Big Mac index

The Economist's latest Big Mac index

THIS time round our Big Mac index looks at changes since global money-markets seized up in the summer of 2007. The index is based on the theory of purchasing-power parity, which says that exchange rates should eventually adjust to make the price of a basket of goods the same in each country. Our basket contains just one item: the Big Mac hamburger. It works by calculating the exchange rate that would leave a Big Mac costing the same in each country. For example: at current exchange rates a Big Mac, which sells for $4.33 in America, costs just $2.29 (75 roubles) in Russia, whereas in Brazil it sells for a sliver under $5 (10 reais). So the dollar buys a lot of burger in Russia, signalling that the rouble is cheap and the real rather pricey. There have been some big shifts in fortune since the first rumblings of the crisis. The Venezuelan bolivar has moved from 1% to 83% overvalued thanks to high inflation and a static currency peg with the dollar which is creating a growing trade imbalance with America. The Australian dollar has moved from being 14% undervalued to 8% overvalued. In the early part of the crisis Australia’s well-capitalised banks proved remarkably resilient; more recently, the currency has benefited from a spike in commodities prices, and from strong exports to China. By contrast, the British pound is now undervalued: its financial industry, a big chunk of the overall economy, was at the heart of the recent turmoil (the pound depreciated sharply in 2008) and its biggest export market, the euro zone, is in a dreadful mess.

Source : The Economist online

Hedge fund industry assets to more than double in five years, says Citi

Assets invested with hedge fund firms could more than double by 2016, according to a just-released survey from Citi Prime Finance.

The study finds that pension funds, endowments, foundations and other institutional investors are increasingly embracing the risk management and diversification that hedge funds offer, and that hedge funds are developing new products that compete with traditional, long-only managers. These trends could contribute to a sharp rise in hedge fund assets over the next few years.

In the third of its annual market-leading surveys of hedge fund industry trends, the newest, titled Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence, finds that institutional investors are refocusing allocations based on risk budgets rather than dollar-weighted allocations alone. The survey and its findings and forecasts are the result of more than 80 hours of in-depth interviews with 73 industry participants, including institutional allocators, hedge fund managers, large traditional asset managers, consultants and fund of funds managers. Participants represent USD821 billion in assets allocated, managed or under advisement in the hedge fund industry.

"We see a second wave of institutional allocations to hedge fund strategies, as well as new allocations to long-only strategies managed by hedge fund firms," says Sandy Kaul (pictured), US Head of Business Advisory Services at Citi Prime Finance, which provides trade execution, financing and business services to many of the world's leading and emerging alternative asset management firms.

The first wave of institutional allocations to alternative investments occurred from 2003 to 2007, when institutions poured more than USD1 trillion into the asset class. Investors at that time followed the example of Yale University and other leading endowments that were able to significantly outperform traditional 60 per cent equity/40 per cent bond portfolios during the 2000 to 2002 market downturn by incorporating hedge funds and other diversified investments into their portfolios.

"While institutions have been allocating to hedge funds for years, such investments were considered to be on the periphery of core portfolio holdings," says Alan Pace, Head of Citi Prime Finance. "That is no longer the case. Today, with investors more focused on risk alignment within the overall portfolio, hedge fund allocations will play a central role in institutional portfolios in the years ahead."

According to the new survey, global assets invested with hedge fund firms could rise from today's record USD2.1 trillion to more than USD5 trillion as a result of two emerging trends. First, is the potential for market-leading institutional investors to increase allocations to hedge fund strategies by USD1.0 trillion in order to better insulate against risk and to help ensure more diversified portfolios.

Second, the survey revealed a "convergence zone," in which hedge funds and traditional asset managers will increasingly compete head-to-head to offer a broad set of equity and credit strategies. The survey observes that there could be an additional USD2.0 trillion in new allocations to hedge fund firms in the form of regulated alternatives and long-only products. Supporting this, the survey found that mature hedge fund firms are leveraging their deep infrastructures and resources towards creating these offerings.

Source : http://www.hedgeweek.com/

Danish Dynamite

For small countries like Denmark and Luxembourg it is only natural to look beyond their national borders. By promoting highly sophisticated financial products and their underlying ICT solutions, Denmark and Luxembourg have been able to attract many internationally operating companies. During a conference at the Public Research Centre Henri Tudor in Luxembourg, experts from both countries expressed their desire to help this trend continue. Louise Bang Jespersen, the Danish Ambassador to the Grand Duchy of Luxembourg was enthusiastic about this cooperation. She looked forward to developing business contacts between the two countries.

Nowadays, money moves from one end of the globe to the other at the click of a button. Banks’ clients and investors are located all over the world. The financial sector would not exist without information and communication technologies. Just imagine a globalised world, where in order to settle a trade, parties would still have to physically move paper instruments or certificates across the globe.

Ernst-Wilhelm Contzen is CEO of Deutsche Bank Luxembourg and chairman of the ABBL, Luxembourg’s Bankers’ Association. In his speech he emphasised that financial innovation has reduced costs for banks and their clients, particularly the cost of credit and transactions.

“Nevertheless, there is room for improvement, particularly when it comes to collaborating with other sectors to innovate.Besides the fact that the financial sector does not have a real innovation culture compared to other sectors, it also has little experience when it comes to cross-industry projects and cooperation. This needs to change”, he said.

Mr Contzen confirms both the European Commission and the European Central Bank’s view that the financial sector is not being innovative enough.He recommends that his criticism be taken as motivation to spur innovation within the sector. In a way, financial institutions have little choice with regard to trends that are observed. “Banks need to defend their market share in an increasingly crowded sector, they need to gain new market shares and, above all, they must find new revenue sources. In both cases, banks will find that they need to cooperate with non-banks to succeed”. 

Very similar but not the same

Copenhagen and Luxembourg follow similar objectives. Both Denmark and Luxembourg want to turn their respective capitals into competitive hubs on a global scale. In Denmark, 25% of IT workers are employed in the financial sector; in the finance and business services, IT accounted for 28% of the economic growth in Denmark.

A similar economic pattern is true for Luxembourg. But Ernst-Wilhelm Contzen makes a distinction in terms of innovation. “Although Luxembourg has not yet created a Luxembourg Finance IT Region initiative like Denmark, things are moving in the right direction. A good example is the Luxembourg ICT Cluster, a network that supports the various actors in the field of information and communication technologies in Luxembourg”. The goal is to create and develop new sustainable business opportunities through collaborative R&D and innovation projects.

During the Denmark-Luxembourg conference, several business specialists and academics spoke about opportunities both countries have seized to increase business. Carsten Mahler is CEO of the Copenhagen-based company FundConnect, which distributes fund data to the markets and customers. 

Big players from small countries

Seven years ago, FundConnect started working with Finesti, a subsidiary of the Luxembourg Stock Exchange. This cooperation makes sense: Luxembourg, as the second largest fund centre in the world, relies heavily on sophisticated IT services for the daily management and distribution of an enormous amount of investment fund data the country distributes across the globe.

Carsten Mahler explains the reasons his company works with Finesti: “We have to receive data, make sure that it is published on the Stock Exchange within split seconds, making sure data is flowing. It is pretty challenging to reach the critical mass. How to promote and market yourself, these are two of our main challenges, which is why we have decided to cooperate with Finesti”.

Data availability is a central concern of the mutual fund industry and its customers. This is increasingly relevant as fund groups face more stringent disclosure requirements from regulators, fund supermarkets, and multi-distribution sales channels. What’s more, increasing cross-border sales have greatly increased the importance of having complete and accessible information on the Internet.

There are 6000 funds in Europe. It is very difficult for consumers to choose a fund. That is why it is important to use a classification system. FundConnect, in collaboration with Finesti, serves as Classification Partner for the European Fund Classification Forum (EFCF) fund classification scheme. The partnership is responsible for collecting portfolio data, processing and generating the results of the classification. CW

Source : Luxembourg for finance http://www.lff.lu/

Rolling back the years

America has lost almost a decade of progress to the financial crisis

TALK of a Japanese style "lost decade" has abounded ever since the financial crisis took hold in 2008. The Economist has crunched the numbers and on the basis of seven indicators covering economic output, wealth and labour markets, the United States has already gone back in time some ten years. Its GDP per person, for example, was at a higher level than today back in 2005 and its main stockmarket index was higher in 1999. Of the countries considered, Greece has fared the worst. In economic terms, it is just entering the new millennium again. As a whole the rich world has been hardest hit by the financial crisis. Just six of the 34 "advanced" economies categorised by the IMF have GDP per person higher in 2011 than in 2007. Notable among them are Germany and Australia. 

Source : the economist, IMF, OECD

Will Emerging Markets Fall in 2012 ?

BERN – Emerging markets have performed amazingly well over the last seven years. In many cases, they have far outperformed the advanced industrialized countries in terms of economic growth, debt-to-GDP ratios, countercyclical fiscal policy, and assessments by ratings agencies and financial markets.

As 2012 begins, however, investors are wondering if emerging markets may be due for a correction, triggered by a new wave of “risk off” behavior. Will China experience a hard landing? Will a decline in commodity prices hit Latin America? Will the European Union’s sovereign-debt woes spread to neighbors such as Turkey?

Indeed, few believe that the rapid economic growth and high trade deficits that Turkey has experienced in recent years can be sustained. Likewise, high GDP growth rates in Brazil and Argentina over the same period could soon reverse, particularly if global commodity prices fall – not a remote prospect if the Chinese economy begins to falter or global real interest rates rise this year. China, in turn, could land hard as its real-estate bubble deflates and the country’s banks are forced to work off the bad loans.

This is not wild doom-and-gloom speculation. The World Bank has justdowngraded economic forecasts for developing countries in its 2012 Global Economic Prospects, released this month. For example, Brazil’s annual GDP growth, which came to a halt in the third quarter of 2011, is forecast to reach 3.4% in 2012, less than half the 7.5% rate recorded in 2010. Reflecting a sharp slowdown in the second half of the year in India, South Asia is slowing from a torrid six years, which included 9.1% growth in 2010. Regional growth is projected to decelerate further, to 5.8%, in 2012.

Three possible lines of argument – empirical, literary, and causal, each admittedly tentative and tenuous – support the worry that emerging markets’ economic performance could suffer dramatically in 2012.

The empirical argument is simply historically based numerology: emerging-market crises seem to come in a 15-year cycle. The international debt crisis that erupted in mid-1982 began in Mexico, and then spread to the rest of Latin America and beyond. The East Asian crisis came 15 years later, hitting Thailand in mid-1997, and spreading from there to the rest of the region and beyond. We are now another 15 years down the road. So is 2012 the year for another emerging-markets crisis?

The hypothesis of regular boom-bust cycles is supported by a long-standing scholarly literature, such as the writings of the American economist Carmen Reinhart. But I would appeal to an even older source: the Old Testament – in particular, the story of Joseph, who was called upon by the Pharaoh to interpret a dream about seven fat cows followed by seven skinny cows.

Joseph prophesied that there would come seven years of plenty, with abundant harvests from an overflowing Nile, followed by seven lean years, with famine resulting from drought. His forecast turned out to be accurate. Fortunately, the Pharaoh had empowered his technocratic official (Joseph) to save grain in the seven years of plenty, building up sufficient stockpiles to save the Egyptian people from starvation during the bad years. That is a valuable lesson for today’s government officials in industrialized and developing countries alike.

For emerging markets, the first seven-year phase of plentiful capital flows occurred in 1975-1981, with the recycling of petrodollars in the form of loans to developing countries. The international debt crisis that began in Mexico in 1982 catalyzed the seven lean years, known in Latin America as the “lost decade.” The turnaround year, 1989, was marked by the first issue of Brady bonds (dollar-denominated bonds issued by Latin American countries), which helped the region to get past the crisis.

The second cycle of seven fat years was the period of record capital flows to emerging markets in 1990-1996. Following the East Asia crisis of 1997 came seven years of capital drought. The third cycle of inflows occurred in 2004-2011, persisting even through the global financial crisis. If history repeats itself, it is now time for a third “sudden stop” of capital flows to emerging markets.

Are a couple of data points and a biblical parable enough to take the hypothesis of a 15-year cycle seriously? Perhaps, if we have some sort of causal theory that could explain such periodicity to international capital flows.

Here is a possibility: 15 years is how long it takes for individual loan officers and hedge-fund traders to be promoted out of their jobs. Today’s young crop of asset pickers knows that there was a crisis in Turkey in 2001, but they did not experience it first hand. They think that perhaps this time is different.  

If emerging markets crash in 2012, remember where you heard it first – in ancient Egypt.

Jeffrey Frankel is Professor of Capital Formation and Growth at Harvard University.

Copyright: Project Syndicate, 2012.
www.project-syndicate.org

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