The Eclectica Fund
The Fund returned 3.5% (net
)
in Q1. The main positivecontributors to this performance were equities and FX. Therewere gains from long positions in consumer staples andJapanese stocks, as well as gains from shorts in industrialcommodity related stocks. In FX, the Fund profited from beinglong the US dollar. Offsetting losses came primarily from longpositions in commodity futures, spread across gold, oil andsofts.
Long Consumer Staples
Given our longstanding caution regarding the prospects for theglobal economy we have looked to express equity risk by beinglong cash generative businesses with the strongest balancesheets and the least economic sensitivity. This served us wellin the first quarter when the performance of the S&P consumer staples index defied recent convention. Such stocks tend tounder-perform their industrial brethren given the seasonaloptimism that tends to surround the global economy at thattime of year.
This time around however they out-performed byrallying 13.8%. But with the annualised Sharpe ratio on our basket looking unsustainably high, we took a tactical decisionto realise profits towards the end of March. An unresolved but pertinent question is whether this priceaction might mark the start of the next asset bubble? Consider the plight of a conservative investor: concerned about the risksto the global economy and hence cyclical equities; fearful of financial repression in Treasuries; trapped (possibly unfairly) bythe prejudice of the ten-year bear market in US dollars; scaredthat governments may have to haircut his savings account inthe bank; and now terrified by the sudden price collapse ingold. It could be argued that for such an investor all roads leadto the safest, least volatile, most liquid consumer non-discretionary blue chips on Wall Street, which provide a 3%dividend income payable in dollars.
Long US Dollar
The second of our major investment themes is the likelydurability of the US economy relative to the rest of the world,and the impact this may have on the US dollar. Unlike the restof the world, America has dealt with the overhang of bad debtsfrom the housing bubble through a vicious house pricecorrection and resulting bust and the recapitalisation of itsbanking system. Wages have come down sharply relative to Asia, the shale gas boom means energy is now far cheaper aswell, and the resulting lower cost base is allowing the US toreclaim market share within the global economy. As such, USreal GDP is 3.3% above the pre-crisis high of Q2 2008,whereas the European economy is still languishing 3.1%below the all-time high recorded in Q1 2008.x As measured by the DXY Dollar Index, the dollar gained 2.5%for the first quarter, and seasonally recorded one of its bestmonthly performances on record for the month of February.This strength was partly attributable to investors' perceptionthat American economic conditions are improving, and alsopartly helped by the continuing crisis in Europe. Perhaps moreinteresting was another break from recent tradition, as the USdollar proved less negatively correlated to the performance of the stock market. It is early to draw anything firm from this, butthe sight of the stock market and the dollar rising in tandemlooks more like the regime which accompanied the last twodollar bull markets of 1980-85 and 1995-2001.
Long Japanese Equities
Another investment theme we have been leaning toward ever since the end of 2012 is a long position in Japanese equities.Back in 2008, we purchased a ten year 40,000 Nikkei one-touch call option. We had been struck by the historicalobservation that it had taken the Dow Jones Industrial Indextwenty five years to recover from the nominal price losses of the Great Crash of 1929 and make new price highs. The goldprice had required twenty-seven years to overcome itsprevious bubble high. Was Tokyo somehow different or wouldthe persistent inflationary threat of a fiat currency and socialdemocracy's abhorrence of deflation be such that direeconomic circumstances could once more persuade them toelect public officials intent on repealing the nominal loss?In order to turn bullish, we had to see a further deflationaryshock. And as we examined Japan's economy we conceived of a catalyst. As a consequence of the mercantilist policy of seeking an external surplus with the rest of the world throughresisting the
yen’s
strength, the Japanese economy had builtup a huge short position against its own currency. This leftthem, we reasoned, vulnerable to exogenous shocks similar innature to the Lehman crisis, when the currency strengthenedas foreign denominated assets had to be sold to make goodyen losses registered back home. We reasoned that further exogenous shocks were likely to produce yet more yenstrength.2011 saw not one but two huge shocks. The global economyweakened as a result of the European crisis, and Japan wasstruck by a catastrophic earthquake. The yen strengthenedsharply. We had posited that further FX strength would createduress at the corporate level and sure enough credit spreadssoon widened. By the start of 2012 we had witnessed thenation's two largest manufacturing debt restructurings, and atone point it seemed that the impossible was becoming a realityas household names such as Sharp, Panasonic and Mazdalooked likely to go bust. Even Sony only just managed to hold ittogether by issuing a large and very dilutive convertible.
1 EUR A shares.2 The S&P 500 consumer staples index return for Q1 2013 was 13.8% whilst the S&P 500 industrial index was up 10.1% for the same period (Bloomberg).3 See first quarter performance of the S&P 500 consumer staples index versus that of the S&P 500 industrial index (Bloomberg):Q1 2012: 4.8% vs 10.7%Q1 2011: 1.7% vs 8.2%Q1 2010: 5.0% vs 12.5%4 S&P 500 consumer staples index achieved a Sharpe ratio of 7.8 for Q1 2013. Calculation based on daily data and a risk free rate of 1.95% (Bloomberg/EAM).5 Sources: Bureau of Economic Analysis (US) and Eurostat (Eurozone). US data is Q1 2013 vs Q2 2008. Eurozone data is Q4 2012 vs Q1 2008.
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The Eclectica Fund
We reasoned that such was the corporate pain that the politicalclass would be forced to intervene more directly in the policiesof the Bank of Japan. And, sure enough, as the economicconditions worsened last year, we saw a newly electedgovernment fire the institution's two most senior decisionmakers and embark on a policy shift on the scale of the Plaza Accord. This dramatic regime shift and the resulting 20%depreciation of the yen is very bullish for Japanese assets(denominated in yen terms) and so with our catalyst in placewe started buying TOPIX index futures and shares in Japaneseproperty companies.
Receive Rates
However, we also caution that Japan's monetary pivot towardsQE will not create economic growth out of nothing. Instead itseeks to redistribute global GDP in a manner that favoursJapan versus the rest of the world. This is the last thing theglobal economy needs right now. For as we have moved intospring, business activity appears to be slowing as the inventorycycle brought about by
Draghi’s
speech and the re-opening of Chinese liquidity taps last year fades away. Reported PMIs arerolling over, and a destocking cycle combined with a resurgentand competitive Japanese export industry does not bode wellfor economies in Europe and the rest of Asia.This slowdown is occurring at a time when better globaleconomic statistics over the last six months had served toenrich the risk premium available at the front end of sovereignbond curves, US dollar 3y1y rates backing up from 95bps to150bps as an example. We judged that the combination of richer rates and weaker economic data justified a much greater and wider fixed income exposure. Accordingly, since the end of the quarter, we have initiated positions split geographicallyacross Australia, Europe, Korea, Switzerland and the US.
Conclusion
In summary, as we move into the second quarter the keyelements of our portfolio are as follows: long the Tokyo stockmarket trading just barely greater than its 50 year movingaverage (comparable to where gold traded ten years ago andwhere the Dow Jones traded shortly after the attack on PearlHarbour in 1941), long low variance US equities, long the USdollar and receiving fixed income at the short end sovereigncurves.
Hugh Hendry, CIO
This document is being issued by Eclectica Asset Management LLP ("EAM"), which is authorised and regulated by the Financial Conduct Authority and registered with the SEC as aninvestment adviser. The information contained in this document relates to the promotion of shares in one or more unrecognised collective investment schemes managed by EAM (the"Funds"). The promotion of the Funds and the distribution of this document in the United Kingdom is restricted by law. This document is being issued by EAM to and/or is directed at personswho are both (a) professional clients or eligible counterparties for the purposes of the Financial Conduct Authority's Conduct of Business Sourcebook ("COBS") and (b) of a kind to whom theFunds may lawfully be promoted by a person authorised under the Act (an "authorised person") by virtue of Section 238(5) of the Financial Services and Markets Act 2000 (the "Act") Chapter 4.12 of COBS. No recipient of this document may distribute it to any other person. No representation, warranty or undertaking, express or implied, is given as to the accuracy or completenessof, and no liability is accepted for, the information or opinions contained in this document by any of EAM, any of the funds managed by EAM or their respective directors. This does not excludeor restrict any duty or liability that EAM has to its customers under the UK regulatory system. This document does not constitute or form part of any offer to issue or sell, or any solicitation of any offer to subscribe or purchase, any securities mentioned herein nor shall it or the fact of its distribution form the basis of, or be relied on in connection with, any contract therefor.Recipients of this document who intend to apply for securities are reminded that any such application may be made solely on the basis of the information and opinions contained in therelevant prospectus which may be different from the information and opinions contained in this document. The value of all investments and the income derived therefrom can decrease as wellas increase. This may be partly due to exchange rate fluctuations in investments that have an exposure to currencies other than the base currency of the relevant fund. Historic performance isnot a guide to future performance. The results portrayed for the Eclectica Fund are estimated, unaudited and subject to adjustment. Also, the net results reflect the reinvestment of dividendsand other earnings and the deduction of costs and the management fees and profit allocation to the investment manager and the general partner, as applicable. Particular
investors’
returnswill vary from the historical performance due to participation in New Issues and due to the timing of subscriptions, withdrawals, and redemptions. The TOPIX index has not been selected torepresent an appropriate benchmark to compare Eclectica performance, but rather is disclosed to allow for comparison of the
Fund’s
performance to that of well-known and widely recognizedindex. Past performance is no indication of future results. Inherent in any investment is the potential for loss. Eclectica has had positive trading results over certain periods in the past in theEclectica Fund. However, prospective investors must consider the uncertain significance of past performance in determining whether or not to invest in the Eclectica Fund. Investors shouldnot substantially rely on
Eclectica’s
past record as a prediction of future performance. Investors should not assume that trading decisions made by Eclectica in the future will be profitable. Aninvestor must realize that he or she could lose all or a substantial amount of their investment in the Eclectica Fund. All charts are sourced from Eclectica Asset Management LLP. Side letters:Some hedge fund investors with significant interests in the Fund receive periodic updates on the portfolio holdings. © 2005-13 Eclectica Asset Management LLP; Registration No. OC312442;registered office at 6 Salem Road, London, W2 4BU.
Sources: CRB, Bloomberg, TSE, MOF and Eclectica AM. Data at 30 April 2013.
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TOPIX
50yr Moving Ave.
6 Source: Bloomberg.
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