Randomly Noted

In my travels around Asia the past couple of weeks, I’ve been meeting with various banks and investors to learn more about the FX market in connection with our big initiative there. Stopped in to see a decent sized U.S. hedge fund and was fascinated by the investment strategy.

Among other tings, these folks invest in convertible bonds issued in local currencies in home countries. They end up with three factors that can affect returns: credit exposure, changes in interest rates and changes in currency values. The manager relayed an interesting anecdote that explained the benefit of such a strategy: the bond and underlying stock hadn’t moved much in price but the currency had to the point it allowed him to convert the bonds into stock and then sell the stock, convert the currency to dollars and make a handsome return. In other words, currency fluctuations in transactions like this can help take an out-of-the-money convertible and all of a sudden bring it in the money.

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There are facts. There is political reality. As those two clash, it won’t come out well for the Securities and Exchange Commission.

The SEC’s chairman, Mary L. Schapiro, marshalled facts in a speech today, hitting hard that the watchdog agency needs more money to modernize to fulfill its role, especially in light of the additional responsibilities handed the SEC by the Dodd-Frank Act.

The reality is the SEC had better review all its operations, set its priorities and stop some things so it can do others well. The top priorities should be enforcement and watching ever-more-sophisticated stock market patterns.  Other functions, such as investor education, will have to fall by the wayside.

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In the Financial Crisis Inquiry Report issued today, there is a fair amount of criticism lobbed at Wall Street and the complicated securities it created that fueled the explosion of toxic mortgages. It also notes that there were quite a few hedge funds that figured this out and entered trades that would make them profitable if “the entire market crashed.”

The FICC report says it surveyed more than 170 hedge funds and a found a common strategy to be one where they went long the equity (extremely risky) portion of a collateralized debt obligation but used credit default swaps to take offsetting positions in different ranches of the same CDO.

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These are tough days for stock pickers.

“Macro” is everything. Broad trends in economics, risk, regulation, currencies, monetary policy and trade are sweeping stocks in one direction or another.

It’s been mostly up lately, but up or down, ‘macro’ has for now made a mockery of the careful study of individual companies and industries to discern the best investment bets.

To be sure, no investment trend lasts forever, but this one has been hanging on for a while.

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Here’s a smart idea – heavily tax business to close your state budget gap and run the risk of driving those businesses elsewhere.

That’s exactly what is going on in New York state. As part of the negotiations to close the state budget gap, Gov. David Patterson agreed to provisions that would add an extra tax on hedge funds and private equity firms that do business in the state. The governor said he had no choice because he needed to get other revenue raising measures through.

So, enter Connecticut Gov. M. Jodi Rell. In a letter to the New York Hedge Fund Roundtable, Rell made it clear she would welcome any fund managers who wanted to pack their bags and come do business in her state – without the threat of that extra tax looming over their heads.

Patterson today, perhaps realizing the implications of that, finally, said he wants to revisit and reconsider that tax. The populist notion of going after the rich could backfire if funds leave the state – and in fact could leave New York with a bigger budget problem.

Deglobalization.

It’s an ugly, awkward word, both in its construction and, more important, its implication.

It was used today in the monthly macro view produced by bond investor Bill Gross, managing director at the investment firm PIMCO. Gross was talking about the “structural headwinds” facing the global economy that form part of the firm’s “new normal” view of low economic growth.

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As she discussed Friday her concerns about the credit-default swaps market, especially when it involves sovereign debt, France’s finance minister, Christine Lagarde, turned a well-worn market notion on its head.

“Now it’s all OTC,” Lagarde said of CDS trading, “which I call ‘under’ rather than ‘over’ the counter.”

In a lunch interview with The Wall Street Journal and Dow Jones Newswires on Friday, Lagarde said she was particularly concerned with the lack of clarity around CDS trading, especially CDS on sovereign debt. The latter she described as a narrow and illiquid market.

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The volatility in trading credit default swaps of soveriegn nations, especially of Greece, will now be stirred by an additional fundamental factor: the real threat of significant government regulation.

An already skeptical governing class in Europe about these instruments when they were confined mainly to insuring against corporate default has ratcheted up to outright disdain in many quarters now that they often focus on countries.

Even believers in free markets have to wonder about credit default swaps. You’ve heard the quotes that put these instruments in sharp relief. George Soros said credit default swaps were like letting someone take out insurance on a stranger and then shoot him. They stand out from regular insurance in a simple way: you can insure against something you have no stake in.

If you make a strong bet that someone is going into default, you have the ability by that very action, if it’s big enough, and through related market moves, to increase the chance of it happening,

If that entity is a nation the impact can be on millions and will resonate far beyond the financial world into the heart of politics and regulation.

This is where recent comments by U.K. Financial Services Authority Chairman Adair Turner make sense. He suggested you limit credit default swaps to those who actually own bonds that need to be insured against default. Others have made similar suggestions and that may be the future of at least soveriegn credit default swaps.

Amid the blizzard of merger news came another indication that the Wall Street-recovers-while Main-Street-suffers play is firmly in place: hedge funds are back to where they were before the credit crisis, the deep recession and the abysmal market year of 2008.

To be specific, hedge funds are back to pre-crisis levels in assets under management, according to advisory firm Hennessee Group LLC. The group estimates hedge fund industry assets rose $751 billion in 2009 to nearly $2 trillion.

Two trillion dollars is a lot of money. That’s why hedge fund adviser registration with the Securities and Exchange Commission is a needed component of financial regulation reform. Too little is on record about many market-involved hedge funds.

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It’s revealing how the presumed universal good of bolstering investor confidence can be claimed by both sides of an important issue such as short selling U.S. stocks.

Here are the quotes.

After duly noting the positives brought to the table by oft-despised short sellers (market liquidity and pricing efficiency), Securities and Exchange Commission Chairman Mary L. Schapiro today said, “We also are concerned that excessive downward price pressure on individual securitues, accompanied by the fear of unconstrained short selling, can destabilize our markets and undermine investor confidence in our markets.”

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