The market-neutral equity strategy continued its steady winning ways, making the only positive contribution to the fund’s performance during this quarter (41 basis points). Gross leverage remained well within recent parameters, ranging between 2.17x and 2.54x. During the quarter, we moved from a slightly net long position, 54.7/45.3, to a slightly net short position, 46.4/53.6, prompted by the greater beta of our short positions. As can be expected in a bear market, more money was made on the short side than on the long side, though the margin was relatively small. Increased dispersion helped; some financials performed extremely well (with large gains in MF Global Ltd., Goldman Sachs and Morgan Stanley) while others lost most or all of their value during the quarter (Banco Popular, FirstFed Corp). On the long side, we continue to favour the housing sector, exchange firms and a select group of financials. On the short side, we favour big-cap brand names such as Walgreen, Procter and Gamble, Johnson and Johnson, Kimberley Clark and Kroger, among others. We don’t expect the latter group to collapse, but we do expect it to underperform market indices.It is likely that Friedberg's M/N fund took a drubbing in March, which was moderated by January and February numbers, especially due to its increasingly short bias, which is systemic of the entire quant industry. If other quant funds were exhibiting the kind of leverage as Friedberg did at March 31 (and there is little reason to believe they did not) and as they are forced to aggressively delevere into this April rally, it is very unpredictable just what the final outcome will be.
We plan to de-emphasize our diversified trading program in coming months. For one thing, its broad mandate parallels, in many respects, the global opportunities section. For example, we are long gold in this program but we are also long gold in the global opportunities section. The duplication leads to confusion at the trading desk and, in addition, the positions necessitate continuous adjustments lest they come to increase overall risk and exposure. Second, we have been running into serious liquidity issues when putting on commodity futures positions. This has limited the scope of our diversified trading program to a mere handful of futures contracts, to wit, stock index futures, gold futures and money market futures. There is then no logical reason for us to maintain a special program allocation to commodities when we are essentially unable to put it into full effect. Instead, we have come up with what we believe is a better and more focused idea on how to bet on commodities markets. Taking a macro view first (do we want to be long? short? neutral?) we have tasked a very competent CTA, Covenant Capital LLC, well known to us, to implement our idea. The principal’s name, Scott Billington, and his background have been disclosed to you in recent weeks by separate mail. I should add that the manager owns a very robust technical system, one that has successfully traded off in the past volatility, trend force and liquidity to produce excellent riskadjusted returns. In effect, we hope to combine the best of our strengths — our macro views and his micro management.
The US is heading towards an astronomic $3-trillion fiscal deficit, an amount that represents 21% of GDP and that exceeds the entire 2008 budget. Clearly, the Feds have overdone it, and in a big way. There is no possible way for the US Treasury to fund, uneventfully, this amount in a stabilized economy, that is, an economy no longer experiencing the type of free fall seen during the last quarter of 2008 and the first couple of months of 2009. At present rates, domestic savings would be woefully insufficient, especially if they are called upon to finance normal business requirements, and foreign savings will certainly not be forthcoming, at least not on that scale. That leaves the Treasury with two bad choices, one worse than the other: substantially higher long-term rates or Fed monetization. Please note: stock prices have been on a tear recently, not because the market expects significant gains in economic growth/productivity and a surge in earnings. That will not happen under this administration. The true reason for this mini-bull market is that the market senses a huge rise in inflation. Better to own businesses and tangible assets, it reasons, than fixed-income pieces of paper. This is true. But, we suggest, it’s better yet to own the tangible assets directly, gold and commodities.
Surplus countries will see their currencies appreciate. This will be bullish for China and Asia in general, though their international reserves will initially be mauled. Others, too, will benefit. Upward floats and the accumulation of tangible international assets instead of other nations’ liabilities will change Bretton Woods II forever.
We are positioned for this eventuality. Long gold and long commodities. Long inflation-linked Treasuries (for now). Short Fed Funds contracts, with trivial risk. Long Chinese equities, especially the offshore H shares, as they become the beneficiaries of a freer capital account. Soon, we hope, other trade ideas will occur to us. We need to make sure that they are liquid, that they are leveraged and that their risk can be controlled. We are thinking.
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