Brevan Howard Global commentary for the month ended September 30, 2016.
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BH 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, Brevan Howard Global 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.
BHMS has the ability to allocate capital to investment funds and directly to the underlying traders of Brevan Howard affiliated investment managers. The Direct Investment Portfolio (the “DIP”) is the allocation of BHMS’ assets to individual trading books. The BHMS allocations are made by an investment committee of BHCM who draw upon the resources and expertise of the entire Brevan Howard group.
Monthly Performance Review for Brevan Howard Global
The information in this section has been provided to BHG by BHCM.
Brevan Howard Global Monthly Commentary
The NAV per share of BHG’s USD shares depreciated by 0.23% and the NAV per share of Brevan Howard Global’s GBP shares depreciated by 0.34% in September 2016.
Brevan Howard Master Fund Limited (“BHMF”)
The NAV per share of BHMF Class Z USD shares depreciated by 0.70% in September. Interest rate trading detracted overall with gains from swap spread and cross market trading in European government bonds more than offset by losses from Japanese interest rate volatility positions which declined in value following the Bank of Japan’s September policy announcement in favour of yield curve control. Further small losses came from directional trading in Japanese and GBP interest rates. Tactical trading in FX markets including the JPY, EUR and GBP also contributed to losses. Small gains were generated from commodity trading in gold and oil as well as in credit markets primarily from US mortgage agency as well as CMBS trading, however these gains were largely offset by losses in equity trading, predominately from option positions in the Nikkei.
Brevan Howard Asia Master Fund Limited (“BHA”)
The NAV per share of BHA Ordinary USD shares depreciated by 0.14% in September. Interest rate trading was modestly positive for the month, with gains from yield curve trading in Korea being partially offset by losses from US directional trading. The impact on interest rate trading PnL from the Bank of Japan’s (“BoJ”) policy announcement of yield curve targeting was roughly neutral with losses from Japanese interest rate volatility positions being offset by gains from directional trading. FX trading detracted over the month in part as option positions failed to cover their theta decay and partly from tactical trading of Australian and New Zealand dollars. Option trading in Japanese and Korean equity indices also detracted modestly over the month.
BH-DG Systematic Trading Master Fund Limited (“BHDGST”)
The NAV per share of BHDGST Class Z USD shares depreciated by 0.47% in September. At the sector level, negative overall returns were primarily driven by positioning in bond futures which delivered a loss of 0.71%. This was partially offset by small gains in agriculturals, FX and equities. Bond risk was reduced during a poor first half of the month before being rebuilt late on via longs in German and US positions across the curve. Equity index performance was mixed across all regions. The best performing market was the Nasdaq however gains made here were largely offset by losses attributed to long S&P positions. Longs in the FTSE also performed notably well with a weaker Sterling supporting the international earnings of multinationals on the index. In FX, September saw the model increase its net long in the Japanese Yen with positive results. The Yen was the best single performing position this month, supported by a combination of weak US data, a dovish Fed and a BoJ policy regime change to yield curve targeting. Positioning in the agricultural sector was the most successful of all commodities. Long positions in Robusta Coffee and Sugar futures were increased, with the latter performing strongly in September as the fourth highest contributor to profits at an individual market level. Elsewhere, returns from metals were muted as BHDGST took an increasingly bullish stance throughout the month, while net long exposure to the energy sector was also increased.
Direct Investment Portfolio (“DIP”)
The DIP appreciated by 0.16% in September. The risk level was kept relatively low during the month and PnL moves were modest in most asset classes with credit trading being the highest positive contributor. Gains in credit, commodities and interest rates were partly offset by losses in FX and equity. In credit, the bulk of the gains arose from US RMBS, where a number of long positions traded at higher levels. Valuations increased partly on the back of putback settlements and the continued strong appetite for yielding assets. Within the ABS/MBS portfolio, there were additional gains from European RMBS and some US legacy CMBS positions. A part of the profits were realised at attractive levels. The portfolio made additional credit gains in emerging market relative value positions and agency trading. Exposures within interest rates were kept low during the month but added small gains in EUR and GBP. In commodities, the portfolio generated modest gains from long exposure to gold and oil early in the month. Gains were partly offset by losses in FX and equity trading. In FX short exposure to JPY was the main detractor. Additional smaller losses arose from a decline in FX volatility and tactical trading in GBP. In equity, long exposure to the Nikkei was the main detractor. The exposures to both FX and equity indices were reduced during the month.
Manager’s Market Review and Outlook
The information in this section has been provided to Brevan Howard Global by BHCM.
Payroll employment rose at a solid pace in September. The unemployment rate ticked up to 5.0%, but that was attainable to an increase in the participation rate. Taking the longer view, the improvement in job opportunities has drawn substantial numbers of workers into the labour force over the last year. As a consequence, the unemployment rate has been broadly unchanged over the same period. Signs point to additional slack in the labour market with the average work week well off its business cycle highs, broader measures of underemployment remaining elevated, and average hourly earnings rising only moderately.
Growth appears to have picked up in the third quarter, led by reversals in the weakness in inventories and trade seen over the last year. In particular, inventory disinvestment sliced more than 1 ppt from growth in the second quarter which mechanically implied a rebound in the second half of the year. Apart from inventories, the indicators of private final demand have been mixed. Retail sales in core categories have been weak in the third quarter, after having surged in the second quarter. Orders and shipments of core capital goods point to a tentative stabilisation in business investment. Housing investment continues to limp along despite historically favourable fundamentals, including low mortgage rates, tight supply, and increased household formation.
Inflation edged up to 1.7% in September after having been stuck at 1.6% for most of the year. In contrast, survey measures of consumer inflation expectations remain weak and market-based measures of inflation compensation have inched up but remain historically depressed.
The September Federal Open Market Committee meeting proved to be another exercise in patience. Nevertheless, the committee indicated that the case for another increase in rates had strengthened, but decided to hold off for the time being in order to let the economy build up some more steam. In subsequent communications, various policy makers suggested that a December rate hike was likely so long as the economy continued to advance.
The UK economy has fared well so far despite the uncertainty caused by the vote to leave the European Union. GDP growth was revised up by 0.1ppt to 0.7% q/q in Q2, in part due to higher than expected business investment. The economy is still expected to be weighed on by slow growth in medium term investment, although the large depreciation in the effective exchange rate since the referendum should support certain sectors of the economy. In particular, there is some evidence of this in the manufacturing sector, with the Purchasing Manager’s Index (“PMI”) survey rising in September to the highest level in two years. The services PMI has also recovered since the post-Brexit vote fall, but unlike the manufacturing survey, it ticked down in September by 0.3ppts to a level of 52.6, well above the threshold, but still below its long-term average levels. Given the weight of the services sector, the PMI surveys point to a rate of economic growth of around 0.4%, still positive but slower than in Q2. For now, underlying growth can be expected to be supported by household consumption, especially while tourists and ‘staycationers’ take advantage of the lower pound, at least until higher import prices feed into retail prices. The recent recovery in consumer confidence also helps explain how retail sales volumes have picked up to a fast annualised pace of over 5%. After having reached multi-year lows after the Brexit vote, surveys on the housing market have also recovered. However, the diffusion index of new buyer enquiries remains somewhat below zero, indicating that buyer enquiries are still falling compared to the previous month albeit at a more gradual pace. This is consistent with loan approvals, which are now 18% lower compared to the peak in January. In comparison to the poor performance of housing survey, national house prices have performed slightly better showing modest (but still positive) rates of house price inflation. However, surveys suggest that the London housing market has performed less well, and that prices have fallen in some areas.
The unemployment rate has currently stabilised at a recent low of 4.9% in the 3 months to July, while employment growth has been relatively resilient, growing at an annualised pace of 1.5%, slightly above historical average rates. Headline inflation has picked up in recent months as the drop in oil and commodity prices continue to phase out: by 0.6ppts from a year ago to 0.6% y/y in August. Core inflation has also picked up from the lows a year ago, but has stabilised at a modest rate of around 1.3% y/y, slightly below long-term average rates. Although the influence of the approximate 15% depreciation in the exchange rate since the referendum has so far been modest, there are clear signs that the lower exchange rate will eventually lift prices. Producer input prices have risen by 6% in the three months to August, and are poised to increase further as the most recent leg of depreciation in October feeds through to import prices. Over time, higher import prices and diminishing base effects will cause headline inflation to rise above the Bank of England’s (“BoE”) target of 2%. To offset the negative impact on activity from the Brexit vote, the Monetary Policy Committee lowered the policy interest rate by 25bps to 0.25% in August, and sought to increase the asset purchase facility by £70bn to £445bn in an attempt to bolster the economy. More recently however, indicators of activity suggest that GDP will grow by more than the BoE’s forecast of 0.1% q/q in Q3, implying that further monetary easing may be delayed, if not halted. In addition, according to recent statements by the Prime Minister and the Chancellor of the Exchequer, the Government appear willing to increase investment in housing and infrastructure to offset a slowdown should one arrive; however, decisions will only be taken at the Autumn Budget statement on 23 November. Overall, the negative effects of the Brexit vote are still expected to weigh on investment and economic growth more broadly in the long-run and are likely to intensify once the Prime Minister invokes Article 50 (the legal process in which the UK leaves the EU) early next year.
The economic picture in the euro area remains largely unchanged from previous months: survey data have not been majorly impacted by Brexit; the IFO Business Climate indicator for Germany dipped in the immediate aftermath of the referendum, but rebounded strongly in September, hitting its highest level since May 2014. Similarly, the European Commission’s Economic Sentiment Indicator eased in July and August, but almost fully unwound those losses in September. In contrast, Markit’s PMI for the euro area has trended slightly lower in recent months, indicating the possibility that the underlying economic momentum is easing. Such a slowdown is certainly conceivable, as the impulses coming from the past depreciation of the euro and credit extension appear to be gradually waning. Hard data available thus far seem to be more in line with the picture depicted by the PMI, highlighting a further, gradual loss of momentum from Q2, which already saw some slowing from the peak recorded in the first months of 2016.
This picture is also confirmed by the slowing progress in the closing of the output gap, stemming from the labour market and price dynamics: the unemployment rate has moved largely sideways in recent months, after declining fairly rapidly between the end of 2013 and the first half of 2016; wage growth keeps slowing; and core inflation remains at a mere 0.8% y/y, much lower than the ECB definition of price stability. Inflation expectations have started to recover recently, but only as a consequence of the moderate rebound in oil prices, but remain at historically very low levels. As past energy price declines drop out of the year-on-year comparison, headline inflation should move higher in the coming months. However, core inflation is expected to remain subdued, keeping pressure on the ECB to maintain an elevated level of stimulus beyond March 2017.
Activity data in China for August/September showed further signs of short-term stabilisation although accompanied by some underlying softening towards the end of the quarter: both the Official and Caixin PMI were roughly unchanged in September, as was the growth rate of both Fixed Asset Investment (8.2% y/y YTD) and retail sales (10.7%), with the strongest indication stemming from both car sales and the property sector. On the soft side, industrial production slowed somewhat (from 6.3% to 6.1%) on the back of weak sequential growth, in addition, both imports and exports fell on both a yearly and a sequential metric, largely undershooting consensus forecasts. Inflation picked up, as the y/y rate of increase of Consumer Price Index climbed back from 1.3% to 1.9% in September, on the back of higher food prices due to holidays, and the yearly rate of increase of the Producer Price Index turned positive for the first time since Q3 2014.
The People’s Bank of China has largely maintained its accommodative stance so as to support a recovery: total social financing growth increased in September from 11.6% to 11.8% y/y, while M2 growth increased from 11.4% to 11.5% y/y. The 7-day repo rate, having risen slightly to an average of about 2.55% in late September before the holiday season, has now fallen back to 2.4%. FX reserves declined slightly to US$3.16 trillion in October and there are signs that actual capital outflow pressures were higher than suggested by the headline figures.
Japan’s near-term future is clearer though uninspiring. Monetary policy is on hold. The Bank of Japan (“BoJ”) has announced its intention to hold the 10-year Japanese Government Bond rate near zero. Rates are already a little below zero, and the BoJ shouldn’t struggle to keep them there as there’s nothing on the horizon to pressure rates upwards. Inflation has slowed significantly, without acceleration in prices, base effects show that the 12-month change will continue to fall on balance for most of the rest of the year. Inflation expectations did tick up in the latest consumer survey, but there’s no reason to think they’ll continue to improve. Indeed, there’s probably some additional drag to actual inflation to come from the previous appreciation in the yen. The real economy continues to trudge along. The Tankan and Economy Watchers surveys were essentially unchanged. The Shoko-Chukin and Sentix indexes improved a little, but remain at mediocre levels, as did industrial production.