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Old Lane to raise stake in KVK Energy

Citigroup-owned hedge fund Old Lane is increasing its stake in KVK Energy & Infrastructure in a deal worth Rs 116 crore, a person

directly involved in the transaction said. Old Lane will invest by subscribing to compulsorily fully convertible debentures of the Indian infrastructure development company. After conversion into equity, the total foreign direct investment in privately held KVK Energy & Infrastructure will rise to 70% from 33%.

KVK Energy & Infrastructure, with interests in power projects and a construction firm, is the holding arm of a number infrastructure ventures of the Hyderabad-based KVK Group. The hedge fund had announced an investment of around $26 million in November 2007 to buy a significant minority stake in the Indian firm. In early 2008, KVK Group had planned to raise $100 million through a Mauritius-based entity S&S Infrastructure.

Source: Economic Times

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Hedge Fund Garners $11 Mln for Buying India’s ‘Slumdog’ Stocks

An India-focussed hedge fund, which owes its name to this year’s Oscar winner for the best song, has garnered $11 million for buying Indian stocks which are ‘slumdogs’, but with potential to become ‘millionaires’.

The money has been raised by ‘Helios India Jai Ho Fund’ named after the theme song of the movie ‘Slumdog Millionaire’ that scooped eight Academy Awards this year— and would be invested in the stocks that are like slumdogs of the market, but could gain significant value over time.

The fund, launched by Singapore-based Helios Capital Management, seeks to replicate the storyline of worldwide box office hit, wherein the protagonist rises from Mumbai slums to become a millionaire after winning a television quiz show.

According to a regulatory filing with the US Securities and Exchange Commission, the fund has already raised $11 million from 14 investors and plans to tap more investors. As per the filing, the minimum investment expected from an investor is 100,000 dollars and the offering is expected to last for more than one year.

However, the capital raised so far is well below the targeted $50 million by the end of July. The fund is aiming to tap investors in the US, Europe and the Middle East.

The managers of the fund are looking to invest in “Indian stocks that have recently got ‘Beaten Up and Cheap’ with strong long-term growth prospects”. The fund is not charging any performance fee for the first three years.

Helios Capital was founded by Samir Arora, a fund manager and former Chief Investment Officer at Alliance Capital Mutual Fund, along with some of other Alliance Capital executives.

Arora, who had been associated with Alliance Capital ever since its foray into Indian MF market in 1995, had become a sort of poster boy of Indian mutual fund industry.

He resigned from Alliance in August 2003 to join mutual fund business of former Standard Chartered banker Rana Talwar-headed SabreCapital. Around the same time, market regulator SEBI barred Arora from dealing in the market for five years on charges including conflict of interest.

This charge was related to Arora making a bid along with Henderson Global Investors for buying the fund house.

In its order, SEBI said that when Alliance Capital planned to sell its stake in the asset management company, Arora tried to thwart the bidders to favour Henderson Global Investors and Henderson buying the fund would have resulted in a personal gain of nearly Rs 30 crore to Arora. However, the Securities Appellate Tribunal exonerated Arora of all charges, as it found nothing wrong with a fund manager making an offer to buy a fund. The fund house was sold to Birla Sun Life MF in late 2004.

Source: India Journal

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Hedge Funds Post Best Performance Since February 2000

Hedge funds returned an average 5.2 percent in May, the best performance in more than nine years, as they attracted more money and global markets rallied, Eurekahedge Pte said.

The Eurekahedge Hedge Fund Index, tracking more than 2,000 funds, has advanced 9.2 percent this year, according to a preliminary report by the research firm based on the 27 percent of funds that reported May performance. The industry recorded net inflows for the first time in 10 months in May, gaining $1.5 billion, while total assets rose by $5 billion, the report said.

“Numbers of this magnitude clearly won’t last, but I do think the industry will have a very good year,” said Peter Douglas, principal of GFIA Pte, a Singapore-based hedge-fund consulting firm. “What we like at the moment is equity long- shorts, and Asia is an equity story.” Long-short equity funds bet on rising and falling stock prices.

Hedge-fund managers are outperforming global benchmarks after posting the worst year on record in 2008. Eurekahedge’s global index slid 12 percent last year, the most since the Singapore-based firm began tracking data in 2000. The MSCI Asia Pacific Index rose for a third month in May, advancing 12 percent in its longest stretch of monthly gains since July 2007.

Hedge funds are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether asset prices will rise or fall.

Recovery Hopes

Signs that the global economy may be recovering have fueled the stock-market rally. Japan’s industrial output rose the most in 56 years in April, while India posted economic growth of 5.8 percent in the first quarter, beating economists’ estimates. In the U.S., the Conference Board said May 26 that its index of consumer confidence surged to 54.9, the most in six years.

Eurekahedge’s seven regional indexes all rose in May. Hedge funds investing in Asia were the best performers, jumping 9 percent, on the back of regional equity-market rallies, the firm said. An index measuring emerging-market hedge funds advanced a record 8.5 percent, the report said.

The Rab-Pi Asia Fund Ltd., run by Alain Barbezat and Caesar Luk at Rab Capital (Asia) Ltd., returned 2.9 percent in May, bringing its year-to-date advance to 5.9 percent, according to a letter to investors. The gains were driven by advances in Chinese and Hong Kong stocks.

The Riley Paterson Asian Opportunities Fund, a long-short equity fund, rose 8.6 percent last month. The fund’s assets have more than doubled this year to $45 million as of May 29.

Japan Managers

The Eurekahedge Japan Hedge Fund Index gained 4.2 percent in May. Myojo Japan Long Short Fund returned 1.4 percent in April in yen terms, bringing its year-to-date gain to 15 percent.

Sparx Japan Stocks Long Short Fund, also known as “Best Alpha” and run by Sparx Group Co., Asia’s biggest hedge-fund manager, returned 2.2 percent in May, according to the company’s Web site.

The Japan Macro Fund, managed by Singapore-based Asia Genesis Asset Management Pte, was up 0.61 percent last month, bringing its year-to-date return to 21.85 percent, according to the firm.

Hedge funds attracted $3.2 billion in May, based on the preliminary data, offsetting redemptions of $1.7 billion, according to Eurekahedge. The industry’s assets were about $1.3 trillion at the end of May, compared with a peak of $1.95 trillion in June 2008, the report showed.

All nine Eurekahedge measures tracking different hedge-fund strategies rose. Event-driven funds, investing in companies such as those involved in mergers and acquisitions, jumped 7.2 percent, making it the best performer, the report showed. The index tracking the long-short equity funds followed, climbing 6.7 percent. Funds investing in distressed debt gained 2.4 percent, the smallest gain among all strategies.

Eurekahedge plans to release a full report later this month.

Source: Bloomberg

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India to Launch Interest-Rate Futures

India will introduce exchange-traded interest-rate futures to provide a mechanism to institutions and households to hedge their interest-rate risks.

The contract will have 10-year government bond with a 7% semiannual compounding notional coupon rate as the underlying security, the Reserve Bank of India and the Securities and Exchange Board of India said in a joint report on interest-rate futures.

The size of a single contract will be 200,000 rupees ($4,196) and the maximum maturity of the contract will be 12 months, it said.

The contracts will be traded on the currency derivatives segment of a recognized stock exchange, the report said.

The contract cycle will consist of four fixed quarterly contracts expiring in March, June, September and December.

The gross open positions of a client across all contracts shouldn't exceed 6% of the total open interest or 3 billion rupees, whichever is higher. For a trading member, the gross open position shouldn't exceed 15% of the total open interest or 10 billion rupees, whichever is higher.

Interest-rate futures will allow market participants a system to gauge the effectiveness of different positions and strategies for managing their risks, the report said.

Also, the system will provide transparency and eliminate counter-party risks by ensuring the guarantee of a clearing house, it said.

Source: WSJ

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Hedge Fund Managers Cautious : focus on China and India

Better fasten those seat belts, investors, because if hedge fund managers have any insight at all, the credit crunch and market turmoil may not be over yet. About 800 gathered for the GAIM International hedge fund and alternative investment event in Monaco. A year ago, with 1,000 in attendance, the conference was kicking off just as markets were starting to fall apart, with the biggest slump yet to come. Of course, it should be noted that hedge funds have been blamed by many for contributing to last year's financial mess. As for the look ahead, a survey of attendees by conference organizers revealed that 65% of those polled expect the crisis to “rumble on,” with just 17% saying it was over and that same amount expecting the crisis to diminish significantly. 

It was an almost even draw for the question about whether market volatility has permanently jumped higher or not. Of those polled, 54% said yes, while 46% said no. Their biggest concerns, in descending order, are market liquidity, lack of alpha, risk management and counterparty risk. Russell Abrams, founder and senior portfolio manager of Titan Capital Group, which manages hedge funds using volatility arbitrage strategies, said 2009 could shape up as mirroring 2008 somewhat. Overly optimistic earnings expectations for the second half could be one big catalyst, he said. “The second half of the year has built in very high expectations and if they're not met, we're going to see nervousness that is going to move very rapidly,” said the New York-based Abrams. The other catalyst that markets will be looking for, he said, is signs that Federal Reserve Chairman Ben Bernanke may not be nominated for a second term. President Barack Obama has praised Bernanke for his efforts in the financial crisis but has been mum on whether he'll reappoint the Fed chief. Investors can protect themselves the next time around, he said, by understanding that they need a plan for when an event happens – and need to stick to it. Abrams said their four funds did well because “we know what we do if the stock market falls 5%. Our basic investment advice to anyone is if you don't know what you'll do if the stock market falls 10%, you shouldn't be in the stock market,” he said. “What they need to know is the higher people's expectations of volatility, the more it becomes a self-fulfilling reality – once you have an expectation of wider moves, they will be occurring,” said Abrams. “People are still very complacent in terms of not doing the research themselves to know what's really going on.”

   Talking Strategies  

The GAIM poll revealed that managers are focusing strategies over the next 12 to 18 months on distressed securities, global macroeconomics – based on primarily on overall economic and political views of various countries – and commodity trading advisers, or CTAs – funds that trade futures on raw materials. Abrams has two types of funds that trade volatility: One has an absolute return strategy, while the other is a defensive bias fund set up to do much better if there is a crisis. He said a lot of volatility is now priced into the stock market, meaning he's looking elsewhere for returns. “We're seeing a lot of opportunity in the currency space, a lot of countries' currencies are perceived as very stable. We don't know what the catalyst will be. Historically, if the U.S. ever starts raising rates, it creates tremendous pressure on emerging market countries. They have to raise their rates and it hurts their economies,” he said. Most affected, he said, would be Eastern Europe and highly leveraged countries where there seems to be no way out of the mess without devaluing the currency. He notes that forward markets are pricing in a devaluation of 50% for the currency of Latvia, one country hard hit by the financial crisis. Seppo Leskinen, the London-based chief investment officer of Skandinaviska Enskilda Banken, said emerging currencies are a big theme for him as well. He runs the SEB Multi-Manager Currency Fund and said they've had a bias toward emerging markets the past two years. As for the major currencies in the short term, he said the dollar will benefit as stimulus efforts begin to kick in: “I feel once [stimulus efforts] they start to bite, the American economy is ready to go and could go really, really strongly.” But for the longer run, Leskinen said, the strength is not that convincing. “I think the shift of the world's economies has gone to China and India and these BRIC (Brazil, Russia, India and China) economies. They are the new economy superpowers in the economic world. “I wouldn't be surprised if in five to 10 years from now, China's currency is freely floating so these countries are still very tiny but the shift of the investments will continue to go that direction very strongly and then the same has to happen in the currency markets,” said Leskinen.

   Looking At Credit 
 

Neal Neilinger, the Stamford, Conn.-based vice chairman of Aladdin Capital, said that looking at the broader market, he doesn't expect the second half of the year to be as good as the first half. “But I also wouldn't say I'm negative. We will see probably a leveling off of the market and maybe from today, slightly up from where we are today.” He said big issues for the hedge fund conference have centered on transparency, liquidity procedures and due diligence – logical given what happened at the end of last year. “I think that the tone is cautiously optimistic. I think investors are looking for ideas, looking for ways to deploy capital, but they're looking to do it in a very directed and strategic approach. They're not coming here to find out what they want to do; in most cases they know what they want to do.” Neilinger, whose firm has traditionally operated as a fixed-income manager, said he still believes in credit as an investment idea. “Yes, it's had a big run since the beginning of the year, but it's still far cheaper than it was toward this time last year, so I do think there's value in it and I do think you can deploy capital intelligently right now whether it be on some of the higher-yielding names, which offer still very wide spreads – even in the high-grade investment range, which still is attractive,” he said. Neilinger sees big interest returning to the corporate credit markets and likes non-investment grade, leveraged loans and distressed debt. New issue markets are having record years in terms of volume in the U.S., and Europe investor demand is tremendous, he said. “Every deal that gets priced is many times oversubscribed. In some cases when a deal gets launched, it's oversubscribed in less than in less than 20 minutes,” Neilinger observed. 

“We're now back to being able to do non-investment grade bond issues, which for all intents and purposes last year was closed, and leveraged loan markets are starting to wake up again. We're seeing the beginning of some of the sponsors being able to do bond deals again.” He notes that those deals have to be well-priced transactions and well structured. While cautious on auto-industry suppliers and some retailers and airlines, he says oil or gold-type companies seem to be holding up a lot better and probably have better prospects. “You still have to be very careful about how you select what you're going to invest in. … We find there are opportunities still to pick up individual names and credits at spreads that are attractive and avoid pitfalls of buying companies that are in a more precarious position.” Again, caution is the byword for Neilinger, something that would probably ring resoundingly well with most of those present here this week. “You can explain to your boss once why you lost money in credit. I wouldn't want to be there the second time,” he said.

Source: WSJ

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Hedge Funds are back

Asia-based hedge funds will see a turnaround in inflows in the third quarter as investor confidence returns, but new players may still struggle on concerns over risk controls in the scandal-hit industry.

Like their counterparts in Europe and North America, Asian hedge funds have suffered heavy redemptions since Lehman Brother's collapse in September and the Madoff fraud spooked investors and spurred a retreat to safer assets.

But the pace of withdrawals is slowing, and several industry players predict Asian hedge funds could see net inflows during the second half of 2009, judging by expressions of interest by potential investors and requests for research and due diligence.

“Appetite for risk will progressively resume, with new fresh money flows poured to emerging countries as investors' confidence is restored,” said Aureliano Gentilini, global head of hedge fund research at Lipper, a unit of Thomson Reuters.

He said inflows to Asian funds will be helped by new asset allocation models adopted by Calpers and other U.S. pension funds that will shift more money to alternative investments.

Asian hedge funds could see a faster turnaround in inflows than their U.S. and European counterparts, boosted by expectations that the region will recover more quickly, a positive outlook for commodity prices and investors' preference for the simpler equity long/short trading strategies more popular in Asia.

“We are very positive on the outlook for new inflows into our funds since our strategy is performing well and the outlook for systematic fundamental equities long/short like ours is excellent at the moment,” said Frank Holle, co-founder of the Singapore-based Quant Asset Management, a fund manager that uses computer models to invest.

OUTFLOWS SLOWING, PERFORMANCE IMPROVING

Asian hedge funds saw net outflows of $3.2 billion (1.95 billion pounds) in April following withdrawals of $18.3 billion in the first quarter and $24.4 billion in the last three months of 2008, according to fund tracker Eurekahedge.

The outflows resulted in around 180 fund closures among Asian-themed funds last year compared with about 100 entrants. An estimated 30 Asian funds have been launched so far this year compared with about 40 exits.

The pace of the stock market rally since early March favoured flows into exchange-traded funds or ETFs, which are designed to deploy cash immediately, rather than into hedge funds, said Samir Arora of Singapore-based Helios, a hedge fund that invests in India.

Asia-Pacific stocks excluding Japan are up more than 50 percent from their March lows.

Ankur Samtaney, senior analyst at Eurekahedge, said he expects Asian hedge funds to see net inflows from the third quarter, following three months of gains that have seen funds return an average 13 percent this year.

Asia's largest hedge funds include the Tokyo-based Sparx Group, Hong Kong's Value Partners and Singapore's Artradis, which each have billions of dollars in assets under management, according to Alpha Magazine. They are joined by hundreds of smaller firms including some set up by laid-off bankers using their own savings.

But while a turnaround is in sight for older and established Asian players that survived the sharp downturn in the hedge fund industry last year, new entrants will find it tougher to attract money and must incur higher costs to meet the more exacting requirements of would-be investors.

Many hedge funds lost money and put up “gates” to prevent redemptions last year, and potential investors now want newcomers to demonstrate not just a good trading record but also show they have robust risk management and internal controls in place.

Some former star bankers and traders who have struck out on their own take with them experience and strong reputations as money makers, but even that is no guarantee of success.

“You don't run a portfolio as you run a trading book,” said Nathanael Benzaken, managing director for hedge fund research and selection at Lyxor Asset Management.

“You always have to get the evidence that they are able to run a fund and control a risk.”

These safeguards include appointing separate fund administrators as well as setting up managed accounts to ensure a client's money is not tied up with those of “weaker” investors who might force hedge fund to sell assets at distressed prices.

Such systems cost money, and it is harder to outsource back-end and other supporting functions in Asia relative to Europe and North America, said Richard Yin, chief investment officer at Hong Kong asset manager First Vanguard.

Lipper's Gentilini estimates that in a post-Madoff era, new funds may need $250 million in assets under management to generate enough fees to cover the overheads needed.

“The quality of some of the new launches is incredibly high, but raising seed capital has been difficult and the size of most of these new funds will be less than $20 million in the main partner's personal capital,” said Harvey Twomey, Deutsche Bank's head of global prime finance sales for the Asia Pacific.

“Allocators can afford to wait a few quarters to assess early performance and operations,” he added.

Source: Reuters

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Helios sees India reform push lifting infra, banks

Hedge fund Helios Capital has overweight positions in Indian infrastructure and bank shares as it hopes the Congress-led government's election victory will expedite reforms and boost growth in Asia's third-largest economy.

State Bank of India, the country's largest, state-run Punjab National Bank, Crompton Greaves and Alstom Projects are part of Helios' holdings, and fund manager Samir Arora said it could buy more.

“If you are playing the stability or policy or better government or reforms, then it has to be basically these two sectors,” Arora, who manages nearly $200 million in Indian equities at the Singapore-based firm, said on Friday.

“This is where the maximum shortages are and where maximum policy decisions could be made,” he told Reuters by telephone.

India has estimated it needs $500 billion over the five years to 2012 to upgrade its overwhelmed airports, potholed roads and inadequate utilities but has lagged behind in making critical reforms needed to do so.

Arora is enthused by the prospects for reforms after Indian voters gave the Congress-led government the most decisive mandate in two decades. The previous Congress government needed support from Left and communist parties, who blocked planned reforms.

The BSE Sensex surged 17 percent on Monday on expectations the Congress win would open the way for reforms such as raising the foreign investment limit in the insurance sector and opening up the pension system to foreign participation.

Arora said a slower-than-expected pace of reform was a risk to the rally, but Congress' efforts not to cede critical cabinet posts to coalition allies showed it was serious. 

“It's extremely positive that the Congress is not trying to do things in the old ways,” he said.

While expecting banks and infrastructure would do well, he was underweight stocks in the pharmaceutical, consumer and technology sectors.

“They (government) can't definitely change pharma's fortune, and mostly they can't change consumers fortune,” Arora said, adding a stronger rupee was a threat to export-driven technology companies.

Economic growth in India is expected to slow to a seven-year low of about 6 percent in 2009/10 (April/March), down from an expected growth of less than 7 percent in 2008/09, and rates of 9 percent or more in the three previous years.

Source: Reuters

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Sovereign wealth funds bullish on investing in India

After overseas pension pools and foreign portfolio funds, it’s now sovereign wealth funds that find India an irresistible investment destination. Governmentpromoted investment funds of various countries have invested close to Rs 14,850 crore during the eight-year period beginning 2000, according to a report released by the United States Government Accountability Office.

Sovereign wealth funds are typically state-owned investment funds that have a global invesment horizon and are sometimes owned by central banks of countries.

Though SWF investments into India during the considered period is fractionally lower compared to peers such as Thailand and Indonesia, investment consultants in India say that SWFs have started looking at Indian assets more seriously over the past few years.

From a couple of SWF investments until 2004, to more than nine funds with direct investments in Indian asset classes at March-end 2009, the trend is growing.

Kuwait Investment Authority’s investments in Chryscapital and ICICI Venture Funds, Malaysia’s Khazanah Nasional’s 9.9% shareholding in IDFC, Government of Singapore’s 6.3% holding in Anant Raj Industries, the Palestinian Investment Funds’ 50% stake in The India-Oman Special Investment Fund and Temasek’s 8.3% and 5% equity shareholding in ICICI Bank and Bharti Airtel respectively, are some of the top SWF investments in Indian asset classes, according to a survey conducted by Londonbased research firm Preqin.

India-based experts say that shallow equities markets-low public floats in listed companies and limited asset classes-caps on foreign institutional holdings and cautious investment approaches by sovereign wealth managers are reasons for SWFs going slow in India. “SWFs are large-based funds,” said a Mumbai-based foreign investment consultant.

“They still find India not big enough to set up a research base. They prefer to have exposure in India through investment banks and private equity companies rather than a direct exposure ,” he added. According to the equities head of a US-based investment bank, the Indian government too hasn’t been keen to allow SWFs to invest in Indian assets.

“Though most of them are allowed to invest as FIIs, there is investment cap on almost all investible sectors. The government is keeping caps just to ensure that SWFs pump in money just to make investments and not have any other motives,” the equities head added. Chinese SWFs have recently made inroads by buying resources and under priced assets across the globe, sparking speculation that companies and some small countries could be overselling their assets and also probably cede control over these assets subsequently.

As per numbers collated by United States Government Accountability Office, net SWF investments into India for eight years through 2008 stood at $3.3 billon. This is lower than Indonesia pocketing $4.2 billion (Rs 18,900 crore), Thailand bagging $4.3 billion (Rs 19,350 crore) and China recording a whopping $12 billion (Rs 54,000 crore). Global crossborder SWF investment increased from $429 million in 2000 to $53 billion in 2007.

“It is certainly not the case that there is something inherent in the Indian market that makes it unsuitable for SWF investments ,” said London-based Baer Capital Partners’ founder president Alok Sama. “SWFs are looking for the right assets to make significant commitments to India.

“Recent losses suffered by SWFs in their commitments to global PE funds, hedge funds have led them to be even more conservative ,” Mr Sama added. SWF investments will increase once the Indian market matures.

“It would be fair to say that large global institutional investors are interested in India but its a fringe market yet, said another market participant. Mr Sama said that for such sovereign funds, the value proposition in the Western world is much more compelling… so there is a natural tendency to gravitate toward what they know best,” Mr Sama added.

Source: Economic Times

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India Private Banks' Contingent Liabilities: Losing the Balance?

A recent RBI (Reserve Bank of India) Report shows that India private banks continued to expand their contingent liabilities, or off-balance sheet exposures, in line with the trend seen in recent years. Contingent liabilities of banks in India increased nearly 88.44% to Rs. 144.3 trillion in 2007-08 as more companies rushed to hedge their foreign exchange contracts to tide over the volatility in currency markets. This is over and above the 80.2% growth in off-balance sheet exposures seen in 2006-07.

As a consequence of this significant rise in contingent liabilities, the total off-balance sheet exposure of private banks in India at the end of March 2008 was more than three times the size of their consolidated balance sheet. At the end of March 2007, contingent liabilities stood at double the size of their consolidated balance sheet. Leveraged positions in derivatives as a means of diversifying income and increasing use of derivatives as tools for risk mitigation appear to have contributed to the growth in contingent liability exposures, said the RBI.

Contingent liabilities or off-balance sheet exposures include forward exchange contracts, derivatives for currency swaps and interest rate swaps, currency options and interest rate futures, letters of credit and guarantees. These are called off-balance sheet exposures because they are not directly funded by banks and do not appear on their balance sheets. However, these remain as liabilities on the books of banks, and the commitment needs to be honoured if the client companies fail to do so. Contingent liabilities often do not ever become actual liabilities. However, if they are large they may pose enough of a risk, and could be expected to have a significant impact on valuation.

The level of contingent liability exposure of India private banks has seen significant rise in the last few years, as mentioned before. Just how large an exposure it is for individual private banks, can be seen from the graphic below. HDFC Bank, one of the most reputed and admired private banks in India, leads the pack with an exposure of 445% of total assets, followed closely by Yes Bank, one of the smallest private banks at 405% of total assets. In contrast, the largest bank, the PSU State Bank of India, has been the most conservative with its contingent liability exposure at 92% of total assets.

Looking at this picture, its apparent that contingent liability impact on valuation has been largely ignored for HDFC Bank, probably due to its impeccable and conservative record so far, coupled with its high growth and earning power. But one of the smallest private banks Yes Bank is still suffering on the valuation front probably due in part to the high contingent liability exposure. It must be said in Yes Banks defence, that even if there was an additional provision made for Rs. 100 crores say in FY 2009, given its great NPA levels, its asset quality levels do not deteriorate much and will remain on par with the best NPA levels in the industry. Yes Bank may thus be a price-mismatch bargain again! And on that coin, so would State Bank of India given that its off-balance sheet exposure is the lowest, being less than its total assets. ICICI Bank (IBN) has managed well on this front, but we have seen ICICI Bank's valuation suffer for big concerns on several other important metrics.

Having said all that, just how much of a risk have these huge exposures actually been? What is the quantum of losses that private banks have had to book and/or make provisions for?

Is it possible to derive some measure of the adequacy/inadequacy of derivatives exposure risk management by private banks in India?

Let's see what we have on the derivative losses disclosures front until now, from leading private banks. From the disclosures, it appears that the range of losses and/or provisions for private banks is from 0.02 to 0.05 percent of Total Contingent Liabilities. However, for the PSU State Bank of India it's only about 0.004 percent of Total Contingent Liabilities. Is that a further indication of prudent derivatives risk management by the PSU bank? Read on!

Defaults on contingent liabilities by private banks' clients in India have been common in 2007 and 2008 as companies had rushed to hedge their foreign exchange contracts to tide over the huge volatility in currency markets. Losses for Indian firms mounted in the year to March as their currency derivatives bets soured because of the unexpected appreciation of the Swiss franc and Japanese yen against the US dollar. Many companies had taken bets in these low-interest currencies to protect themselves from the rupee’s gains, which climbed the most in more than three decades against the dollar in 2007. The rupee appreciated by over 12% in 2007, and in 2008-09 has depreciated by over 20%! Under RBI guidelines, any such outstanding contract would be classified as an NPA, 90 days after a default in payment to the bank.

However the level of disclosures with respect to such defaults by clients is not as common. Axis Bank is perhaps the most prominent private bank that was the first to explicitly disclose the quantum of defaults and the provisioning cover made. According to Axis Bank, at the end of March ’08 it had structured 188 outstanding derivatives transactions in which the banks clients had aggregate MTM losses of $168 million or Rs 674 crore (70 transactions in which bank's clients had aggregate MTM profits of Rs 8.67 crore). Explaining the details of the provisioning, the bank said, of the 188 transactions with MTM losses, 6 have been repudiated by two clients, involving an MTM loss to the clients of $18 million or Rs 72 crore. The two companies have gone to court over these cases. Axis Bank had made full provision of Rs. 72 crore for these losses. That amounts to 0.03 percent of Total Contingent Liabilities for FY 2008 standing at Rs 258,895.66 crore.

ICICI Bank made additional provisions of around $45 million (Rs 180 crore) for mark-to-market losses (MTM) on its credit derivative obligations (CDOs) and credit-linked note (CLN) portfolio during February and March 2008. This takes the bank's total provision for these instruments to $170 million (Rs 680 crore) during the year, which amounts to 0.05 percent of Total Contingent Liabilities for FY 2008 standing at Rs 1,250,595.22 crore. Asked about the cases filed by the bank's clients related to the derivative deals, Chanda Kochar, joint-MD said,

Corporates take derivative products to hedge their exposure. Some corporate clients have taken a mark-to-market loss. The bank does not disclose any profits or losses incurred by its clients. There are a few cases which are under dispute and the bank has made adequate provisions for it.

The nation’s largest bank, State Bank of India (SBI), said its customers may have lost as much as $175 million or Rs700 crore because of currency derivatives trading in the year ended 31 March. “We have been in derivatives and have done deals for our own customers with underlying assets,” chairman O.P. Bhatt said on Wednesday. “They made profits a year back. This year, they may make a loss of Rs7 billion.” Bhatt said the bank doesn’t face any court cases from companies on derivative transactions and it won’t set aside funds to cover losses in its earnings for the year ended March. However the bank may also set aside about $10 million (Rs 40 crore) for potential losses because of the meltdown in the credit markets after the US subprime crisis began last year, amounting to 0.004 percent of Total Contingent Liabilities for FY 2008 standing at Rs 945,770.21.

Another private bank, Kotak Mahindra Bank said it had made a provisioning of $21.5 million or Rs 86 crore to cover the mark-to-market (MTM) losses of its clients on account of forex derivative transactions. The bank has around 45 clients, having exposure to forex derivatives, who have suffered MTM losses of $153 million or Rs 612 crore on account of forex transactions as on May 8, 2008. “We carry a provision of Rs 86 crore toward stressed assets. In this regard (exposure to forex derivatives), the bank has no exposure to SME clients,” Uday Kotak, the bank’s vice-chairman and managing director, told reporters.

And what is the position of HDFC Bank (HDB), the most reputed and admired private bank in India? HDFC Bank made a provision of around Rs 100 crore on currency derivative trades. “We have made a provisioning of Rs 172.7 crore for multiple contingencies, including around Rs 100 crore for a possible hit on account of domestic derivatives exposure. We have no exposure in any instruments like collateralised debt obligations and credit linked notes,” said a bank official. The bank, which has been dragged to court by a few customers over derivatives, also set aside a small sum for litigation. “The amount is very small,” said Paresh Sukhtankar, executive director of HDFC Bank. Unlike other banks like Axis Bank and State Bank of India, HDFC Bank has not revealed any mark-to-market losses of its clients. The Rs 100 crore provision on domestic derivatives exposure amounts to 0.02 percent of Total Contingent Liabilities for FY 2008 standing at Rs 593,008.08 crore.

One of the smallest private banks, Yes Bank said that one of its clients had gone to court over a dispute involving a derivatives transaction. Yes Bank has around 130 foreign exchange clients. Most of them are large companies and emerging corporates companies with a turnover in the range of Rs 150 crore to Rs 750 crore. Nearly 70 per cent of the bank’s derivatives exposure is to large companies.The bank said its clients were meeting obligations (for derivatives) as and when the contracts fell due. “The bank has made contingent credit provision of Rs 17 crore reflecting the market environment (due to rising risk) in which it is operating. This provision is not for any specific client, but for future without any actual loss incurred by the bank,” MD Rana Kapoor reiterated. The Rs 17 crore provision amounts to 0.02 percent of Total Contingent Liabilities for FY 2008 standing at 68,899.54 crore.

Disclosure: Long HDB, Short IBN

Source: Donald Francis, Seeking Alpha

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Childrens' Investment Fund sells Indian state bank holdings

The Childrens' Investment Fund, the $9.5 billion (6.5 billion pounds) London activist hedge fund, has liquidated its holdings in Indian state-owned banks, according to the Financial Times, in one of the biggest single selldowns by a foreign institutional investor in the country's stock market.

In the past three months, the fund has sold holdings in eight banks, from state-owned Bank of Baroda to Union Bank of India, the FT reported.

The positions were worth 45.8 billion rupees (620.7 million pounds) at end-December, according to market data.

Enam Securities, a Mumbai-based brokerage, was given the sole mandate to execute the sale, the paper said in an report dated March 20.

TCI bought the stocks three to four years ago, in the early stage of a rally in Indian stocks, the paper said. India's main benchmark stock index .BSESN has lost 7.1 percent so far this year after a 52 percent plunge in 2008 as global markets slumped.

Source: Reuters

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