According to Mr. Jason Booth of Steel Partners, our January 12, 2009 blog entitled “Beware the 2009 Hedge Fund Overhang”, had a serious factual error regarding Steel Partners. In our article, we discussed the failures, closures and asset shrinkage of the hedge fund industry, and the possibility that more selling from hedge funds would be coming down the pipeline as investors in hedge funds--where redemptions had been frozen--gain access to their capital.
In particular, we stated that “Of particular relevance to Japan is the travails of the activist hedge fund Steel Partners. The hedge fund is now seeking to become a listed partnership after clients have withdrawn 38% of their money because of losses on investments of around 39% in 2008, which was much worse than the average 19% loss for the hedge fund industry. Steel closed redemptions in December last year. This after returns of some 22% per annum between 1993 and 2007". Our “of particular relevance” statement referred to Steel Partners’ Japan operations and the affect they have had on Japanese stock prices, and was not aimed at drawing or implying a direct financial or operational link between the activities of the Steel Partners II fund and Steel Partners Japan.
As Mr. Booth of Steel Partners pointed out in a January 13 email to iStock Analyst.com, our article failed to distinguish between the hedge fund manager’s Steel Partners II flagship fund (which was originally called the Steel Partners Offshore Fund Ltd.) and the Steel Partners Japan fund, which are separate legal entities with different investors. Mr. Booth maintains that the recent developments of Steel Partners II have no impact whatsoever on Steel Partners Japan. Edgar filings in the US however describe Steel Partners Group, operating through Steel Partners, as having Steel Partners II, L.P. as its main investment fund, while Steel Partners Group co-manages Steel Partners Japan Strategic Fund (Offshore), L.P. and Steel Partners II, L.P. is also a significant investor in Steel Partners Japan Strategic Fund (Offshore), L.P..
It is a fact that Steel Partners is seeking to convert its flagship hedge fund, Steel Partners II, into a public traded partnership. It was also reported by Bloomberg.com (quoting a presentation to investors the previous week) on January 12, 2009 that the $1.2 billion Steel Partners II fund lost 39 percent last year and froze redemptions in December 2008. Bloomberg quoted Mr. Peter Douglas, a principal of Singapore-based hedge-fund consulting firm GFIA Pte.、as saying at least 20% of hedge-fund assets were subject to restrictions on withdrawals last year. Bloomberg also reported that Mr. Lichtenstein, Steel Partners founder, is seeking investor approval for a plan to merge the Steel Partners II fund with WebFinancial LP ( a publicly traded partnership it already controls) to allow withdrawals to resume without forcing the Steel Partners II Fund to liquidate assets.
Reuters.com also reported on January 14, 2009 (Hedge Fund Steel Partners sued for fraud—documents) that ACF, a maker of railcars and components that is reportedly affiliated with Carl Ichan and Bank of America are suing Steel Partners, The lawsuit charges that Steel Partners was not in compliance with its obligations to investors as it pursued its plan to become a publicly traded partnership because it failed to give ample notice of the plan or an opportunity to vote on the proposal. The lawsuit also reportedly claims that by December 31, the Fund had transferred all of its investments to a non-SEC reporting 'public' shell company and that all of this had been done "without the knowledge and consent of investors."
Separately from what is happening in the U.S. with the Steel Partners II Fund, Mr. Yusuke Nishi, a co-founder of Steel Partners Japan, left the company in September 2008. Around this time, Mr. Lichtenstein, in a late September 2008 interview with the Nikkei (“Interview: A Kinder, gentler Steel Partners? Lichtenstein talks strategic shift”) Mr. Lichtenstein was quoted as saying that “we realized that we needed to have more frequent and clear communication with the companies in which we invested. We made the change so that we have much more frequent and clear communications with the companies. And we even went so far as to clip all communications in writing and post them on our Web site so that other interested people could review them.” This after a press conference in June 2007, when Mr. Lichtenstein was quoted as saying that Steel Partners needed to "educate the management of the Japanese companies that we invest in", and after Steel was designated by the Supreme Court in Japan as "an abusive acquirer" in their activism against Bull-Dog Sauce Co.
Large holding filings with the Kanto Local Finance Bureau in Japan reveal that Steel Partners Japan’s Steel Partners Japan Strategic Fund (Offshore) has been significantly reducing and selling out its holdings in Japanese stocks. According to these filings, the fund has sold its shares in Ezaki Glico Co. and Yushiro Chemical Industry Co. sometime before December, as well as all the Kikkoman Corp. shares it held before March last year. The fund also reduced its shares in Nissin Foods Holdings and Citizen Holdings Co. In addition, a large holding filing with Kanto Local Finance Bureau December 18 revealed that the Fund had reduced its stake in Brother Industries from 10.17% to 8.81%. News of this filing helped push Brother Industries’ stock to fall to a near seven-year low in Tokyo trading on fears the office equipment maker’s biggest shareholder will sell more of its stake. This selling was not related to the activities of Steel’s US operations, but to Steel Partner Japan’s actions in selling its holdings in Japanese shares.
According to an article by Japan’s Nikkei (January 12, 2009, Nikkei Net Interactive, “Steel Partners Dumped Y115bn In Japan Stocks Last Year”), selling by the fund was particularly noticeable after September, the month in which Lehman Brothers declared bankruptcy. The Nikkei article speculates that Steel Partners was forced to sell (as were many other hedge funds) to meet increased redemption requests from investors. The Japan fund apparently took losses on some transactions, such as the sale of Brother stock, but realized gains on others, such as the sale of Ezaki Glico. A full-scale unloading of broker/prime broker in-house inventories of Japanese stocks also contributed to the sell-off in the Nikkei 225 below 7,000 (6,994.90) on October 28, 2008.
Overall, Steel Partners Japan has had both successes and failures in its activist activities vis-à-vis Japanese companies. A much-publicized butting of heads with Bulldog Sauce resulted in the Company being designated “an abusive acquirer” by the Tokyo courts. On the other hand, Steel Partners was also successful in voting out the management of hair-piece manufacturer Aderans.
Tokyo Takes provides updates on market moving news from a Japan perspective.
Thursday, January 15, 2009
Corrections and Clarifications: The 2009 Hedge Fund Overhang
Tuesday, January 13, 2009
Will Savers Retreat Back to Bank Savings or Mattress Money?
We have already highlighted the potential selling pressure from hedge funds that had blocked redemptions in the final quarter of 2008. The other negative factors affecting demand for stocks in 2009 will be risk aversion by individual savers as well as risk aversion by private and public pension funds that now face significant underfunding of pension liabilities.
In the US, some $320 billion was withdrawn from mutual funds in 2008, and the balance of stock funds (market value - withdrawals) is down to $3.6 trillion in November of last year versus $6.5 trillion in December 2007, according to the Investment Company Institute. The story is the same in Japan, where investment trust (mutual fund) balances have fallen 40%. The negative impact on individual investors however is much larger in the US, where 45.6% of households owned shares in mutual funds, the majority of which had moderate incomes of between $35,000~$99,999 per year.
In addition, public pension funds as well as corporate pension funds around the world were already facing substantial underfunding liabilities. In the UK, only 11% of pension funds were in surplus as of December 2008, and deficits had risen to 136 billion pounds. In the US, the deficit for corporate defined benefit pension plans has risen to a record $409 billion, the largest in 10 years. The US also faces a pension funding shortfall among public pension funds that has ballooned to upwards of $750 billion.
Substantial underfunding of pension funds will, a) force managers to re-assess asset allocation, meaning they are likely to reduce exposure to equities and hedge funds/alternative assets in favor of principle guaranteed fixed income investments, and b) greatly reduce their risk tolerance in all investments.
What this means for Japanese savers is that they have become much more risk adverse and are shifting their savings back into time deposits, as time deposit balances at banks in Japan were rising 5%~6% in November~December last year, while investment trust balances were tumbling. In total, such deposits are now JPY190.7 trillion for Japanese banks alone, and JPY257 trillion including foreign banks and credit unions. In addition, there is some JPY179 trillion of deposits in Japan Post, who is seeing a renewed rise in deposits after losing around JPY10 trillion per year in savings to sexier investment opportunities over the past several years.
In the US, some $320 billion was withdrawn from mutual funds in 2008, and the balance of stock funds (market value - withdrawals) is down to $3.6 trillion in November of last year versus $6.5 trillion in December 2007, according to the Investment Company Institute. The story is the same in Japan, where investment trust (mutual fund) balances have fallen 40%. The negative impact on individual investors however is much larger in the US, where 45.6% of households owned shares in mutual funds, the majority of which had moderate incomes of between $35,000~$99,999 per year.
In addition, public pension funds as well as corporate pension funds around the world were already facing substantial underfunding liabilities. In the UK, only 11% of pension funds were in surplus as of December 2008, and deficits had risen to 136 billion pounds. In the US, the deficit for corporate defined benefit pension plans has risen to a record $409 billion, the largest in 10 years. The US also faces a pension funding shortfall among public pension funds that has ballooned to upwards of $750 billion.
Substantial underfunding of pension funds will, a) force managers to re-assess asset allocation, meaning they are likely to reduce exposure to equities and hedge funds/alternative assets in favor of principle guaranteed fixed income investments, and b) greatly reduce their risk tolerance in all investments.
What this means for Japanese savers is that they have become much more risk adverse and are shifting their savings back into time deposits, as time deposit balances at banks in Japan were rising 5%~6% in November~December last year, while investment trust balances were tumbling. In total, such deposits are now JPY190.7 trillion for Japanese banks alone, and JPY257 trillion including foreign banks and credit unions. In addition, there is some JPY179 trillion of deposits in Japan Post, who is seeing a renewed rise in deposits after losing around JPY10 trillion per year in savings to sexier investment opportunities over the past several years.
Beware the 2009 Hedge Fund Overhang
Strategists and hedge fund industry watchers are warning that there is more selling from hedge funds coming down the pipeline. While some estimate that 1,500 hedge funds already collapsed last year (2008) and the industry's assets have shrunk about $900 billion from a peak of $1.9 billion last June, some like Barclays Capital strategist Robert McAdie forecast that 70%~80% of hedge funds will disappear in 2009.
Others estimate that about 20% of all hedge funds subjected their investors to restrictions on withdrawals late last year, which effectively froze about $300 billion that wanted out.
Of particular relevance to Japan is the travails of the activist hedge fund Steel Partners. The hedge fund is now seeking to become a listed partnership after clients have withdrawn 38% of their money because of losses on investments of around 39% in 2008, which was much worse than the average 19% loss for the hedge fund industry. Steel closed redemptions in December last year. This after returns of some 22% PA between 1993 and 2007.
A high profile nemesis of Japanese corporate management, the Nikkei is reporting that Steel dumped some JPY115 billion of Japanese stock last year, and that the activist's holdings in Japan have fallen to JPY170 billion from a peak of JPY470 billion in November 2007 as Steel reportedly dumped JPY30 billion of Japanese stock in December alone. The company is now out of positions in Ezaki Glico (2206), Nissin Foods (2897) and Brother Industries (6448).
Moreover, a much-publicized butting of heads with Bulldog Sauce got the company designated as an "abusive acquirer" by the Japanese autorities. Following the resignation of Steel Partners Japan co-founder Yusuke Nishi in September of last year, Steel is now trying to adopt a more accomodative line of communication with its target companies.
Japan's Nikkei 225 bottomed last October as foreign investors (under duress to raise cash positions) dumped Japanese stocks in droves. Initially, prime brokers (the suppliers of stock loaned to hedge funds) absorbed a good deal of this selling for their in-house positions. After Lehman Brothers declared bankruptcy in September, however, (and Goldman, Morgan Stanley and Merrill Lynch) ran to the arms of the government and white knights to be converted into "normal" banks, all (prime broker) bets were off in a scramble to de-leverage balance sheets. Consequently, prime brokers holding significant inventories of Japanese stocks joined pure investors in dumping their holdings of Japanese stocks, pushing the Nikkei 225 back under 8,000 again.
Now, value investors are reviewing their underweight of Japanese stocks in light of the poor investment environment for Europe as well as other Asia, and are looking for opportunities to pick up "cheap" Japanese stocks. However, it looks like Japanese stocks might have to weather more hedge fund unwinding before finding solid support from overseas investors, despite the fact that hedge fund activity in Japan in 2008 was already significantly lower than in 2006~2007.
Others estimate that about 20% of all hedge funds subjected their investors to restrictions on withdrawals late last year, which effectively froze about $300 billion that wanted out.
Of particular relevance to Japan is the travails of the activist hedge fund Steel Partners. The hedge fund is now seeking to become a listed partnership after clients have withdrawn 38% of their money because of losses on investments of around 39% in 2008, which was much worse than the average 19% loss for the hedge fund industry. Steel closed redemptions in December last year. This after returns of some 22% PA between 1993 and 2007.
A high profile nemesis of Japanese corporate management, the Nikkei is reporting that Steel dumped some JPY115 billion of Japanese stock last year, and that the activist's holdings in Japan have fallen to JPY170 billion from a peak of JPY470 billion in November 2007 as Steel reportedly dumped JPY30 billion of Japanese stock in December alone. The company is now out of positions in Ezaki Glico (2206), Nissin Foods (2897) and Brother Industries (6448).
Moreover, a much-publicized butting of heads with Bulldog Sauce got the company designated as an "abusive acquirer" by the Japanese autorities. Following the resignation of Steel Partners Japan co-founder Yusuke Nishi in September of last year, Steel is now trying to adopt a more accomodative line of communication with its target companies.
Japan's Nikkei 225 bottomed last October as foreign investors (under duress to raise cash positions) dumped Japanese stocks in droves. Initially, prime brokers (the suppliers of stock loaned to hedge funds) absorbed a good deal of this selling for their in-house positions. After Lehman Brothers declared bankruptcy in September, however, (and Goldman, Morgan Stanley and Merrill Lynch) ran to the arms of the government and white knights to be converted into "normal" banks, all (prime broker) bets were off in a scramble to de-leverage balance sheets. Consequently, prime brokers holding significant inventories of Japanese stocks joined pure investors in dumping their holdings of Japanese stocks, pushing the Nikkei 225 back under 8,000 again.
Now, value investors are reviewing their underweight of Japanese stocks in light of the poor investment environment for Europe as well as other Asia, and are looking for opportunities to pick up "cheap" Japanese stocks. However, it looks like Japanese stocks might have to weather more hedge fund unwinding before finding solid support from overseas investors, despite the fact that hedge fund activity in Japan in 2008 was already significantly lower than in 2006~2007.
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Japanese Finance
Sunday, January 11, 2009
Developed Country Debt Explosion Versus Shrinking Developing Country Excess Savings
Developed Country Deficits Versus Developing Country Surpluses
A big factors in the "bubbles" of credit seen prior to the current financial/economic crisis was the emergence of a global saving glut during the past eight to ten years.
A number of key industrial countries other than the United States have seen their current accounts move substantially toward deficit since 1996, including France, Italy, Spain, Australia, and the United Kingdom. The principal exceptions to this trend among the major industrial countries are Germany and Japan, both of which saw substantial increases in their current account balances 1996. A key difference between the two groups of developed countries is that the countries whose current accounts have moved toward deficit have generally experienced substantial housing appreciation and increases in household wealth, while Germany and Japan--whose economies have been growing slowly despite very low interest rates--have not. As higher home prices in turn have encouraged households to increase their consumption, there is an evident link between rising household wealth and a tendency for the current account to shift toward deficit. However, the greater extent to which capital inflows acted to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt became.
Thus the large current account deficit of the United States in particular requiredsubstantial flows of foreign financing even before the current financial/economic crisis. This financing was increasingly dependent on foreign investment, particularly the recycling of excess savings in the developing markets through foreign government purchases of US treasuries.
On the other hand, the balance of payments of developing countries moved into surplus as the result of successive crises (Asian currency crisis, Russia, Brazil, Argentina debt crises), emerging-market nations either chose or were forced into new strategies for managing international capital flows. Asian developing nations in particular built up "war chests" of foreign reserves used as a buffer against potential capital outflows. These countries increased reserves through current account surpluses and the expedient of issuing debt to their citizens, thereby mobilizing domestic saving, and then used the proceeds to buy U.S. Treasury securities and other assets. Another factor that contributed to the swing toward current-account surplus among other non-industrialized nations (particularly the Middle East) was the sharp rise in oil prices. Between 1996 and 2003, for example, the bulk of the increase in the U.S. current account deficit was balanced by changes in the current account positions of developing countries, which moved from a collective deficit to a surplus between 1996 and 2003.
The result was rapid capital flows into the United States and other developed nations, fueling bull markets in stock prices and in the value of the dollar. Thus the rapid increase in the U.S. current account deficit between 1996 and 2000 was fueled to a significant extent both by increased global saving and the greater interest on the part of foreigners in investing in the United States.
What Has Changed?
In the aftermath of the financial/economic crisis, fiscal deficits of the developed nations are set to explode. It is now estimated that total government bond issuance by the US, Europe and Japan will reach the JPY equivalent of JPY400 trillion in 2009, which represents an increase of JPY100 trillion over 2008. According to the US Congressional Budget Office, the US will be issuing approximately JPY136 trillion of Treasuries in 2009 to fund a projected fiscal deficit of USD1.2 trillion, which represents a 1.6-fold increase. According to Barclays Capital forecasts, sovereign debt issuance in the Euro area will reach JPY108 trillion. Japan on the other hand is expected to issue JPY132 trillion of debt including debt to refinance maturing JGBs.
High Risk of Sovereign Debt Indigestion
It is in this context of planned massive sovereign debt issuance that the recent failure of the first Euro sovereign debt issuance by Germany is an ominous warning.
If the excess savings glut in the developing nations was still growing at the pre-crisis pace, this JPY400 trillion of new sovereign debt might have been much easier absorbed. However, China, with the worlds largest pile of foreign exchange reserves, will need to fund their own massive domestic stimulus plan of $586 billion. On the other hand, oil exporting nations will have trouble funding fiscal budgets based on crude oil prices well above $60/bbl. Below $50/bbl, these nations will have to use increasing amounts of crude oil export revenues to offset budget deficits, and in the worst case, will have to dip into their sovereign wealth funds to plug budget holes. Moreover, forecasts for a decline in global trade in 2009 mean significant reductions in developing country balance of payments surpluses.
What this strongly implies is that all of the developed country planned debtissues may not be able to be smoothly absorbed by excess developing country savings without higher interest rates. As current government bond yields have priced in ultralow inflationary expectations of +/-1% for the next 10 years, there is also significant capital loss risk should all these efforts to kick-start the global economy unleash the dogs of inflation.
Debauching of the USD and Euro
The corrolary to massive developed country sovereign debt issues is the debauching of the USD and Euro. The JPY will not be debauched as much because a) Japan remains a net supplier of excess savings to the developed world, and b) less than 10% of Japan's sovereign debt is owned by foreigners, even though Japan will need to attract more foreign capital to fund its latest round of debt issues. Foreign investors do need however to closely monitor, a) the rapid decline in Japanese individual savings rates (to 2.2% of late) and b) the increasing reluctance of individual Japanese savers to buy JGBs.
From what we can determine, the surge in JPY was much more the product of repatriation of excess Japanese savings in the form of reduced holdings in US treasuries and reduced forex trading as well as holdings in foreign funds by Japanese individuals than it was due to an unwinding of leveraged yen carry trades. Thus further repatriation of Japanese savings could, a) push JPY to a new high beyond the prior JPY79.5/USD in 1995, and b) exacerbate the supply-demand balance for US treasuries.
A big factors in the "bubbles" of credit seen prior to the current financial/economic crisis was the emergence of a global saving glut during the past eight to ten years.
A number of key industrial countries other than the United States have seen their current accounts move substantially toward deficit since 1996, including France, Italy, Spain, Australia, and the United Kingdom. The principal exceptions to this trend among the major industrial countries are Germany and Japan, both of which saw substantial increases in their current account balances 1996. A key difference between the two groups of developed countries is that the countries whose current accounts have moved toward deficit have generally experienced substantial housing appreciation and increases in household wealth, while Germany and Japan--whose economies have been growing slowly despite very low interest rates--have not. As higher home prices in turn have encouraged households to increase their consumption, there is an evident link between rising household wealth and a tendency for the current account to shift toward deficit. However, the greater extent to which capital inflows acted to augment residential construction and especially current consumption spending, the greater the future economic burden of repaying the foreign debt became.
Thus the large current account deficit of the United States in particular requiredsubstantial flows of foreign financing even before the current financial/economic crisis. This financing was increasingly dependent on foreign investment, particularly the recycling of excess savings in the developing markets through foreign government purchases of US treasuries.
On the other hand, the balance of payments of developing countries moved into surplus as the result of successive crises (Asian currency crisis, Russia, Brazil, Argentina debt crises), emerging-market nations either chose or were forced into new strategies for managing international capital flows. Asian developing nations in particular built up "war chests" of foreign reserves used as a buffer against potential capital outflows. These countries increased reserves through current account surpluses and the expedient of issuing debt to their citizens, thereby mobilizing domestic saving, and then used the proceeds to buy U.S. Treasury securities and other assets. Another factor that contributed to the swing toward current-account surplus among other non-industrialized nations (particularly the Middle East) was the sharp rise in oil prices. Between 1996 and 2003, for example, the bulk of the increase in the U.S. current account deficit was balanced by changes in the current account positions of developing countries, which moved from a collective deficit to a surplus between 1996 and 2003.
The result was rapid capital flows into the United States and other developed nations, fueling bull markets in stock prices and in the value of the dollar. Thus the rapid increase in the U.S. current account deficit between 1996 and 2000 was fueled to a significant extent both by increased global saving and the greater interest on the part of foreigners in investing in the United States.
What Has Changed?
In the aftermath of the financial/economic crisis, fiscal deficits of the developed nations are set to explode. It is now estimated that total government bond issuance by the US, Europe and Japan will reach the JPY equivalent of JPY400 trillion in 2009, which represents an increase of JPY100 trillion over 2008. According to the US Congressional Budget Office, the US will be issuing approximately JPY136 trillion of Treasuries in 2009 to fund a projected fiscal deficit of USD1.2 trillion, which represents a 1.6-fold increase. According to Barclays Capital forecasts, sovereign debt issuance in the Euro area will reach JPY108 trillion. Japan on the other hand is expected to issue JPY132 trillion of debt including debt to refinance maturing JGBs.
High Risk of Sovereign Debt Indigestion
It is in this context of planned massive sovereign debt issuance that the recent failure of the first Euro sovereign debt issuance by Germany is an ominous warning.
If the excess savings glut in the developing nations was still growing at the pre-crisis pace, this JPY400 trillion of new sovereign debt might have been much easier absorbed. However, China, with the worlds largest pile of foreign exchange reserves, will need to fund their own massive domestic stimulus plan of $586 billion. On the other hand, oil exporting nations will have trouble funding fiscal budgets based on crude oil prices well above $60/bbl. Below $50/bbl, these nations will have to use increasing amounts of crude oil export revenues to offset budget deficits, and in the worst case, will have to dip into their sovereign wealth funds to plug budget holes. Moreover, forecasts for a decline in global trade in 2009 mean significant reductions in developing country balance of payments surpluses.
What this strongly implies is that all of the developed country planned debtissues may not be able to be smoothly absorbed by excess developing country savings without higher interest rates. As current government bond yields have priced in ultralow inflationary expectations of +/-1% for the next 10 years, there is also significant capital loss risk should all these efforts to kick-start the global economy unleash the dogs of inflation.
Debauching of the USD and Euro
The corrolary to massive developed country sovereign debt issues is the debauching of the USD and Euro. The JPY will not be debauched as much because a) Japan remains a net supplier of excess savings to the developed world, and b) less than 10% of Japan's sovereign debt is owned by foreigners, even though Japan will need to attract more foreign capital to fund its latest round of debt issues. Foreign investors do need however to closely monitor, a) the rapid decline in Japanese individual savings rates (to 2.2% of late) and b) the increasing reluctance of individual Japanese savers to buy JGBs.
From what we can determine, the surge in JPY was much more the product of repatriation of excess Japanese savings in the form of reduced holdings in US treasuries and reduced forex trading as well as holdings in foreign funds by Japanese individuals than it was due to an unwinding of leveraged yen carry trades. Thus further repatriation of Japanese savings could, a) push JPY to a new high beyond the prior JPY79.5/USD in 1995, and b) exacerbate the supply-demand balance for US treasuries.
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