Subject: Happy Fourth
From: "Jay Rouse" <[email-masked]>
To: "Hunter Biden" <[email-masked]>, "Eric Schwerin" <[email-masked]>, "Devon Archer" <[email-masked]>, "Chris Heinz" <[email-masked]>
Date: Mon, 4 Jul 2011 11:03:08 -0400

Feature
Hedge funds rely on consultants for advice on risky political  
environment
Risky business
Author: Madison Marriage
Source: Hedge Funds Review | 04 Jul 2011
Categories: Hedge Funds, Strategy
Topics:	Risk, European Central Bank, Greece, MENA (Middle East/North  
Africa), Federal Reserve, Bank of England, Saudi Arabia, Middle  
East,China, Energy, Commodities, Political risk

Hedge funds are using consultants and political advisors to monitor  
political events such as elections, civil unrest and regulation,  
particularly in the Middle East, North Africa and emerging markets.
“I don’t think I can remember a time when political risk has been so  
important,” says Steven Bell, director of $1.3 billion asset  
management company GLG.

Dithering by the eurozone and generally hostile exchanges between key  
players, like the German Bundesbank and the European Central Bank over  
the fate of Greece, is just one example of the kind of political risk  
hedge funds now need to take into consideration for even the most  
basic market trades. The surprise election of Peruvian left-wing  
candidate Ollanta Humala in April is another.

Since the financial crisis, markets have been hit by the interference  
of politicians. Quantitative easing makes it a headache for hedge fund  
managers to second-guess what markets will do. Added to this are the  
bigger political events such as the recent upheavals in the Middle  
East and North Africa (Mena) region.

Regulators in Europe and the US are pushing through financial  
legislation that could have unintended consequences for the hedge fund  
community. Paying attention to politicians has become vital for many  
managers who previously thought watching the Dow Jones or FTSE was  
sufficient.

The political arena affects a range of hedge fund strategies and so  
managers are employing a range of tactics to make sense of it.

Amer Bisat, partner and portfolio manager of two hedge funds at New  
York-based Traxis Partners, says getting expert advice is crucial.  
“Most of us are not political scientists, we are macroeconomists by  
training. We all love to talk about politics and read newspapers. It  
is a fun thing to discuss. But let’s be clear, we are all amateurs and  
there is a science to this,” he comments.

Hedge funds can either bring a political scientist into their shop or  
hire a consultant. The latter option is preferable, Bisat says, as  
taking on board an internal advisor can be “inefficient”.

Although Bisat admits such advice may not translate directly into  
returns, “you want to know what the distribution of probabilities on  
political events and what the risks are. At least you will know the  
various states of the world that are available out there politically.”

Apolitical
Chris Wright and Brian Ostroff, managing directors of Canadian  
resource-focused investment management company Windermere Capital,  
take a different approach to managing political risk: steering clear  
of it.

Windermere Capital runs mining-focused hedge fund Breakaway Strategic  
Resource Fund which tactically dodges political developments. “Some  
funds thrive on [political risk]. We really try and steer clear of  
trouble. It is hard enough to find a deposit, work that deposit, build  
a resource and bring that into production. The odds are so stacked  
against you from the very get-go that we try not to take on any  
additional risks, mainly political,” Ostroff explains.

His fund disregards regions with a whiff of political impropriety,  
ruling out most of Africa and large portions of Central and Latin  
America.

Ostroff recalls a broker who tried to pitch an investment idea in  
Uganda, claiming it was, comparatively speaking, a safe bet for  
investment in Africa. “I said thanks but no thanks. One week later the  
opposition candidate [Kizza Besigye] wound up getting shot in a  
demonstration and there were riots,” Ostroff notes.

While avoiding politically unstable environments might lead to safe  
investments in most cases, some events are simply unforeseeable,  
Ostroff concedes. His Breakaway Strategic Resource Fund held a large  
position in Peru which, fortunately for the fund, he closed earlier  
this year when return objectives had been met and well before the  
surprise election of left-wing presidential candidate Ollanta Humala  
ahead of right-wing runner Keiko Fujimori. “That really came out of  
nowhere,” Ostroff stresses. Humula’s victory now calls into question  
the entire future of mining in Peru, believes Ostroff.

This is partially the result of politicians catering to  
environmentalists in the run-up to elections, he claims. “A couple of  
weeks before the Peruvian election the government in power started to  
get tough on some of the mining companies. Bear Creek Mining [a  
Canadian mining company focused on Peru] was really the target of that  
pre-election manoeuvre,” he says.

Peru has some of the world’s largest supplies of commodities such as  
gold, copper and phosphate. Any disruption to Peru’s mining capacity  
brought about by political sentiment is likely to have a serious  
impact on commodity supplies worldwide.

To benefit from this risk, Ostroff has devised a key theme for the  
fund: scarcity and security of supply. “Being able to make investments  
in companies that have these scarce commodities in secure  
jurisdictions will ultimately win out,” he declares.

Regulation
GLG’s Bell identifies another key political risk: regulation. “People  
are making major changes to financial regulation, making mistakes and  
the credibility or public support for financial systems and banks is  
very low,” he notes.

To keep track of such concerns, Bell talks to local analysts as “all  
politics is local”. Although he has a good understanding of British  
politics, “I can be surprised by German or US politics, so it is very  
important to talk to local analysts. We are particularly keen to talk  
to Spanish analysts in terms of whether the political process is going  
to proceed smoothly in passing austerity measures and what the social  
cohesion is to accept those,” Bell explains.

He notes the importance of the media for keeping up to date with  
politics. However, he remains wary of certain news channels with a  
definite political slant. “I felt there was a very distinct tilt in  
the BBC and New York Times on the Japanese earthquake looking for  
negative angles on the story in contrast to the Japanese press.  
Reading the local press is absolutely crucial,” he affirms.

Maintaining proper analysis of politics can result in a lot of work  
without much of an impact on returns, Bell says. “I very rarely invest  
on the basis of a prediction of politics.”

To profit from the present mix of political risks in the eurozone,  
Bell decided to “distil them in a Spanish credit default swap [CDS].  
If [the eurozone] collapses we found we could encapsulate that in a  
Spanish CDS,” he explains.

Similarly the political ongoing risks in the MENA region is reflected  
in the oil price, what Bell terms “distilling [political risk] into  
something quantifiable”.

London-based consultancy Exclusive Analysis also attempts to quantify  
political risk. Using information from over 1,000 sources it breaks  
political risk down into several components: political stability and a  
number of risks including regulatory, taxation, currency and  
corruption risk.

These criteria are then entered into a database called Cream which  
creates political forecasts, allocating each area of risk a score of  
one to 10. The ratings cover a range of factors such as civil unrest,  
war risk and terrorism risk.

According to Brian Lawson, special economic consultant at Exclusive  
Analysis, hedge funds are a new source of demand for such  
intelligence. Lawson identifies China, Brazil, commodities and energy  
as the main areas where hedge funds are interested in gaining  
political information.

Lawson believes his company can help a hedge fund discern fact from  
fiction when it comes to investing in markets mistakenly perceived  
either as risky or attractive.

Ishan Bhaskar, global economist at Exclusive Analysis, points to  
Vietnam as an example. He thinks many are mistakenly put off investing  
in the country because of its communist government and what he says  
are “alarmist” reports in the English-language financial press.

Inflation in Vietnam is just shy of 20%, coupled with a large current  
account and trade deficit, but “when you look at foreign direct  
investments into Vietnam, it is another story,” he says.

While Bhaskar and Lawson do not offer straightforward investment  
advice, “we are identifying indicator events and trends and what these  
are likely to do to prices,” says Bhaskar.

Exploring outcomes
Mark Ford, director of Cross Border Information (CBI), a consultancy  
offering advice on Africa and the Middle East, says clients look for  
situations where the perception of political risk differs from  
reality. According to Ford, CBI provides hedge funds with insight into  
potential political outcomes.

According to Ford, the central political issue in MENA markets is  
succession. “In Tunisia we all know Ben Ali is gone but who will  
succeed him? In Egypt now that Mubarak is gone, are we going to get a  
democratising government or is the Muslim Brotherhood going to come  
in? With that sort of instability there are huge questions,  
particularly when the boundaries between business and politics are non- 
existent in places,” he explains.

Although Ford believes Saudi Arabia is politically stable at present,  
he concedes succession risk is a major issue.

Seemingly immaterial and innocuous events such as a wedding can mask  
important political meaning, Ford says. A Gulf marriage, “curious as  
it seems from a Western perspective, probably is incredibly important  
in informing us where the power in a particular ruling family lies,”  
Ford maintains.

Exclusive Analysis’s Lawson believes the largest hedge funds should be  
careful from whom they chose to gain political insights. There have  
been a number of high-profile engagements in recent years with hedge  
funds turning to leading political figures for advice.

Former deputy governor of the Bank of England Sir John Gieve advises  
GLG. Lansdowne Partners uses former UK prime minister Tony Blair.  
Former US secretary of state Condoleezza Rice and national security  
advisor Stephen Hadley advise US hedge fund group Everest Capital.

Although Lawson admits “we should never play down the value of the  
contacts, intelligence and information gained by very senior political  
figures over an extended period of time”, no politician has all-seeing  
knowledge spanning every market.

“If you have Condoleezza Rice or Tony Blair on your payroll,  
fantastic. That may open a lot of doors. The danger is if that person  
is perceived internally as the source of all information, they may  
become a block to where you need to go,” Lawson cautions.

Limitations
On the other side of the debate, Gieve is frank about the limitations  
of his advice. For example, GLG is currently most interested in  
attitudes towards banks and banking policy in the UK as well as the  
likelihood of a dramatic approach to regulation in future, according  
to Gieve.

“They’re not looking to me for the definitive answers on these because  
I am not in a position to give them. Alongside their direct contact  
with politicians and wider [contact with] economists and analysts from  
the investment banks, they are looking for a mix of views and then  
it’s very much up to the investment manager what they can make from  
that,” Gieve comments.

“On the whole, looking at political advice and certainly my advice,  
there is very rarely a direct trade [for GLG]. I provide one  
background factor in the equity world alongside all sorts of more  
direct factors: is the company any good, are its profits going to be  
any higher,” he adds.

“I’m one of a number of advisors GLG uses and I think that is pretty  
common across hedge funds. I don’t think there is any magic in  
political risk and broadly [hedge funds] try to adopt the same  
approach: get a wide range of views on what is happening and what is  
likely to happen,” he concludes.

According to GLG’s Bell, conversations with such high-profile figures  
are “invariably interesting” but he would be surprised to “come out of  
one of these meetings with a clear trade idea. Put it this way: a  
really good political analyst is unlikely to generate as much return  
to my fund as a really good strategist.”

Traxis Partners’ Bisat agrees the largest hedge funds often have  
armies of former economists from the Federal Reserve, European Central  
Bank and the Bank of England. They can provide some useful insight, he  
says but he cautions again making investment calls based purely on  
political risk.

“Political risk is never about predicting with certainty. Nobody can  
tell you what is going to happen in politics tomorrow,” Bisat concludes.

Read more:http://www.hedgefundsreview.com/hedge-funds-review/feature/2082101/hedge-funds-rely-consultants-advice-risky-political-environment#ixzz1R9J15hGr
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