Fed Says Dealers Tighten Terms on Hedge-Fund Security Trades

December 29, 2011, 11:22 PM EST By Scott Lanman and Matthew Leising

(Updates with interest-rate swap spread in seventh paragraph.)

Dec. 29 (Bloomberg) -- Wall Street dealers made it tougher for hedge funds to finance trading of securities and derivatives in the three months through November, a Federal Reserve survey showed today.

Responses “indicated a broad but moderate tightening of credit terms applicable to important classes of counterparties,” especially hedge-fund clients, trading real estate investment trusts and nonfinancial corporations, according to the quarterly survey of senior credit officers at 20 dealers covering the period of September to November. The central bank released the report in Washington.

The report adds to evidence of stress in the financial system from Europe’s sovereign-debt crisis. Investor concern about the continent’s turmoil has helped drive the premium banks pay to borrow dollars to the highest in more than two years. The Fed survey didn’t discuss causes of the tighter financing terms.

Respondents reporting tougher borrowing terms for hedge funds “most frequently pointed to a worsening in general market liquidity and functioning and to reduced willingness to take on risk and, to a lesser extent, adoption of more-stringent market conventions and deterioration in the strength of counterparties as the reasons,” the Fed said.

Credit Limits

The Fed’s Senior Credit Officer Opinion Survey on Dealer Financing Terms was conducted from Nov. 15 to Nov. 28. Respondents, who aren’t identified, “account for almost all of the dealer financing of dollar-denominated securities for nondealers and are the most active intermediaries” in over-the- counter derivatives markets, the Fed said.

Measures of stress in credit markets soared during the three-month period surveyed to the worst levels in more than two years as Europe’s fiscal imbalances intensified, fueling concern that the region’s upheaval would taint bank balance sheets globally,

The U.S. 2-year swap spread rose 40 percent in the three- month period to 41.55 basis points as of Nov. 30 after peaking at 59.25 on Nov. 22, according to data compiled by Bloomberg. The difference between the two-year swap rate and the comparable-maturity U.S. Treasury note yield expanded to 48.63 basis points today.

Another signal of weakness in the banking system, the spread between the three-month London interbank offered rate, or Libor, and the overnight index swap rate, has more than doubled in four months to 0.49 percentage point today. That’s the widest since May 2009, as financial markets were still recovering from the collapse of Lehman Brothers Holdings Inc.

Interbank Lending Divergence

While the Fed said today that 80 percent of dealers reported lowering credit limits for some specific financial- institution counterparties, evidence grew that banks were growing more wary of lending to each other.

The gap between the highest and the lowest rates that banks say they can borrow from each other in dollars is close to a 2.5-year high.

The divergence from reported fixings by the 18 banks contributing to the three-month London interbank offered rate reached 28 basis points today, within two basis points of the widest since May 2009. Libor for three-month loans climbed to 0.581 percent, the most since July 2009, even as central banks injected cash into the market.

U.S. economic data released today may point to some easing of terms for bank customers as the world’s largest economy improves. Companies cranked out more goods in December and pending sales of existing homes jumped in November for a second month.

‘Signs of Life’

The Institute for Supply Management-Chicago Inc. said its business barometer was little changed at 62.5 from a seven-month high of 62.6 in November. The index of signed contracts to buy previously owned houses rose 7.3 percent after climbing 10.4 percent the prior month, the National Association of Realtors said. Both figures surpassed the median estimate of economists surveyed by Bloomberg News.

“2011 is ending on a solid note,” said Ryan Sweet, a senior economist at Moody’s Analytics Inc. in West Chester, Pennsylvania, who forecast a reading of 63 for the Chicago index. “Manufacturing has some momentum,” he said, and “we’re starting to see some signs of life in housing.”

Combined with a drop in firings over the past month and improving consumer confidence, the data show the world’s largest economy may be strengthening enough to fend off major damage from the European debt crisis. Stocks rallied, buoyed by the stronger-than-projected readings and by a decline in Italian borrowing costs and a benchmark gauge of U.S. company credit risk dropped to a three-week low.

Corporate Credit Risk

The Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declined 2 basis points to a mid-price of 119.9 basis points at 4:52 p.m. in New York, according to data provider Markit Group Ltd.

The swaps index, which typically falls as investor confidence improves and rises as it deteriorates, has declined from 127.8 on Nov. 30. It rose from 114.5 at the end of August to 150.1 on Oct. 3, the highest level since May 2009.

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The Standard & Poor’s 500 Index climbed 1 percent to 1,263.02 at 4:33 p.m. in New York. The yield on the benchmark 10-year Treasury note fell two basis points, or 0.02 percentage point, to 1.9 percent, according to Bloomberg Bond Trader prices.

Dealer Report

The Federal Reserve began querying dealers in 2010 as part of efforts to boost surveillance of financial markets following the panic of 2007-2008 that caused the worst economic downturn since the Great Depression.

The prior survey, covering June through August, showed that 86 percent of respondents reported that the number of dealers tightening financing rates outnumbered those easing.

The latest responses “reflect an apparent continuation and intensification of developments already in evidence in the September survey,” the Fed said today. About one-third of respondents tightened pricing terms, such as financing rates, to hedge funds, while one-fourth reported tightening nonprice terms including maximum maturity, the central bank said.

Hedge Fund Leverage

At the same time, more than half of dealers “indicated that hedge funds’ use of financial leverage, considering the entire range of transactions with such clients, had decreased somewhat over the past three months,” the Fed said.

The Fed survey also found that liquidity and functioning were little changed in the U.S. Treasury securities market since the second quarter, while one-fifth of respondents said equity- market functioning had “deteriorated somewhat.”

The European Central Bank’s balance sheet ballooned this month to a record 2.73 trillion euros ($3.53 trillion) on a surge in loans to financial institutions. The ECB last week awarded 523 banks three-year loans totaling 489 billion euros to encourage lending to companies and households and prevent a credit shortage.

The Fed’s balance sheet has also increased this month to a record, reaching $2.92 trillion last week, on dollar loans to European banks through currency-swap lines.

The ECB this month cut its benchmark interest rate to 1 percent, matching a record low, as the debt crisis threatened to engulf Italy and Spain, the euro area’s third- and fourth- largest economies. The Fed has been considering further measures to ease U.S. borrowing costs and protect the economy from the European turmoil.

--With assistance from Bob Willis in Washington and Anchalee Worrachate in London. Editors: Pierre Paulden, Alan Goldstein

To contact the reporters on this story: Scott Lanman in Washington at slanman@bloomberg.net; Matthew Leising in New York at mleising@bloomberg.net

To contact the editors responsible for this story: Carlos Torres at ctorres2@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net

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Hedge-Fund Managers Miss Big Commodity Rally

December 28, 2011, 1:16 PM EST By Elizabeth Campbell

(For more commodity columns, click CMMKT.)

Dec. 27 (Bloomberg) -- Hedge funds reduced bets on higher commodity prices to the lowest level since 2009 just as raw materials headed for their biggest weekly rally in two months.

Money managers cut their combined net-long position across 18 U.S. futures and options by 15 percent to 454,512 contracts in the week ended Dec. 20, the lowest since March 2009, data from the Commodity Futures Trading Commission show. The Standard & Poor’s GSCI gauge of 24 commodities climbed 4.5 percent last week, erasing this year’s declines and pushing the index toward its third consecutive annual advance.

While the S&P GSCI is 15 percent below the 32-month high reached in April, prices gained last week on signs the U.S. economy is proving resilient. Durable-goods orders rose in November by the most in four months, and jobless claims unexpectedly fell to the lowest in more than three years. Concern that shortages will emerge in commodities from copper to crude oil spurred Goldman Sachs Group Inc. to stick with a bullish outlook this month even as funds cut their holdings.

“Commodities are in the process of bottoming,” said James Paulsen, the Minneapolis-based chief investment strategist at Wells Capital Management, which oversees about $340 billion of assets. “You’re going to find out that the U.S. economy is going to continue to grow much faster than people thought. You’re going to see people coming back to commodities.”

Commodity Rally

Last week’s gain in the S&P GSCI was the biggest since Oct. 14 and left the gauge up 2.2 percent in 2011. It rose 20 percent in 2010 and 50 percent a year earlier. The MSCI All-Country World Index of equities climbed 3.1 percent last week, paring this year’s decline to 9.3 percent. The U.S. Dollar Index, a measure against six trading partners, dropped 0.4 percent. The yield on 10-year Treasuries climbed 18 basis points, or 0.18 percentage point, to 2.02 percent, Bloomberg Bond Trader prices show.

Twenty of the 24 raw materials tracked by the S&P GSCI rose last week. Gasoline surged 8 percent to $2.6872 a gallon. Wheat capped six consecutive daily advances, the longest winning streak since January. Oil added 6.6 percent, the biggest weekly gain since October. The commodity gauge climbed as much as 1.4 percent today.

Commodities will return 15 percent in the next 12 months, led by industrial metals and energy, because the global economy is likely to avoid another recession, Goldman said in a report Dec. 1. That’s still the bank’s view, Sophie Bullock, a London- based spokeswoman for the bank, said in an e-mail Dec. 15.

Durable Goods

U.S. bookings for equipment meant to last at least three years rose 3.8 percent after no change in the prior month, a period that was previously reported as a contraction, data from the Commerce Department showed on Dec. 23. Sales of new U.S. homes rose in November to a seven-month high, the department said the same day.

The S&P GSCI is still headed for a 0.7 percent monthly decline after Europe’s debt crisis escalated. Funds are net- short, or betting on price declines, in copper, cocoa, soybean meal, wheat, soybean oil and natural gas, CFTC data show. Crude- oil holdings fell 11 percent to the lowest since Oct. 18, and net-long positions in gold dropped 13 percent to the lowest since April 2009.

European Central Bank President Mario Draghi said Dec. 19 that lenders in the euro region will experience “very significant” funding constraints next year and there are “substantial downside risks” to the economy. The Dollar Index rallied 2 percent this quarter as investors sold other assets for the perceived safety of the currency. The gauge declined in six of the past nine years and is 31 percent lower than at the start of that period.

‘Hefty Declines’

“Going into 2012, there’s a very, very high probability that we can see some fairly hefty declines in the commodity markets,” said Stephen Hammers, the Nashville, Tennessee-based chief investment officer at Compass EMP Alternative Strategies Fund, which has about $500 million of assets. “There’s a tremendous amount of uncertainty about what is going to happen around the world in terms of the global economy.”

Pacific Investment Management Co., the world’s largest bond fund, said the U.S. may stagnate next year. Europe may contract and Chinese growth may slow, Saumil H. Parikh, who leads Newport Beach, California-based Pimco’s cyclical economic forums, said in a report posted on its website on Dec. 22.

The economy in China, the biggest consumer of everything from nickel to soybeans, may expand 8.5 percent next year, down from 9.2 percent this year and 10.4 percent in 2010, according to the median of 19 economist estimates compiled by Bloomberg.

$490 Million

Investors pulled $490 million from commodities funds in the week ended Dec. 21, according to data from Cambridge, Massachusetts-based EPFR Global, which tracks money flows. Gold and precious-metals outflows totaled $1.59 billion, and non- precious-metal commodities had net inflows of more than $1 billion, said Cameron Brandt, the director of research.

“Commodities, ex-gold, had one of their better weeks,” Brandt said. “We are seeing some more durable faith in the U.S. recovery at the moment.”

Confidence among U.S. consumers climbed more than forecast in December, to a six-month high, according to the Thomson Reuters/University of Michigan sentiment index. The increase to 69.9 from 55.7 in August is the biggest four-month increase since the period ended June 2009.

Builders broke ground in November on more U.S. houses than at any time in the past 19 months, led by a surge in multifamily units, the Commerce Department said Dec. 20.

China Copper Imports

Refined-copper imports by China climbed to the highest since June 2009 last month, the General Administration of Customs said Dec. 21. Global oil demand will rise 1.4 percent next year, with China accounting for more than a 10th of the total, according to the Paris-based International Energy Agency.

A measure of 11 U.S. farm goods showed speculators cut bullish bets in agricultural commodities by 7.9 percent to 202,544 contracts, the lowest since March 17, 2009. Investors trimmed bullish bets on coffee by 48 percent to 2,954 contracts, the lowest since Aug. 9.

“People are focusing too much on the day to day in Europe,” said Michael Cuggino, who helps manage about $15 billion of assets at Permanent Portfolio Funds in San Francisco. “There’s an overall environment that remains favorably biased towards an increase in commodity prices heading into 2012.”

--With assistance from Mark Shenk in New York. Editors: Millie Munshi, Patrick McKiernan

To contact the reporter on this story: Elizabeth Campbell in Chicago at ecampbell14@bloomberg.net

To contact the editor responsible for this story: Steve Stroth at sstroth@bloomberg.net

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Hedge-Fund Millionaire Diggle Bets on Farms, Life Sciences

December 28, 2011, 6:12 AM EST By Netty Ismail

(Updates with assets under management in ninth paragraph.)

Dec. 28 (Bloomberg) -- Stephen Diggle, who co-founded a hedge fund that made $2.7 billion in 2007 and 2008, plans to open his personal farmland portfolio to investors and start a fund that will trade life-sciences companies.

Diggle will transfer the farm assets from his family office to Singapore-based Vulpes Investment Management, which he set up in April after liquidating his previous firm’s volatility funds. Diggle’s family also holds “significant stakes” in life sciences, including biotechnology companies, which will be moved to a fund he plans to set up next year, the 47-year-old said.

“Everything that we are investing in personally is available to investors,” Diggle said in an interview. “We have got capital committed, we are focused on a number of things where we think there’s a compelling opportunity to make money.”

Diggle is widening his new firm’s investments after starting a volatility fund in May and taking over the Russian Opportunities Fund and Testudo Fund from Artradis Fund Management Pte, which he and co-founder Richard Magides closed in March. Once Singapore’s biggest hedge-fund manager, Artradis’s funds, which sought to profit from price swings, lost $700 million as volatility declined in 2009 and 2010.

“The one thing I didn’t want to do was to spend the rest of my life talking about how great 2008 was,” Diggle said. “You have to move on and find new challenges. That’s what gets you up in the morning.”

Volatility Cost

Vulpes, which focuses on alternative investments, started its long Asian volatility and arbitrage fund, LAVA, on May 1 with $30.5 million, of which $30 million was the founding partners’ money. The fund size has increased to about $50 million after some of Artradis’s former clients returned to invest Diggle. The fund has gained 6 percent since May, he said.

LAVA seeks to produce returns that aren’t correlated with the market by trading instruments that thrive on volatility, such as options, warrants, and convertible bonds. The fund uses strategies such as arbitraging or profiting from disparities in the price of similar securities simultaneously traded on more than one market, and tends to work well when markets go down.

“The cost of being long volatility on a daily basis as a buy and hold strategy is not going to make money in the next few years,” Diggle said. “You have to be more deft in your timing and more selective in what you own.”

Farmland Transfer

Diggle plans to transfer ownership of his farmland into a holding company, in which outside investors can hold shares, he said. Vulpes, which currently manages about $200 million, will own and operate the company. After buying farms in Uruguay and Illinois, as well as a kiwi-and-avocado orchard in New Zealand, he plans to pour money into Africa and eastern Europe as global food prices soar.

The value of farmland in the U.S. has probably gained 20 percent to 30 percent in the last two years, while Diggle’s investments in Uruguay may have risen 50 percent as sheep and cattle prices almost doubled in Latin America this year, he said.

Agriculture would be the “single most interest opportunity over the next 10 to 20 years,” Diggle said.

Vulpes favors investments in metals, energy and food, and “dislikes” government bonds, he said.

“Being long stuff in the ground is going to be a better place to be than holding pieces of paper,” Diggle said.

The firm’s Testudo Fund, which is heavily invested in precious metals and the mining industry, has gained 2.5 percent this year. The Russian Opportunities Fund has declined about 10 percent in the same period.

‘Biggest Risk’

Governments and their policies represent the biggest threat to investors, he said. “The biggest risk will come from governments: government interference in markets, government debt and government manufacturing of paper money to pay off the debt,” he said.

Diggle said he’s focusing on “new exciting commercially viable technology” in the life sciences industry that will find cures for illnesses including cancer and Parkinson’s disease.

“We certainly see a lot of interest by big pharma in small innovative biotechnology,” Diggle said. “If we can find those small new exciting biotechnology companies before big pharma gets to them, there’s a big uptick in terms of valuation if they can prove their work.”

--Editors: Linus Chua, Andreea Papuc

To contact the reporter on this story: Netty Ismail in Singapore nismail3@bloomberg.net.

To contact the editor responsible for this story: Andreea Papuc at apapuc1@bloomberg.net

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Citadel Said to Ease Withdrawal Rules for Hedge-Fund Clients

May 17, 2011, 2:52 PM EDT By Katherine Burton and Saijel Kishan

(Adds reduction in withdrawal penalty fees in sixth paragraph.)

May 17 (Bloomberg) -- Ken Griffin’s Citadel LLC will allow clients to withdraw their money more quickly from its two biggest hedge funds as the firm attempts to attract new investors, according to a letter.

Starting in July, clients in the Chicago-based firm’s Kensington and Wellington funds will be able to take out 10 percent of assets every quarter, meaning they can exit the funds entirely over two and a half years, Griffin said in a May 16 letter, a copy of which was obtained by Bloomberg News. Currently, withdrawals are limited to one-sixteenth every quarter, requiring four years for investors to get out.

Citadel, which has seen its assets under management fall by almost half since a 2007 peak of $21 billion, is relaxing investor terms that are among the most restrictive in the industry, as it seeks to win clients that have allocated money to rivals. The firm’s biggest funds lost 55 percent in 2008 as global markets tumbled in the wake of Lehman Brothers Holdings Inc.’s bankruptcy, spurring investors to pull their money.

“Since the financial crisis, to have significant restrictions -- even if they are less than before -- is somewhat puzzling,” said Geoff Bobroff, an East Greenwich, Rhode Island- based consultant who advises money-management firms. Typically, hedge funds that restrict redemptions do so for no longer than one year, Bobroff said.

‘Tremendous Stability’

Citadel said in the letter that its withdrawal terms, introduced in July 1998, created “tremendous stability in our capital base” and “allowed us to maximize our returns across numerous market cycles.”

The firm will raise the portion of the funds’ assets that it allows clients to pull to 5 percent from 3 percent, according to the letter. Citadel is reducing penalty fees for excess withdrawals to a range of 4 percent to 7 percent from 5 percent to 9 percent.

Devon Spurgeon, a spokeswoman for Citadel, declined to comment.

The $7.5 billion Kensington and Wellington funds climbed 62 percent in 2009, 10 percent last year and 9 percent through May 16. Citadel still needs to return an additional 15 percent to make investors whole and be able to charge a 20 percent performance fee.

Citadel has also told clients that it’s considering changing its fees. It’s among a handful of hedge funds that pass along all expenses to clients rather than charging the industry- standard 2 percent annual management fee. Expenses at the firm have reached as much as 8 percent of assets, and typically range from 4 percent to 6 percent.

Fee Structure

Citadel has told potential investors it may change its fees to 3 percent of assets, and raise its percentage of profits to 30 percent. The industry charges an average 20 percent performance fee.

Separately, Citadel agreed to sell Omnium LLC, its hedge- fund servicing business, to Northern Trust Corp. yesterday for at least $100 million. Griffin, who founded Citadel as a hedge fund in 1990, started Omnium in 2007 to provide other funds with administration and monitoring services.

He has also expanded Citadel by starting a securities business to advise corporations on mergers and acquisitions, underwriting and trading stocks and bonds. That group has been subject to 10 high-level executive departures since it was created at the height of the financial crisis in 2008.

--Editors: Steven Crabill, Josh Friedman

To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net; Saijel Kishan in New York at skishan@bloomberg.net

To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net

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