Horseman Global, the hedge fund branded by Zerohedge as the “world’s most bearish hedge fund” lost -2.68% for investors for the month of July. Year-to-date the fund has returned 3.13% even though it is running a net short book.

At the end of July Horseman’s gross long position was 29.35% and gross short was -116.44% for a net exposure of -87.09%. The fund’s bond book was 65.14% net long at the end of the half, according to a letter to investors obtained by ValueWalk.

Hedge Fund Letters To Investors

Even though Horseman may be the world’s most bearish hedge fund, the fund has achieved outstanding returns for investors over the past 15 years, so when the fund takes a position, the market usually pays attention.

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Horseman’s performance during July was hurt by its overwhelming short book. While the long book, bond book, and currency book made money in the month, the short book was responsible for all of the fund’s losses.

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Horseman Global: The world’s most bearish hedge fund

Unsurprisingly, Horseman remains concerned about the outlook for the global financial markets. In the July letter, the fund’s investment manager Russell Clark discusses how capital markets have changed over the years and how this change will ultimately be responsible for a market collapse.

 “To central banks, capital markets are now considered an important tool for the transmission of monetary policy to the real economy. Most economists consider them an important part of the economy to enable price discovery, so that capital can be moved to where it is most needed, and taken from where it is not. A corollary of this view, in my mind, is that capital markets try to make plentiful what is scarce. Think about the supply of housing that markets were able to produce in mid 2000s, or the internet stocks that listed in late 1990s, or mines that started producing during the mining boom.” 

“The central banks’ main way of using the capital markets to boost the real economy is to push down interest rates, and to make investors seek yield elsewhere. In this respect, they have been very successful, as both stock markets and corporate bonds markets have marched higher. For those of a bullish bent, the fall in yield of long term bonds implies that central banks are probably never going to normalise interest rates, and corporate bond yields will remain low. This implies that equities are a buy.”

“However, the markets are very good at transforming capital into yield. After the dot com bubble burst, interest rates were suppressed, and saw the emergence of asset back securities. In my view, these securities were supplying yield to the investors, while also driving capital appreciation of the underlying asset (i.e. US housing). Ultimately, neither the yield nor the underlying capital appreciation was sustainable.”

Russell goes on to write that today, capital markets are creating yield in VIX trading at autocallable products, which provide investors with yield by selling insurance on the equity market. The problem with these products is that they suppress volatility most of the time, but when things become rough, they can increase volatility significantly. As Russell sums up, “just like  we saw with mortgage backed securities and US housing, first they support the market, and then crush the market.”

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It will take some significant shock for structured products to start to unwind but when this shock emerges, it’s likely a structured product unwind will apply further downside pressure on the asset prices, and the chain reaction will crush the market.

What’s In An Equity Research Report?

Brexit was supposed to be the shock that set off a structured product unwind but with US markets now at all-time highs, and the VIX at some of the lowest levels seen since the financial crisis, it’s clear Brexit was not enough of a shock. So, what will it take to spark the great unwind? Russell Clark believes it could be any small shock now that markets have pushed to new highs:

“Having looked at structured note selling closely, I have found that probably the most dangerous time for the markets is when the index has hit a new high, when market volatility is low. The reason for this is that at new highs many structured products have to be reset, but if market volatility is low then their associated knock-in level will have to be set close to the new high in order to generate yield. This means that a much smaller fall in the market is needed to set off the chain reaction. Short equities and long bonds looks attractive to me.”

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See the full text below

Horseman Global Fund Ltd July 2016 Commentary

Your fund lost 2.68% net this month, giving back some of its gains from last month. The long book, bond book and currency book made money, while the short book lost money.

Why do we have capital markets? The answer to this question will depend very much on who you ask these days. To central banks, capital markets are now considered an important tool for the transmission of monetary policy to the real economy. Most economists consider them an important part of the economy to enable price discovery, so that capital can be moved to where it is most needed, and taken from where it is not. A corollary of this view, in my mind, is that capital markets try to make plentiful what is scarce. Think about the supply of housing that markets were able to produce in mid 2000s, or the internet stocks that listed in late 1990s, or mines that started producing during the mining boom.

The central banks’ main way of using the capital markets to boost the real economy is to push down interest rates, and to make investors seek yield elsewhere. In this respect, they have been very successful, as both stock markets and corporate bonds markets have marched higher. For those of a bullish bent, the fall in yield of long term bonds implies that central banks are probably never going to normalise interest rates, and corporate bond yields will remain low. This implies that equities are a buy.

However, the markets are very good at transforming capital into yield. After the dot com bubble burst, interest rates were suppressed, and saw the emergence of asset back securities. In my view, these securities were supplying yield to the investors, while also driving capital appreciation of the underlying asset (i.e. US housing). Ultimately, neither the yield nor the underlying capital appreciation was sustainable.

So how are capital markets creating yield today? Well, as I point out in my last two market view notes (Autocallables, Volatility Compression and Eurostoxx and VIX and VIX ETFs Volatility Is No Longer An Independent Variable), trading volatility and autocallables look like good places to look. While autocallables are fiendishly complicated, at essence they provide investors with yield by selling insurance on the equity market. The presence

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