Today’s blog is late because I had to deal with a virus infestation on my desktop.
Michael Kurtz of Macquarie Securities (of Australia) comments on China which is only indirectly related to Pres. Obama’s and Congress’s call for China to let its currency rise. He writes:
“With the aftershocks of the Global Financial Crisis and ‘global imbalances’ still reverberating through international markets, and with China having recently attained the status of the world’s second-largest economy, investors are looking toward October’s 12th Five-Year Plan for key guideposts.
“Investors need to temper expectations. With China well along in its market development, the days are gone when Beijing could exactly determine China’s economic path; and much of the new plan’s thrust should be a continuation of the economic rebalancing initiatives laid out in the 11th Five-Year Plan –a policy bias already well known to markets, and thus largely priced into listed equities.
“Still, we believe China is marking a path where the quality of growth – in composition, efficiency, and environmental impact – now commands more attention at the margin than sheer quantity. This includes efforts to rebalance aggregate demand toward domestic consumption and service-sector activity from export manufacturing and investment.
“This implies reduced material- and energy-intensivity, through higher factor costs – wages, energy/utility tariffs, land, and (potentially) capital costs. While these initiatives will generate relative winners, they may also imply downward pressure on margins generally, and a decline in China’s overall profits-to-GDP.”
Here is some opinion of exchange-traded funds from yesterday’s (London) Financial Times‘ Lex column:
“ETFs encourage some invstors to be lazy, and others to play the market by frequently buyand and selling. Does this mean the end of good old-fashioned stock picking?
“Such funds blindly buy fixed proportions of ‘good’ and ‘bad constituents alike. In the short run, this is terrible news for active managers. The flood of money willing simply to accept ‘beta’ (fisk-adjusted market returns) leaves less space for traders who look for ‘alpha’ (excess return).
“But in the long run, the more money that is managed lazily the more money will be allocated inefficiently. The greater the pricing distortion from indexing, the cheaper ‘good’ and dearer ‘bad’ stocks can become. That will create a target-rich enfironment for those who are patient.
“To be sure, indexing has helped investors overall, particularly by cutting costs for small players. Expensive active managers are capturing a smalelr slice of their savings, and managers who did little more than ‘shadow’ the main indices—closet indexing—deserve to be driven out of business.
But the very popularity of ETFs leave excess returns on the table, reacy to be swept up by active invstors. Successful stockpickers should once again look like geniuses.”
Separately, the Lex column also noted that many non-US based ETFs do not actually own the assets whose performance they are tracking, according to a report from Royal Bank of Scotland. Instead they use OTC derivatives and swaps to create a synthetic equivalent with low-risk assets as collateral for the trades. This generates lots of fees for the middleman. Collateral accounts for 90% of the total ETF value in Europe, where only 1/3 is invested in supposedly tracked assets. In Asia, the collateral is unknown but about 75% of ETFs are not actually invested in the assets they claim to track.
This creates risk because the pseudo assets may not be as safe as believed, as shown by the market collapse two years ago. Ulitmately the managers, in most cases banks, are selling complex derivative products whose risks they do not understand.
Under SEC rules, US ETFs may not use synthetic assets.
An alternative, closed-end funds, issue a fixed number of shares but are priced by the market. Many yield ETFs use preferred shares auctioned to institutions to enhance returns. Now according to yesterday’s Wall Street Journal, Standard & Poor’s proposes to tighten its criteria for rating these CEF preferreds to better reveal liquidarion risk. This could increase the cost of issuing the preferreds and cut the return of these funds.
The auction rate prefered (ARP) market froze in Feb. 2008 during the financial crisis. Initially many CEFS switched out of ARPs, but they are back in them now. While some older yield funds never leveraged and others reduced their gearing, others have piled in to ARPs.
Last year Fitch Ratings revised its criteria for CEF ARPs, which the funds reacted to by dropping the No. 3 rater. Now, however, with S&P also considering tighter standards, it will not be so easy.
Interviewed by the WSJ, Cecilia Gondor of Thomas J. Herzfeld Advisors, the CEF guru firm, said: “The result could be widespread downgrades” that “in the current market environment, would result in higher leverage costs for funds using penalty rates to calcucate dividends on their auction-rate preferred shares.”
More for paid subscribers about what the CEF rule tightening may mean follows, along with the usual stock news from Brazil, Britain, China, and Charleroi, Belgium.
