Macro funds and arbitrage keep the bourses flying

 

MUMBAI: In November alone, 20 new foreign institutional investors (FIIs) entered India. That’s the second-highest arrival seen in a month after the May meltdown. Only August saw more - 22 entries.

 

They entered the scene just when the Bombay Stock Exchange Sensex’s price-earnings (PE) multiple was already a rich 21.25 times trailing 12-month earnings (October 30). On Friday, the PE stood at an even richer 22.63 times.

 

In these numbers lies the story of the advent of a new market animal — the Global Macro Hedge Fund.

 

By nature, the macro hedge fund participates everywhere - equities, bonds, currencies, commodities - though not always at the same time, according to Dion Friedland, chairman, Magnum Funds, and a US-based writer on the world of hedge funds.

 

“VS”- he can’t be named here for obvious reasons - says that’s the story of the Street now. As a dealer with a foreign brokerage in Mumbai, he handles a clutch of US-based portfolio investors and hedge funds.

 

“A couple of my fundmen in the US said don’t book profit yet, despite the high valuations, because the flow from macro funds is very strong.”

 

What could they be betting on at these market levels? “They are not really plonking a lot in from their perspective,” says VS. 

 

“About 5% or less of their total global exposure.”

 

The bet is, if the India growth story continues at 8 to 8.5%% or even 9% for the next two years, the power of compounding makes for a compelling case. If things go awry, it still does not make a big dent in their overall returns.

 

“There is no other country, barring China, where there is such a growth opportunity. But the problem with China is the inadequacy of the market there,” he says.

 

Remember how a “phantom” dealer of the State Reserve Bureau of China shorted copper throughout 2005? He was found out by the FIIs who were long and wanted to sell but couldn’t, despite Chinese denials.

 

The incident left FIIs sceptical about the conflict resolution framework in that country. This is said to have worked in India’s favour.

 

Macro funds have been winning both ways - through heavy currency arbitrage and rising stock prices. They bring in dollars, buy equities in the spot market, short in futures, and thereby short the dollars since the greenback is on a decline.

 

VS says because of all this, there is little likelihood of an immediate change in this trend.

 

Another dealer with a Delhi-based brokerage says the run in December should be fine due to the smooth rollovers and the low cost-of-carry. Not to forget fresh FII allocations.

 

“Open interest in index futures remains very high compared with single-stock futures and options. This means there are more hedged positions - they are betting on the overall market doing well than on single-stocks.”

 

It’s also a hint, he says, that retail presence is very low. “If the annualised cost-of-carry goes to around 20% from the current 10-12%, it shows an overbought market and that’s when the big institutions and brokers exit - it’s also a sign that retail players are entering into the market, to get shot.”

 

But another player says around this time of the year, FII fund managers go on a vacation and prefer to book profit.

 

But there is some warehousing done in index heavyweights and favourites such as ITC. This increases the cost-of-carry. So this should not be taken as the only factor, the player points out.

 

There are also some FIIs who buy in December, and sell in January - and are assured of a 1 or 2% return. That leads to a lot of FII-to-FII deals, says a player. While old FII are booking some profit, new funds are betting on the India story continuing.

 

“For them, a 15% to 20% return on investment is considered great. That will be possible in the strong counters in the short-term,” says VS.

 

The year-end also brings about fresh FII allocations, which start trickling in January and February, with a first-half peakout in April, 2007.

 

 

Macro hedge funds invest on the basis of expected global macro-economic changes rather than merely the potential of one market or an industry sector or a company’s fundamentals.

 

When global economies are changing direction, they tend to impact interest rates and the prices of all financial instruments in various markets - from currencies to stocks, commodities and bonds. For example, macro fund managers believe that US interest rates will rise further - as they did earlier this year - they could be move funds to US government bonds, betting that other fund managers will do so sooner or later.

 

They may simultaneously sell equity in emerging markets, in anticipation of the fact that when other funds move into US Treasury, they will be pulled out from elsewhere, and hence stock prices may fall in the emerging markets.

 

The world’s most famous macro fund manager is George Soros, who famously short-sold the British pound on expectations that it would be devalued. When that happened, his investors made a clean profit of over $ 2 billion.