Demand produces its own supply. That is the contrary of Says Law, and it is the moral of Deutsche Bank’s new report on monthly hedge fund trends. Specifically, the demand for aggressive employment of money in a climate where central bankers keep stoking equities is producing a supply of new fund launches with related strategies.
The two most popular alpha strategies in Europe are: event driven on the one hand and equity long/short on the other. The event driven strategy takes its popularity from the recent uptick in deals: 60% more deals in Western Europe in the first quarter of 2014 than there were in Q1 2013. This year’s first quarter also saw the highest levels of IPO activity since 2007.
Want a clue to the reason for that state of affairs? As DB mentions up front, the ECB has stepped up its long-term refinancing operations (LTRO). LTRO is for Europe what “quantitative easing” is in the United States, the fashionable way to describe old-fashioned inflationist creditor-punishing, debtor-rewarding policies. DB says that “a new targeted LTRO” was “the star of the show” in a new package delivered by the ECB in early June.
If such institutions keep rewarding indebtedness, then in time they get their way. Institutions and individuals go into debt ever more heavily, and use some of the leverage to buy equity, and that rewards both long positions on such equities and deal making, even if it amounts to frenzy, amongst the issuers of that equity.
Frenzied Deal Making
In May, a UK based consumer electronics retailer, Dixons Retail (DXNS), agreed to merge with Carphone Warehouse (CFW), creating a new combined firm to be known as Dixons Carphone. This seems a classic case of frenzy-based deal making. The market is certainly unimpressed. Shares in Dixons immediately fell 10.3% upon the announcement. Shares in Carphone Warehouse fell somewhat less sharply (8%).
Perhaps related, electronic retailers in Europe also saw heavy short covering in May. This space has become “the most shorted subsector after department stores and catalogue retailers.”
On the other hand, sourcing non-equity-oriented UCITS funds in Europe these days remains a challenge. Investors want to benefit from the credit squeeze; they don’t want to suffer from it.
High Quality and Not-so-high quality
In this report DB records its pleasure that supply is meeting demand, that there have been high quality new launches in the event driven space.
In the U.K., Germany, and the Nordic countries in particular there is a good deal of optimism about the longer time-horizon deal space. Investors are ready to lock up money for 3 to 5 years “in order to access investments that are not typically available through their more liquid credit investments.”
This is a taste of institutions but not of institutions alone. Ultra high net worth individuals and their family offices, too, find “one item” investments simple to understand and are ready to fund them at the expense of illiquidity.
Convertible bond deals also picked up in Europe in May. Here the quality of the supply that meets the investor demand is not so high. Such offerings totaled 1.48 billion euros in May. DB cautions that “the quality of these deals was perhaps not the highest.”
Well … yes. I’m afraid that is what one would expect a priori. Frenzies, greater-fool thinking seems as likely here as elsewhere a priori.
Other Observations
More broadly, DB observes that March and April were very bad months for hedge funds, but that the frown of early spring turned upside down in May globally. Emerging markets equity funds did best, gaining 1.8%
The report concludes with a convenient multi-colored timeline of upcoming regulatory developments around the world. Highlights:
- August 1st is the deadline for responses to ESMA’s consultation papers on MiFID 2.
- In August 2014, Her Majesty’s Revenue and Customs issues its next update on UK FATCA, regulations deliberately parallel to those of the US FATCA (Foreign Account Tax Compliance Act).
- On the first day of 2015, a new liquidity coverage ratio of 60% will be introduced under Basel III.
- July 2015 represents a deadline for compliance with a swaps push-out rule under the OCC.
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