Friday, July 24, 2009 2 comments ++[ CLICK TO COMMENT ]++

More thoughts on Hugh Hendry & Eclectica; A quick look at Kanaden (8081)

Read a whole hoard of articles on the Eclectica website and Hugh Hendry is really into technical analysis. Although I like his macro views, his investment style is not attractive to me. Here is some tidbit from the Feb/Mar 2006 Hedge Fund Journal article (as usual, any bolds in the quote are by me):

A key point here is the importance of technical analysis to both Hugh Hendry and OAM. For some years veteran chartist Brian Marber had provided a technical input on markets/stocks/sectors to the investment professionals at OAM. Through the course of time Hendry came to recognise that he was placing more reliance on the chart patterns and levels than his mentor Odey. Just as Hendry was increasingly relying on technical signals to tell him he was right (or wrong) on the timing or correctness of his market and stock views...

...


What is Eclectica Fund? It is described by its management company as “an opportunistic fund investing in global equity, fixed income, currency and commodity markets,” and it “aims to fully utilise the balance sheet.” The last part expresses the risk appetite necessary to produce “superior risk-adjusted returns over the long term”.

...


The fund comparisons that come to mind are not even latter day American hedge funds: Hugh Hendry is on a path to re-create the funds that Steinhardt, Soros and to some extent Robertson became, funds that outgrew their equity-focussed beginnings, and that flowered to utilise the full scope of wide investment powers.


Eclectica doesn't do much fundamental analysis (so they clearly aren't value investors.) Based on the article, it seems they are more like the famous hedge funds of a few decades ago. However, I'm not really sure how much technical analysis was used by George Soros (anyone know?). Jim Rogers doesn't seem to use technical analysis at all and he was a key member of Soros' team a few decades ago, so I wonder if Soros used technical analysis at all (anyone know?).

I remember looking at some technical analysis stuff when I started investing in 2004 but sort of gave up on it completely in the last few years. Just about the only technical analysis stuff I pay attention to, if it comes across my view, is the Dow Theory, sentiment indicators, and margin usage. I don't use technical analysis to make purchase decisions. I break one of the cardinal rules of technical analysis in most of my purchases. That rule is the one that says never to buy stocks that are falling and to buy stocks that are going up (this is usually measured by a short-term moving average crossing above or below a slower-moving average e.g. 50 dma (day moving average) above 200 dma is bullish.)

Performance

The Eclectica Fund also has very high turnover (at least when the article was published back in 2006) and Hugh Hendry seems to hold as many as 100 or 200 securities at once.

Like nearly all hedge funds, they also use a lot of leverage. The article mentions that in January 2006, Eclectica was net long 277.4%, which consisted of:

+31.4% in bonds
+56.8% in commodities
+70.5% in currencies
+223.6% in long equity
-104.9% in short equity

The use of leverage is why I am skeptical of high returns attributed to many hedge fund managers. It completely masks skill! I'm not saying they shouldn't use it—they should do whatever works for them and whatever enables thme to become rich :)—but we need to discount any high returns. It just doesn't compare to a typical, unleveraged, retail investor or mutual fund manager. In the Seth Klarman post, I mentioned that Klarman didn't use much leverage, and some readers also suggested that his leverage is actually a drag (negative) since he tends to hold a lot of cash.

Eclectica's hedge fund posted returns of -4.5%, +49.9%, +8.1%, +15.6%, and +13.0% in 2002 (4 months only), 2003, 2004, 2005, 2006 (January), respectively. Hugh Hendry also became famous and certainly came within my radar after he posted something like +30% last year. Nevertheless, it's just really tough to say how good Hugh Hendry's skill is.

A 2003 Barron's interview, when Hugh Hendry was part of Odey Asset Management, had this to say about his style:

Hedge-fund manager Hugh Hendry happily concedes that he’s an apostate from fundamentalism, uses technical analysis liberally, and hasn’t met with a company management in “five years, thank God.” The Scotsman with Glasgow working-class roots admits to having no friends beyond the Reuters mini-terminal he carries in his pocket. He eschews the focused-fund approach and what he calls Taliban-like fundamentalism in the market. Instead, Hendry believes that asset allocation is crucial. Choosing among a wide variety of asset classes that he considers promising, he populates the fund with hundreds of small positions. “We’re like a centipede. You can lose 30 legs and you can still march forward,” he says.


Hugh Hendry's thinking is closer to someone like Marc Faber or Jim Rogers than Warren Buffett. Similar to Faber and others, his view is that being in the right asset matters most.

Pretty Good Macro Forecasts

Hugh Hendry is very good at macro investing. His timing seems to have been somewhat off but read the following, which was said in 2003 and think about what just happened in the last two years.

Barron's: Today, liquidity is being pumped in by Greenspan, then?

Hugh Hendry: Yes. The mechanism is the government sponsored enterprise sector in America, the Fannie Maes and the Freddie Macs. The U.S. has nationalized the credit-creating process, previously the preserve of the banking sector. Freddie and Fannie can borrow money at almost the risk-free rate. At times of anxiety, they are profitmotivated to expand their balance sheets because government bond yields, the risk-free rate, fall during times of risk aversion. The spread widens between riskier assets like mortgage-backed securities, which Fannie and Freddie buy, and Treasury bonds. The combined balance sheet of Fannie and Freddie is $3 trillion, 30% of the U.S. economy. The annualized growth rate in September and October of their balance sheets was 50%. Now when people talk about M2 or the old monetarism, it hasn’t kept pace with the disintermediation, which has gone on in the economy. It doesn’t include agency paper. The money supply looks as if it’s waning. It’s not. There’s enormous dollar creation. You can control the domestic price of money. Short-term interest rates have not gone up in America because of this economic Frankenstein. But you can’t control the external price: The dollar is weakening versus everything, even versus the ruble.

The response to the crash since March 2000 has been to create even more money. Just as it was 300 years ago [he is referring the disastrous policy by another Scot, John Law, in France.] We’ve created a tidal wave of liquidity, with the Dow back at 10,000.


Everyone was warning about the GSEs. Warren Buffett criticized them; Alan Greenspan was critical of them; the GSEs even had to restate their financials a few years back; but I haven't seen anyone suggest the GSEs were going to facilitating the creation of so much money. I think Hendry is way to extreme in comparing to John Law's France but he did say, back in 2003 in this interview, that there was huge risk.

He suggested two scenarios back in 2003. The first one:

He [Alan Greenspan] knows the consequences are a period of prolonged economic weakness and that terrifies him because he’s got so much debt in the economy. Debt today is 360% of GDP. Not just in America but elsewhere. We’re ill-prepared for a rise in savings. And so he’s done everything to prevent a rise in savings. If the Fed succeeds in re-inflation, then the good news is that the Dow is going to be at 10,500 . . . in 2020.


Hugh Hendry was actually wrong with the timing. The Dow actually hit 10,000 much sooner... His second scenario:

The stock market today is capitalized at 100% of GDP and debt is 360%. Here we are with the U.S. gross domestic product recently having shown 8.2% growth, a classic economic recovery. But history suggests that if growth continues, then 10-year bond yields will have to go to 6%-7%. But that debt level—i.e., mortgage refinance-based consumer spending—can’t accommodate such high interest rates. That’s why the Fed keeps saying that it will be putting the short rate up; it’s desperate to control the long rate. This is a bear-market rally... If it rolls over, if all the bears are converted back into bulls, concluding it’s a natural cycle, then this market will test last year’s lows. If those are breached, then I believe you could lose 80% of the value of the S&P and the Dow from their peaks.


I think his second scenario actually unfolded but not quite how he or anyone else imagined. The market did not fall below the 2002 low; instead, the bears were converted to bulls and it rallied all the way to a new nominal high.

But the crash that Hugh expected did materialize—sort of. The market crashed almost the day after the Dow hit 14,000. It didn't fall 80% as Hugh was expecting but it did fall around 40%. It can still fall but I don't think it will fall 80% from the peak.

If we look at returns in real terms, the market is certainly approaching the 80% figure. In real terms, it is close to the 1930's collapse. But as I remarked when I wrote about the 1930's comparison, the stock marke was more overvalued in 2000 than in 1929 so the fall can be even larger (but do note that the stock market hit an extremely low valuation in 1932 and we may not hit such valuations; instead, something like the valuation in 1933 is more probable.)

The rest of the Barron's article contains his stock picks and shows how he was right one certain themes. He was loading up on commodities (this was 2003) and was even bullish on Japan. I can turn out to be wrong but I think it is too late for commodities. Even if commodities still have room to run, they are not out of favour, with very low valuations like they were in early 2000's. But I think whatever he said of Japan is applicable since Japan sold off sharply and is literally back to what it was in 2003. He mentions a few Japanese real estate companies, as well as a company called Kanaden.

Kanaden

Just to show why people keep saying that Japan is Benjamin Graham's dream right now, Hugh points out that Kanaden (TSE: 8081), an electronics component supplier, was trading at a remarkable price to sales ratio of 0.03!!! This for a company that has $1 billion in revenues. Wow! Can you think of a company that is trading for $30 million while having sales of $1 billion? Assuming its debt situation is under control, that's amazing. There are many microcaps in America that trade at p/s of 0.03 but they have very low sales and depend on one customer or stuff like that. But a billion in revenues is amazing. One still needs to do their homework and make sure the balance sheet is good, there are no legal problems, and so forth.

Hugh suggested that he bought on the thesis, not that sales would increase or the situation would improve, but, that the market would re-price it upwards to a p/s ratio of 0.2 (he gets 0.2 by looking at the lowest p/s ratio for any company in Europe).

Here is quick look at the stats from the Tokyo Stock Exchange (note: some numbers may be wrong so one should look at official documents if available; not sure if anything in English):



Without knowing what happened in the intervening time period, it looks like Hugh's targets weren't hit. The stock "only" ran up 100% (roughly 30% annualized.) Assuming the sales didn't change much, Hugh's estimate (admittedly wildly optimistic :) ) would have seen the p/s go from 0.03 to 0.2, which is roughly +567% (if my calculation is right.) I'll take 100% any day of the week though. Like nearly all Japanese stocks, Kanden did a round-trip and is basically back to the 2004 price (I hope Hugh Hendry sold it by 2006 ;) ). If English information is available, this company may warrant a look... I think the sun is about to rise over Japan...


To sum up, I think Hugh Hendry is worth checking out once in a while, if you are into macro stuff.

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2 Response to More thoughts on Hugh Hendry & Eclectica; A quick look at Kanaden (8081)

Daniel M. Ryan
July 25, 2009 at 5:15 PM

Regarding Alan Greenspan: I have a hunch as to why he kept the monetary spigots going for as long as he did. I believe that there was a fear, around 2004 or so, that the U.S economy would have gone through a credit crunch like 1970's if the Fed had put the brakes on back then. So, the Fed kept churning out the money to postpone that crisis.

The current collapse is reminiscent of both 1970 and 1974. I think the Fed's easy-money policy, up 'til 2007 or so, postponed a 1970 repise - but at the price of making the current crisis a double whammy.

Sivaram Velauthapillai
July 26, 2009 at 1:01 AM

Yeah... they were genuinely worried. I just started seriously investing, and hence following the markets, around that time, and the consensus supported the FedRes actions. I saw very few people being overly critical.

But, like you say, in the end, everything fell apart anyway... we ended up with, not just double, but triple of quadruple the damage...

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