Hedge Fund Role in S&P 500 and Emerging Markets Sell-Off

Hedge Fund Role in S&P 500 and Emerging Markets Sell-Off
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Hedge Fund Role in S&P 500 and Emerging Markets Sell-Off

The market volatility of the past couple of weeks is a common feature of market activity when Hedge Funds make changes in their perceptions of future returns in various asset classes. Often what we see is a temporary fall in the SPDR S&P 500 ETF Trust (NYSEARCA:SPY). In the current environment we are seeing the SP500 sell off with the sell off in the iShares MSCI Emerging Markets Indx (ETF) (NYSEARCA:EEM) (MSCI Emerging Market ETF), iShares JPMorgan USD Emer Mkt Bnd Fd ETF (NYSEARCA:EMB) (MSCI Emerging Market Bond ETF) and EWJ ( MSCI Japan Index Fund)-see the chart below. This deserves some explanation.

screenshot 134 484x420 Emerging Markets & The S&P 500

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When Hedge Funds invest, the managers tend to be diversified across a wide group of asset classes attempting to take advantage of price movements in multiple asset classes. What often occurs in the less liquid asset classes is that too many funds in a single asset class creates the situation where they find themselves trapped and unable to sell efficiently when they all want to sell at the same time. What they do to meet the inevitable margin calls which occur each afternoon (2:30PM in the US markets) is to sell the more liquid investments which often proves to be US stocks, i.e. the SPDR S&P 500 ETF Trust (NYSEARCA:SPY). The effect is that investors witness smaller, less liquid asset classes causing a fall in the LgCap more liquid issues for no apparent reason. This is something I have witnessed since Hedge Funds evolved in 1995 to have considerable impact on short term market volatility.

It is also my observation which is supported by observations of well known value managers over many years that economic growth trends have the largest long term impact on securities prices. I call your attention to the chart above. This chart covers only the period of early 2011 thru today’s pricing. The information I had available indicated that we exit Emerging Markets with large gains in early 2011 but remain invested in several other asset classes including the SP500. If economic trends are rising, so do the associated equity asset classes.

The SP500 has risen from $1,272 from the beginning of the chart to $1,610 when this data was collected or a 26.5% gain while the EMB had a 6.5% return, the EEM lost ~15.5% and the EWJ had a gain of 3%. Hedge Funds noting this are adjusting portfolios as they are leaving behind the anti-US$ bet which favored commodities and the Emerging Markets which produced them. The economic data which supported our decisions in the past continues to indicate that the SP500 and Intl LgCap equities are the better asset classes to hold in portfolios.

It is my opinion that the recent sell off in the SP500 as others sell their Emerging Market positions is simply the effect of Hedge Funds adjusting their portfolios and selling what they need to meet daily margin calls. This is something which longer term investors should ignore and trust the economic data which has served us so well.

By: valueplays

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Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a RealMoney.com contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.
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