Hedge Fund Contagion and Liquidity Shocks - Example

Name Professor Title Date Global Economy Introduction In 2014, the global economy persisted to grow at just a modest projected rate of 2.7% (Reid 24). Recovery was slowed down by various challenges as well as several unanticipated shocks like sensitive geopolitical disagreements in various parts of the globe. According to Ali, Majority of the economies have observed a change in the GDP expansion to a visibly lower direction than pre-crisis rates, increasing the phantom of long-term average economic growth (202). Even though, some progress are predicted for the year 2015 and 2016 in developed countries, considerable shortcoming risks continue particularly within the Japan and euro area (Reid 24). Growth levels in the developing nations and economies in evolution have turned out to be more conflicting in 2014, with a strong slowdown in some of the emerging economies, especially in Commonwealth of Independent States and the Latin America. However, 2015 have provided some hope some managers who are interested in investing in growing economies. Therefore, this paper will analyze the appeal of global macro hedge funds. In addition, the paper will discuss the past and current role of quantitative easing in the US and Japan today, how a stronger dollar impacts US Businesses and how the falling oil prices are impacting the world economy. 1. Macro Hedge Fund Strategy In 2010, Stowell defined Hedge fund as a dynamically managed, collective investment medium which is widely open to just a group of the investors whose performance is gauged in total return units (7). In normal cases, such investors employ high risk modes like investing using the borrowed money in bid of getting better capital gains. In the face of globalization, the managers are convinced to look for foreign markets to invest so as to increase brand awareness and also increase shareholders returns. Having operated in local settings for quite sometimes and the returns looks like stagnating managers find it prudent for the company to expand its markets and its customer base (Stulz 179). However, the market is marred with several challenges and risks which managers must get concerned. In this case, global macro strategies of hedge fund become an important to reduce such risks. Normally, economic experts argue that Hedge fund strategies become the driving factors behind the manager's capability to create profits for his shareholders (Strachman 43). Global macro strategy emphasizes on investing on the instruments with fluctuating prices based on shifts in the economic policies as well as capital flow across the globe. Drobny & Ferguson stated the macro in the name depicts the managers endeavor’s to apply the macroeconomic principles to determine disorders in the asset prices, whereas the global in the name shows that such disorders are sought after everywhere in the global markets (13). Numerous macro dealers would claim that international macroeconomic variables and issues influence every investing strategy. One of such issues is the global appeal of hedge funds. The appeal is determined by the currency stability, interest rates equity markets and stock index. The appeal of global macro hedge funds have changed over the last ten years (Drobny & Ferguson 17). Since late 2007 numerous considerable macroeconomic aspects have taken over the international investment scene. What began as a disintegrating of the housing bubble majorly in the US became a cascading sequence of happenings which finally shaken the whole international financial system majorly in 2008 to 2009. Ali claimed that the managers witnessed a situation where stocks prices were falling, fuel prices increasing, currency prices weakening and interest rates increasing (9). It made consumers to fear investing in stocks, real estates, taking bank loans and travelling in other countries because of high interest rates. In a nutshell, global macro hedge funds were not appealing. However, the period of 1990 to 2005 had been fairly appealing to managers to invest in developing and developed countries across the globe as major companies should positive performance in terms of revenues and stocks. The economic performance only slowed down in 1994 top economic slump posting some loses of up to 4.3% (see figure 1). Another slowdown took place in 2008 which prompted poor performance by companies. In 2015, Chief Investment Officer reported that falling prices of commodities, for instance fuel prices, especially the petrol have provided more room for the customer spending. Picardo claimed that an example is the US which is today 70% consumption-based. In general, the economy of the world is now is now appealing and in good shape. Most countries in Europe today have a low interest rates and overwhelming liquidity injection. Japan also experiences a period of low interest rates. JPMorgan Chase & Co. argued that the dropping oil prices and the improving of the US dollar and debt crisis of Greece have in the last five year been generating an appealing atmosphere for the managers. The economic strength of the US is making the nation deal with a strong currency whilst the other countries particularly from Europe and Asia, gets additional help through a weaker currencies, low prices of oil and low rates of interests (Boyson, Stahel & Stulz 1791). Low interest rates attract more customers to take banks loans and invest in stocks. Chief Investment Officer stated that stock markets of Asia have been flat in domestic currencies; however, in terms of Swedish currency the tendency is evidently positive because of weak krona. British economy has shown positive appeal to global macro hedge funds. Following a clear fall, Eurozone has reclaimed some dynamism from late 2014. Figure 1: HFRI Macro Index Source: (Drobny and Ferguson 76) 2. The past and current role of quantitative easing in the US and Japan today In 2015, The Economist opined that Quantitative easing often shortened to QE and defined as a form of the monetary policy employed by the central banks to inspire economy when the standard policy has turned out to be inefficient. Central bank adopts quantitative easing through purchasing the financial asset from the financial institutions such as commercial banks hence increasing financial asset prices and reducing their yield, whilst concurrently raising the money supply. Quantitative easing is marred with freed up capital and lower interest rates in the United States and stimulated a solid growth in the risk appetite, assisting shares prices to increase markedly from 2009 (Elliott 19.). Allen claimed that a quantitative easing policy was first applied by the Bank of Japan in early 2000s to control domestic deflation. Bank of Japan had upheld temporary interest rates nearly closer to zero from 1999. Bank of Japan had for a longer time before 2001 held that quantitative easing approach was not effective and discarded its application for the monetary policy. Bullard claimed that the central bank of Japan implemented quantitative easing in March 19th of 2001 (37). In its quantitative easing, Bank of Japan overflowed the commercial banks with surplus liquidity to support the private lending, leaving a hefty stocks of surplus reserves and thus little threat of shortage in terms of liquidity shortage. Bank of Japan realized this by purchasing numerous government bonds more than required in order to put interest rate at zero. The bank afterwards purchased equities and asset-backed securities and prolonged commercial paper the terms based on purchasing operation. Bullard contended Bank of Japan raised the account balanced of commercial bank from 5 trillion yen to 35 trillion yen for a four-year duration which began in March 2001 (42). In the US, the federal banks bank which is the central bank has been buying securities and financial asset from commercial banks too. Before recession of 2008, US Federal Reserve was maintained between treasury notes of $750 billion and $850 billion on the balance sheet. However in late of 2008, Federal Reserve began purchasing $600 billion of the mortgage-backed securities. By early 2009, Federal Reserve had held up to$1.76 trillion of the mortgage-backed securities, Treasury notes and bank debt which increased to $2.1 trillion in mid 2010 (Elliott 67). Additional, Allen asserted that buying were stopped as the US economy began to get better, but recommenced again in August of 2010 when Federal Reserve decided that country’s economy was not robustly growing. Today Japan has almost similar quantitative easing policies. In 2015, Allen went ahead to affirm that the current quantitative easing of Japan started in 2013 and is worth $1.4 trillion. Under the new quantitative easing arrangement, Bank of Japan committed to buying of 7 trillion yen of the government bonds every month through electronically generated money. Fujioka and Hidaka claimed that in April of 2013, Bank of Japan stated it would increase its asset buying plan by ¥65 to ¥70 trillion annually. The practice was conducted with an aim of changing from deflation to inflation of 2 percent in Japan. The purchases were large and were anticipated to increase money supply and double the existing. Allen posited that as brainchild of the current Japan’s Prime Minister, Shinzō Abe, the policy was named Abenomics and is based on three issues including monetary easing, fiscal stimulus and the structural reforms. The practice has often caused high inflation in Japan than preferred because the amount of money for easing needed is overvalued and much money is generated by buying of the liquid assets. On the other hand, quantitative easing policy has led to strong US currency against Japan and high growth on the GDP. On the contrary, Allen claimed that the quantitative easing in the US and Japan today have made creditors to earn less due to low interest rates. In 2015, the Economist argued that Japan devaluation of Yen has harmed importers in the current years because the currency devaluation inflates cost of imports. 3. The possible factors behind the asset allocation change of weighting equities more heavily announced by Japan’s Government Pension Investment Fund Ishikawa and Miura stated In June 2014, Government Pension Investment Fund of Japan announced plans to change to asset allocation of weighting equities. Indira claimed that the new allocation assets policy reduced government bond objective from 60 to 35% and increasing its set targets for the domestic and foreign stocks to 25% each. Experts claim that that change in allocation of asset is a radical diversification which is intended at increasing the retirement incomes to its 67 million subscribers. The factors behind that change of all action of assets of weighting equities is said to make the stocks or equalities more attractive. In 2015, White asserted that Global fund executives are keen on how the Japan pension fund adjusts its strategy due to potential for billions of dollars to stream into the local and international markets. On the other hand, the GPIF has increased the foreign bonds to 15% from 11% a move which was prompted by the need to look for high returns on the investments. Investors had been anticipating for GPIF to declare amended allocation set targets following recommendation by a panel selected by the state for the institution of pension to raise its asset or equity allocation in order to improve investment returns. Indira held that this practice will assist in covering the increasing payouts to the aged population whilst the contributions shrink. Changing asset allocation was also part of economic reforms that was pushed by Japan’s Prime Minister Shinzō Abe. Another factor for change in allocation of asset was to stabilize returns and make them efficient. Indira believes that the $1.2 fund institution has a drawn fiscal plan which reserves asset which will be used to attain economic balance within nearly 100 years. White argued that the overarching objective of the fund is to realize investment returns needed for pension system of the public, with fewer risks, only for benefit of the pension subscribers from a long-standing context, hence leading to stability of economic system. A failure in realizing the returns on investment needed for this pension framework is thought to be the biggest risk for the fund. Experts believe that when trying to invest for a longer time, it is viable to create and uphold policy mix rather keeping on changing the asset allocation over short period of time. White argued that Rise in the age of retirement, high rates of pension contributions and an obligation for the part-annuitisation of the savings are also required in making sure that pension system of Japan becomes sustainable over a long period of time. 4. How a stronger dollar is impacting US Businesses In current times, the increasing dollar has turned into an important theme in the financial markets. Currency change has often been complex both in causes and outcomes. Nevertheless, relatively simple explanations exist for the surge of dollar in 2014 and 2015. However, high rate of dollar has both challenges and advantages for both U.S. corporations and investors. Picardo claimed that today, consumer spending represents nearly 70 percent of the economy of US, and experts regards a stronger dollar as a net prime driver for this economy. It enables imports to be cheaper; hence products from luxury automobiles to noodles cost less. In 2015, Picardo contended that a luxury sedan from Europe which is charged at $70,000 at the time euro fetches 1.40 dollars can be charged at $57,500 when the dollar surges and the euro was worth just 1.15 dollars. On the other hand, the stronger dollar enables US export to be more expensive, thus an excess of locally-produced goods ought to be charged at lower prices (Reid 23). Cheap consumer products results into high disposable income for the American citizens and hence resulting to more money which can benefit others industries. The reality is that when there is high disposable income, people tend to spend it in supermarket shopping, entertainment, vacations and eating out. Particular sectors which would benefit with a stronger dollar as a result of high spending consist of retailers, casinos, restaurants, travel companies, cruise lines and airlines. Strong local demand assist in reducing the harmful impact of the strong US dollar on the tourism sector of the US, with foreign tourist declines considerably due to the fact that high dollar makes it expensive tour the US and have a vacation. The impact of a strong dollar on various industries can be argued to be mixed. For example, Picardo stated that majority of the global products are priced based on US dollar as a currency, hence a strong dollar might lower foreign demands, and therefore affecting profitability and revenues of resource producers in the US. Research has also established that rising dollar in the US benefits local firms which import equipment and machinery because it would cost less. Another study on the US trade has found out that stronger dollar affects earnings and sales of several of the US multinationals which trades globally (Reid 27). Technology and Pharmaceuticals companies are some of the companies which normally get affected by the situation. Picardo provided an example with Microsoft Corporation which announced in early 2015 that its sales would be reduced by 5 percentages due to high strength of the US dollar. 5. How falling oil prices are impacting the world economy A study into the energy industry confirms that Oil Prices have dropped in the world swiftly from mid 2014 (see figure two). When calculated in the US dollars, the situation depicts that the cost has dropped by nearly 50% from June (Swedish National Bank 1). The dropping oil costs are majorly attributed to the impact of the growing oil supply, but somewhat aggravated global growth potential which have been claimed to have contributed to the effect. Forward pricing estimations portray a case where oil prices are likely not to return to its recent year levels in the near future. A researched into world markets has shown that falling oil prices have impacts on the economy. Low oil costs reduce inflation both directly and indirectly. In this context, directly means when the cost of related goods also fall while indirectly means an impact in oil-importing nations. Swedish National Bank stated that the fall has a great impact in oil importing nations such as Sweden (5). The countries which import oil will have a positive growth in the long because people will have extra money to save. Fall in oil prices means importers also reduce their price per barrel. Consumers will have extra money which they can choose to save or spend on other items or services such as entertainment or bringing more stock to their stores. The level of consumption also increases with the oil price drops while production costs of companies decrease, leading to more profits hence more investment. It happens that when oil falls, fewer budgets are allocated on transportation of people and products into the market. Therefore money which would have been used for transport is used in other investments. India, Indonesia and China have energy-intensive industries than most of the developed countries and hence get more benefits when oil prices falls. China and India have already capitalized on the fall of oil prices to decrease local oil subsidies and raise taxes on oil-related items so as to enhance public finance. On the contrary, net oil exporters like Saudi Arabia, Qatar, India and Norway have experienced slow growth of GDP because export revenues have continued falling (Swedish National Bank 4). The practice among some oil-producing nations to produce more oil to pay off for the reduced prices have perhaps led more prices falls in recent months. Therefore, the negative impact has adversely affected oil producing nations. Fall in oil costs also contributes to easing of current deficits of a country. For example, India imports nearly 75 percent of the country’s oil, and experts argue that falling oil costs will ease India’s existing account deficit (Swedish National Bank 3). Figure: Drop of oil prices from 2014 Source: Stratford Conclusion The paper has provided has provided an outlook into various developed economies which still various economic challenges based on hedge fund appeal, oil prices and dollar fluctuations. The outlook and appeal give modern managers with an opportunity to scrutinize their company’s internal competence and see if it matches the external environment to enable the company invest in a new market and increase shareholders’ revenues. Despite some countries like the US and Sweden showing appeal for global macro hedge funds due to low interest rates the situation changes so quickly and the managers must be up to date to changes with business environment so as to avoid risks of losses. Works cited Ali, A. Reimagining the emerging economies. International Journal of Commerce and Management 24.3(2014):202 - 208 Allen, K. Quantitative easing around the world: lessons from Japan, UK and US. 22 Jan. 2015. Web. 4 Nov. 2015 http://www.theguardian.com/business/2015/jan/22/quantitative-easing-around-the-world-lessons-from-japan-uk-and-us Boyson, N. M, Stahel, C.W & Stulz, R.M. Hedge Fund Contagion and Liquidity Shocks. The Journal of Finance 65(2010): 1789–1816. Print Bullard, J. Quantitative Easing — Uncharted Waters for Monetary Policy. Federal Reserve Bank of St. Louis, 2010. Print Chief Investment Officer. Investor Appetite for Global Macro Heats Up. 5 May. 2015. Web. 4 Nov. 2015 http://www.ai-cio.com/channel/ASSET-ALLOCATION/Investor-Appetite-for-Global-Macro-Heats-Up/ Stowell. D. An Introduction to Investment Banks, Hedge Funds, and Private Equity: The New Paradigm. Academic Press, 2010. Print Drobny, S & Ferguson, N. Inside the House of Money: Top Hedge Fund Traders on Profiting in the Global. John Wiley & Sons, 2013. Print Elliott, L. Guardian Business Glossary: Quantitative Easing. The Guardian (London), 2009. Print Fujioka, T & Hidaka, M. Kuroda Surprises With Stimulus Boost as Japan Struggles. 31 Oct. 2014. Web. 4 Nov. 2015 http://www.bloomberg.com/news/articles/2014-10-31/boj-unexpectedly-boosts-easing-amid-weak-price-gains Indira V. Japan pension giant’s equity shift to trigger multi-billion dollar move. 23 Oct. 2014. Web. 4 Nov. 2015 http://citywireasia.com/news/japan-pensions-giant-selects-four-managers-for-stock-investments/a797099 Ishikawa, M & Miura, K. Japanese Bonds Rally as BOJ Stimulus Surprise Enables GPIF Exit. 31 Oct. 2014. Web. 4 Nov. 2015 http://www.bloomberg.com/news/articles/2014-10-31/japanese-bonds-advance-after-boj-unexpectedly-expands-stimulus JPMorgan Chase & Co. 2015. The Impact of Falling Oil Prices. 11 Jul. 2015. Web. 4 Nov. 2015 https://www.chase.com/commercial-bank/executive-connect/falling-oil-prices Picardo. E. How A Strong Greenback Affects the Economy. April 22 2015. Web. 4 Nov. 2015 http://www.investopedia.com/articles/forex/030215/how-strong-greenback-dollar-affects-economy.asp Reid, C. D. World Economic Outlook April 2013: Hopes, Realities, Risks. Reference Reviews, 28.5(2014): 23 - 27 Strachman, D.A. The Fundamentals of Hedge Fund Management. Wiley, 2012. Print Stratford. How Quantitative Easing Differs in Japan and Europe. 17 April. Web. 4 Nov. 2015 https://www.stratfor.com/analysis/how-quantitative-easing-differs-japan-and-europe Stulz, R. Hedge Funds Past, Present, and Future. Journal of Economic Perspectives 21.2(2007): 175–194. Print Swedish National Bank. Monetary policy report February 2015: Effects of the falling oil price on the global economy Swedish National Bank, 2015. Print The Economist. What is quantitative easing? 9 Mar. 2015. Web. 4 Nov. 2015 http://www.economist.com/blogs/economist-explains/2015/03/economist-explains-5 White, A. Japan’s GPIF sets investment principles. 27 May. 2015. Web. 4 Nov. 2015 http://www.top1000funds.com/profile/2015/05/27/japans-gpif-sets-investment-principles/ Read More