Hugh Hendry had a strong 2015 despite a big long position in Chinese futures (which was offset by some timely shorts in bets such as short oil companies). The hedge fund run by the eccentric UK fund manager was up 6.1% in the year in which many hedge funds struggled. ValueWalk has obtained the full letter which can be viewed below.
Also see Hugh Hendry: How I Learned To Stop Worrying And Love The Bomb…
The Eclectica Fund
Discretionary Global Macro
Hugh Hendry – Performance Attribution Summary
• The Fund made +0.8% in December, bringing the net return for 2015 to +6.1%.
• Fixed income contributed +0.9%, with Chinese offshore interest rate payers again the key driver of positive returns as the deleveraging of long yuan positions continued.
• FX strategies added a further +0.5%, with gains from our consumers versus producers basket and a short MXN position outweighing losses on our EUR short.
• Equities were a relatively minor drag on performance, costing -0.4% as the ECB dashed expectations of further stimulus, prompting the EuroStoxx index to tumble -6.8%.
• Profits came from holdings in UK housebuilders, which bucked the general trend (led by Bellway which was up +8.4% on the month after a positive trading update), and a tactical long position in Chinese index futures.
• Elsewhere, shorts on oil services companies and our Italian banks RV strategy were also profitable, helping to partially offset losses sustained on European index exposure.
Hugh Hendry – Is it all a misunderstanding?
Paradoxically, today’s angst that the yuan might devalue to stave off capital flight began with China’s decision to slowly embrace the free market. Back in 2010, the PBoC finally allowed appreciation of the yuan after two years of being pegged against the US dollar owing to the financial crisis of 2008. Given China’s trade surplus and expanding economy, and QE in the US, it was fairly clear that the yuan was profoundly undervalued. The appreciation happened in a fairly managed way, which meant that volatility was very low and an appreciating yuan was all but a given. This opportunity proved exceptionally rewarding and low risk; accordingly both foreign investors and locals alike built up very large exposures to the yuan in the offshore CNH market. In early 2014, the PBoC started to worry about the huge leverage that speculators and commercials had built up in both the onshore and offshore (CNH) markets. They decided to act. The first foray was to push the yuan from the strong to the weak end of its trading band in an attempt to flush out weaker or newer speculators. The build-up in leverage had created a huge distortion in the level of offshore interest rates at 1% compared to onshore rates at 5%. This provided an opportunity to pay offshore interest rates and speculate that the unwinding of the carry trade would cause interest rates to normalise. This happened over the course of 2014 and especially 2015 when large scale capital outflows started to worry global investors.
Hugh Hendry – Going forward
China continues to neither be a fully free-market or a fully managed economy but we believe the underlying size of the speculative carry trade has been significantly unwound. In our minds the question is not one of capital flight but the extent to which commercial hedging of foreign trade has been brought into line. That is to say, to what extent Chinese exporters now hedge their overseas revenues into yuan. Previously the carry trade meant that exporting companies if anything over-hedged their expected foreign profits to build up excessive long yuan positions. But two years after the PBoC’s assault and having deployed $700bn of reserves to prove their point our expectation is that hedging practices are becoming more conventionally conservative. When capital controls meet free markets huge distortions present themselves Whilst the structural move higher in offshore Chinese rates has happened, paying rates still makes sense as a hedge against fears of a Chinese currency devaluation. Unlike traditional hedges such as the US Dollar Index and US Treasuries, paying CNH rates continues to be an effective hedge to global equities with a higher negative correlation.
Hugh Hendry – Conclusion
If we were to rewind clock 10 years ago Eclectica were profoundly pessimistic. The world seemed out of sorts. Last year we found a way of expressing the malady that we could sense back then. It is shown overleaf in the chart that chronicles the S&P’s 75% drawdown versus a monthly risk-adjusted benchmark of 10-year treasuries.
The persistent relative weakness of stocks indicated ongoing imbalances in the economic system. We concluded that owing to a combination of the inflation shock of the 1970s, and the subsequent and powerfully disinflationary forces of globalisation and the World Wide Web, monetary policy was persistently set too tight. With hindsight it was a great time to be a creditor as policy tightness ultimately transferred a disproportionate share of global income from industrious debtors to rent seeking sovereign creditors. Today it seems the system is healing albeit with great turbulence. First QE eliminated the excessive risk premium embedded in sovereign debt markets and now the excessive (and arguably unproductive) savings accumulated by giant commodity and mercantilist nations is coming under challenge from the fall in trade prices and by the pivot to promote endogenous domestic growth from the household sector via higher wages in countries such as China and Japan.
Accordingly whilst we are conscious, and indeed believe that we are prepared, for the fundamental challenges that confront the global economy we simultaneously must weigh the opportunities that will arise in a world where monetary policy remains stubbornly accommodating. For it seems very plausible that future economic historians will look back and conclude that today, just like the US during the 1990s, really was a great time to be a risk taker as the economic system shifted back to favouring the wealth creators. However, successful macro investing must cross some challenging short-term threats if we are indeed to prosper from such a benign scenario; stay tuned.
Hugh Hendry’s full letter can be found below.