Hedge Fund Assets Increase in October

Hedge-fund assets increased by $7.8 billion in October, according to Bloomberg News. This marks a sixth straight month of increases. With inflows of $10.2 billion in inflows and now around $1.45 trillion under management the hedge fund industry seems to be recovering from its disastrous 2008 year which saw around 150 funds closing shop. The industry has seen 140 new funds open up this year.

Europe and Asia (with the exception of Japan) posted the increases as foreign investors have been piling back into the hedge-funds. Europe in particular has seen close to $4 billion of increases for the past three months with around $340 billion now under management.

What might these trends indicate for the future of the industry?

For now the answer seems to be clear, investors will continue to pay for performance. With hedge funds significantly outpacing the broader markets this year it makes sense many investors are shifting their assets out of equities and into hedge funds. While the 140 new funds this year is partially due to replacing the funds that went belly-up a year ago the environment still seems considerably strong for new fund openings as the cash continues to flow in. The relatively large increases in European fund assets could also indicate a recovering European economy as well as a greater interest in hedge funds in Europe. Overall, the past six months have shown that the industry is alive and well and that as long as funds continue to outpace the markets, they can expect more inflows to come their way.

Group 6: Warren Doubles Down

Mr.Buffet's Move-
In the third quarter, which ended September 30th, Warren Buffett nearly doubled his holdings on Wal-Mart Stores Inc. At the end of June, he held 19.9 million shares, but that number rose to 37.8 million shares by the end of the third quarter. Buffett has raised his annual earnings growth projections from 9% to 15%; which would make his purchase price cheap. Although this will be difficult, his reasons include smaller stores with lower prices, and from the anticipated growth in international markets such as China and Brazil.

In addition, Wal-Mart expects to get higher returns on Supercenters in 2010 and going forward, and in turn opened 15 new Sam’s club locations in the last fiscal year. Shares are trading approximately 23% below their all-time high in 2000, however not cheap by many standards. This brings into question Buffet’s reasons, as he is typically seen as a value investor. Given his extremely high earnings projections, it appears he must have a different idea than most of the street. WMT’s CEO, Michael Duke, said “The economy remains challenging for customers and Wal-Mart sales, but we are encouraged by increased traffic and our market share gains".

What to expect this holiday season-
This space is filled with other wholesalers like BJ's( which has a large presence of the northeast) which saw a weaker 3Q with their consumers' focus on basics. The trend of late has been saving money on staple items. The recession has worked in BJ's favor with membership growing and shoppers continuing to flock to its stores. BJ's management said they are starting to see shoppers slowly begin to buy more general merchandise, but said sales of items like electronics, tires and video games remain weak. However, the company said the coming quarter — its holiday period — will have shoppers buying more food than other items, and falling food prices will continue to be a challenge in the fourth quarter. Standard & Poor's Equity Research downgraded its opinion on shares of BJ's to "Hold" from "Buy," saying it sees pricing competition for food retailers to remain intense as food deflation weighs on them. According to these trends Wal-mart it would seem is in a very good position to benefit consumers trading down, due to the fact they offer much of the cost savingings that BJ's and Costco do, yet require no membership.

Anaylsts at Goldman have raised its price target for Costco to $61 from $57, citing “improving trends in higher end discretionary items.” Goldman also raised its full-year 2010 sales and profit estimates through 2012 for the membership warehouse operator. The analyst currently rates COST as “Neutral.”

This Holiday season will be very important for these companies and their 4Q, hoping to see the gap narrow between staple good spending over discretionary. With US Unemployment crossing double digits, this next month will certianly be interesting.

Goldman

Goldman Sachs seems to be in another jam, at least in the eyes of the public. They have decided to establish a program to inject $500 million in the small business sector. This was said to be an attempt at providing capital to the small businesses that play a "vital role" in creating wealth, fostering innovation, and adding jobs. $300 million of the injection has been earmarked for community development financial institutions which then go ahead and finance small companies. The other $200 million has been tagged for education.

The public obviously has not necessarily reacted as GS hoped. This was an attempt to soften Goldman's image, they even brought in Buffett to serve on the advisory board. However, it is being looked upon as an abuse of shareholder's money and it seems as though Goldman's plan to improve its image has backfired a bit.

Article

-Group 3

The Waning Dollar

The value of the dollar continues to be a concern. However, on Monday, Bernanke reassured the Economic Club of New York that the decline in the value of the dollar is natural; thus, no further fed action is necessary. He pointed to high long-term unemployment as a major factor that will keep GDP growth and inflation low for at least a year. Other countries certainly seem to be acting on Bernake's statements, even though they continue to publicly denounce the use of the dollar as the global reserve currency. For example, possession of treasuries increased $7 billion by BRIC countries and $20.4 billion by Japan during the month of September.

The Federal reserve is actually beginning to reduce its emergency lending facilities implemented in late 2007 through early 2009. The maturity of discount window loans to banks will soon be cut from an extended period of 90 days to 28 days, because liquidity has returned to acceptable levels. The Libor-OIS spread, gauge of the bank's willingness to loan, is at 13 basis points, down from a record of 364 bps in October 2008.

While inflation seems to be at bay and liquidity has increased, many investors are still concerned with weak economic data, such as the University of Michigan Consumer Sentiment Survey of 66.0 for the current period compared with a value of 70.6 for the previous period and an unexpected fall in housing starts earlier today. Moreover, many investors have turned to gold, which reached near-record levels of $1150 per ounce earlier today, rather than the securities market, indicating a lack of confidence in the U.S. economy.

Group 5

Links:
http://online.wsj.com/article/SB10001424052748704782304574542040005455698.html
http://online.wsj.com/article/SB10001424052748704431804574541161588915066.html
http://online.wsj.com/article/SB10001424052748704431804574539160726487446.html
http://www.bloomberg.com/apps/news?pid=20601087&sid=akC02cF4YHC4&pos=2
http://www.nytimes.com/2009/11/17/business/economy/17fed.html?_r=1&ref=business

Flashback to the '80s: Insider Trading

So the topic of choice for this week is the current buzz about the recent M&A deal between Hewlett Packard and 3Comm - two very large IT infrastructure corporations. After announcing a $2.7 billion deal for Hewlett's acquisition of 3Com, there has been a suspect and unexpected jump in behind-the-scenes options trading regarding the two firms, as the options contracts on 3Com jumped just hours before the deal was made public.

As such, there is a large SEC (Securities and Exchange Commission) investigation into the matter, and rightfully so. Many corporate officers', boardmembers', and priveleged stockholders' portfolios flourished throughout the 1980's and 1990's amid the slurry of insider trading scandals, which drew a large amount of attention to Wall Street and from then on has given it a tainted reputation. To the majority of the American people, as well as foreign investors, insider trading is just another reason not to trust in the ability of large corporations to "protect" their interests and have become the subject of many otherwise accepting, naysayers.

Recently, however, after several years of relative tranquility, the need for easy cash has arisen once again, and Wall Street (along with many other international trading institutions), has been plagued by scandal. A little over a month ago, the Galleon Group hedge fund scandal arose, shedding light on Mr. Rajaratnam's insider trading scheme that has trumped all prior incidents. From the S.E.C's point of view, this is a call to arm the troops and to get ready to buckle down for a long, drawn out war against corporate greed, especially as the down economy threatens investors' senses of security and their ability to milk legitimate profits from otherwise legal and moral sources.

As the share price of 3Com's stock rose over 5% on the day the deal was announced and the November call options skyrocketed to over SEVENTEEN TIMES the 4-week average, one must look at this situation with some dismay: Are we really reverting back to this? Is America going to repeat the atrocities that the government has sought to rectify for years? Can the world continue with this barrage of immoral action? The answer is that no one knows. One can only trust in the governing bodies which have sworn to uphold legal trade and believe in their ability to keep America's head above the waters of recession, unemployment, and corruption as they continue to rise.

http://dealbook.blogs.nytimes.com/2009/11/18/3coms-dealmaker-of-the-week/
http://dealbook.blogs.nytimes.com/2009/11/16/sec-is-said-to-examine-3com-options-trading/

Gabriel Suprise
Group 2

Is The VIX Providing Us An Accurate Forecast of Market Volatility?

The CBOE Volatility index, known by its ticker symbol, VIX, is a popular metric used to estimate the level of implied volatility for S&P 500 index options. The value derived in this asset exists through an estimation of this implied volatility over the next 30 days. When the value of the VIX is raised, this translates to a more volatile underlying market (S&P 500), and vice versa. In October and November of last year, the VIX peaked above 80, which the VIX is currently trading at 22.41. This value is nearly equivalent to pre-2008 market crash levels.
Relating to this, there is a well written article in Barron’s that claims that current implied volatility levels do not accurately reflect the fundamentals of current market conditions. (http://online.barrons.com/article/SB125846366940352017.html) I would have to agree with the author for the following reasons. Times have been cheery for investors over the last six months, and the S&P 500 alone has gained a solid 25.76% over this time period. Although economic indicators such as unemployment, consumer confidence, housing data, and GDP growth remain less than encouraging, the equity markets have in many ways over-extended itself in terms of anticipating recovery. However, the VIX itself hardly provides any pessimism through its underlying value.

One last interesting area of activity regarding the VIX can be seen through VIX options. Calls have become increasingly more expensive as of late, and trade volume of this derivative has been steadily increasing. This portrays that many traders are anticipating that volatile times lie ahead.

High-yield sowing the seeds of underperformance?

For the year to October 31st, the Merrill Lynch High Yield Master II index had returned a total of 51.2%. By comparison, the Russell 2000 index (a small-cap index) had returned a mere 14.1%.

Leverage World , a reputable publication on high-yield, compiles a crude benchmark of relative performance between junk bonds and small-cap equities. This index simply divides the performance of the Russell by that of the ML index starting in the year 2000. Since then, the two indices have tracked fairly closely. For the aforementioned period in 2009, the index shows a stark underperformance of the Russell 2000 by a 2.2x standard deviation. Historically, as noted by Leverage World, such a deviation of performance has not persisted for long.

According to the ICI, for first three quarters of 2009, U.S. long-term bond mutual funds have experienced net inflows of some $267 billion in comparison to U.S. long-term equity mutual fund net inflows of just $4.3 billion. Meanwhile, globally, investors have bought into a record $2.7 trillion of corporate bonds (WSJ). (Interestingly, of the new domestic issuance in the U.S., 75% has been used to refinance old debt.)

Where does this leave us? It seems that the relative outperformance of high-yield debt combined with a glut of debt issuance bodes poorly for these securities. In terms of relative performance for the foreseeable future, it seems equities are the way to go.

Group 12

Wal-Mart Exceeds Estimates, Sees Sluggish Holiday Season

On November 12, Wal-Mart reported earnings for the third quarter ending October 31 of $3.24 billion or 84 cents a share, up 3.2% from last quarter’s results. Analysts expect earnings of approximately $1.12 per share for Wal-Mart’s fiscal year fourth quarter, while the world’s largest retailers expect $1.08 per share.

Eduardo Castro-Wright, Wal-Mart’s U.S. chief offered tempered guidance in last Thursday’s conference call, warning about customers being cautious in their holiday spending. Other prominent retailers, such as Macy’s and Kohl’s provided similar guidance, expecting sales to be slightly below analyst estimates.

While we’ve seen the equity markets skyrocket over the last six months, it doesn’t seem as if their gains are instilling any life into consumer confidence. Investors are most likely asking whether or not aggressive pricing strategies can do anything to bolster the bottom lines of these big-box stores, and if any higher-end retailers can compete.

With unemployment hovering above 10%, and real unemployment right around 18%, this holiday season should certainly be sluggish, which makes Wal-Mart, TJX Companies, and Family Dollar very enticing to investors.

http://online.wsj.com/article/BT-CO-20091112-713379.html

~Group 8

Mutual Funds Time Market

To address the concerns of investors that mutual funds are not adaptable enough to hold their own in a down market, a number of funds have taken a more dynamic approach to portfolio allocation and have begun to time the market by shifting in between cash and regular investments on a frequent basis. The managers of these funds claim to outsmart the volatility of the market.

This strategy has worked for some funds, such as Ivy Asset Strategy, which has made 14.9% annually for the five years ended this November (about 14% above the S&P 500). For other funds, attempts to time the market have led to increased volatility. For example, the Encompass Fund used the strategy of jumping in between allocation to cash and allocation to investments. It fell 62% last year and gained 110% this year.

Additional problems with the timing the market as a mutual fund are higher transaction costs due to the increase in trading and the possibility that the fund goes to cash before a market rally.

Regardless, these types of funds add some much-needed variety to the predominately buy-and-hold mutual fund market and should be considered in a down market for investors that don’t actively manage their portfolio.

-Erik Ringo – Group 11

Hedge Fund Watch – Watching the Smart Money – Kraft Acquiring Cadbury

Background Information

Watching the smart money is very important. John Paulson, hedge fund manger specializing in risk arbitrage (betting on mergers) has doubled his stake on Cadbury and betting this deal will close. Eton Park , run by Eric Mindrich, also has a sizable investment of about 2.5%. A recent SEC filing has showed that Paulson owns about 2% by buying 14.8 million shares.

The bet came after Kraft took its $16.7 billion bid for Cadbury directly to shareholders on Monday, after the board of Cadbury, a chocolate company based in Britain, rejected the offer as too low.

Why the deal will go through

The reason this deal will go through is due to the rules of the deal. The differences between British rules and US rules are likely to bring a quicker close to the takeover battle and force Cadbury to fight this hostile offer on issues of price instead of resorting to the takeover defenses commonly employed in the United States.


The main difference between Britain and the United States in rules is that Britain requires that any bidder that have committed financing at the time of the making of its offer. Because of this, Kraft has been forced to drop its financing condition and replace it with a committed debt facility. In addition, because Britain does not allow due diligence conditions, Kraft has now dropped this condition as well (i.e deal goes a lot faster and costs less).


These regulatory differences, seem really weird, but exist for good reasons. For example, they need these rules because the US needs a special mechanism for a board to protect the corporate enterprise by adopting takeover defenses. In Britain there are substitutes for takeover defenses such as different labor laws so they don’t need one. Thus, again faster and cheaper cost of the deals.

By Group 1