Infrastructure: an attractive asset class

Infrastructure investment comes up as an attractive asset class in this deteriorating market with big depression loom. A growing number of pension funds worldwide are now attracted to investing in infrastructure. These have several positive features from an investment perspective, concluded by EDHEC Risk and Asset Management Research Center:

Pros:

• The typically very long-term nature of infrastructure investments, some of which are as long as 75 years and can even be regarded as perpetuities, sits very well with pension funds, particularly the ones with a long liability stream of similar duration. This long-term nature is common to both fully privatized entities such as airports or PPP projects where the government has an ongoing involvement.
• The revenues are implicitly linked to inflation, either as a government promise built into regulatory provisions or the business being a basic consumer service which can easily be linked to inflation. Quite often, the charges are increased explicitly with reference to retail price inflation or a wage index and are backed by the government.
• Since infrastructure investments often concern basic consumer or government activities, the cash flows are reasonably stable and have a low elasticity of demand, conferring defensive characteristics.
• They involve monopolistic or quasi-monopolistic activities, and at the least the large scale of the investment required represents a strong barrier to entry.
  

Cons:

• In the primary phase, failure by the contractor to meet time, cost and performance targets can lead to penalties
• Regulation is the most important risk at the secondary stage.
• Political risk. For example, investors need to rely on deals made with the government being honored. For instance, if a thirty-year agreement is entered into and the government, possibly a new one, pulls out, then recourse to court should be possible.
• Physical risk e.g. earthquakes, landslides.
• Interest rate risk. PFI and PPP deals are often highly leveraged. Any rise in interest rates would therefore directly affect borrowing costs. It could also lead to a higher discount rate being applied to the long-term cash flow from the scheme, reducing the value of the project accordingly.
• Liquidity risk. One of the main disadvantages has been that infrastructure is considered a relatively illiquid investment. But liquidity is expanding significantly as many of the early primary stage investors are now selling out to funds that prefer to invest in established assets with long-term low-volatility investments.
• Capital risk. In some circumstances, the capital value could be at risk.

Banks link loan to CDS

It’s a new move in the credit market. Some banks including Citi and Credit Suisse are tying corporate loan rates to credit- default swaps. It’s reported that Nestle, the biggest food producer, and Nokia, the largest mobile-phone maker and at least other four companies agreed on banks’ demand to link the interest rate on their credit line to the CDS.

The inclusion of the CDS shows that banks are shifting away from setting loan pricing by relying on debt ratings and Libor. This move may leave companies exposed to fluctuations in derivative instruments that not tightly regulated by government.

This transformation is partly due to the concerns that Libor may not truly reflect borrowing costs helped bring about the change. Earlier this year, widespread suspicion arose that a number of banks had been understating the interest rates they were paying, particularly for 3-month money, and that official Libor rates had therefore been falling short of actual rates in the market place. At times the gap was believed to be as high as 30 bps. While millions of borrowers have clearly been better off as a result of the understatement, this small difference translates into billions of dollars collectively for those on the wrong side of the contracts.

Though collusion between the banks was suggested, a less blameworthy reason is more likely. Individual banks were apparently scared of being seen to be paying too much for their loans, fearing that this might spark off questions about their creditworthiness and lead to bigger problems, such as those suffered by Northern Rock and Bear Stearns.

Banks are also seeking to shift from a reliance on credit ratings amid concern Moody's Investors Service and S&P have been too slow to act when credit quality deteriorates.

It also could be regarded as a self-saving measure by banks. It wasn't long ago that banks were basically giving away credit. That could be major reason we're in the problem today. And those days are gone.

Commercial paper market recovered

Sales of longer-term commercial paper soared 10-fold, a sign that the Fed's efforts toward unlocking the market may be working.

The Fed’s move as I wrote in my blog several days ago is helping to free up money for investors to place in other assets and it is also reducing the corporate sector's dependency upon bank credit, freeing up money for the inter-bank market.
The commercial paper market shrunk by $366 billion, or one- fifth, to a three-year low of $1.45 trillion from Sept. 11 to Oct. 22, its worst slump on record. During the last recession seven years ago, the commercial paper market declined 17 percent from its then peak in December 2000 to September 2001.

The surge in borrowing longer-term means more issuers, especially financial companies, will have fewer funding concerns through the end of the year. In money market, LIBOR rate fell another 5 bps today, its 13rd straight decline. This rate has dropped 140 bps since Oct. 10, when it rose to a record high 4.82 percent. Ted spread remains 192 bps, up from 80 bps three months ago.

Sentiment has improved given easing in commercial paper market, money market and measures taken by the central banks. But rates are still not back to normal levels as there's still concern that people would rather keep cash for themselves than blow their balance sheets again as year-end approaches.

Debt-Deflation Theory

A 70 year-old paper by Irving Fisher and its debt-deflation theory still hold water in today’s complex intertwined system of finance.

Yale economist, Professor Irving Fisher is known for a lot of economic principles such as the Fisher Equation, the Price Index, the Phillips Curve, the Money Illusion.

The interesting thing in his bio is that although he did warn of the 'permanently high plateau' of stock prices only a few days before the great crash of 1929, he believed a recovery was just around the corner and as a result, managed to lose most of his personal wealth and his reputation in the multi-year selloff during the great depression. Following the destruction, Fisher analyzed the Great Depression and came up with his debt-deflation theory.

His opinion is that in the great booms and depressions, each of the named factors (over-production, under-consumption, over-capacity, price-dislocation, maladjustment between agricultural and industrial prices, over-confidence, over-investment, over-saving, over-spending, discrepancy between saving & investment) has played a subordinated role as compared with two dominant factors, namely over-indebtedness to start with and deflation following soon after; also that where any of the other factors do become conspicuous, they are often merely effects or symptoms of these two. In short, the big bad actors are debt disturbances and price level disturbances.

The two diseases act and react on each other. Pathologists are now discovering that a pair of diseases are sometimes worse than either or than the mere sum of both, so to speak. Just as a bad cold leads to pneumonia, so over-indebtedness leads to deflation.

And, vice versa, deflation caused by the debt reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes. In that case, the liquidation defeats itself. While it diminishes the number of dollars owed, it may not do so as fast as it increases the value of each dollar owed. Then, the very efforts of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. The more the debtors pay, the more they owe.

The following table gives a logical order of nine events of a depression, with reaction and repeated effects:

China and Hong Kong market U-turn?

Before this crisis, I've paid less attention to technical anlaysis. However, in current abnormal enviornment, as fundamentals are ruined, techonical analysis might be a bright spot to read the market.

The following two charts tell us China and Hong Kong markets are about to have a nice rally in short term. Let's see what will happen. Hopefully this signal would help restore the confidence a little bit.

IMF dosen't forget Emerging Markets

Emerging markets are victims of this crisis not of their making and beyond their control, investors are selling emerging-market stocks, bonds and currencies as the rout that began with the collapse of U.S. subprime mortgages last year pushes the world toward a recession and lowers the price of commodities that sustain developing economies.

The emerging countries with the biggest falls are the economies that were most connected to developed nations. Hungary, Poland and other eastern European countries will be hit most severely.So where is the IMF - the one played an important role in the ’98 Asian financial crisis?

Actually the demand for the fund's emergency loans had dried up over the past five years as developing nations boomed – but now is soaring. Hungary, Ukraine, Belarus, Iceland and Pakistan have all announced this month that they are seeking financial support from the IMF, and the IMF is considering loans of up to five times the quota contributions of member nations, in an unprecedented effort to avert an economic collapse in emerging markets.

Emerging market central banks have been left out of agreements between the U.S. Federal Reserve and its European and Japanese counterparts to provide unlimited funds of dollars to stabilize money markets. What a BAD story!

Hedge funds, politics and market crash

Some investors benefited handsomely from this credit crisis. Hedge fund manager John Paulson personally has made billions of dollars over the last two years from the collapse of the subprime mortgage market.

Who else may have benefited? George Soros for one. Soros is a legendary hedge fund manager who has become a political powerbroker of unrivaled influence within the Democratic Party. It’s reported that Soros invited Paulson for lunch. Soros has refused to answer questions from the Wall Street Journal about his now infamous lunch with Paulson. This is somewhat surprising silence from a man well known for his loquaciousness. And his relative, Peter Soros, directly invested with Paulson.

George Soros was a very early and influential backer of Barack Obama. He is a very prescient investor. Hedge funds have been a big source of the problems besetting the market. Heavily leveraged, they have had to sell vast quantities of securities to meet margin calls as well as fund withdrawals from investors.

Democratic Senators of New York have been in the forefront of protecting hedge funds. Senator Schumer was among the Senate Democrats who recently led the fight against taxing hedge funds at a higher rate. The Democrats are far from alone, however. The effort to rein in hedge funds was led by Republican Senator Charles Grassley.

Hedge funds are a major source of donations for Democrats. The Democratic Senatorial Campaign Committee, which Schumer heads, received $779,100 from employees of private-equity head funds in June 2007, far exceeding the $60,000 received by the Republican Senate Committee.

Senator Chris Dodd is a "beloved advocate of many of the hedge funds housed in his state" and has benefited mightily from donations from these hedge fund managers. He is the head of the Senate's powerful Banking Committee that helps draft legislation regulating hedge funds.

It seems that Obama was just lucky that a market slide seems to have decisively swung the campaign in his favor. That Obama was again lucky that the meltdown occurred just as John McCain was overtaking him in the polls. And that Obama simply lucked out that one of his most influential supporters, one of the world's most adept fund managers (as the Bank of England learned the hard way) also benefited from the meltdown in the markets.

Close eyes on money market funds

The Federal Reserve announced yesterday would provide up to $540 billion in loans to help relieve pressure on money-market mutual funds beset by redemptions.

The initiative is the third government effort to aid the funds, which usually provide a key source of short-term financing for banks and companies. Last month, the Fed agreed to give loans to banks so they can buy back asset-backed commercial paper from money funds. There was $122.8 billion of such loans outstanding as of Oct. 15. The Treasury separately used a $50 billion emergency pool as well.

How important is the money market funds for U.S. credit market? U.S. money-market funds held more than 63 percent of outstanding unsecured commercial paper and 39 percent of asset- backed commercial paper at the beginning of September. If this source dries up, U.S. banks and companies have to shut down in a considerable number.

What the Fed and the Treasury did is to give a liquidity buffer to credit market, and ultimately avoid the “Great Depression II”. But it will take a lot of pressure off the Fed and the Treasury. Once their balance sheets keep deteriorating, the next shoe to drop is Treasury bills! United States of America will go bankruptcy!

TIPS broken

TIPS fell 7.85 percent since June as investors shunned all but the most easily traded debt amid the seizure in credit markets. TIPS were the only part of the U.S. government bond market to lose money in that time as Treasuries of all maturities gained 2.11 percent. TIPS make up about $520 billion of the $4.8 trillion in U.S. marketable debt outstanding.

Fed officials watch the TIPS market for signs of inflation expectations. The slump of TIPS reflects the dire economy. The inflation rate will fall below 1 percent by the second half of next year as the economy lapses into a recession.

But some institutions including BlackRock Inc., Brown Brothers Harriman & Co., DWS Investment GmbH and New Century Advisors are buying the securities because they bet that inflation will likely increase at a faster pace over the next decade than the 1 percent annual rate TIPS yields suggest. According to the median estimate of 69 forecasters surveyed by Bloomberg, consumer prices, unchanged in September, may increase 4.5 percent this year and 2.65 percent in 2009.

Maybe it’s not a good time to bottom fishing the U.S. equity but a good time to bottom fishing TIPS?

Is Japanese stock too cheap to buy?

The entire Japanese stock market is left trading close to book value at levels, in real terms, equating to where it traded in the early 1970s.

I remembered at the beginning of this year, some investors already paid attention to cheap Japanese market on the Journal. But the truth is, it never stop heading south in the entire 2008.
Nikki reached its nominal all-time high of 38,957 in December 1989; it closed on Oct. 21 at 9306, 76% down from the peak and just 800 points or so north of its 2003 low.

An interesting point is that Japan, of course, knows what it's like to go through a credit crisis and a vicious deleveraging -- and it’s had two decades to reconfigure itself into a viable post-crisis economy. Which is not to say that Japanese stocks are a screaming buy right now, but which is to say that if you think that stocks in the US are cheap, maybe you could look across the Pacific and find some equally-attractive assets which are even cheaper. Or, to put it another way, the lesson of Japan is that even cheap stocks can continue to decline for decades.

I will keep eyes on Japanese stocks anyway. Japan's companies are well-run, and its financial institutions, as we saw with the MUFG deal, are today more part of the solution than they are part of the problem.

Hedge funds are hurting

The data is from CS/Tremont index. It shows that September was a difficult month for hedge funds across strategies. Convertible Arbitrage was the worst performing sector, finishing down 12.26%.

Also according to the data released the other day by Hedge Fund Research, steep performance losses and record investor capital redemptions reduced the size of the hedge fund industry by $210 billion in the third quarter of 2008. Investors withdrew over $31 billion. Total industry capital industry stood at $1.72 trillion, down from $1.93 trillion at the end of second quarter.

The third quarter withdrawls entirely offset the capital inflows into hedge fund during the first half of the year, bringing YTD net capital flows to a negative $2.5 billion. The decline in industry assets also exceeds the entire amount of investor capital inflow from 2007, which was a record $194 billion.

Funds of Hedge Funds also experienced performance losses and investor capital outflows in the third quarter, with these declining by 9.68 percent for the period and 11.82 percent for the year. Total capital invested in Funds of Funds fell by approximately $78 billion as investors withdrew $13.3 billion from Funds of Funds during the quarter.

The third quarter outflow from Funds of Funds partially offsets the capital inflow experienced in the first half of the year, and year-to-date inflows for Funds of Funds now total just under $10 billion, while total capital invested in Fund of Funds stands at $747 billion.

What a bloodbath to hedge funds!

Hedge funds face Darwinian Rule

Hedge funds are the Galapagos islands of the financial services industry, with participants following Darwinian rules. After periods of relative stability they will undergo periods of intense change as participants evolve to take account of new realities.

For much of this decade, hedge funds had appeared to evolve far more nimbly than their brothers in the regulated financial industry. At the beginning of this decade, as the conventional “long-only” equity funds that dominate the retirement saving industry were suffering severe losses in the wake of the bursting of the internet bubble, hedge funds avoided losses. That spurred huge new investments in hedge funds by wealthy individuals. In this decade, they dominate trading volumes and, in the short term, move markets.

What let them survive and flourish? Apart from being small, nimble and, in some cases, smart, they had three key advantages.

Unlike most conventional funds, they can sell stocks or commodities short, to profit from declines in price. They can borrow; a trade that makes not even 1 per cent is worth doing if you borrow enough money to make the same trade 10 times(10x leverage). And they can limit withdrawals by investors, allowing them more flexibility than funds that must be prepared for redemptions every day.

For the first year of the credit crisis that began last July, they remained at least one evolutionary step ahead of the herd. Judged as a sector, hedge funds continued to make money as equity funds lost badly.

But something happened to disrupt the delicate ecology of the Galapagos. Hedge fund indices differ widely but they agree that hedge funds started to lose money in July – and lost it in a big way in September.

Why? This must be guesswork, but a popular hedge fund strategy involved selling short the stocks of banks while betting on energy prices to increase. The argument was that lower rates to combat the credit crisis would feed through into inflation and cause funds to flow into oil. In the year to mid-July, this trade netted 345 per cent. But then the oil bubble burst. Since then, the “long oil short banks” trade has lost 57 per cent.

The end of September gave hedge fund investors one of their periodic opportunities to remove money. It appears many took it. According to Hedge Fund Research, $31bn was yanked from the sector in the third quarter. TrimTabs estimates that withdrawals were even higher, at $43bn in September alone.

Meanwhile, the Lehman Brothers bankruptcy in mid-September prompted a sudden increase in the price of leverage as investment banks on whom hedge funds rely for their short-term funding applied much tighter restrictions.

Then came the ban on shorting financial stocks. All hedge funds’ critical evolutionary advantages had been removed. Once hedge funds cracked, equity markets also cracked, with the MSCI World index falling more than 30 per cent since early September. The “crash” of last week was followed by the most volatile week in history, with huge and utterly illogical swings as funds struggled to reconcile their positions. On Thursday afternoon alone, while oil prices fell, the S&P energy index rose 14 per cent, raising its market value by about $140bn. Hedge funds were the marginal investor.

So this credit crisis help the participants in Galapagos islands crowded out losers. Leverage, as the chart shows, was vital to the eco-system of the Galapagos. Hedge funds’ great outperformance dates from a period when leverage was historically cheap. While markets stayed stable, that leverage made hedge funds look much nimbler than the rest.

2008 Hedge Fund winner and loser

Citic Pacific reported huge loss from currency bets

Citic Pacific Ltd., the Hong Kong arm of CITIC, China's biggest state-owned investment company, said it may lose as much as HK$15.5 billion ($2 billion) from unauthorized currency bets and replaced two finance executives.

A loss of HK$808 million has been incurred from terminating some leveraged currency contracts, and it's sitting on further potential losses of HK$14.7 billion, the Hong Kong- listed company said in a filing. Its parent will provide a standby loan of $1.5 billion.

The loss position is from the company’s bets on the Australian dollar as the currency tumbled 30 percent against its U.S. counterpart from a 25-year high reached in July. Citic Pacific bought currency contracts to fund an A$1.6 billion ($1.1 billion) iron ore mine in Australia. The potential loss of as much as HK$15.5 billion represents almost half of Citic Pacific's market value.

In this global financial turmoil, we will see other Chinese companies may suffer currency losses from their Australian investment. There have been a lot of transactions by Chinese companies, not just banks but mining companies, buying coal and other assets in Australia. The bad thing is most of them don’t have hedging positions against those currency exposures. As the commodity bubble burst, these investments would worth much less than their initial values.

If you wait for the robins, spring will be over

Warren Buffett said he's buying U.S. stocks now and, if prices stay attractive, his personal investments, as distinct from his stake in Berkshire Hathaway Inc., will soon be wholly in American equities.

This is his principle: be fearful when others are greedy, and greedy when others are fearful. While short-term stock-market movements can't be foretold, the likelihood is that the market will recover before the economy or general investor sentiment do so. Referring to the 1930s depression, Buffett pointed out that the Dow reached its record low on July 8, 1932; economic conditions continued to deteriorate until Franklin Roosevelt became president in March, 1933, but by that time the market had climbed 30 percent.

Look at how the market behaved in this credit crisis: the recent market downturn looks brutal
However, looking at that same DJIA data using a log scale, a different picture emerges. It shows that equities appear to have grown above trend since the mid-1990's and may just be reverting back to its long-term average.

My position:
· Ambac Financial (ABK)
· AIG (AIG)
· Goldman Sachs (GS)
· JA Solar (JASO)

Hedge fund is facing severe redemptions

New data just came out from TrimTabs Investment Research: Investors withdrew a record $43 billion from hedge funds in September, the outflows were the most since 2000. Among this withdraw, investors pulled $14.4 billion from funds focused on distressed securities and $8.4 billion from long-short funds.

Hedge funds fell 4.7 percent in September, the $1.9 trillion industry's worst month since LTCM collapsed in 1998, the drop left funds down 9.4 percent for the year.

I believe most of the hedge funds have sold enough equities to cover the redemptions. 40 percent or so cash position is a popular holding strategy for hedge funds after the bloodbath for last year. There shouldn't be more forced fire-selling.

Tiger Cubs

This Monday on CNBC, Julian Robertson, legendary investor and founder of notable hedge fund Tiger Management revealed some purchases he made in the market carnage last week. His buys include:
· Apple (AAPL)
· Microsoft (MSFT)
· Baidu (BIDU)
· Mastercard (MA)
· Visa (V)
· Ryan Air Holdings (RYAAY)

His argument, being a notable value player, was that these equities were trading at very favorable prices. However, at the same time, he curiously noted that he thought the US was just now entering into a period of prolonged recession (possibly 10-15 years). He thinks that this time around, consumers are broke and will be forced to cut their spending. It’s interesting when you compare his thoughts to the purchases he just made.

Robertson is well known for the 'descendants' that left Tiger Management to start their own firms. Many of Julian's "offspring”, known as Tiger Cubs in hedge fund industry, have had large positions in AAPL, BIDU, MA, and V. Notable Tiger Cubs include Lee Ainslie at Maverick Capital, Stephen Mandel at Lone Pine Capital, and John Griffin at Blue Ridge Capital.

All of them are famous for their value investment. They seek alpha through finding out the valuable companies with brilliant prospects, hold them until the values of these companies are realized by the market. But in this market circumstance, long-hold strategy is severely challenged. For instance, Lee Ainslie saw his Maverick Fund lose 19.47 percent in September, leaving the fund down 21.24 percent for the year.

Corporate turn to hedge fund for help

An unprecedented cash crunch is limiting the ability of banks to lend. Banks have been scrambling for capital to offset losses from bad mortgages and other investments at the same time as both credit and stock investors have been hesitant to back the companies. Companies that have relied on bank borrowing to grow, or even maintain their business, are turning to hedge funds in a move that some say may signal a broad shift of lending from banks to asset managers.

It dose not mean that those hedge funds are becoming banks, but they’re going to provide the functionality and interface with people looking for capital, like the investment banks used to, but with an asset management balance sheet approach.

Some hedge funds began lending directly to companies earlier this year, focusing on making loans that are secured against cash flows. Most recently, some funds even arranged a financing package for the purchase of two ships that will be leased to a unit of Mexican state-owned oil company Petroleos Mexicanos, or Pemex.

The U.S. government has scrambled for ways to shore up the financial sector, including a plan to pump $250 billion into institutions in exchange for equity stakes early this week. Even when the financial sector does finally stabilize, however, banks ability to lend will remain constrained relative to recent years. The capital constraints on banks are opening up opportunities for those hedge funds, who can take leveraged credit assets and loans from bank balance sheets.

Hedge Fund Face Margin Calls on Frozen Assets

There are some connections between the collapse of Lehman Brothers and shrinking hedge fudn industry.

Lehman’s London-based prime brokerage has about 3,500 active clients including hedge funds that own about $45 billion in securities. They hold an additional $20 billion in short positions. After the bankruptcy, investors are unable to access their Lehman accounts, the value of the securities continues to fluctuate along with the markets. The clients may be required to put up more collateral if the value of those securities drops, a process known as a margin call.

Lehman's bankruptcy, the world's biggest, has rocked hedge funds that relied on the firm to provide loans, clear trades and handle administrative tasks. Some hedge funds reluctantly close in part because of their assets stuck with Lehman.

Some managers are looking at funds that will have to shut down, but they can't even shut down because they don't know what they have left. The thing is they cannot now even liquidate the fund. They always urged PwC to work fast to unlock assets. PwC has told some clients they can get their securities back early provided they agree to return them at a later date if other creditors have claims on the same assets.

Until now, Lehman’s hedge fund clients are stuck in limbo.

The blame game begins

Let start with a typical American humor: “Now that the bailout vote's done, it's time for Washington to return to a more familiar game: finger pointing.”

A hearing on the collapse of Lehman Brothers was kicked off yesterday in Washington. Fuld, fomer CEO of Lehman, was spreading the blame. He said regulators "were privy to everything as it was happening," he said, explaining the last days of Lehman in his prepared remarks.

Get used to it. Remember House Republicans blaming a speech by House Speaker Nancy Pelosi, D-Calif., for the bill's initial failure last Monday? Today, as former AIG CEO gathered, they repeated this finger-pointing game again, they blamed each other for the AIG downfall.

Here are a few other dates when it's possible to catch "The Blame Game" on Capitol Hill:
--Oct. 16: George Soros, John Paulson and others hedge fund managers to discuss the role of hedge funds and their regulation.
--Oct. 22: Top executives from Standard & Poor's, Moody's Corporation and Fitch Ratings will talk about the responsibility of rating agency.
--Oct. 23: The committee's not letting regulators off the hook so easily. Former Federal Reserve Chairman Alan Greenspan, former Treasury Secretary John Snow and Securities and Exchange Commission Chairman Chris Cox are expected to testify.

None of this will solve the credit crisis, but the hearings may set the stage for what's likely to be a monstrous fight over financial regulation in 2009. While it’s fair to say there is no single issue or decision one can trace as a cause of the current financial crisis; it was multiple decisions and issues involving many actors over time led us to where we are today. In other words, there's plenty of blame to go around.

Short the favorate

Hedge funds are responding to tough times in the markets by embracing cannibalistic trading strategies: these so-called “liquidiation-unwind" trades involve hedge funds selling short shares that are widely held by their rivals. Goldman Sachs publishes a list of 50 "very important" hedge fund positions that can serve as a guide for investors pursuing such strategies.

The strategies are designed to make money when hedge funds are forced to sell holdings in response to redemptions by their investors. Because so many funds hold similar positions, forced selling by one can destabilise the strategies of others.

For many hedge funds suffering from this crisis, forced selling to cover redemptions and deleveraging has put downward pressure on such shares. As a result, a favourite hedge fund strategy during the bull market - mimicking the positions of others - has changed. Buying the most concentrated stocks has been a poor strategy during the current bear market.

Here is the example. Once Ospraie Management was winding down its flagship fund last month, one Hong Kong-based manager sent a note urging friends to short energy and mining shares favoured by Ospraie. Some managers say they have been monitoring the positions held by Ospraie so they will be ready if other funds with the same positions liquidate their holdings.

So in today’s market, value investment already lost its ground. Speculation instead took its place and it would put more downward pressure to the market.

China would slow outreach pace

In the first six months of 2008 alone, Chinese outbound M&A reached $32 billion in 102 deals. The numbers eclipse the entire year of 2007 and dwarfs preceding years. As of mid-2008, China's total cumulative outbound investment approached $150 billion, and the rate of growth is unlikely to slow in the near to medium term.

Chinese companies have many reasons for undertaking cross-border deals. Some of the most common motivations include gaining access to resources, brand building and strategic rationale.

Recent cross-border deals outside of the resources arena have also stemmed from Chinese firms wanting to broden its position in international financial market, for instance, CIC’s deal with Blackston and Ping An with Fortis. But amid the most severe crisis on Wall Street in more than half a century, Chinese companies would become more and more cautious for their next step.

The ghost of deflation could be dragged out of the closet

Manic Monday, Dow plunged 800 points before it bounced back. But the Dow still tumbled below 10,000 for the first time in four years.
With asset markets tumbling, commodity prices plunging the most in 50 years and banks keeping a tighter grip on credit, as LIBOR rose to 4.33 percent, the highest from January and Ted spread rose to record as well. As Federal Reserve Chairman Ben Bernanke and his global colleagues fight the worst financial crisis since the 1930s, one danger is looming larger by the day: deflation.

The deflation scenario might go like this: Banks worldwide, stung by $588 billion in writedowns related to toxic assets will further reduce the flow of credit. That will push house prices lower, forcing additional losses and making banks even more reluctant to lend. As the credit crisis worsens, businesses will find it almost impossible to raise prices. Prices are already falling in parts of the world economy. Home values dropped more than 10 percent in the U.K. and in the U.S. in the past year. Oil, copper and corn drove commodities toward their biggest weekly decline since at least 1956 on Oct. 3. So for now, a global recession is already looking more likely.

It makes us to stir memories of Japan's decade-long struggle with deflation in the 1990s, the Lost Decade”. It started from a stock and property price crash at the beginning of 1990s. The caution of Japan's leaders -- who waited until 1999 before using taxpayers' money to bail out the banks -- cost their economy dearly. Lending shrank, unemployment more than doubled to 5.5 percent, and Japan experienced three recessions between 1990 and 2002. From 1997 to 2007, consumer prices dropped 2.2 percent. In the U.S., prices climbed 29 percent in the same period.
Fed chairman Ben Bernanke, who has studied Japan's ``lost decade'' of deflation and of course Great Depression since his graduate school, pointed out governments and central banks must respond immediately to such a deflationary shock by dropping money into the banking system.

When credit markets started seizing up in August 2007, Bernanke set up more than $1.4 trillion in emergency borrowing for financial institutions. Fed also has chopped its benchmark rate 3.25 percentage points since August 2007 to 2 percent. Today, the Fed said it's doubling emergency loans to commercial banks to as much as $900 billion.

The ECB, Bank of England, Bank of Japan and other central banks have set up similar lifelines. It included China Central Bank which fought for inflation for a long time. For ECB, inflation target is its top interest since its inception, but now, European policy makers have considered reversing their decision in July to raise their benchmark rate.

The Fed has already responded to one deflationary scare this decade. With inflation approaching 1 percent in 2003, then- Chairman Alan Greenspan slashed its rate to a 45-year low of 1 percent and kept it there for a year, which its critics say helped fuel the property and credit boom that is now unraveling.

This time, the crisis is an increasingly dysfunctional banking system that may not be able to continue making loans that grease economic activity. Such a pullback, combined with slowing growth and falling asset and commodity prices, makes deflation more of a threat.

Two reasons why another Great Depression is not likely

"We're going into another Great Depression." The continuing market turmoil with the passage of 700 billion bailout package makes those G-D words seem possible for the first time. But I don't think another depression is likely, for two reasons.

First, when you spend time studying the Crash of 1929 and the depression that followed, what stands out the most is that people hadn’t realized or believed the casualties actually happened. But today lots of people already worried about them and the market already digested enough bad news. Although worsen situation could be expected, but people could take actions worldwide at least.

Second, the Great Depression and other panics in earlier years occurred before the Federal Reserve Bank had aggressively grown into its role as "lender of last resort." In the wake of 1873, after a railroad-building boom had swept the nation and then gone bust, companies and consumers alike were left gasping for capital. The same thing happened in the Panic of 1907, while the banking magnate J.P. Morgan gathered New York’s bankers at his home, where they worked through the night until he persuaded them to form a joint pool of capital to pay depositors at bank under threat. Nothing but the passage of time could supply it; the Fed would not be established until 1913. After the crash of 1929, when the Fed was still weak, years passed before the federal government could flood the economy with cash.

Today, however, the resolve of the Fed is not in question; nor is there any doubt that the Treasury Department is willing to provide the financing it takes to get the economy moving again. So it's hard to see how a depression could get under way when so much capital is waiting in the wings.

Put it differently, in the down market, cash flow is not die, instead, diversification is dead. It means that the tightness of the linkages among various assets like U.S. and foreign markets, stocks and bonds, commodities or real estate. Normally, one asset will tend to zig while another zags. But in bear markets, they converge -- and in really terrible bear markets, they move in complete lockstep.

Hedge fund is not alone

It seems that hedge fund is not alone to suffer in current enviornment. According to Morningstar Inc., 91% of all mutual funds in existence have lost money so far this year. To put that in perspective, in 2001 -- the year Enron imploded, Internet stocks kept crashing and 9.11 attack, more than one out of every three funds still managed to generate positive returns.

So you could imagine how much worse might things get. “Get the hell out!”

Hedge Fund turmoil

The chart above gives you a very good indication of what called "bloodbath ahead" in the hedge-fund industry.

No one wants to invest in an underperforming hedge fund right now -- and half of the hedge funds in America are underperforming. What we see in the chart is the enormous range of returns between the best-performing and wosrt-performing hedge funds -- a range which has never been wider.

In any event, the hedge-fund shakeout over the coming months could be brutal, and have nasty systemic consequences if hundreds or thousands of hedge funds are all trying to unwind their positions at the same time. In the worst-case scenario, a fund which wrote a lot of credit protection could go bust, leaving its investors with nothing and its counterparties with very little. If the counterparty dominoes then started to fall, the financial system could end up in much worse shape than anything we've seen so far.