Brevan Howard Global Limited commentary for the month ended July 31, 2016.
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Brevan Howard Global Limited (“BHG”) is a closed-ended investment company, registered and incorporated in Guernsey on 25 February 2008 (Registration Number: 48555).
Prior to 1 September 2014, BHG invested all its assets (net of short-term working capital) in Brevan Howard Global Opportunities Master Fund Limited (“BHGO”). With effect from 1 September 2014, BHG changed its investment policy to invest all its assets (net of short-term working capital) in Brevan Howard Multi-Strategy Master Fund Limited (“BHMS” or the “Fund”) a company also managed by BHCM.
BHG was admitted to the Official List of the UK Listing Authority and to trading on the Main Market of the London Stock Exchange on 29 May 2008.
Total Assets: $476 mm1
1. As at 29 July 2016 by BHG’s administrator, Northern Trust.
ASC 820 Asset Valuation Categorisation*
Portfolio Update for BHG
The information in this section has been provided to BHG by BHCM.
Monthly, quarterly and annual contribution (%) to the performance of BHG USD Shares (net of fees and expenses) by asset class*
Monthly, quarterly and annual contribution (%) to the performance of BHG USD Shares (net of fees and expenses) by strategy group*
BHG Underlying Investment Exposures as at 29 July 2016 (allocations subject to change):
Exposures by Asset Class as at 29 July 2016 (exposures subject to change):
Monthly Performance Review for BHG
The information in this section has been provided to BHG by BHCM.
BHG Monthly Commentary
The NAV per share of BHG’s USD shares appreciated by 0.13% and the NAV per share of BHG’s GBP shares appreciated by 0.13% in July 2016.
Brevan Howard Master Fund Limited (“BHMF”)
The NAV per share of BHMF Class Z USD shares depreciated by 0.96% in July. Interest rate trading generated modest losses overall, predominantly driven by long directional positioning in US and Japanese rates as well as European swap spread and peripheral bond trading. Gains in short end US basis trading as well as interest rate volatility trading provided a partial offset. FX losses came from directional trading in a broad range of currency pairs; most notably JPY and EUR, and to a lesser degree emerging market currencies.
Brevan Howard Asia Master Fund Limited (“BHA”)
The NAV per share of BHA Ordinary USD shares appreciated by 0.26% in July. Gains in interest rate trading were due in most part to relative value basis trading in the short end of the US curve whilst offsetting losses came predominantly from curve trading in Japan as well as directional trading in the Sterling curve. FX and equity trading generated small gains and losses respectively with little by way of themes.
BH-DG Systematic Trading Master Fund Limited (“BHDGST”)
The NAV per share of BHDGST Class Z USD shares appreciated by 1.44% in July. Equity index futures were the best performing sector this month with gains also realised in bond and metal futures. BHDGST moderated exposure in most bond futures in July. Notable exceptions were additions to longs in Gilts, BTP and Australian bond futures. Within STIR futures, the model reversed a long position in Canadian Bankers’ Acceptance to a short, whilst cutting longs in Eurodollar and Euribor futures across the curve. In contrast, BHDGST more than doubled its position in short sterling futures as UK rates expectations fell in the run up to and post the Brexit referendum. The model reversed short positions in the CAC 40, DAX and Euro Stoxx amongst other European indices to long. In FX, overall exposure outside of the major currencies was little changed. Dramatic moves related to the Brexit referendum saw the model increase its short position in GBP and flip a net short to long in the euro. The model reduced its long stance in JPYUSD in response to volatility observed from reports over the BoJ’s expected stimulus package. In the energy sector, July saw the model adopt a more bearish position.
Direct Investment Portfolio (“DIP”)
The Direct Investment Portfolio (“DIP”) appreciated by 0.78% in July. The DIP generated the bulk of the profits in FX and equity index trading. In FX, short exposure to GBP against USD as well as FX volatility trading were the main positive contributors. In equities, long exposure to the S&P and Nikkei generated gains. Additional gains were generated in credit where agency mortgage trading was a key driver. Some of the profits were offset by losses in interest rates trading where long exposure in JPY at the end of the month was one of the main detractors. Additional smaller losses arose from long exposure to oil.
Manager’s Market Review and Outlook
The information in this section has been provided to BHG by BHCM.
Reassuring signs from the labour market allayed concerns about the downside risks to the economic expansion. Payroll employment surged in July by 255,000 bringing the average monthly gain over the last three months back up to 190,000. Although the unemployment rate was unchanged at 4.9%, the same as at the start of the year, other details in the report were generally solid.
At the same time, growth through the middle of the year looks moderate at best. After expanding at only 1.2% (annualised) in the second quarter, the available indicators about the third quarter point to an unspectacular bounce-back to above-trend growth. Consumption spending took a breather in July after setting a heady pace in the previous quarter. Business fixed investment intentions suggest a tepid outlook; however, inventory investment should add to growth for the first time in more than a year now that stocks appear to be better aligned with sales.
Price inflation has been quiescent. Headline inflation is stuck at around 1% and core inflation has been approximately 1.6% since the beginning of the year. Wage inflation is a little more evident, with average hourly earnings reaccelerating to a 2.6% rate over the last year. Given the weak readings on price inflation, nominal wage gains are translating into better real wage gains. With real income expanding, household wealth holding near record highs, and a favourable environment for borrowing, the fundamentals supporting consumption spending in the second half of the year are positive.
Following its July meeting, the Federal Reserve noted that near-term risks to the outlook have “diminished.” However, following an ill-fated flirtation with calendar-based guidance after its April meeting, there was no hint about the timing of future actions. With the economy’s neutral rate of interest significantly lower than in the past and no signs of inflation overheating, policy makers appear content to wait and see how the outlook shapes up in the second half of the year before making any decisions.
Although growth was still resilient up to the end of Q2 2016, the UK faces considerable policy, and thus economic uncertainty, resulting from the referendum vote to leave the European Union. More recently, business surveys suggest that economic growth is likely to slow considerably, if not turn negative, in the coming quarters as the uncertainty caused by Brexit will likely cause investment, purchasing decisions and hiring to be postponed. The July Purchasing Managers’ Index (“PMI”) business survey fell to the lowest levels since the global financial crisis in 2009. The fall was widespread across the services, manufacturing and construction sectors. Current levels of the surveys are consistent with GDP contracting meaningfully. Surveys on retailing have also fallen markedly since the referendum and are now back down to average historical levels. In addition, consumer confidence fell 11pts in July (the sharpest monthly fall since 1989) also returning to historical average levels, pointing to more modest growth in retailing in the quarters ahead. The 7% depreciation in the trade-weighted exchange rate since the referendum will raise retail prices, consequently slowing demand for imported retail goods. The housing market appears to have softened as well. House prices have moderated in recent months, but have continued to increase. However, surveys on activity (which tend to be linked to prices) remain at very subdued levels.
Headline inflation remains subdued on account of low food and energy prices, only rising 0.4% y/y. Core inflation, which excludes volatile items such as food and energy, also remains fairly modest growing 1.4% y/y, below the Bank of England’s (“BoE”) target of 2%. The BoE released its most recent economic projections alongside the August Inflation Report. Growth in Q4 2017 was revised down 1.5ppts to 0.8% y/y, whilst inflation was raised 0.2ppts to 2% y/y, supported by the sharp depreciation in the exchange rate. The unemployment rate was revised up by 0.7ppts to 5.6% in 2018. As a result, the Monetary Policy Committee (“MPC”) lowered the policy interest rate by 25bps to 0.25%, and sought to increase the asset purchase facility by GBP70bn to GBP445bn in an attempt to bolster the economy. With Prime Minister Theresa May taking office and her newly appointed cabinet in place, concerns over Government leadership should be allayed. However, there remains little guidance as to when Article 50 (the legal process by which the UK will leave the EU) will be invoked. In addition, the new chancellor of the exchequer, Philip Hammond, has postponed making any changes to the budget until the Autumn Statement later in the year. As such, the lingering uncertainty over policy developments should keep economic activity subdued until clear policy guidance is given.
Survey data suggests that the UK’s decision to leave the European Union has not yet had a major economic impact on the euro area economy. Although surveys showed declines in consumer and business confidence in the immediate aftermath of the vote, the falls were either small in magnitude or at least partially reversed in subsequent releases (e.g. Sentix investor confidence). The Composite PMI for the euro area ticked up to 53.2 in July from 53.1 in June, although, importantly, these dynamics are the result of some progress in core countries and deterioration in the more vulnerable periphery. However, the significant slowdown observed in the UK economy suggests caution as the effects on the EMU economy may simply be delayed. Moreover, hard data suggests that some moderation has actually occurred during Q2, with GDP growth slowing to 1.2% q/q (annualised) from 2.2% recorded in Q1. The European Banking Authority’s stress results that were released on 29 July did highlight the undercapitalisation of parts of the European banking system that will need to be addressed. In particular, any turmoil in the Italian banking system could also negatively impact the outcome of Italy’s constitutional referendum in November, to which Prime Minister Renzi has tied his political future.
The unemployment rate has extended its downward trend, reaching 10.1% in June, down nearly 1pp on the year, but still considerably above its pre-crisis average. Amid a still large output gap, extremely muted wage growth, lower NAIRU (“Non Accelerating Inflation Rate of Unemployment”) and exchange rate dynamics, inflationary pressures remain largely absent beyond the base effects that are expected to raise headline inflation closer to its current core rate by the beginning of next year. Hence, the ECB has maintained its easing bias and may announce an extension of its asset purchase programme beyond March 2017 by the end of the year.
Activity data in China showed mixed signs in June and July. The July official manufacturing PMI came out weaker than market expectations, but the Caixin PMI rose sharply from its prior figure of 48.6 to 50.6. Such inconsistency is due to a sampling difference, geared towards small, export oriented firms for the Caixin survey. Actual Industrial Production (“IP”) growth rose in June from 6.0% y/y to 6.2% y/y, but Fixed Asset Investment growth YTD continued to slow, from 9.6% y/y to 9% y/y, mainly due to private investments. Retail sales growth improved somewhat from its prior reading. Inflation in July fell from 1.9% to 1.8%, in line with expectations.
The People’s Bank of China has maintained a neutral monetary policy stance so as to support a recovery; the 7-day repo rate has been stabilised at approximately 2.4% for the past month, while credit data was strong generally due to seasonality. Despite some continued pay back from an exceptionally strong March, total social financing growth remained strong, at 10.9% y/y in June. Investments in infrastructure and investment by State Owned Enterprises, both a gauge of policy-driven growth, somewhat softened in June after strong growth since late 2015.
Policy packages announced around the start of August were disappointing. The Japanese Government introduced a ¥13.5 trillion package of fiscal measures, split between ¥7.5 trillion in spending and ¥6 trillion in loan guarantees. It estimates that the stimulus measures will push up real GDP by 1.3% in the near term. Recent history, however, suggests that the boost to aggregate demand will be attenuated. When the authorities tried to raise infrastructure spending around the time of the value-added tax hike, it proved difficult to ramp up construction given tight labour markets in that sector. Indeed, some early private-sector forecasts suggest that the fiscal impetus to the latest program will only be a fraction of the Government’s estimate.
At its latest meeting, the Bank of Japan (“BoJ”) made only small amendments to monetary accommodation. It raised its annual ETF purchases to ¥6 trillion, but that program remains relatively small. It chose not to increase its pace of Japanese Government Bonds purchases and left the 0.1% level of interest it charges on a portion of excess reserves that banks hold unchanged. Except for updating 2016 for the passage of time, board members left their inflation forecasts unchanged on balance. As in April, they continue to believe that monthly core inflation will immediately jump to a 0.15% monthly rate, despite the fact that prices excluding food and energy have changed little over the last six months. That outlook remains even harder to imagine than it did three months ago given the 4.2% appreciation in the yen against the dollar between the meetings. After the BoJ released the July statement, Governor Kuroda defended the efficacy of monetary policy. He denied that the Bank had reached the limits to further monetary stimulus, which some bank watchers had concluded after seeing the BoJ’s only small adjustment to accommodation. The statement tried to soften the disappointment by saying that it would conduct a comprehensive review of its policy measures in order to reach 2% inflation at the earliest possible time.
The BoJ also announced two measures “to ensure smooth funding in foreign currencies by Japanese firms and financial institutions.” The Bank doubled the size of its dollar lending program and established a new facility for lending securities to be pledged as collateral for dollar funding. While useful as a larger safety net in case of an emergency, they are unlikely to have a meaningful effect on economic activity outside of times of stress. Banks tend to eschew such programs normally to avoid the stigma of tapping central bank help.
Indicators of economic activity do not suggest any shift in the modest trajectory for economic activity. The Shoko-Chukin survey of small and medium-sized businesses slipped for August and remains at a subdued level. The Economy Watchers’ survey also eased, though from a more depressed level. The Markit manufacturing survey improved slightly but remains below its par line. Despite its latest uptick, industrial production still appears to be trending down slightly.
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