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There is no doubting Michael Carrick quality as a player; he also plays the kind of passing game that Tottenham have been missing for years. But can we really not survive with out him?

I think he will certainly be a loss but if we look to what we already have within our ranks we will find a perfect substitute, if not an out and out replacement! One comment that springs straight to my mind whenever anyone has asked me how we would cope without Carrick is ‘what about Tom Huddlestone?’.

Tom, from the games in the first team and the reserves I have seen him in, is every bit as good as Michael and given the needed games and experience will prove to be a better player. People have been branding Carrick as one of the world’s best central, holding midfield players and I don’t wish to doubt that because he is but he, in my opinion, has one vital floor in being shy in the tackle. Like Glen Hoddle he is one of the best passers in the game but he ‘couldn’t tackle his dinner’. Tom Huddlestone is a great tackler (and is built like a brick outhouse – unlike the sticklike Carrick), and he has a passing ability every bit as good as Carrick and in
him I can see a perfect replacement for Michael.

But Tom is not the only player we can look to, we have Edgar Davids who has been one of the best central midfielders in the world for over a decade! Teemu Tainio, over the last season has proved he is an excellent midfield player, he is always active, never seems to run out of energy and is a childhood spurs fan after all! Hossam Ghaly, he arrived at the Lane carrying an injury which didn’t totally clear until the end of the season therefore he didn’t get any first team action last season but from the reserve games he got at the end of the season and the performances in pre-season he seems a good player, he delivered the final ball for one of
Dimitar Berbatov’s goals and was usefully involved in the making of the other. We also have Didier Zakora, Danny Murphy, Jermaine Jenas, and the young and up-coming Jamie O’Hara so to say we have a few options in an understatement.

No player is ever worth silly amounts of money either in transfer fees or weekly wages. If Carrick wants mega-money he will have to look elsewhere as Spurs have an excellent wage structure and ‘breaking the bank’ to keep him hear will harm the club in the long run. And if the reports are true in him stating he wants to move to Manchester United then fine let him go as it is obvious his heart is not in playing for Tottenham and the club want player who want to play for us.

£14.5 million (as reported in The Sun) is a good profit from a player we originally bought for £2.25 million. We are not a club in crisis in terms of finance I know but a deal like that is well worth it, and will give the ‘Three Musketeers’ (Jol, Levy, and Comolli) a nice little sum to play with while looking for a Left Midfielder if this is their wish. All I could ask, and I know they wont be anyway, is not to panic buy like we did with Gregorz Rasiak, we have a great squad already and all we now need are the final touches.

Article by Chigwell Spur

REDS LEGEND: Ole Gunnar Solskjaer
HE put the ball in the Scousers’ net, he put the ball in the Germans’ net, and he even put the ball in Nottingham Forest’s net four times in 11 minutes.

But those feats of goal-scoring glory only make up half of the Ole Gunnar Solskjaer legend.

Solskjaer, who celebrated 10 years at Old Trafford last weekend, is the longest-serving foreign player in United’s history.

And yet it almost seems disloyal to give him that “foreign player” tag, because he has been welcomed into the hearts of Red Mancunians without reservation.

When United fans saw Solskjaer back on the pitch last Christmas, as a substitute against Birmingham and then starting against Burton Albion in the FA Cup, the emotions were churning.

It was great to see the baby-faced assassin back on a football field, when it seemed like we had seen the last of him. Even Sir Alex Ferguson had believed the player would never pull on the red shirt in earnest again. It appeared that only Solskjaer himself had the belief and unswerving dedication to make it happen.

Even then, it seemed like these were the last throes of a stunning career – a career studded with golden highlights and shot through with a vein of loyalty and commitment to the cause, in an age of mercenary footballers.

Goal trail

And yet, here we are on the brink of another season and Ferguson has enough faith in Solskjaer to cite him as one of five strikers vying for a place in the first team. Now he is in line for a return to the Norway squad for a friendly against Brazil later this month. Perhaps his career will have a deserved Indian summer, after all.

United fans took to the lad almost immediately. Just six minutes into his debut as a sub against Blackburn in 1996, Solskjaer scored. The fresh-faced kid from Norwegian champions Molde netted five goals in just 233 minutes of football, with just one start, and the super-sub tag, which would irritate him throughout his career, was fashioned.

Solskjaer bagged 18 goals in that first season, as United retained the Premiership title, but could not nail down a place in the starting-up.

But with Teddy Sheringham arriving at Old Trafford to replace the retiring Eric Cantona, and then Dwight Yorke scorching into town the following summer, Solskjaer was again destined to be frustrated.

Solskjaer, however, would not be denied. The ultimate professional, he saw the subs’ bench as a challenge and an opportunity.

In the summer of 1998, inevitably, another club was ready to pay big money for his services. Tottenham offered £5.5m, United accepted the bid, and it was down to Solskjaer.

No-one could have blamed the lad if he had taken the money and run, especially with Yorke’s £12.6m arrival meaning his opportunities would be further restricted.

Solskjaer would have none of it. He took the view that any move away from United was a step down, and that view was all the encouragement Ferguson needed.

It set the tone for the incredible events of the following season, culminating in Solskjaer’s roof-lifting, knee-sliding, tear-jerking injury-time winner in the Nou Camp. The image of Solskjaer, all alertness and reflex, watching the ball bulge the roof of the Bayern Munich net, adorns many a Manchester chimney breast.

Solskjaer’s own contribution to the mother of all seasons was immense, with 18 goals in 18 league games. His four goals in 11 minutes after coming on as a sub in the 8-1 win at Nottingham Forest was breathtaking.

And, of course, it was that season that he stuck the ball in the Scousers’ net, an injury-time winner against Liverpool in the FA Cup fourth round.

Wondrous

It all led to that wondrous night in Barcelona.

But while some players allowed their games to slide after that ultimate achievement, Solskjaer was hungry for more.

In December 1999, he was at it again, scoring four against Everton in a 5-1 Old Trafford thrashing, and netting twice as the Reds beat Sunderland 4-0 to break the Premiership `goals for’ record with five games to spare. He even nabbed a goal as the Reds secured the title again with a 3-1 win at Southampton.

Another outstanding memory came the following season at Charlton. Ryan Giggs’ audacious lob from half-way sailed high into the murky south London sky.

Goalkeeper, players and spectators all stood in open-mouthed awe and suspense as the ball dropped on to the crossbar. It appeared that the only movement in the ground, apart from the arc of the ball, was a flash of red darting into the goalmouth as Ole volleyed the rebound into the net. It was a goal that summed him up – alert, quick and too smart for dumb defenders.

And still there was no guarantee of a first-team place.

When David Beckham was injured in 2002, Solskjaer popped up on the right wing, and brought grace and devotion to his new role and scored 16 goals.

Everything began to unravel the following season when he was injured against Panathinaikos which led to extensive knee surgery. Even after his comeback last Christmas, the future was still gloomy, and at one stage Ferguson appeared to prepare the media for the news that supporters had dreaded.

Then Solskjaer popped up at a training session, a spring in his step, a twinkle in his eye, and United backtracked.

Even when a fractured cheekbone sustained in a reserve team game in March added to the supporters’ fears, Solskjaer was not giving up the ghost.

Ferguson responded by handing him a new two-year deal and outlining his intentions to keep him at OT for as long as he could, as a coach and an ambassador.

It’s not the end for Solskjaer, or even the beginning of the end. There is no end to legend.

June 14, 2006
Although the price-weighted Dow Jones Industrial Average approached its all-time high in early May, the large capitalization-weighted indexes—such as the S&P 500 or the Russell 3000—in which most investors hold their “indexed” investments are still substantially below their tech-bloated peaks reached in March 2000. Those of us who have linked our portfolio returns to these popular indexes wonder whether there is a better way to capture the market’s return without enduring the wild swings that characterized the last bubble.

Don’t get me wrong. Capitalization-weighted indexation has been one of the great innovations in the last quarter-century. It has allowed millions of investors to capture the return on the market at a very small cost, and has outperformed most actively managed mutual funds. The $5 trillion invested in portfolios tracking cap-weighted indexes speaks to its popularity.

But we are on the verge of a revolution: New research demonstrates that it is possible to construct broad-based indexes offering investors better returns and lower volatility than capitalization-weighted indexes. These indexes are weighted by fundamental measures of firm value, such as sales or dividends, instead of allowing the market price alone to dictate how much of each firm should be included in the index.

Strong Appeal

The vast majority of indexes, with the exception of the Dow Jones Averages, are capitalization-weighted. This means that the weight of each stock in the index is proportional to the total market value of its shares. This methodology has strong appeal since the return on these indexes represents the aggregate or “average” return to all shareholders.

Strong support for these indexes also emanates from the academic community. The philosophical foundation of these indexes is the “efficient market hypothesis,” which assumes that the price of each stock at every point in time represents the best, unbiased estimate of the true underlying value of the firm.

The efficient market hypothesis does not say a stock’s price is always equal to its fundamental value. But the theory implies it is impossible to tell which stocks are undervalued and which are overvalued without either costly analysis or an innate skill possessed only by a chosen few, such as Warren Buffett, Peter Lynch or Bill Miller.

It can be shown that under standard portfolio models, if stocks are priced according to the efficient market hypothesis, then capitalization-weighted indexes offer investors the best risk-return combination. And there is no doubt that capitalization-weighted portfolios have performed very well for investors. Research conducted by Jack Bogle, Charles Ellis, Burton Malkiel and myself has undeniably shown that active mutual fund managers fail, after fees, to keep pace with the market indexes.

But as indexed investing gained adherents, cracks were found in the efficient market hypothesis. In the early 1980s, Rolf Banz and Don Keim showed that small stocks earned an outsized return compared to their risks. And, earlier, Sanjoy Basu and David Dreman discovered that stocks with low price-to-earnings ratios had significantly higher returns than stocks with high P/E ratios; small stocks with low P/E ratios (small value stocks) enjoyed particularly outstanding returns. The magnitude of these size- and value-based returns could not be rationalized using the standard asset pricing models of the efficient market hypothesis.

This caused schizophrenia in the financial community. Efficient-market believers still dominate the field of financial research, but many practitioners, including moonlighting academics, recommend that investors overweight value and small stocks in their portfolios. Eugene Fama from the University of Chicago and Ken French from Dartmouth’s Tuck School built a very successful investment firm based on slicing the universe of stocks into value- and size-based sectors to market to large individual and institutional investors.

Since the 1980s, the finance profession has searched in vain for the reason why small and value stocks outperformed the market. Efficient-market diehards maintain these stocks contain deeply buried risk hidden in the historical data. They predict that one day, when a crisis hits and investors critically need to liquidate their portfolios, small and value-based stocks will crumble while large growth stocks will shine.

But if this is true, the data are unfortunately moving in the wrong direction. In the past decade we witnessed a huge tech bubble, 9/11, a recession, major corporate scandals and wars in Afghanistan and Iraq—yet not only did small and value stocks survive, they outperformed the big cap, high-priced stocks by wider margins than they had in the past.

Current attempts to explain the hidden risks in value stocks remind me of the astronomers in the 16th century who attempted to save the earth-centered Ptolemaic view of the universe. They were forced to add complicated “epicycles” to the orbits of the planets to rationalize their movements in the evening sky; the model collapsed when Copernicus showed that a simple sun-centered solar system was an easier explanation. As with Copernicus, there is now a new paradigm for understanding how markets work that can explain why small stocks and value stocks outperform capitalization-weighted indexes.

This new paradigm claims that the prices of securities are not always the best estimate of the true underlying value of the firm. It argues that prices can be influenced by speculators and momentum traders, as well as by insiders and institutions that often buy and sell stocks for reasons unrelated to fundamental value, such as for diversification, liquidity and taxes. In other words, prices of securities are subject to temporary shocks that I call “noise” that obscures their true value. These temporary shocks may last for days or for years, and their unpredictability makes it difficult to design a trading strategy that consistently produces superior returns. To distinguish this paradigm from the reigning efficient market hypothesis, I call it the “noisy market hypothesis.”

* * *

The noisy market hypothesis easily explains the size and value anomalies. If a stock price falls for reasons unrelated to the changes in the fundamental value, then it is likely—but not certain—that overweighting such a stock will yield better than normal returns. On the other hand, stocks that rise in price more than their fundamentals become “large stocks” with high P/E ratios that are likely to underperform.

These discrepancies are not easy to arbitrage away on a stock-by-stock basis. The noisy market hypothesis does not say that every stock that changes price does so by more than what is justified by fundamentals. Any particular stock may still be undervalued when it moves up in price or overvalued when it moves down.

New research indicates that there is a simple way that investors can capture these mispricings and achieve returns superior to capitalization-weighted indexes. This is through a strategy called “fundamental indexation.” Fundamental indexation means that each stock in a portfolio is weighted not by its market capitalization, but by some fundamental metric, such as aggregate sales or aggregate dividends. Like capitalization-weighted indexes, fundamental indexes involve no security analysis but must be rebalanced periodically by purchasing more shares of firms whose price has gone down more than a fundamental metric, such as sales, and selling shares in those firms whose price has risen more than the fundamental metric.

Robert Arnott, editor of the Financial Analysts Journal and chairman of Research Affiliates, LLC, has published research documenting both the theoretical and historical superiority of fundamentally weighted indexes. It can be rigorously proved that if stock prices are subject to noise, then capitalization-weighted indexes will offer investors risk-and-return characteristics that are inferior to those of fundamentally weighted indexes.

I have long advocated the use of dividends in evaluating stocks. Dividends are the only fundamental variable that is completely objective, transparent and unable to be manipulated by managers who tinker with accounting assumptions. (In the interest of full disclosure, I am an adviser to a company that develops and sponsors dividend-based indexes and products.)

According to my research, dividend-weighted indexes outperform capitalization-weighted indexes and are particularly valuable at withstanding bear markets. For example, the Russell 3000 Index lost almost 50% of its value between the bull market peak of March 2000 and the October 2002 low. Over this same period, a comparable total market dividend-weighted index was virtually unchanged. A dividend weighted index did have a bear market, but it only corrected by 20%. Moreover, the dividend-weighted index bear market didn’t start until March 2002, and it lasted only six months (compared to 24 months for the cap-weighted index). The dividend-weighted index is now about 40% above its March 2000 close, whereas the S&P 500 and Russell 3000 are still not yet back to even. A similar performance occurred in other bear markets.

The historical data make an extremely persuasive case for fundamental indexing. From 1964 through 2005, a total market dividend-weighted index of all U.S. stocks outperformed a capitalization-weighted total market index by 123 basis points a year and did so with lower volatility. The data indicate that the outperformance by fundamentally weighted indexes during the same period is even greater among mid-sized and small stocks.

‘Value Cuts’

Furthermore, dividend-weighted indexes had better risk and return characteristics than capitalization weighted indexes in each industrial sector and each country that I analyzed. Dividend-weighted indexes even outperformed “value cuts” of the popular capitalization-weighted indexes such as the Russell Value and Barra-S&P Value that attempt to choose those stocks whose prices are low relative to fundamentals.

With the advent of fundamental indexes, we’re at the brink of a huge paradigm shift. The chinks in the armor of the efficient market hypothesis have grown too large to be ignored. No longer can advisers claim that capitalization-weighted indexes afford investors the best risk and return tradeoff. The noisy market hypothesis, which makes the simple yet convincing claim that the prices of securities often change in ways that are unrelated to fundamentals, is a much better description of reality and offers a simple explanation for why value-based investing beats the market.

If you are a fan of indexing, as I and so many other investors are, you are no longer trapped in capitalization-weighted indexes which overweight overvalued stocks and underweight undervalued stocks. Devotees of value investing who are searching for a simple, low-cost indexed portfolio in which to hold their stocks need wait no longer. Fundamentally weighted indexes are the next wave of investing.

WisdomTree Funds are distributed by ALPS Distributors, Inc.

Introduction

My good friends and London associates, Absolute Return Partners, have recently released their monthly letter. The letter consists of two essays with the first by ARP President Niels Jensen and the second by partner Jan Vilhelmsen. Given that the equity sell-off around the world has been far more dramatic than in the US, I thought it might be useful to get a view from “over the pond.”

Niels comments on the correlation between commodities and stocks and takes a look at what history can teach us from years past. In light of all of the talk, this is a contrarian’s view opposed to the “it’s different this time” camp (like we haven’t heard that one before). On the other hand, Jan explores a sector of hedge funds that, by definition, do not live up to their name. He concisely summarizes this discovery by stating, “If you pay the high fees that hedge fund managers demand, you would at least expect to get something that you cannot easily create yourself.”

With most observers ranting and raving about the “new economy,” I trust that you will enjoy this article that bets against the consensus by siding with history and the data. Enjoy the read and continue to think “Outside the Box.”

John Mauldin, Editor

The Absolute Return Letter – July 2006

by Niels Jensen and Jan Vilhelmsen
Absolute Return Partners, LLP

So Much Nonsense

So much nonsense has been written recently, following the dramatic sell-off in equities that we thought we would take a quick look in the rear mirror and see what history may be able to teach us in terms of what to expect of both stock, bond and commodity prices over the next year or so.

Let’s begin by putting a marker down. We are great believers in the value of past experience. So often we hear the dreaded words – this time things are different – and every time those words make us cringe. As students of economic history we believe we can learn a great deal from the past. In the world we observe, things are rarely that different.

Back in 2004, Gary Gorton and K. Geert Rouwenhorst wrote a paper called Facts and Fantasies about Commodity Futures¹. The paper has been updated recently and offers some revealing insight into the interaction between stocks, bonds and commodities.

Let’s begin with a table which may surprise you a bit. It certainly surprised us. The National Bureau of Economic Research in the United States (NBER) divides every business cycle into periods of economic expansion and recession respectively. Since they started doing so in 1959, the U.S. economy has undergone seven full business cycles, each consisting of one expansion and one recession.

As you can see from table 1 below, it is very tempting to conclude that there is no real reason to add commodities to your portfolio, as the returns you have achieved during both expansions and recessions are broadly similar to those of the equity market. During periods of economic expansion, equities modestly outperform commodities whereas, during recessions, commodities do marginally better than equities. However, the difference in performance does not really get the adrenalin going.

Table 1:
Average Returns during Expansions and Recessions

Stocks      Bonds         Commodities

Expansion      +13.29%   +6.74%         +11.84%
Recession       +0.51%    +12.59%       +1.05%

Source: NBER, Working Paper 10595 Also, bear in mind that the returns in table 1 are not annual returns. They are returns from economic cycle peak to trough (or trough to peak). Since the periods of economic expansion tend to run considerably longer than the recessionary periods, average bond returns are not quite as attractive as they appear in table 1.

However, what Gorton and Rouwenhorst did next, changed everything. Following NBER’s methodology, they divided each period of economic expansion into early stage expansions and late stage expansions. The results are summarised in chart 1 and are really fascinating. We make the following observations:

1. As we already pointed out, over an entire economic cycle, stocks and commodities behave quite similarly, at least as far as the total return pattern is concerned.
2. Stocks (and bonds) do much better than commodities in late recessions and early expansions. Late recessions are, in fact, the worst environment for commodities where the average return has been negative.
3. The best environment for commodities is late expansions where the average return both in absolute and relative terms is very attractive.
4. In early recessions, where stock and bond returns really suffer, commodity returns are still quite attractive, at least in relative terms.

All this leads to the $1 million question: Where in the cycle is the global economy today? Knowing the answer to that may explain the difference between poor and good performance in your portfolio over the next 12-18 months. Before we go there, an important disclaimer:

Absolutely no assurances can be made that history will repeat itself. Furthermore, the performance numbers in chart 1 are average performance numbers over seven economic cycles. The performance from cycle to cycle may in fact vary considerably.

Having said all of that, chart 1 contains important information unless you believe that globalisation and cheap money has changed the way stocks and commodities correlate with each other. This argument was put forward by Merrill Lynch in a report earlier this year² and reiterated in a Wall Street Journal article only a few weeks ago.

The cheap money argument may carry some validity in the sense that low interest rates globally have contributed to the rolling asset inflation phenomenon, which started with the equity boom in the late 1990s only to move on to property markets and recently also to commodities. However, cheap money is becoming more expensive by the day, so that explanation may not hold water for much longer.

The globalisation argument simply does not stand up to closer scrutiny. It implies that either globalisation has changed the way we cover our commodity needs or that globalisation has fundamentally changed the nature of economic cycles or possibly even both. Neither, in our opinion, is true.

So, back to the $1 million question: Where in the cycle are we? Well, the world’s largest economies are not synchronised at the moment, so the philosophical answer to the question is that it depends. The Anglo-Saxon economies are clearly at a more mature stage in the cycle than most continental European economies and certainly more advanced in the cycle than Japan.

So, in order not to confuse matters, let’s keep our eyes on the U.S. economy which, whether we like it or not, drives everything else anyway.

The yield curve tells you that the U.S. economy is past the peak and is rapidly approaching the next recession. On chart 1, this point is represented by the red dot. If this is the point where the U.S. economy finds itself at the moment, the May/June stock market correction is probably only the beginning of something worse to come. However, in such a scenario, history suggests that commodities may do relatively well for a fair bit longer.

The problem with the yield curve approach, as we pointed out in our March 2005 Absolute Return Letter, is that the yield curve may not be as good at predicting recessions as it once was. Structural changes in the bond market have changed the shape of the yield curve. We concluded back then (and we stand by that conclusion) that a mildly inverted yield curve should be interpreted with care. A strongly inverted curve, on the other hand, is probably still a pretty good indication of recession knocking on the door. As these lines are written, the yield curve is only marginally inverted.

Meanwhile, virtually all other indicators suggest that the U.S. economy has not yet peaked. It may be prudent to expect a modest slowdown from the rampant growth in the first quarter of this year but, overall, Uncle Sam is still firing on most cylinders. This scenario is represented by the green dot on chart 1. Importantly, the behaviour of both stocks, bonds and commodities over the past 12 months supports this line of thinking, i.e. that we are in the latter stages of economic expansion but that we have not yet passed the peak. We prefer to listen to the markets. They usually don’t lie.

As an aside, we actually think something completely different caused the hiccup in May and June. We often disagree with Stephen Roach of Morgan Stanley but believe that he nailed the issue when suggesting that the correction was a result of the world’s leading central banks once and for all closing the book on the Greenspan era of cheap money and bail outs.

Chart 1: Average Returns by Stage of the Business Cycle

The so-called Greenspan put (the Fed’s apparent limitless willingness to flood the system with liquidity and bail out markets every time someone caught the flu) has been ruthlessly removed and the change in policy has radically altered investors’ appetite for risk. Don’t expect it to be reinstalled anytime soon.

If our read is proven correct, then global equity markets will enjoy a decent spell over the next several months before markets start to discount the point at which the U.S. economy finally tips over and lands in the next recession. At that point in time, you do not want equities in your portfolio.

If, on the other hand, our analysis is wrong and the U.S. economy has already passed the peak, you can draw your own conclusions from chart 1. The picture isn’t pretty. And that goes for European and Asian stock markets as well. However, wherever we are in the cycle, do not expect stocks and commodities to continue to move more or less in parallel. History suggests that this is a highly unlikely outcome. The sooner you decide whether to put your chips on green or red, the better.

Show Me the Hedge

With the strong growth in emerging market economies as well as booming equity markets (well, until about six weeks ago), we are frequently asked by our clients if we know any good hedge funds in this area. The problem is, when we invest in a hedge fund we expect to get some degree of ‘hedge’ on our investment. Without having any tangible statistical evidence, we long suspected that emerging market hedge funds do really well in strong markets but suffer noticeably in weak markets. As a result, with one or two exceptions, we have chosen not to invest in emerging market hedge funds, simply because we have not been able to identify any funds in this area which satisfy our strict risk/reward criteria.

To our aid came a research report from Darren Read, a strategist at UBS, tackling exactly the issue we have been struggling with. The study, which he called The Alpha and Beta of Emerging Market Hedge Funds³, found that alpha⁴ in emerging market hedge funds has been positive and stable for the past couple of years. Chart 2 below shows the cumulative return of emerging market hedge funds since the beginning of 1997. In addition to showing the total return, the alpha and beta⁵ components have been shown separately. The findings are hardly surprising.

Chart 2: Where Have the Returns Come From?

Source: UBS
More interestingly, UBS then looked at alpha and beta in rising and falling markets, respectively. The results, seen in table 2 below, are striking. Emerging market hedge fund managers beat the market in positive markets and underperformed in negative ones – exactly as we suspected. In other words, they add value in good markets and destroy value in bad markets. This was the case even when the Russian crisis of 1998 was excluded from the study.

Table 2:
EM Hedge Fund Alphas and Betas

Market Direction                        Alpha    Beta

Positive                                    9.6%    0.64

Negative                                    -3.0%  0.72

Negative,Ex Russia crisis            -11.4%  0.52

Source: UBS. Benchmark is 50/50 bonds and equities. We would go one step further and suggest that the results would look even worse if the numbers were adjusted for leverage. In the UBS report, the (often) leveraged hedge fund results are measured against un-leveraged indices, which will tend to overstate alpha in positive markets and understate alpha in negative markets. Since there are more positive than negative months in the study, the net effect is that the alpha is inflated through leverage.

Chart 3 below shows the average return profile of emerging market hedge funds relative to the market. In the upper right quadrant (representing ‘positive markets’), you will note that hedge funds (the solid line) outperform the benchmark (the dotted line). However, in the lower left quadrant (representing ‘negative markets’), hedge funds underperform the benchmark.

Chart 3: Average EM Hedge Fund Returns v. Market

Source: UBS. Benchmark is 50/50 bonds and equities.

The important point here is that, given the risk investors take and the fees they pay, the two light blue lines in the lower left quadrant would be expected to be on the other side of the dotted line (which is the market). Furthermore, if the hedge fund manager is true to the absolute return philosophy, he should be able to protect investors against losses in negative months. We note that this is particularly important in emerging markets which are notoriously volatile.

The conclusion is inevitable. On average, emerging market hedge fund managers do not deliver on this most critical element of hedge fund investing – the ability to protect investor assets in difficult times. The problem is well documented in that it is difficult from a regulatory and liquidity point of view to go short in many emerging markets.

In short, we believe that return profiles of emerging market hedge funds look very similar to that of leveraged long-only funds. A friend of ours once defined hedge funds as ‘compensation schemes’ as it is about the only thing they have in common across the board. In emerging markets, that definition seems to be spot on. We have no interest in paying exorbitant fees for a leveraged long-only fund.

When it comes to investing in emerging markets, we generally prefer to put our money with a solid long-only manager where we are comfortable with the level of risk and we know we do not pay for a hedge which does not exist in the first place.

The UBS report is obviously based on historic returns. Going forward, we would expect the picture to change gradually as shorting becomes more and more accepted across emerging markets. Given this trend, we would expect more sophisticated and properly ‘hedged’ funds to emerge out of these markets in the not so distant future.

³ UBS Investment Research, May 2006.

⁴ Alpha is a measure of excess performance, i.e. if the global emerging market index is up 10% and a global emerging market hedge fund is up 13%, we say that the hedge fund in question has generated an alpha of 3%.

⁵ Beta measures the volatility of (for example) a hedge fund relative to the overall market. A beta above 1 suggests volatility above the market average while a beta below 1 indicates below market-average volatility.

The program is based on MSCI World Data collected. Users can update the data via the data input form by clicking on the View >> Index Data Input.

Setup

Inflation – estimated inflation rate. used to calculate any real values in the program.

Expense Ratio Mth – Expense ratio used for monthly contribution. this is used to calculate the total value for the selected period where the contribution is monthly.

Expense Ratio Yr – Expense ratio used for annual contribution. this is used to calculate the total value for the selected period where the contribution is annual.

Txn Expense Mth – Transaction ratio for monthly contribution. This will  be used to calculate the total transaction cost for the selected period where the contribution is monthly.

Txn Expense Yr – Transaction ratio for annual contribution. This will  be used to calculate the total transaction cost for the selected period where the contribution is annual.

Monthly Invested Amt – This monthly invested amount will be used to calculate the annual invested amount together with the cash account interest. This is taken with the assumption that the investor does a monthly contribution to his/her portfolio.

Accumulated Sht term interest – This is the cash account interest that the investor can earn for 11 months if he accumulates this in cash rather than invest monthly.

From and To Date – Used this to select the period to investigate. Once calculate is clicked, the values will be calculated and populated. Note that if you select a period that is way out of the data collected, it will only take to the point where there is data collected.

• Performance difference between monthly investment interval vs annual investment interval.
• Can we offset high transaction costs and miscellanous fees to invest in Exchange traded funds because of its low expense ratio compared to majority of the mutual funds in singapore.
• The amount of Transaction and Expense Cost incurred for a given period based on period data.
• Investigate whether there is a certain “tipping point” where expense cost will out weigh transaction cost advantage when comparing investing choices such as Exchange traded funds vs mutual funds.

Completed

• MSCI World Data Input
• Total Value after transaction and expense for a given period
• Nominal and real difference between accummulation using monthly contribution vs annual contribution.

To-Do

• Factor in selling cost
• Factor in 30% withholding tax
• currency conversion cost.

Richard Kang submits: S&P has been publishing their Standard & Poor’s Indices Versus Active Funds Scorecard [SPIVA] results long enough for investors to understand that indices beat comparable funds more often than not. Fees and the costs of implementation are the main culprits for the difference. Really, the comparison should be with similar ETFs, not the index.

What is interesting in the latest SPIVA report from July 19th is that S&P has extended their work into international equities, including emerging markets. This is an area where many observers have commented on the outperformance of active managers versus their respective benchmark. Here are some comments from their press release related to the results of international equities from the report:

International Equities

SPIVA now reports on the performance of international funds versus their relative international S&P benchmark. For the first half of 2006, the SPIVA scorecard shows that indices outperformed actively managed funds. The S&P/Citigroup PMI outperformed 59.7% of global equity funds, the S&P/Citigroup PMI World ex U.S. outpaced 62.5% of international funds, the S&P/Citigroup EMI World Ex U.S. outperformed 63.3% of international small-cap funds, and the S&P/IFCI Composite outperformed 80.9% of emerging market equity funds. Similar to domestic equities, international indices outperformed actively managed funds over a three- and five-year basis.

While indices have historically outperformed actively managed domestic equity funds over long periods of time, our report provides the first evidence of this being true for fixed income and international equity funds,” says Srikant Dash, Index Strategist at Standard & Poor’s. “Even in relatively inefficient asset classes, such as Emerging Market Equities and High Yield Bonds, a majority of active funds underperformed benchmarks over five-year horizons.

Wow. 81% of emerging market equity funds underperformed the index. I’d like to know what the number is versus something like the MSCI EM Index. 81% just seems so big to me, but it really was a very bad May and June.

From the looks of it, core holdings for international equities should still be:

· Broad EAFE exposure: EFA or a combination of VGK/VPL
· Emerging market exposure: EEM or VWO
· Also watch to see what comes down the pipe from PowerShares (FTSE/RAFI) and WisdomTree

It’s looking more and more like we have to move towards a “portable alpha” world. If these numbers are correct, even emerging markets is an asset class where a passive instrument may make more sense than an active manager in the long run… or at least hold more ETFs than managed funds. Truly alpha oriented (beta-neutral) strategies, if they really exist after fees and are repeatable, is the only domain left for active management.

Otherwise, investors will have to become more like pension funds and give up liquidity to enter areas like infrastructure, timber, private equity and other alternative investments.

July 13, 2006

SHANGHAI — Amid the towering glass-and-steel splendor of the Plaza 66 mall — packed with boutiques offering Dior, Prada, Cartier and other luxury brands — shop clerk Xu Junyuan idly scratched his bald head as a lone shopper browsed the deserted aisles.

“I’m just bored,” said Xu, who works at the jeans boutique Diesel.

At Fendi, black-suited clerks yawned as they propped themselves against counters. At the palatial Louis Vuitton shop next door, a 7-foot-tall plasma television played to no one.

In this populous city of fanatical shoppers, Plaza 66 is what some locals call a gui gouwu zhongxin — a ghost mall.

The prices are so high that no one buys much. But then, no one really cares.

Just as Stalin erected Potemkin villages to display the glories of communism to outsiders, Shanghai is creating its own illusion of prosperity out of the world’s most luxurious brands.

Offering cut-rate rents to top-tier fashion houses, this city of about 18 million is determined to make itself look like a world capital of high fashion.

And the Burberrys, Hermes and Chanels are all too happy to join in the charade.

“Most leading luxury brands will need to have a flagship store in Shanghai if only to put Shanghai along with London, Paris, Milan on their bags,” said Paul French, founder and China chief of Access Asia, a marketing research firm in Shanghai.

The illusion is so thin that some stores don’t bother to carry much stock. Others may have lots of clothes on the racks, but they carry just one size: medium, which is too big for most Shanghai women.

Some shops “don’t ring up a single sale for days,” Xu said.

Before World War II and the communist takeover in 1949, Shanghai was often called the Paris of the East — a fashionable cosmopolitan city, the place to be.

At its height in the 1930s, the city was an international trading center and money flowed in from everywhere. Tens of thousands of British, French, Germans, Russians and Americans had settled in the city — a legacy of the first Opium War, when Shanghai was carved up into concessions. The foreigners brought to this onetime farming village elegant Art Deco architecture, haute couture, posh restaurants, dance clubs, brothels, everything to satisfy the whims of the rich.

The party ended in 1937 with the Japanese invasion. After World War II, the city endured battles between the nationalist army and communist forces. When Mao Tse-tung emerged victorious in 1949, Shanghai, along with the rest of China, shut itself off from the rest of the world.

In the last decade, city leaders have sought to regenerate the lost hype in part to draw foreign investment. And they’ve been largely successful, capturing worldwide attention from the media and others who gush about Shanghai as Asia’s most vibrant city, overflowing with wealth and grandeur. Gleaming malls like Plaza 66 have risen to replace decrepit neighborhoods.

But Shanghai isn’t what it appears to be.

The Shanghai Stock Exchange boasts Asia’s largest trading floor inside a 27-story glass building modeled on the Arc de Triomphe in Paris. But the floor stays largely empty because trading is electronic, and the stock exchange remains a joke among serious traders for its lack of transparency and inadequate regulations.

At a cost of $1.2 billion, Shanghai built the world’s fastest train in 2003, which at a regular speed of 267 mph beat out Japan’s bullet trains. But residents have complained that the magnetic-levitation train to Shanghai’s largest airport is a white elephant because it doesn’t run during hours when many flights arrive or depart. Although the train’s hours were recently extended, passengers still have to go to the outskirts of the city to catch the train.

Shanghai has been host to an international fashion model contest and a film festival, but they draw few celebrities from outside China.

Shanghai’s upscale malls are another daily reminder that there is less to the city than meets the eye. “Shanghai is a dreadful retail market,” French of Access Asia said.

Many of the well-to-do have their assets locked up in property, he said. Others are too busy squirreling away money for healthcare, retirement and their children’s education — all signs of a metropolis and a population that are maturing.

Government officials who worked with Hong Kong developer Hang Lung Properties to build the five-story Plaza 66 know that the mall is hardly bustling with people.

“If you walk into Plaza 66, you will find it cold and cheerless. There’s hardly anybody,” said Zhang Zuofeng, an economist with the planning department at Shanghai’s Jing An district government.

But he said that Plaza 66′s office tower was doing well and that the complex generated $80 million in taxes last year.

Terry Ng, Hang Lung’s executive director, acknowledged that traffic wasn’t heavy.

“Expensive items, man,” he said, insisting that the mall is profitable for the tenants and his company.

Jiu Guang City Plaza, another Nanjing Road shopping center near the 1,800-year-old Jing An Temple, was so keen on attracting Burberry, the upscale British apparel maker, that it offered the first year rent-free, brokers said.

Plaza 66 and other malls like it in Shanghai “are solely a window for these brands,” said Chen Jun, manager of commercial real estate at Shanghai Hanyu Property Agency.

“For Louis Vuitton, the district and municipal government singled out this brand for Plaza 66,” Chen said. So although it has the best location on the first floor, the French company enjoys one of the lowest rental rates per square foot. Other tenants pay a percentage of their sales.

Representatives of Burberry, Louis Vuitton and other premium labels generally declined to talk about individual store sales or lease arrangements. But, said Grace Chao, a spokeswoman for Chanel in Shanghai, “Not all brands are paying rent.”

Chao wouldn’t comment on the merchandise at the Shanghai store, saying that “each market has its own strategy in terms of buying.”

The real Chinese high-end spending is taking place in Hong Kong and in smaller mainland cities such as Dalian and Shenyang in the north.

Managers at five-star hotels near Plaza 66 talk in hush-hush tones about the mall’s stores, trading stories about high-end customers being courted privately, flown for shopping weekends in Hong Kong, where there are better selections, newer styles and bigger savings. Luxury goods there cost at least 10% to 20% less because Hong Kong doesn’t have the duties, taxes and special surcharges of the mainland.

Among those who spend their cash at Plaza 66 are so-called rich wives’ clubs, groups of women who come during weekends from Wenzhou and other entrepreneurial hot spots in Zhejiang or Nanjing provinces. Another group of luxury customers: local Communist Party cadres who buy items such as Mont Blanc pens as gifts.

There are plenty of local nouveaux riches who aren’t bashful about conspicuous spending. But most know better than to burn their money in Shanghai.

Tiffany Hua, a 25-year-old yoga instructor and daughter of a Shanghai restaurant magnate, goes on shopping junkets to Hong Kong three or four times a year. She visits malls like Plaza 66 and Jiu Guang more often than that, but mainly it’s to browse and scribble model numbers for her next trip.

Hua recently was sitting at a coffee shop on Nanjing Road, a stone’s throw from the gold- and silver-lettered malls and boutiques.

She was wearing 1960s-styled Prada sunglasses that she picked up in Tokyo (they don’t carry them in Shanghai, she said) and a silver Cartier watch, which she bought in Hong Kong for $2,300 — about $900 less than the price offered at Plaza 66.

“In Shanghai, it’s window-shopping,” she said.

On a recent weekday mid-afternoon, the mall was so quiet that the clicking of shoppers’ heels could be heard on the synthetic marble floor. On the shopping center’s third and fourth floors, one boutique clerk was polishing her nails and others were chatting or leaning on counters.

Phoebe Lao, a 24-year-old clothes designer, was one of the few shoppers on the third floor. She said she didn’t buy much here because she preferred clothes from cheaper labels.

But she is a regular at Plaza 66. She likes the mall, she said, because it’s one of the few places in Shanghai that isn’t crowded.