Navarro's Broad Market Outlook: Jobs Report Gumbo
I will be brief this week as Matt Davio has some very interesting points to offer in his column this week. 

Suffice it to say that last week, the GDP came in at a very healthy 3.6ish and, as I had surmised, the markets liked that.   This week, I'll be keeping my eye on the Jobs Report to see if this economy is finally creating all those jobs that we've been hoping. 

Look for a big market move if the Jobs Report surprises.  Also look for fairly slow summer trading, particularly in advance of Friday's jobs report.

Portfolio Musing: Die Rich Redux and Stem Cell Musings

The news about a pandemic influenza outbreak continues apace from Asia as more and more bird flu news is finding its way into the hospital wards and papers.  I previously bought SVA and watched that sucker fall, cut my losses, and scratched my head.

I have now reloaded a new small SVA position, which is at 2 bucks BUT also put on a much bigger position in long Call option position in CHIR.  It is one of the big players in flu vaccines and still hasn't made it back from its winter fiasco involving a botched vaccine production snafu.   (The position is a 2007 leap with a strike of $45)

With Congress and the Prez about to go mano a mano on stem cells and with good news in from Asia about a new technique for them, STEM, ASTM, and GERN have been all a twitter.   In the past, I've done very well with STEM and ASTM but this time my money - a medium sized position - is on GERN as it has more tangibles that are likely to lead to real revenues.  Also looking at AVII.

Hedging Your Bets With Matt Davio: The Latest Boogeyman
SECOND IN TWO-PART SERIES:

Okay, let's look a little more closely at the whole hedge fund controversy.  Basically, there's a bunch of chatter out there about the “trouble” that hedge funds are in.  There are really two things you need to know about this chatter.

First, both the mutual fund industry and stock brokerage industry hate hedge funds for different reasons.  Thus, a lot of this chatter has a hidden agenda.

Second, as I will show you down below, there are many different garden varieties of hedge funds.  Talking about them as a single group is a little silly.

Now, the most important difference between mutual funds and hedge funds is the compensation structure.  In a nutshell, mutual funds work on a fixed commission based on asset size.  In contrast, hedge funds get a fixed percentage plus a percentage of the profits.

You should see the problem right away from putting your money in a mutual fund.  These funds make more money OFF you but getting people like you to put more money into them.   Hence, growing the asset base is more important to mutual funds than actual performance - although good performance can, of course, be a useful marketing tool

As for hedge funds, the entire incentive structure is aimed at making BOTH you and the hedge fund manager money by increasing your return.  Hence, increasing the firm's return is the goal, not simply getting you to commit to the fund.  

The big caution, of course, with a hedge fund is that some “bad apples” will take on too much risk in order to boost return.  That's why it's important for you to do your due diligence in selecting a good fund manager.

Another thing about hedge funds is that as a group, they tend to attract better stock traders.  Why?  Simply because the rewards are higher and the market for managers sorts this out.

Now, two more points:  First, hedge funds tend to be a lot more flexible than most mutual funds because they can go both long and short and do so on a regular basis.  In an up and down market, they outperform and in a down market, they can really outperform mutual funds.

Second, its also useful to understand why the brokerage industry is anti-hedge fund.  In this regard, there exists a long standing symbiotic relationship between the mutual fund industry and stock brokers. The brokers expect the funds to give them commission business, AND the fund expects the broker to sell their fund shares to new customers. This is the main reason that mutual fund managers don't care about commission costs. The more they spend in commissions the more new money comes in.

Note that new money is the fastest way to increase the size of their fund assets - and their revenues.   This phenomenon also helps explain why mutual funds consistently under perform the market averages.

The bottom line: The mutual funds enjoy a very profitable relationship within the status quo. The recent rise of hedge funds with their performance based incentives is inimical to the way business is done in the mutual fund industry.

Major Hedge Fund Strategies
Here's a quick primer on the various hedge fund strategies that are used.  You can see that there are 8 basic strategies under four major categories.

One of the takeaways from this list is that it is ridiculous to lump all hedge funds together into a single group.

Discretionary Hedge Funds

1.      Equity Long/Short strategies attempt to add value through stock selection with a hedged market exposure that generally has a bias to the long side of the market. The objective is to profit from continued equity market growth, while reducing portfolio volatility. Approximately 34% of the hedge fund market uses this strategy, and this is the strategy we at Infinium use. 

2.      Global Macro strategies make leveraged “directional” investments on anticipated price movements of global stock markets, interest rates, foreign exchanges, and physical commodities, using any investment instrument.  Approx 9% of hedge funds play here.  It's the approach made famous by George Soros.

Equity Arbitrage Hedge Funds

3.      Equity Market Neutral strategies aim to minimize exposure to general market movements and individual industries by balancing long and short stock portfolios with similar market, industry, and style characteristics. This is about 7% of market.

4.      Statistical Arbitrage funds use quantitative models to project pricing discrepancies. This is less than 1%.

Fixed Income Arbitrage

5.      Fixed Income Arbitrage seeks to capture pricing inefficiencies between related fixed income securities, while neutralizing exposure to interest rate risk. 8% of hedge funds play here.

Event Driven Plus

6.      Convertible Arbitrage strategies involve the purchase and sale of related securities, generally long convertible securities and short the underlying equities, seeking to profit from mispricing in the relationship of the two. 8% of market.

7.      Distressed strategies invest in different levels of the capital structures of troubled companies, which are most often already in bankruptcy. 4% of market

8.      Merger Arbitrage, sometimes called risk arbitrage, involves taking long and short positions in companies engaged in a proposed transaction, such as leveraged buy-outs, mergers and hostile takeovers.  5% of market.

In addition to these eight strategies, there are also Managed Futures accounts that make up about 5% of the hedge world. Several other outliers make up another 9-10% of the total market.

The broader point here is that if you are considering a “hedge fund,” you need to know that there are many different garden varieties.  Find the one best suited for YOUR needs.

Peter Navarro is a business professor at the University of California-Irvine (www.peternavarro.com).  Matt Davio is a managing partner at the hedge fund, Infinium Partners, and be contacted for hedge fund services at infinium@peternavarro.com.

DISCLAIMER: This newsletter is written for educational purposes only.  By no means do any of its contents recommend, advocate or urge the buying, selling, or holding of any financial instrument whatsoever.  Trading and investing involves high levels of risk.  The authors express personal opinions and will not assume any responsibility whatsoever for the actions of the reader.  The authors may or may not have positions in the financial instruments discussed in this newsletter.  Future results can be dramatically different from the opinions expressed herein.  Past performance does not guarantee future performance.