« Abril 2007 | Main | Junio 2007 »

Juan Toro

This is how one fund managers sees the opportunities offered by been short sub-prime mortgage bonds. These are US bonds backed by home loans from less creditworthy borrowers that became well know in mid February when the sub-prime crisis hit the street. Though there is a myriad of these bonds there is a benchmark index called ABX that is tradable and tracks different sectors of this market. The most frequently traded ABX index (http://www.markit.com) corresponds to mortgage-backed bonds rated BBB and issued in 2006. In February the ABX fell 30 %. This sharp drop was initiated by shaky conditions in the sub-prime markets. Foreclosure rose in the US and many lenders got out of business. The performance of the ABX index was largely exacerbated by hedge funds’ following the trend and leaping into the trade. Despite of this, some hedge funds took contrarian views and funds such as Farallon or Citadel went long the sub-prime market at the end of February.

Continue reading 'This is a once-in-a-lifetime trade'

Juan Toro

The European regulations known as Mifid (Markets in Financial Instruments Directive) will come into force in November. Mifid has not been discussed much in the financial press, though we will probably hear more and more about it. The main goal is to bring transparency and competition to the European financial markets.

Continue reading 'Mifid should bring down your brokerage fees'

Juan Toro

Fingers are being pointed everywhere for reckless lending. It is not just the housing market that has borrowed too much and in too easy conditions. This leverage trend has extended to many other sectors. This phenomenon has led some institutions to get worried about the problem. The BIS (Bank for International Setlement) is warning banks of careless lending to Hegde Funds . The OECD is claiming that loose monetary policy is responsible for the frenetic private equity activity. And last, the Financial Stability forum is acknowledging the existence of new risks in HF's activity (see link below for the report update).

Continue reading 'Where did the risk originate?'

Juan Toro

Today’s FT had a full page article on Trichet. It is a profile of the Central Banker together with some bits of an interview that can be fully read in the web version of the newspaper.

He deals with a bunch of relevant things. The monetary pillar of the ECB is discussed and the recent volatility of the M3 monetary measure is analyzed. There is a brief discussion on the pressure and criticism he has suffered from politicians. Especially when he decided on his first interest rate hike. The entrance of the UK is analyzed and Trichet praises very much the entry of the UK into EMU.
Other relevant concerns for Trichet are: a) the overheating housing market; b) current account imbalances; and b) the need of regulation for the hedge fund sector.

Continue reading 'Trichet’s interview and the photos of Madrid´s suburbs'

Juan Toro

The amount of housing loans in the Euro area decreased in the
first quarter of the year by 28 % according to a report released by the ECB
based on a survey of banks.

Continue reading 'ECB reports fall in housing loans'

Juan Toro

A quick answer to this question seems to be a big YES, at least in the US and for a specific class of assets, namely, private equity investment. Recent evidence shows that, over the last twenty years, investments by university endowments in private equity funds have excelled, attaining returns that are on average 14 % greater than those obtained by their peers (pension funds, banks, insurance companies, etc.)

This is what economists call a puzzle or a conunundrum. Given the heterogeneity of institutional investors that populate the private equity business, how can one of these investors persintently obtain better returns?

Private equity investment is generally managed through a general partner (or group of skilled managers) that raise funds from a group of institutional investors (limited partners) for a long lock up period (ten years on average). Limited partners are generally endowments (public/private universities or foundations), public/corporate pension funds, insurance companies, banks, or investment advisors. Deals that private equity get into are generally classified as venture capital (in early or late stage) and leverage buyouts (LBO).

Across a large sample of private equity funds gathered from 1991 till 2001, Josh Lerner, Antoinette Schoar and Wan Wong* from Harvard University find out that private university endowments do better than their peers (20 % against a 6.7 % internal rate of return). This performance is mostly obtained in venture capital funds (35 % return for early stage fund and 19 % for late stage funds) whereas they do poorly in LBOs, obtaining just a meagre 1 % return

Continue reading 'Are private university endowments top investors?'

Juan Toro

John Authers a journalist from the FT described the Spanish consumers as bad decision makers in terms of their real state buying decisions. He grounded his appreciations on arguments from behavioural finance widely discussed by Robert Shiller in his book Irrational Exuberance. Though Irrational Exuberance dealt with the dot com boom instead of the real state boom, the same principles apply. According to Shiller, traditionally the trend on housing prices has moved closely with that of rents, as any asset pricing valuation model would predict. But in the last years they have been diverging widely. Prices have increased by 182 % and rents have barely moved. This movement has been exacerbated in countries like Spain. Shiller summarizes the principles of behavioural finance that has led many to buy a house without much looking at any valuation model or economic reasoning as follows. First, homebuyers are affected by wishful thinking; they all believe their house is a winner. Second, the human brain filters and processes ideas in terms of stories rather that documented facts. Stories from relatives of friends blur our thinking on the value of housing. Last, money illusion. People only report their buying and selling prices. Transactions costs- notaries, taxes…-, maintenance and other costs of the investment are not generally input at the time of calculating the return of the investments.

Continue reading 'Real state prices in Spain and bad decision making'

Juan Toro

Private equity activity is booming both in the US and Europe, especially in the form of leverage-buy-outs. The number of deals is increasing, as well as their sizes. Though a great amount of money is devoted to this asset class, it is still unclear whether they perform better than the market benchmark. There is a recent academic literature for the US that unveils the performance of this industry over the last two decades. A paper by Kaplan and Scholar * from MIT shows that: a) returns of LBOs’ activity are slightly lower that returns on the S&P 500 for the last two decades; b) gross of fees, the results are roughly similar; c) there is a large variance across general partners; whereas there are top achievers that outperform the market by far, there are also a set of poor managers that do well below the market benchmarks; d) there is persistence in the returns, so that those general partners that did well in the past repeat stellar performance in the future.

Continue reading 'Private equity performance'