?? The Hedge Funds Did It! ?? Also: Hermès, Soft Landing, Man Utd; Big banks making big money off your small money ?? What actually are Hedge Funds?

• US large-cap S&P 500 closed 0.21% DOWN ???
• Tech-heavy Nasdaq Composite closed 0.35% DOWN ???
• Pan European STOXX Europe 600 closed 0.58% UP ▲?
• HK's Hang Seng Index closed 0.46% UP ▲?
• Japan's TOPIX closed 0.54% UP ▲?

?? Focus

• The Hedge Funds Did It! (Probably!)

?? In the Markets

• Hermès, Soft Landing, Man Utd
• Big banks making big money off your small money

?? MoneyFitt EXPLAINS

• ?? What actually are Hedge Funds?

?? Focus

The Hedge Funds Did It! (Probably!)

Gary Gensler, chair of the Securities and Exchange Commission, told the FT that the SEC would be investigating the role that hedge funds?? played in March's banking crisis. Not, as an informed, casual observer might guess, because they made money "short selling" shares of banks that were potentially in trouble (which they absolutely did), but because of the wild swings in the US government bond markets. Known as "US Treasuries", they are incredibly important across finance globally because they are deemed ultra safe and as such are used to price other assets and to calculate the cost of capital for businesses and projects.

“A really important focus" - SEC chairman Gary Gensler on oversight of hedge funds by the SEC, including access to more real-time data in times of market stress

..... ? As the SVB (+Signature+CS) hit the fan in March and uncertainty over contagion soared, investors inevitably piled into safe-haven assets, US Treasuries included. When bond prices go up, their yields, the interest rate paid at the price, go down. The drop in Treasury yields may not have been a record move, but it was right up there. The 2-year Treasury yield saw the biggest 3-day decline since the 1987 stock market crash (bigger than Covid in 2020 or anything in the 2008 GFC.) 10-year yields had their biggest monthly drop since August 2011 when the US credit rating was downgraded by S&P.?

..... ? Interestingly, it's not hedge fund profiteering from the misery of others that has Gensler lurking. In fact, many macro hedge funds (ones that trade based on big global economic or political trends, and which won big in 2022 betting bond prices would fall, sucking in even more investor money) lost billions of dollars in that bond rally as hedge funds rushed en masse to close out short positions. Those short positions were being "squeezed" and losing them money, thereby making a somewhat natural trade into an unnaturally wild rally. The concern is over the risk that increasingly enormous hedge funds and other highly leveraged "shadow banks" pose to financial stability. Shadow banks operate with little to no oversight from regulators yet provide credit and liquidity into the financial system.

"The most important market in the world is being dominated by a bunch of hedge funds,” - Christian Kopf, head of fixed income at Union Investment, quoted by the FT in March

Hedge funds will be getting much closer scrutiny from the SEC

- Image credit: The Simpsons / Fox via Tenor

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..... ? But hedge funds aren't any one thing, and though they can sometimes (often) move as a herd just like other investors, they do come in all stripes. Some of those stripes made a lot of money in March, while others lost, like the macros above.?

..... The macros had been sitting in an exceptionally "crowded trade" (February had the largest short bet on record according to the CFTC), expecting, like everyone else in the investing world, interest rates to go up and hence bonds to go down.?

..... But S&P reports that during the turmoil, other hedge funds were piling into banks like First Republic which were being sold by investors (not only by other hedge funds shorting) thinking they would be the next to go under as deposits fled.?

..... Other hedge funds did make a lot of money shorting banks in March, according to ORTEX, like SVB (profits of $1.3bn), First Republic ($848mn) and Credit Suisse ($684mn) - across the US and European banking sector as a whole, profits from short selling came to $7.2bn.?

..... And meanwhile, other hedge funds had been betting on banks as beneficiaries of higher interest rates (see mini-explainer in the ITM below) and they were, naturally, creamed, with exposure to the sector at a 12-month high going into the month.?

..... Then you have trend-following, computerised algorithm hedge funds, which had their heads handed to them in March, particularly the so-called CTA funds (commodity trading advisors, which are regulated by the Commodity and Futures Commission because they operate with futures and other derivatives, rather than securities) and which manage about $200bn in assets. Like the macro funds, they were positioned in March with what had worked well for them in 2022.

..... ? In other Gary Gensler news, the SEC sees decentralized crypto platforms as exchanges as DeFi-platforms allow users to lend, borrow and save in digital assets, bypassing traditional banks and exchanges. "Make no mistake: many crypto trading platforms already come under the current definition of an exchange... regardless of whether they call themselves decentralized", Gensler said.

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?? In the Markets

European markets remained strong on Friday as optimism about the return of the Chinese luxury consumer continued to boost France's luxury goods sector, driving France's CAC-40 to another new high. 23% of the CAC-40 is from the consumer cyclical sector, which includes luxe giants such as LVMH (the largest in the index at 12.51%), Hermès (3.4%) and Gucci-owner Kering (2.6%.)?

Luxury is a Constance

- Image credit: Iamevelynlim via Instagram

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..... ? Hermès International is now the world’s second most valuable in the luxury space after LVMH, with a market value of EUR207bn or USD230bn, having rallied 60% in the last year. It is now the eighth most valuable company in the pan-European Stoxx 600 index. In perspective, though, that puts the whole company's value at $10bn UNDER that of LVMH boss, Bernard Arnault, now the richest man in the world by some stretch (see Hermès MFM and Arnault MFM from Dec-22.)

Banks across Europe were also buoyed by strong big bank results in the US (see below), released during the trading day. Those results drove US markets higher too, but March retail sales, which fell more than expected, took the shine off stocks by the close as traders, temporarily ignoring inflation, glanced warily at both a strong start to the results season and mounting fears of a recession.

Results season, good. Recession, bad.

- Image credit: The Simpsons / Fox via Tenor

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US Treasury Secretary Janet Yellen told CNN that banks will likely become more cautious and tighten their lending following the recent bank failures. This may mean that the Federal Reserve, where she was the chair before current boss Jay Powell, may NOT need to hike interest rates any further. And a soft landing, one where inflation comes down without soaring unemployment, is still possible!

..... ? BUT meanwhile, Christopher Waller, a Fed governor (meaning he's in the rate-setting committee without heading any of the regional Fed banks), said that the turmoil that led to March's bank failures has NOT had a significant negative impact on lending, hence he supported another rate rise in May. Same message from Atlanta Fed President Raphael Bostic, saying data coming in was "consistent with us moving one more time." Chicago Fed President Austan Goolsbee seemed less sure, since "we've raised a lot, it takes time for that to work its way through the system."?

Meanwhile, the selling Glazer family is pushing the two final bidders for Manchester United to "prove" they have the money to complete the deal, while simultaneously pushing for higher offers in the next and final round of the sale. (See November and March MFMs for more on the saga.) British petrochem billionaire and local Man Utd supporter man and boy, Sir Jim Ratcliffe, is up against Sheikh Jassim bin Hamad al-Thani, son of one of the richest men in the world and a former Qatar prime minister, but with private equity firms Elliott and Carlyle lurking in the background.?

..... ? Worth noting that stock markets don't quite seem convinced that the bids, said to be $5-6bn, will be upped by much, if at all, with the stock 19% off its Feb-23 highs, after a Friday drop of 4.8% in NYSE trading, valuing the equity at just US$3.8bn. (Any bid would have to take into account net debt, which in its 2022 results was ￡515mn or $640mn.)

Rio wants a higher bid

- Image credit: Tenor

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Big banks making big money off your small money

Three of the biggest US banks posted very strong and higher-than-expected first-quarter results on Friday, reminding everyone that banks make a LOT of money when interest rates rise... particularly big ones with a "deposit franchise."?

..... ? The biggest, JPMorgan Chase, saw profits up 52% to $4.10 per share, well above the $3.36 that Wall Street's Finest were forecasting, and lifted its full-year outlook. Following Silicon Valley Bank’s collapse it also added $37bn in deposits. The stock rose 7.5% to add $28bn to its market capitalisation (share price X number of shares.)

..... ? That single-day increase was over a quarter of the total market value of Citigroup, which also beat expectations, with profits up 7%. Citi saw strong consumer spending and corporate activity, but also higher credit costs (i.e. loans going or already gone bad.) Citi's deposits were flat.

..... ? Wells Fargo also reported higher-than-expected earnings, with a 35% increase, but somehow managed to lose deposits as much smaller banks have done, which was a bit strange (or maybe not) Meanwhile, it warned of potential losses in commercial real estate lending, where it spotted problems in its loans to developers and office building owners. If even Wells Fargo can see it, we may hear more bad news from this space quite soon.

"Is commercial Real Estate going 'through the windshield'?"

The Interest Rate Trade-off for Banks (a mini-explainer)

There is a trade-off for commercial banks when interest rates go up.?

The effect can be bad for them because

? New loans can fall (higher interest rates mean a higher cost for borrowers)

? An economic slowdown can lead to losses from some existing borrowers, with more unable to make either interest payments or repay the principal borrowed. Banks will also usually deduct "provisions" against future loan losses from their revenues.?

? Fees, including those on investment banking deals (if any), also tend to be lower in a slowing economy.

The positive side, however, is on pricing:

? Spreads, the interest rate it lends at (in loans to customers) vs the amount it borrows at (from its depositors), tend to be wider. This increases net interest margins and, therefore, net interest revenue, the difference in dollar terms between how much a bank earns on its loan book and what it pays out for deposits.

? When rates go down, banks benefit because more deposits are short-term and go down quickly, compared to loans which take longer to change their rates. But when rates go up, banks can often take their own sweet time to raise deposit rates, so they don't lag the higher loan rates by much, if at all. (Especially large banks with deposit franchises).

MoneyFitt EXPLAINS?

?? Hedge Funds

• A hedge fund is a type of investment fund that pools capital from multiple investors, much like mutual funds do, but because they use various complex strategies to generate returns are typically only available to accredited investors (i.e. rich folks) and not regulated like traditional investment vehicles.
• The term "hedge fund" refers to managers "hedging" or protecting the portfolio in case they are wrong, but actually it's just an umbrella term and there are many different strategies and styles (often not involving "hedging" at all.)
• Many of them lock up investor money for relatively long periods of time and charge high fees, such as "2-and-20", meaning an annual management fee of 2% of assets plus a 20% share of all gains made in the portfolio. This rewards, on purpose, either long-term thinking or a high-risk / high-return investing mindset.
• Hedge funds are usually run by highly experienced investors who use sophisticated investment strategies, such as short selling and derivatives, to generate returns. One element of that is the use of leverage, borrowing money to increase the size of their investments, which can amplify returns but also increases risk if the trades go wrong. (Using derivatives like options creates leverage, too, without explicit "borrowing.")
• One of the benefits of hedge funds is that they have the potential to generate high returns, which can be especially attractive to investors looking for ways to either turbocharge, hedge or diversify their portfolios (or all of the above.) On the downside, hedge funds can be highly risky, partly due to the leverage taken.