Home Value Investing Brevan Howard March Letter: China Still Murky

Brevan Howard March Letter: China Still Murky

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Brevan Howard letter for the month ended March 31, 2016; titled, “China Still Murky.”


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, 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: $ 527 mm1

1. As at 31 March 2016 by BHG’s administrator, Northern Trust.

Brevan Howard

Brevan Howard – Q1 2016 Portfolio Update

The information in this section has been provided to BHG by BHCM.

Profits were generated in interest rates trading, where long exposures to interest rates in EUR were the main contributor. Additional gains came from trading within other interest rates markets including JPY & CAD. Part of the gains were offset by losses in USD interest rates trading where the Fund’s short exposure in the early part of the quarter generated losses.

Credit trading contributed positively to the performance over the quarter. Agency mortgage trading as well as corporate credit trading during the second half of the quarter contributed to the gains.

FX trading was a detractor over the period where the Fund’s short exposures to the EUR against the USD generated most of the losses. Part of the losses were offset by gains from long exposures to FX volatility as well as long exposures to a basket of currencies including CAD and AUD against the USD.

Equity and commodity trading were both detractors over the quarter. Long exposures to equity indices in Europe and Asia in January generated the bulk of the losses. In commodities, long exposure to oil early in the quarter generated small losses.

Systematic trading had a positive quarter with most of the gains generated from long exposures to global bond markets. Additional gains were generated in FX whereas equity and commodity positions generated losses.

The investment committee (“IC”) increased the allocation to the Direct Investment Portfolio (“DIP”) and diversified its exposure across a larger number of traders. At the end of the quarter the Fund allocation to the DIP stood at approximately 38% with an allocation to ten underlying trading books across macro, emerging markets and credit strategies. The IC believes that the diversified return streams should benefit the Fund’s performance in the medium and longer term.

Portfolio Update for BHG

The information in this section has been provided to BHG by BHCM.

Brevan Howard

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Brevan Howard

Brevan Howard – 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 depreciated by 0.89% and the NAV per share of BHG’s GBP shares depreciated by 1.09% in March.

Brevan Howard

Brevan Howard Master Fund Limited (“BHMF”)

The NAV per share of BHMF Class Z USD shares depreciated by 1.82% in March. Losses in March were fairly evenly split between FX and interest rate trading, with smaller gains from credit trading being offset by losses in equity. Interest rate losses came predominately from long positions in Europe, with further losses from Japanese directional and volatility trading. Smaller gains in NZD, BRL, MXN and TRY interest rate trading were offset by losses in U.S and European volatility positions. FX trading generated an overall loss, driven primarily by short positioning in EUR as well as to a much lesser degree losses in KRW & GBP which were partially offset by gains in commodity linked currencies, such as AUD, CAD, MXN, NOK and BRL. Credit gains from European credit indices were offset by losses from directional equity positioning in the U.S and Europe as well as losses in equity volatility trading.

Brevan Howard Asia Master Fund Limited (“BHA”)

The NAV per share of BHA Ordinary USD shares depreciated by 1.48% in March. Losses in March came primarily from FX trading, with smaller losses also generated in interest rate and equity trading.

The bulk of FX losses were spread between directional and relative value trades in China as well as from directional trading in Korea and Singapore. Interest rate losses came from US curve trades as well as Japanese interest rate volatility positioning. Interest rate curve trading generated small losses in Korea which were offset by gains in Australia. Smaller equity losses came from directional and volatility positioning primarily in the Japanese Nikkei.

BHDG Systematic Trading Master Fund Limited (“BHDGST”)

The NAV per share of BHDGST Class Z USD shares depreciated by 3.92% in March. During the month, BHDGST recorded losses in all asset classes. The portfolio VaR decreased from 1.42% at the end of February to 1.35% at the end of March. At the end of the month, the portfolio VaR was 60% of the sum of individual sector VaRs, down from 67% at the end of February. In STIR futures, the model reduced its overall long stance, increasing the net short CAD but adding to long short sterling. In bond futures, the model decreased its overall long positions in all currencies. A long position in Italian BTP futures was increased. With the exception of the CME Nikkei futures contract and the OMXS 30 in Sweden, where the model increased short positions, shorts in European and Japanese index futures were greatly reduced. The model reverted from short to long in the other emerging market indices plus bourses in the U.S. and Canada In FX, the model increased its overall exposure to FX markets, turning USD into a short exposure versus most currencies.

In commodity futures, the overall allocation remained short. The model reduced short energy positions. Within metals, a long gold position was reduced, but the strategy increased its net short stance in base metals. Short positions in agricultural futures were also reduced.

Direct Investment Portfolio (“DIP”)

The Direct Investment Portfolio appreciated by 1.00% in March. The DIP generated the bulk of the profits in FX and credit where agency mortgage and corporate credit trading generated most gains. In corporate credit, gains came primarily from longs in corporate CDOs, recovery in high yield names and outperformance of secured debt vs unsecured debt in a few high yield relative value positions. In FX, long exposure to commodity currencies AUD, CAD & MXN against the USD generated most gains. Part of the gains was offset by losses in interest rates trading where in particular curve positions and directional long exposures to EUR & JPY Interest rates were a detractor. In commodity trading long exposure to oil generated gains whereas equity trading generated small losses.

Brevan Howard – Manager’s Market Review and Outlook

The information in this section has been provided to BHG by BHCM.

Market Commentary


Growth appears to have been disappointing in the first quarter. Consumption outlays have slowed and business investment is at a standstill. Growth was also weak in the first quarter of the last two years, but that could be attributed to obvious transitory factors, for instance bad weather. The somewhat puzzling pattern of consumption spending coupled with a lack of pick up in business investment, creates the worry that a combination of financial market volatility and the global slowdown may be impacting the key parts of aggregate demand. At this point, the best scenario is that the lull is temporary given the robust labour market, which is creating jobs at a brisk pace, bringing in workers from out of the labour force, and driving income growth.

Wage and price inflation have been scrutinised for signs that they are moving up. The evidence is mixed. After surging in January, average hourly earnings slowed in the last two months leaving the year-over-year gain stuck in the middle of the 2%-2.5% range that has prevailed for the last year. The news about price inflation has been punchier. While headline prices have been pushed down and then back up by developments in energy markets, the underlying trend in core Personal Consumption Expenditures (“PCE”) inflation looks to have firmed. The combination of favourable base effects and an especially robust increase in core inflation in January has brought the year-over-year rate to 1.7% for the last two months. That is close to the Federal Reserve’s 2% inflation target, an encouraging sign that would point to a healthier economy and perhaps a faster pace of interest rate increases. However, some caution is appropriate since the upside surprises have been driven importantly by volatile prices, such as apparel, that may fall in the coming months. Given that the economy is at or near full employment, any news about inflation takes on outsized importance in shaping the prospects for monetary policy.

After having been stung by markedly tighter financial conditions during the first quarter, Federal Reserve (“Fed”) policy makers decided not to raise interest rates in March. In a notably dovish move, the majority of them pointed to two rate hikes in 2016 and a lower longer-term neutral interest rate. Following the meeting, Chair Yellen in a major speech at the New York Economic Club highlighted some of the reasons for the Fed’s cautious approach which included headwinds to the recovery and the asymmetric risks posed by the zero lower bound on nominal interest rates. The difficulties experienced by the European Central Bank and Bank of Japan with negative rates only underline the Fed’s cautious approach.


February data suggests euro area activity accelerated slightly in Q1 relative to the previous quarter, supported by domestic demand. Construction was buoyant spurred by unseasonable warm weather and consumer spending was brisk as indicated by both retail sales, growing at a 3.8% pace in February on a 3m/3m annualised metric, and car registrations, mainly due to the steep drop in energy prices. Industrial production (“IP”) growth moderated in February after overshooting in January. German IP fell by 0.5% m/m following a downward revision to 2.3% m/m expansion, looking forward it should moderate further, indicated by available business surveys. In addition, consumer confidence is deteriorating, the European Commission survey indicator fell to -9.7 in March from -5.7 at the end of 2015, and the impact of the terrorist attacks in Brussels in March could dent it further. The EMU labour market continues to send positive signals, due to the extremely low potential growth rate. Even the current, modest rate of expansion is enough to lower the unemployment rate, which fell to 10.3% in February (the lowest level since September 2011). The common currency labour market still has a long way to go in order to return to pre-crisis levels of employment and the amount of slack remains ample. Accordingly, price pressures remain muted. The euro zone Harmonised Index of Consumer Prices (“HICP”) inflation rate remained in negative territory for a second consecutive month at -0.1% y/y in March, up slightly from -0.2% y/y in the previous month, still far away from the ECB’s definition of price stability. Core inflation (which excludes volatile items including energy and food), rose to 1.0% y/y in March from 0.8% in February although only because of a temporary effect due to the early timing of Easter this year, and it is poised to fall back in April. In general, underlying price pressures remain extremely weak, as highlighted by the steeper fall of producer price inflation, and are poised to slow further under the impact of the recent appreciation of the Euro on import prices.

The measures of monetary policy easing announced in March by the ECB have failed to ease financial conditions, although the impact on credit conditions is still unclear. Since the March ECB policy easing, the Euro has risen while equity prices have generally fallen, especially in the periphery. Government bond yields have dropped in the core, while in the weakest countries of the periphery they are showing renewed upward tensions. Long-term inflation expectations expressed by financial markets have in general fallen back towards all-time lows, as council members are struggling to convince markets that they would be willing and able to ease monetary conditions enough to boost inflation towards the central bank target. The ECB’s accommodative policy is also facing increased criticism from the German public opinion and financial lobbies. Renewed financial and political tensions are emerging in the periphery; from Greece, where there is a struggle on how to proceed between the IMF and Germany as the public finance targets set seem out of reach, to Portugal, Spain and even Italy.


The UK economy grew solidly in 2015, however 2016 is proving more challenging due to the uncertainty created by the EU referendum, an unforgiving global environment and on-going fiscal austerity. The latest estimate of Q4 GDP was revised up by 0.1 percentage points to 0.6% q/q, due to an upward revision to services output, demonstrating that UK private domestic demand remained resilient in earlier months. Looking forward, business surveys continue to point towards moderation in the manufacturing sector. Although the recent depreciation of Sterling (approximately 10% against the dollar in the last 6 months) may provide some support, it is unlikely to be enough to offset the drag from modest external demand, as well as the uncertainty caused by the referendum. Surveys on the services industry have also deteriorated in recent months. Although the services Purchasing Manager’s Index (“PMI”) ticked up one point in March to 53.7, it is still more than five points below the level of a year ago. Retailing and general consumption has continued to do well, supported by persistently high consumer confidence, increasing consumer lending and a further fall in the savings rate. Mortgage approvals had picked up in recent months as individuals sought to buy properties ahead of the additional 3% stamp-duty tax on secondary homes that came into effect in April. However, some surveys suggest this recent flurry has started to unwind and it’s possible the housing market will cool in the coming months. House prices continue to rise at a pace of around 7% y/y, broadly in line with recent history. The unemployment rate declined 0.5 percentage points in the period from June 2015 to November 2015 and has since been unchanged at 5.1%. In that same period, employment grew at a very high pace of 2.5% annualised but surveys indicate it has since lost momentum. Despite the tightening in the labour market, wage inflation fell from a peak of 3% down to 2% in November, and has since stabilised. Overall, wage inflation remains well below the 4% pace experienced before the crisis. Headline inflation remains subdued at 0.3% y/y and it continues to be pushed down by low energy prices. Core inflation (which excludes volatile items like energy prices) also remains muted, recording 1.2% y/y in February.

Whatever the outcome on 23 June (the referendum date), the uncertainty may delay both investment and hiring, stinting growth in the 2nd and possibly 3rd quarters of 2016. The Bank of England’s (“BoE”) Monetary Policy Committee (“MPC”) voted again unanimously to keep rates unchanged (at 0.5%) at its latest meeting in March. Given the lack of inflation in both Consumer Price Index (“CPI”) and wages, the BoE is not yet under any pressure to vote for an interest rate hike. In addition, it will be difficult for the BoE to give clear guidance regarding monetary policy just ahead of the referendum.


China activity data in March showed signs of a near-term gradual turnaround. Both the official and the Caixin PMIs improved notably, recording the strongest reading since mid-2015. Industrial Production (“IP”) growth peaked from the extremely subdued levels recorded in the first two months of the year. On the demand side, the support seems to be provided by infrastructure investments and housing activity, both spurred by a renewed large increase in credit formation. Exports are not contributing to the cyclical pick up, as global demand remains subdued. The People’s Bank of China has maintained a relatively accommodative monetary policy stance; cutting the required reserve ratio by 50bps in February while keeping the 7-day repo rate stable at around 2.3%. However, the transmission mechanism from interbank market rates to economic growth is less clear. FX reserves in March increased by about US$10bn, slightly more than market expectations.


According to press reports, the Bank of Japan (“BoJ”) will likely debate easing monetary policy at its upcoming meeting at the end of April. The economic backdrop supports that supposition. Survey data on economic activity have either deteriorated or moved sideways at subpar levels. The index of actual conditions for all enterprises in the quarterly Tankan surveys declined in the first quarter, though the level remains in the range seen over the last few years. The index of expected conditions also moved down but barely above zero – the index is currently at the bottom of the range seen recently. February data in the economy watchers survey dropped sharply to its lowest level in over five years, excluding a brief pothole due to the introduction of the consumption tax. The Shoko-Chukin index of small and medium-sized businesses slipped in April. It has generally drifted sideways in the past year. Industrial production fell noticeably in February to its lowest level in over three years.

Inflation-related data didn’t fare much better. National consumer prices excluding food and energy (western-core price index) moved up 0.2% on a seasonally adjusted basis in February, following a 0.1% decline in January. The six-month annualised rate at 0.4%, is half the 12-month change. The seasonally adjusted Tokyo western core rate was flat in March. The yen has appreciated 7-8% against the US dollar in the last three months, pointing to further downward pressure on inflation. Consumer inflation expectations appear to continue to deteriorate.

At the same time, the Government appears to be wrestling with a decision on whether to raise the consumption tax next year. Prime Minister Abe indicated that there are no plans to delay the hike barring some big external shock. However, according to press reports, at the same time the administration is actively considering plans to support consumption in the event that VAT is raised, such as cutting income taxes. When VAT was raised in 2014, increased Government spending plans to help cushion the blow were inadequate. It’s likely that any fiscal offsets this time are akin to a consumption subsidy or tax cut, rather than increased Government spending. Despite these plans, some analysts suspect that a delay is still possible. The Prime Minister was right when he said a month ago that following through with the tax hike involved politics; it’s probably tied to a decision to call lower-house snap elections. A definitive decision is expected towards the end of May.

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