The Reserve Bank of India (RBI) today said hedge funds posed a risk to financial institutions through their credit exposures in securities transactions and derivatives trades. On account of leverage, hedge funds might get into trouble if their assets experience a sharp drop and the market for these assets lacks liquidity so that funds cannot exit their positions. The collapse of large hedge funds, in particular, may have serious implications for financial institutions having exposure to these funds. The liquidity risk arises from the ability of hedge funds to move out of trades quickly when prices turn against them. The problem could be serious if too many funds have set up the same trade. Hedge funds may also create excess volatility risks by making trades leading to overreaction of prices to diverge from fundamental values. These risk are crucial from the financial stability point of view, said RBI.   more »

Monsoon Capital’s flagship India Inflection Fund ended October with a bang, recording its biggest gains since it launched almost three years ago. The $1.2 billion hedge fund returned an estimated 21.9% last month, bringing its year-to-date return to 65.6%. By contrast, the BSE Mid Cap Index—which covers the Bombay Stock Exchange in Mumbai, India—is up 57.6% year-to-date. The fund invests in the Indian small- to mid-cap space through a private equity-like process, with up to 10% of assets invested in p.e. deals and 30% are in private investment in public equity transactions. Its performance was driven by strong price performance in its top holdings, according to managing director Gautam Prakash. “In fact, five of our top 10 names were each up over 20% for the month,” Prakash wrote in his latest investor letter. For example, a textile concern in the fund’s portfolio saw revenues grow by 120%, tripling its profits from a year ago. “These results stunned analysts given the strong headwinds (rupee appreciation and intense competition by lower cost countries) faced by the garment textiles industry,” Prakash wrote. “In fact, most competitors, including those backed by some other private equity and hedge funds, reported weak numbers: Gokaldas Exports reported a 50% drop in profits while Celebrity Fashions reported revenue growth of only 30% and negative profits.” The firm recently reopened the flagship offering in an effort to garner an additional US$200 million in assets, after which it will again close its doors to new investors. ( Fin Alternatives)   more »

The rapid growth of hedge funds in emerging Asia was underscored by their increased activity in the highly volatile and opportunistic credit markets of China and India, according to a study released today by the financial services industry consultancy Oliver Wyman. Nearly 80% of the largest Asia-focused hedge funds are investing in China and India's credit markets, reflecting the growing importance of the Asia Pacific region to the $2.5 trillion hedge fund industry worldwide. The study, which gauged the market and product preferences of Asia-focused hedge funds active in credit markets, revealed that trading in certain products is limited by low liquidity, but that fund managers expect a steady maturation of the credit market throughout the region. The investment preferences of 60 of the largest Asia-focused hedge funds were examined for the study. The study also shows that, in addition to trading a range of credit products, Asia-focused hedge funds are investing heavily in special situations and private placement deals, indicating growing confidence in the financial prospects of an array of the region’s emerging corporations. “A favorable environment for hedge funds continues to develop in Asia,” said Bradley Ziff, director of the hedge funds advisory practice at Oliver Wyman. “Not only are there more than 600 funds domiciled in Asia, but hedge funds have become an important part of the capital equation that is central to the growth of Asian economies.”   more »

The U.S. dollar is hitting new lows against a basket of currencies, the oil price is rapidly approaching the $100 mark and now Credit Suisse is warning that falling gold production could cause a “quantum upward change” in the price. A perfect storm of bullish factors for gold as it approaches the all-time high of $850. “Our studies indicate in the long term global gold production will begin to decline as the diminishing number of new reserves fail to compensate for dying mines,” noted David Davis, a research analyst at the bank, in the most recent “Gold Note.” Last year, South African gold output fell to 275 tonnes, down from 296 tonnes in 2005; U.S. gold output declined from 262 tonnes to 260 tonnes; Australian production fell to 251 tonnes from 263 tonnes; Peru production declined to 203 tonnes from 207 tonnes; Russian gold output dropped to 152.6 from 156.6 and Canadian output fell from 118 tonnes to 104 tonnes. In fact, China was the only major producing country to increase production, from 224 tonne in 2005 to 240 tonnes in 2006. Even though the country’s production is set to increase again this year, already up 13% from last year, production from South Africa, Australia and the U.S. is forecast to further decline in 2007. “The decline in global gold production will likely be accelerated, should the gold mining industry continue to incur significant year-on-year inflation rates which are not offset by similar or significantly higher gold price increases year-on-year,” said Davis, alluding to the impact of cost increases on marginal mines. Global production for gold peaked in 2001 at 2,604 tonnes or 83.7 million ounces. With 2006 production at 2,467 tonnes, annual gold mining supply has fallen 4.4 million ounces in five years. Since 2001, prices have more than tripled from $260/oz. In addition, the World Gold Council forecasts increased jewellery demand from India in 2007, which accounts for nearly 40% of all global gold jewellery demand - with jewellery demand making up 70% of the global gold demand.   more »

Foreign institutions keen to register themselves as FIIs in India are grappling with a tricky question: Can they set up an ‘investment holding company’ in Mauritius to enter India? While this is a tax-friendly and convenient route, and the investment vehicle can be put in place within a few weeks, there is a question mark on whether this would be adequate under the present regulations. Such a downline investment company would be handy for entities based in Delaware and Cayman Islands and other jurisdictions. However, it is feared that an investment holding company based in Mauritius may not qualify for FII status. It may still be acceptable to set up a proprietary sub-account or a sub-account with an FII, but there are doubts whether the investment entity would be recognised as an FII. "We are awaiting more clarity on the issue. While the present regulations don’t provide for any such category, we need to find out whether an investment holding company will be eventually treated as an eligible entity," said legal & tax counselling firm Nishith Desai Associates’ Suneet Barve.   more »

If the surge in dollar inflows continues and there is pressure to keep rupee appreciation in check, it is expected that the government/RBI could further monitor inflows, including those into real estate, lower domestic rates to encourage inflows and propose more measures to encourage outflows, according to Citigroup. Curbs on capital inflows have remained top policy priority. The various measures to rein in flows this year include tightening the norms for external commercial borrowings, encouraging dollar outflows and the P-note proposals. SEBI’s approval of the draft circular on P-notes comes on the back of strong trends in capital inflows and is an attempt to temper the pace of rupee appreciation. Following the 50 basis points cut in the Fed funds rate, forex reserves have risen by $57.5 billion during the fiscal year while portfolio flows have surged by over $15 billion. As a result, the RBI has been taking a number of measures such as encouraging outflows, as well as raising the limit of issuance of market stabilisation bonds.   more »

Have you heard of the infamous double play that hedge funds used to bring Hong Kong’s economy to its knees in 1998? India, as it tries to understand the games hedge funds play, could learn from that episode. The Asian economic crisis started in July 1997. Hong Kong had initially done far better than Thailand, South Korea, Indonesia and Malaysia. Till it was attacked using what has come to be called the double play. Here’s how it went. Hong Kong was committed to a fixed exchange rate against the US dollar through a currency board. By the end of 1997, a group of hedge funds thought that they could make a killing by forcing Hong Kong to devalue its currency. That’s what they had done successfully in many Asian countries in the preceding months. What they did in Hong Kong was more complicated. In early 1998, the hedge funds built up their armoury by swapping US dollars for Hong Kong dollars. They then shorted the stock market in a sudden coordinated attack, both in the cash and futures segments. They followed it up by shorting the Hong Kong dollar as well. The Hong Kong Monetary Authority (HKMA) was forced to increase interest rates all the way up to 280% to defend the fixed exchange rate. That brought down the stock market. The short sellers made a killing. Meanwhile, the Hong Kong dollars that the hedge funds had collected in the swap market started earning them usurious rates of interest.   more »