about finding the next Bolton or the next Warren Buffett? Malkiel has in the past conceded that there are individuals who can consistently beat the index, noting that Buffett is "an investment genius". The problem, he notes, is that "trying to find the next Buffett is like trying to find a needle in a haystack. Why not just buy the haystack?"
Norton adds: "The question boils down to how can you pick the active funds that will outperform in advance? You would need a crystal ball. Allacademic research shows that there is little persistency in the outperformance of active managers."
Bolton agrees: "The real question here is, given that so few managers beat the index consistently over time, can a retail investor identify those managers who will outperform in advance? That's why you need to research the manager and the investment house. For most investors, this means consulting an IFA. So, if you do your research you will have a good chance of identifying which managers beat the index."
Not so, according to Bogle. His book not only casts doubt on how much worth advisers add to investors. It also questions whether just because a manager has done well in the past he will necessarily do so in the future. "Every firm in the investment industry acknowledges my conclusion that past performance is of no help in projecting future returns of mutual funds. This is stated in all prospectus'," he writes.
In terms of investors seeking advice to select funds, Bogle writes that a survey by a research team led by two Harvard Business School professors found that between 1996 and 2002 alone, the weighted average return of equity funds held by investors who relied on advisers (American brokers and excluding all upfront or redemption charges) averaged just 2.9% a year, compared with 6.6% earned by investors who took charge of their own affairs.
While Bogle says advisers may provide a valuable service in reassuring clients in helping establish a portfolio that matches their risk/reward appetite, "advisers as a group cannot be credibly relied upon to add value by selecting winning funds for you."
Justin Modray, head of communications at Bestinvest, says that Bogle makes a fair point. "In terms of the entire IFA market, it's fair to say that a number of firms don't put enough effort and thought into the picking of funds. This is why more and more firms are outsourcing their funds selection to fund of funds - it's an admission they are no good at it themselves."
However, he says the larger IFA firms, such as Bestinvest and Hargreaves Lansdown, have their own in-house research teams. This means, he argues, they can add value.
This need to add value is seen as important. Modray says it has conducted research that shows over three-year rolling periods, going back 20 years, more than two-thirds of active managers have failed to beat their index.
So how much of picking the right active manager is luck and how much judgement? Indeed, how much of an active manager's performance is luck and how much is skill?
In the late 1990s Albert Morillo, at the time the manager of the Investec European fund, and Rory Powe, the manager of the Invesco European fund, were two of the big names in the industry. However, at the start of this decade, as the bear market set in, Powe's growth style of investing, with large amounts invested in technology stocks, fell out of favour and his fund underperformed substantially.
Meanwhile, Morillo built his strong track record in the 1990s while at Scottish Widows. He took over the Investec European fund in April 2000 on an outsourced basis, after he joined Blackrock. However, his fundamental value approach to investing in firms led him to miss out on bounces in sectors during equity rallies, and the fund consistently underperformed the sector from the third quarter of 2002 onwards. On January 1, 2007 Investec ended the outsourcing agreement, bringing the fund back in-house to be managed using its four-factor equity investment process.
Malkiel says the same is true in America. He has written that the fund managers who did well in 1998 and 1999 managed to outpace the S&P 500 by more than two times. However, in early 2000 they underperformed the index by about three times. Similarly the top-performing funds in America in the 1970s underperformed in the 1980s and the top funds in the 1980s underperformed in the 1990s.
Dampier also says there are not many decent active managers for British investors to choose from at present. "Putting it in football terms, how many Cristiano Ronaldos are there? There is no right or wrong answer when it comes to this debate. I object to the religious right of those such as Vanguard who think passive funds are the only place to be, but I'm also aware that 90% of active managers are crap too. As a result you have to spend a lot of time to find the best managers," he says.
Dampier argues that investors can pursue a core/satellite approach, in which their core funds are index trackers, then use active funds for satellite holdings. Modray says it uses index funds as he notes they can be sensible core holdings in clients' portfolios.
Alternatively, Dampier says that investors should look for fund managers they believe will outperform. "While you can try and find the Ronaldos, investors have to realise active managers will have times when they don't perform well. It's all about putting the work in and those who can't are better off going down the indexation route," he says.
However, Chatfeild-Roberts argues that truly passive investment does not exist. This, he says, is because investors are always making choices, with there being more than 13,000 indices in existence, each of which he says have different characteristics. "By picking one rather than the other you are, in effect, being forced to take a view. This will have consequences for the returns you make," he says.
Malkiel notes that over the past few years the S&P 500 index has itself become more actively managed, in terms of the amount of changes made to it. However, he says that it is far less actively managed than active funds.
In the more recent editions of A Random Walk Down Wall Street, Malkiel recommends investors use an index that offers a broader representation of the American stockmarket. These include the Wilshire 5000 or the Russell 3000. This is primarily because he says the S&P 500 only represents the larger American firms that make up three-quarters of the total market. As a result, investors who only invest in an S&P 500 index fund do not have exposure to smaller or mid-sized companies.
In 1981 David Booth and Rex Sinquefield, former students of Eugene Fama, a leading American financial economist, founded Dimensional Fund Advisors. Its business was based on Fama's hypothesis that markets are efficient: prices accurately reflect intrinsic value. It rejects not only the idea that active managed funds can sustain long-term returns through exploiting mispriced stocks, it also rejects the purely passive management concept.
Instead, it uses a third way called "value added management". It has identified three equity and two fixed-interest "factors", or core elements, to its strategy. The equity factors are that shares will return more than fixed interest and that small company and value shares will return more than large company and growth shares. The fixed interest factors are that longer-term and lower credit quality instruments incur greater risk. Indeed, Dimensional's name reflects these three factors or "dimensions" to its approach.
Its strategy also aims to minimise portfolio turnover (which Bogle argues is a hidden cost in active funds) and therefore beat active and passive approaches on dealing costs. Worldwide, the group manages $136bn (£69bn) of assets under management. Most of these assets are run in its so-called "enhanced index funds". The goal of these enhanced index funds is to add 100-200 basis points a year over conventional benchmarks, while tracking their benchmarks almost as well as index funds.
Samuel Adams, the vice-president of financial adviser services at Dimensional, says its primary goal of its funds is to deliver the return of the asset class every year. "If we can add 100 to 200 basis points over the benchmark that would be fantastic, but people buy our funds because we deliver the return of the asset class," he says.
In Britain the group manages six Oeics, with assets under management totalling £750m. The most recent, the UK Core Equity fund, was launched in June last year and now has assets of £170m. The fund provides a broad exposure to the FTSE 350 index and has been designed so that it is not concentrated on just the large cap names.
Adams says: "The fund takes weights out of the top 10 stocks and buys more outside, buying more small cap and value companies, as these are the areas that traditionally provide stronger returns. However, the funds we run are 100% passive and remain within 1-3% of the FTSE 350."
As Dimensional funds are designed for long-term investing, all discretionary IFAs who want to sell its funds must attend a two-day training course.
Ian Shipway, the director of investment at Thinc Group, has used Dimensional's range of UK Oeics ever since it first launched at the start of 2004. Thus far he says he has been happy with the results. "Dimensional is not an index tracker, it engineers passive portfolios. Using its funds allows us to gain pure exposure to the asset classes we want at very low cost."
The obvious presumption is that despite the benefits listed of passive funds, most investors in Bolton's fund will continue to want their money managed in an active manner. Whether or not this is the best way to invest in stockmarkets is a debate that will continue for a long time.
Dampier says: "If everyone agreed that indexation was the way to go and money was invested in size in index tracker funds, the result would be more capital becomes misallocated. This happened in the late 1990s to 2000 when there was a gigantic misallocation of capital to large caps, purely because of their size, rather than the fact they were good businesses."
Chatfeild-Roberts concludes: "On the upside, I would argue that passive funds are great news for active investors, as the more money that becomes passively managed, the more potential profits there are to be made by the best active investors."
However, whether or not there are the active managers to pick up on these returns, consistency remains the big question.
Hot fundsOne criticism often directed at the active funds industry by advocates of passive investing is the propensity of group's launching funds based on the short-term performance of certain sectors in stockmarkets. These are the so-called hot funds. In Britain, a classic example of this was during the technology boom of the late 1990s.
As the tech bubble grew and grew, ever more fund management groups cashed in the sector's popularity by launching dedicated technology portfolios. In May 1999, Framlington launched its NetNet fund and Gartmore created its Techtornado fund in February 2000. Jupiter, meanwhile, launched its Global Technology fund right at the top of the cycle in March 2000, with the fund taking in £132m in its offer period.
Indeed, in March 2000 some £877m of Isa money was invested into the technology sector, with the money flowing into a 28-strong fund sector. However, since the dotcom crash in the same month, only 14 funds remain. In May last year, Axa Framlington merged its NetNet and Nasdaq funds into one portfolio, AXA Framlington Global Technology, while Gartmore merged Techtornado into its UK & Irish fund in February 2003.
The most recent fund to announce its impending closure was Aegon Technology. Launched in 1985 it was one of the oldest tech portfolios, but its assets peaked in October 2000, reaching £341m. Since the tech crash, however, its assets have fallen to £8m and the group announced at the start of this month its intention to close the fund on July 31.
Following the bursting of the tech bubble, commentators have consistently looked for the next potential bubble, and one such sector could be property. Buoyant demand for commercial property and the launch of real estate investment trusts has seen several groups launch dedicated property portfolios over the last couple of years.
The IMA specialist sector, which contains all the commercial property and global Real estate investment trust funds, was the best-selling net retail sector for the whole of 2006 and the first quarter of 2007. And in March this year, £471m was invested into property funds according to the IMA.
John Bogle, founder of the Vanguard Group and author of The Little Book of Common Sense Investing, writes: "There have been many new paradigms over the years. None have persisted. The "concept" stocks of the Go-Go years in the 1960s came and went. So did the "Nifty Fifty" era that soon followed. The "January effect" of small-cap superiority came and went. In the late 1990s, high-tech stocks and "new economy" funds came as well. Today, the asset values of the survivors remain far below their peaks. Intelligent investors should approach with extreme caution that any new paradigm is here to stay. That's not the way financial markets work."
Diagram: Length of Fund Manager Service
Diagram: Active Funds vs. Trackers
hedge funds, investment management, business process outsourcing
Labels: business process outsourcing, hedge funds, investment management
Algorithms Finding A Foothold In Fixed-Income Markets
Fixed-income algorithms find their wayThe main object of algorithms in the equities market is to find price discrepancies between markets offering the same security. The fixed-income market is made of markets with different structures, making algorithms harder to gauge. For the last few years, however, an algorithmic strategy for the fixed-income world has been taking place.
Algorithms Finding A Foothold In Fixed-Income MarketsAs Advanced Trading first attempted to gauge the extent to which algorithms have been deployed in the fixed-income market in the
November 2005 issue, it became apparent that it would be some time before these strategies became as prevalent in the market as they are in equities. While many of the structural issues discussed in
that first article — such as the format of the dealer-to-customer trading venues, which use a request-for-quote (RFQ) system — still exist, some of the major interdealer venues now are seeing high levels of automated trading, and there is automated arbitrage between them.
There now are algorithms that can be used on RFQ venues, and perhaps more important, algorithms are being written on the buy side to support decision-making and assist in transaction processing, lowering the effective cost of transactions. And while the entry of a new participant,
NYSE Bonds, has yet to cause a major ripple, its unconventional firm-quote platform for the most-active corporate bonds has the potential to change the paradigm for this dealer-driven market.
It is clear that the fixed-income market will never look like the equities market — which has few parameters and security types, and where the main object of algorithms is to capitalize on price disparities between markets offering the same security. In contrast, the fixed-income world is comprised of several markets that are structured quite differently from one another and each of which has thousands of securities and many specialized order types.
However, if one expands the definition of "algorithm" beyond the typical equities function of splitting an order and executing against a benchmark to include any automated routine that processes incoming market data and provokes trading activity, one could conclude that algorithms indeed are prevalent in the fixed-income world.
"Algorithmic trading has two pieces: one, decision support; and two, execution," explains Jon Dean, head of global connectivity at MarketAxess. Algorithms have been used in decision support — for example, tracking price correlation between bonds and futures contracts derived from those bonds, and creating hedging strategies based on the information — for some time. And now that price data is improving and electronic trading is becoming more prevalent, according to Dean, bond algorithms are moving closer to combining decision support and execution. Pricing data has become much easier to obtain since the National Association of Securities Dealers (NASD) began offering the
Trade Reporting and Compliance Engine (TRACE) in 2002, with adoption increasing steadily in 2005 and 2006, Dean says, making corporate bonds a much less murky category and paving the way for further automation.
If You Want It, Build ItAt present, most of the buy-side firms using fixed-income algorithms extensively build and deploy them in-house. Because of the amount of IT effort this requires, some firms, including Bank of New York (BNY) Asset Management, are making algorithmic development part of a firmwide integration strategy.
BNY recently completed an 18-month IT overhaul that produced a common trading and data information backbone called the Transaction Processing Layer (TPL). The goal of the initiative was to integrate trading and analytical platforms in all asset classes so that traders could see a representation of the market at any given point, says Eric Karpman, a VP at the firm and head of its FIX fixed-income technical committee.
The strategy came about because the bank was concerned with updating its asset allocation strategies across multiple asset classes, part of a growing trend toward sector-based trading, according to Karpman. The availability of TRACE data convinced bank executives that this would be a sound investment. "The proliferation of data gave us a reason to go forward," Karpman says. "Algorithmic trading was just a natural exploitation of the resources that were made available by the TPL."
The FIX-based TPL was built on Informatica's data-integration software. Drawing historical and real-time price and portfolio data off this backbone, BNY Asset Management's algorithms facilitate cross-asset trading across all desks, including the personal, global and institutional fixed-income desks; short-term money markets; institutional equities; and index funds, Karpman says. A team of 11 technologists built the system, but frequent input from other bank divisions, including securities master data, market data and quantitative analysts, also was required in order to obtain timely data and satisfy the business needs for each desk, he relates.
The first tier of assets to be automated consisted of foreign exchange, credit derivatives, government bonds and to-be-announced mortgage-backed-securities (TBA-MBS), Karpman notes. The second tier consisted of corporate bonds, municipal bonds and other structured products, he adds.
About 25 percent to 30 percent of BNY Asset Management's fixed-income trades in liquid areas, such as U.S. Treasury bonds and
credit default swaps (CDSs), are conducted algorithmically, Karpman says. "We use the TPL as the glue — there is indicative data, market data, price data, all in one central place," he relates. "We were able to easily create plug-ins for the trading systems to send the trades electronically through our custom algorithms."
Karpman admits that the system is probably more cutting-edge than what reigns at most institutions, which tend to be dependent upon vendors for technology solutions. However, he believes most large institutions working in multiple asset classes are close behind BNY on the way to an algorithmic apotheosis. "All the large buy-side firms have some kind of quantitative framework to analyze liquidity and find the best strategy for execution," Karpman asserts. "That is the first step in building an algorithm."
Buy-Side Demand on Rise
The increasing availability of price data and the shift of the entire financial services industry toward sector-based, cross-asset trading means that the production of elaborate strategies to capitalize on miniscule price adjustments across multiple asset types has probably only just begun, industry observers suggest.
"Corporates have been very interesting," notes Brad Bailey, senior analyst at Aite Group. "There has been more transparency in that market, and the credit default swap has risen as a means of giving greater transparency in pricing." Credit derivatives, typically used as a hedge against corporate bonds, have grown at about a 200 percent annual rate for the past few years, according to Bailey.
In the interdealer world, Icap and eSpeed have indicated that more than 20 percent of their order flow is from automated strategies, Bailey adds. Increasingly, this traffic is from hedge funds, such as those operated by Citadel Investment Group, as much as traditional dealers, he says. Algorithms are being used in the market both to arbitrage one platform against the other and to support the decision-making process, Bailey contends. Icap, eSpeed and Citadel officials did not return calls seeking comment.
In the dealer-to-customer area, algorithms are being deployed on the dealer side in order to generate prices, and to modulate those prices based on the class of customer requesting them and the up-to-the-second price data being fed in, says John Bates, founder and VP of Progress Apama Software, which creates risk management, event processing and trading algorithms for financial firms. "The more-recent engines are skewing the price of the bond in real time, based on data changing in real time, and may be changing the spread as corresponds to the tier of customer," Bates comments. "When a request comes in, you spawn a millisecond-length calculation that uses your analytic libraries built up over the years." In other words, dealer firms now can offer not only up-to-the-millisecond pricing based on real-time data feeds and historical information, they also can offer more-loyal customers a better price, or selectively offer improved pricing to less-frequent customers as an incentive to trade more frequently.
Algorithms also come into play when firms take a position in both futures and bonds at the same time, Bates adds. They can be programmed, he explains, to rehedge when set thresholds are crossed.
On the dealer-to-customer sites, such as MarketAxess, which primarily deals in corporate bonds, a few customers have created algorithms that attempt to exploit the latency in the RFQ model, MarketAxess' Dean says. "You can perform intraday arbitrage between RFQ and an order-driven system," he relates. "It can be solved programmatically, but it is not as optimum as in an equities scenario." Traders still must manually press the button to ensure the order has been executed because the information the algorithm was acting on was only an indicative price, Dean explains.
Dean says he believes that nearly all of the 100-plus buy-side firms that write to MarketAxess' application program interface (API) are using some type of automated strategy to inform their trading. But, he predicts, it will be six to 12 months before execution algorithms and cross-platform strategy trading really takes off among the mainstream institutional customers. And it may be even longer before traditional vendors of buy-side order management systems (OMSs) offer algorithmic fixed-income capability, Dean notes.
This frustrates potential customers, such as Travis Bagley, head of fixed-income transitions at Russell Investment Group in Tacoma, Wash. Bagley says his main goal in trading on behalf of his fund customers is cost-minimization rather than rapid profits.
"We are ready and poised to include some kind of algorithmic trading into our process as soon as they become available from vendors," Bagley says. "The algorithms that are out there and working today are created by proprietary users, such as hedge funds and prop trading desks doing arbitrage and alpha-generation strategies. What we'd like to see is one of the trading software vendors create an algorithm for cost minimization as we trade across multiple venues."
It seems that buy side-focused vendors, most of which grew up in the equities marketplace, may still be overwhelmed by the flurry of algorithms that brokers continue to develop for equities.
Sell Side PrioritiesFor the sell side, it makes sense to allocate technology and resources for the business lines that are most likely to pay off in the shortest amount of time. That means that fixed-income algorithm development ranks behind foreign exchange, options and futures at Credit Suisse's Advanced Execution Services (AES), according to Guy Cirillo, AES global sales channel manager. "We would develop fixed income further down the road as that pent-up demand matures," says Cirillo. "Once these markets are ready for algorithms, we will develop them."
There also must be a global market for the technology in order to fully commit to it, Cirillo notes. "With everything we do, we want to see it applied to not only the North American market, but also Europe and Asia," he says. "If there is something that is only in demand in one region of the world, we are more hesitant to develop that."
Another factor preventing widespread deployment of fixed-income algorithms is the variety of FIX flavors in the marketplace, according to Gary Maier, CIO at Five Mile Capital. Version 4.4, which has the greatest support for fixed income, has yet to be adopted by many brokers, and FIX 5.0 already is on the horizon, notes Maier. "They are mainly doing 4.2," he says.
In the structured product arena, FpML [Financial products Markup Language] is probably better than FIX. "Algorithmic trading will become more pervasive, but it is hard to anticipate when that happens," Maier adds.
FOR MORE ON ALGORITHMIC TRADING in the fixed-income space, view Wall Street & Technology's Editorial Perspectives TechWebCast at advancedtrading.com/events/ondemand.full articleelectronic trading, structured products, credit derivatives, fixed income, CDS, IRD, EQD, algorithmic tradingLabels: algorithmic trading, CDS, credit derivatives, electronic trading, EQD, fixed income, IRD, structured products
Dark-liquidity pools cooperating as they gain in popularity
Dark-liquidity pools cooperating as they gain in popularityAs the number of dark-liquidity pools increases, traders have to confront the challenge of fragmentation. Growing from four a year ago to a recent count of 40, dark pools are now trying to entice traders through partnerships, cooperation and linkages.
Dark Pools Link and Partner to Combat Fragmented LiquidityDark pools are partnering and linking as they grow in popularity and in number to benefit the buy side.
May 21, 2007
Joe Gudorf is head trader at Des Moines, Iowa-based Principal Global Investors, a diversified asset management business with more than $200 billion in assets covering a range of equity, fixed-income and real estate investments.
Gudorf actively trades in dark liquidity pools, and to execute his trades and serve his clients better, Gudorf needs to be in as many dark pools as possible. But as dark pools multiply — from only four a year ago to as many as 40 by recent counts — dealing with the fragmentation becomes increasingly challenging for Gudorf and his buy-side peers.
But all dark pools aren't the same and can't be lumped together under a single classification. In fact, there are four types of nondisplayed liquidity pools — the independent or agency-owned platforms, which include the likes of Instinet, Liquidnet and ITG's Posit; the broker-dealer internalization engines, such as Goldman Sachs' Sigma X, Credit Suisse's CrossFinder and UBS' PIN; the consortium-owned pools in which many broker-dealers are investing, such as BIDs and LeveL; and the exchange crossing networks that are anonymous and complete matches at set times during the day.
Gudorf employs a focused strategy for accessing these fragmented dark pools. He says he connects to a handful of the major dark pool platforms that are independent and broker-neutral, and then depends on these to connect to other dark pools, such as broker-dealer internalization engines and other crossing networks, to provide an extended reach and ensure he's in as many liquidity pools as possible.
But as the dark pools continue to proliferate, the reality has set in that it's impossible for a buy-side trader to connect to each as a one-off trading destination. And of course, there are different types of dark pools for different types of orders and different trading strategies. As a result, through partnerships, linkages or cooperation, operators of these dark pools are trying to find ways to offer more liquidity to keep traders coming back.
Dark Is Here to Stay
While traders grapple with the best strategies for trading in dark pools' nondisplayed waters, the amount of dark pool action will only continue to rise. TABB Group predicts that the combined daily volume of dark crossing networks and internal markets will increase from 512 million shares a day this year to nearly 1.5 billion per day by 2010. That would account for about 15 percent of total market share among the major exchanges, the regionals and ECNs.
"One hundred percent of the buy side is crossing some portion of their orders," contends Jeromee Johnson, senior analyst at TABB Group. "As the percentage of orders crossed continues to go up, by the nature of better tools to tap into different crossing networks the liquidity is improved and the hit rates are improved."
According to TABB Group, consolidation, aggregation and interconnectivity will be par for the course. But, the consultancy notes, the dark pools that will thrive will focus more on innovative types of liquidity and ways to differentiate themselves.
Principal's Gudorf found out the hard way that paying attention to which dark pools he's connected to and which are the most successful for his trading strategy was an ongoing process to be continually assessed and reassessed. "If you think the dark pools you're currently in are working well, I would recommend trying others," says Gudorf. "We were pleasantly surprised when we added another one or two and found we had been missing significant volume. The landscape is dramatically changing on a daily basis."
Let the Linking BeginDark pool aggregation is occurring on a higher level and is likely to continue until the dark pools shake out their competitive advantages. One major move came in March when Lehman Brothers and Fidelity Brokerage Services announced a direct link via FIX connection between their dark pools. This allows traders on both sides to access Lehman's Liquidity Center Cross and Fidelity's CrossStream to improve their hit rates.
And Lehman isn't stopping there. "We will be looking to link up with others as well and already have tentative agreements with some and are in talks with others," says Michael Bleich, the firm's head of liquidity strategy. "We're competitors but there's value we can deliver to customers by working together."
Lehman also is a Streaming Liquidity Partner on Liquidnet H20. The block-trading system opens up trading for buy-side members against smaller size order flow from the partners at the midpoint of the NBBO.
Additionally, Lehman is a member of LeveL, the consortium of dark ATSs that allows users to cross orders internally using LeveL as the internalization engine or interact with liquidity provided by other LeveL members. The LeveL joint venture also includes Citigroup, Credit Suisse, Fidelity and Merrill Lynch.
"It's a big plus that we're seeing these linkages now," says Principal's Gudorf. "The fragmentation of the marketplace is very real, and without gaining some efficiencies through these linkages, the market would be a tough place to operate, especially for institutional accounts."
Joan Stack, trading manager at the Ohio Public Employees Retirement System (OPERS), agrees that the fragmentation of dark liquidity has become a burden. "It's reached a point where fragmentation is more of a detriment than a benefit," she says. "Linkages will consolidate some of the liquidity, and I think it's a good thing."
Who's Linking to Whom?"Most of our major competitors have begun running crossing networks within their firms," notes Lehman's Bleich. "So how do you unlock value by linking these different pools together?" he asks, adding that the marketplace is in a phase of experimentation with linking these dark pools.
Michael Plunkett, president of Instinet North America, says his company's CBX dark pool is "aggressively" linking to other dark pools, including Credit Suisse, Fidelity, Liquidnet H2O and ISE's MidPoint Match. Instinet made the decision a year ago to link to and form partnerships with other dark pools and "never looked back," he says.
However, Plunkett adds, while the physical FIX connection is relatively simple to establish, it's the philosophy and strategy of partnership and linkage deals that delay the process. For example, pricing — how much is paid to each partner when a transaction is passed though a linkage — is up in the air. "People will charge whatever price they want to, and we agree to that with each of our partners individually," says Plunkett. "Our opinion is that we should treat each other as partners and charge a fair rate that encourages trading with each other's platforms on behalf of our clients."
ITG was selective about with whom it partnered for its Blockalert product, according to Chris Heckman, the firm's managing director of U.S. sales and trading. "Our strategy was to initially focus on one partner, and a large partner like Merrill Lynch made the most sense for us," he says. "Over time we will evaluate adding other partners. But historically, when these consortium-type arrangements get too large it becomes impossible to move forward."
NYFIX Millennium saw the writing on the wall and also moved toward relationships with clients and passive liquidity providers. CEO Brian Carr says a formal aggregation effort around nondisplayed liquidity is in the works. "Liquidity begets liquidity, and the more we can match, the more compelling it is to put an order in," he says.
Differentiating PoolsThe ultimate success or failure of the multitude of dark liquidity pools will depend on "unique liquidity offerings," according to Tim Reilly, managing director and head of North America electronic execution sales at Citigroup, which operates the dark book Liquifi. He says that major broker-dealers with their own internal crossing networks that are profitable and complement their existing business will continue to operate separately. Reilly points to UBS' PIN crossing network, which offers unique liquidity in the Schwab retail order flow.
But Reilly also says that Citigroup won't turn away affiliations with other liquidity pools for Liquifi. "They're in vogue now," he notes. "On the other hand, if you're Citigroup and you have Smith Barney retail flow and a healthy institutional business and principal liquidity that you can market in an appealing way, then why would we open up to another big guy and say, 'Come play in our thing'?"
The unique liquidity that Reilly points to as a driving force for successful dark liquidity pools includes consolidated retail order flow, derivatives flow, or delta hedge flow and transition services, he explains.
Trading costs also can make a platform stand out, says TABB Group's Johnson. "It's one of the biggest considerations when searching for liquidity and the judgment by a trader or algorithm where the total best execution is." But cost isn't the only factor in best execution. Are you getting the best execution if an order is being routed to multiple dark pools and taking longer to hit each than if it were to be routed to more-aggregated pools directly?
Principal's Gudorf explains that coming into a dark pool via a secondary linkage may have its disadvantage. "You're not getting the first look at liquidity, so there is a trade off," he says. "If I was going through the main pipe to hit Fidelity's CrossStream, then I'm getting in the fastest and time priority. If I come in through other means, though, ... I am kind of disadvantaged in some ways and can miss liquidity. But at the same time, if I had to physically cut my order into 10 pieces and route into 10 different places, I would be even more disadvantaged."
Gudorf adds that pricing among dark pools and whether orders are routed out to other pools doesn't matter much to him. "That's between the brokers themselves, really. Our commission is with the sponsor broker and the platform we use," explains Gudorf.
OPERS' Stack also cautions that algorithms hitting linked dark pools should be closely monitored. She wants to know if her algorithms are hitting internal pools first and how long they stay in certain pools and at what parameters. "I don't want the opportunity cost of missing liquidity somewhere because an order is lingering too long in a broker's internal pool," Stack says.
full articledark liquidity pools, private trading, investment banking, asset managemetLabels: asset managemet, dark liquidity pools, investment banking, private trading
Checking Out China Funds
Checking Out China Funds
Managers still see solid opportunities away from Shanghai's frenzy. Here are five savvy plays
by
David BogoslawAlan Greenspan may have warned of a possible "dramatic contraction" in Chinese equities in a May 23 speech, but investors appear so far to be unfazed. Despite the bubble talk, many fund pros are still focused on opportunities in the Middle Kingdom.
When investors think of opportunities to make money in China, companies riding the wave of huge exports are typically the first to spring to mind. But fund managers have begun to pay attention to stocks whose fortunes are tied more to growth in the domestic market, as the sizzling Chinese economy creates a widening population of eager consumers.
With China's economy growing at around 11% a year, investors are looking for ways to grab a piece of the action. Although the current Year of the Pig may excite investors with visions of becoming fat, happy, and prosperous, a note of caution is in order: Investors should be wary of gorging themselves amid what appears to be a stock-market bubble to many economists (see BusinessWeek.com, 5/18/07,
"China Tries to Turn Down the Heat").
Consider the relatively new Shanghai Stock Exchange, whose composite index has jumped 50% since the beginning of the year. Some fund managers are steering clear of the index, warning that its sharp and sudden gains reflect a torrential inflow of domestic money with nowhere else to go at the moment. That's bound to change as the government's Qualified Domestic Institutional Investor (QDII) plan, which would allow a greater portion of domestic funds to be invested in other markets, gains traction, albeit ever so slowly. The government quota on how much money can be invested outside the country is a paltry $15 billion to $17 billion, chump change compared with China's $2.6 trillion economy.
With an eye toward prudence, some portfolio managers who wish to play China are sticking to stocks that list in Hong Kong, where transparency and corporate governance are far better than on the mainland. While economic growth is expected to moderate in 2007 due to slowing U.S. export demand, the continued rise in property prices is likely to support local investor sentiment in the months ahead, according to a May research note from Aberdeen Asset Management.
Obviously, investing in China carries notable risks. Investors who want some exposure to one of the world's most dynamic economies may want to do some homework first. With that in mind, this week's Five for the Money looks at a few funds with sizable exposure to China that remain open to new investors.
1. Guinness Atkinson China & Hong Kong Fund (
ICHKX)
This $172 million fund has been making money by focusing on companies staking a claim in the infrastructure boom. That includes energy companies with ADRs trading on U.S. exchanges such as CNOOC (
CEO), PetroChina (
PTR), and Yangzhou Coal, and industrials such as Angang Steel and Dongfang Electrical Machinery.
Dongfang is one of the two largest domestic manufacturers of electrical turbines, which are in great demand in "a country installing the equivalent of the U.K. national grid every year," says Edmund Harriss, who has co-managed the fund since 1998.
He prefers Dongfang to its competitor Harbin Power, which he faults for over-diversifying, and points to Dongfang's slimmer balance sheet; cleaner, more straightforward business focus; and superior returns on investment.
In the auto industry, Harriss has been a buyer of Denway Motors, which, through a joint venture with Honda Motor (
HMC), makes the Honda Accord and Odyssey for the Chinese market. There has been a general upgrade in the car models available to Chinese consumers; they're now as good as anything being sold in the U.S. or Europe, he says.
Harriss advises investors interested in China to avoid getting caught up in the vaunted huge growth story and instead to drill down into particular market niches, with the aim of finding those companies that have genuinely been generating high growth, beating their competitors, and capturing higher margins. The fund has a 70% weight in Hong Kong-listed stocks, with the other 30% invested in Hong Kong-based companies doing business in other parts of Asia.
2. Oberweis China Opportunities Fund (
OBCHX)
Managed by James Oberweis since its launch in October, 2005, the China Opportunities Fund is taking cues from the explosion in consumer buying power on the mainland. Looking beyond the 20 largest companies favored by most institutional investors, Oberweis is buying up shares of second-tier companies that have strong retail potential.
"This is a country where the biggest consuming class in the world is likely to develop over the next 20 years, and it's already happening," he says. That creates an opportunity for retailers to develop brands—and they stand to profit nicely by doing it sooner rather than later.
Li Ning (
LNNGF), which makes athletic shoes, is an obvious choice, since domestic sports-apparel manufacturers are well-positioned to go up against international rivals like Nike (
NKE) in catering to domestic Chinese demand with their lower prices. But an equally savvy way to play the surge in consuming power is the advertising market, Oberweis says.
He points to the focused approach Focus Media (
FMCN) is taking, targeting affluent consumers by placing flat-panel display screens in the lobbies of large office buildings in China's biggest cities. With a 95% market share in this area, Focus Media nearly tripled its sales in 2006 from the prior year, with sales expected to nearly double this year. Focus Media is a Chinese-owned company based in Shanghai, but its shares trade only as ADRs on the NASDAQ exchange.
Oberweis is also leery of shares trading on the Shanghai Stock Exchange and says the bulk of his portfolio is in H shares of Chinese companies, or those listed on the Hong Kong Stock Exchange, which can be bought for half the cost of Shanghai-listed A shares. Once the government's QDII scheme takes hold and is expanded beyond the initial quota of $17 billion, he expects prices of H shares to rise and prices of A shares to drop, as investors take advantage of arbitrage opportunities between the two markets.
"We're not buying for the arbitrage opportunities. We're buying because we think they're good companies. And [buying H shares] is the cheapest way for us to invest in those companies," he says. Oberweis has $825 million in assets under management.
3. U.S. Global Investors China Region Opportunities Fund (
USCOX)
For 2007, this $90 million fund is pushing the theme of "asset-injection" plays as an easy concept for investors to wrap their minds around. Romeo Dator, who has co-managed the fund for the past five years, is betting on Hong Kong-listed names that are buying assets at hefty discounts to market prices from their government-controlled parent companies on the mainland. "It's a way for the parent company to realize the benefits of getting these assets off their books, and the government getting out of the business of owning some of these companies," Dator says.
The bonus is that this is happening mainly to resource companies at a time when the massive infrastructure buildup in China has stoked demand for these products. The stock price of China's premier copper producer, Jiangxi Copper, is up at least 50% since it bought cheap copper mines from its parent earlier this year. And coal producers China Coal Energy and China Shenhua Energy should see comparable gains after their asset injections, Dator predicts.
The China Region Opportunities Fund also favors health-care suppliers such as Shandong Weigao, a manufacturer of female sanitary napkins and other health-care-related products. Dator says he believes these stocks will benefit from the emphasis the Chinese government has placed on health-care spending in its latest five-year economic plan.
The fund's turnover rate was 200% in 2006, the result of the managers' decision to prune their holdings and take profits following dramatic runups in stock prices across the board.
4. Eaton Vance Greater China Growth A Fund (
EVCGX)
Portfolio manager Pamela Chan is also a great believer in the profit potential of branding. She likes high-end department stores such as Ports Design, Peace Mark, and Parksons that have come to dominate the market thanks to strong brand recognition.
With the infrastructure development in China showing no sign of abating, she's also a fan of building-materials manufacturers such as Anhui Conch and China National Building Materials. These companies are benefiting from ongoing consolidation within the cement industry, which has been aided by government policy stressing sustainable growth. That has driven out highly polluting kilns, which had been a source of excess supply and low pricing in recent years.
Chan thinks the property sector is another attractive bet amid rising income levels and the ability of developers to increase their land-banks, she wrote in an e-mail message.
5. Dreyfus Premier Greater China A Fund (
DPCAX)
Don Martin, president of Mayflower Capital, a California-based financial adviser, recommends this fund, which invests in midcap growth stocks. With 20% of its portfolio allocated to consumer-discretionary names, 17% to industrials, and 15% to financial companies, he sees Dreyfus' China fund as a safer bet than some other options that are too heavily weighted in financials and more vulnerable should the volatile China market crash.
To avoid the potential for capital-gains taxes of around 30%, which would be triggered if portfolio managers started selling off shares of stocks, Martin advises new investors who haven't benefited from the stock gains to buy through a fee-only planner that can get the load fee waived on these funds.
full articlechina, foreign investment, mutual fundsLabels: china, foreign investment, mutual funds
