Bond pricing policy is not subject to regulation, so each fund house handles the problem in a different way
The hedge fund sector often seems like the theatre of fund management, distilling the wider industry's ups and downs into a more concentrated, dramatic form. Simon Treacher's resignation from BlueBay Asset Management last week and the simultaneous closure of his emerging market debt hedge fund, which accounted for 6 per cent of the firm's assets under management, is a case in point.
The company insisted the two events were unrelated, attributing the former to a "breach of internal valuation policy" and the latter to deteriorating "financing and liquidity conditions". Yet, as trading activity in bond markets has dried up over the past three months, how to value credit holdings has become a worry for even the most conservative of retail fund managers.
Because bonds are traded over the counter rather than at a central exchange, they have no official price. Most managers therefore rely on iBoxx, an index run by the data provider Markit, to value their holdings.
iBoxx collects trading data from the market-making investment banks, runs a series of algorithms to eliminate any anomalous values, and averages the rest. This proved reliable in the credit boom, when the market was awash with liquidity. But since the Lehmans default in September, when the great sell-off began, the information chain has come under strain.
"In markets like these, traders have better things to do all day than update their electronic price feeds. Several of the banks that contribute prices no longer make markets any more because they've boiled down the number of staff," says Stephen Snowden, manager of the GBP828m Old Mutual Corporate Bond fund.
A second problem is the radically reduced number of trades, which means that any updates the banks do supply can differ significantly, while bid/offer spreads are highly stretched. Faced with an inconsistent set of inputs for a given instrument, iBoxx defaults back to the previous period's value - which in today's sharply falling markets is invariably higher.
"The process does not have the flexibility to adjust to the stressed market conditions quickly enough at the moment," admits Stephan Flagel, head of indices at Markit.
He says the company is working with the investment banks, regulators and investors to develop an alternative set of rules that will allow iBoxx to discard anomalous price feeds without compromising the objectivity and transparency of the programme. The new regime should be implemented by the end of the month.
Meanwhile, some bond managers are turning to alternative sources to value their holdings. Philip Milburn, co-manager of the GBP355m Aegon Sterling Corporate Bond fund, reports that 20 per cent of the fund house's bond portfolios are manually priced.
"If we think a price is wrong, we'll chase it up with the brokers. But we can't be there to police and price the whole market," he says, describing the middle-office process as "arduous".
But the blockages in iBoxx do not just make extra work for fund managers. Crucially, they call into question the performance statistics that are the backbone of the entire industry. If a bond is overvalued, so too is any fund that holds it.
Mr Snowden, who uses alternative sources to price 50 per cent of his portfolio, says turning iBoxx back on would add around 4 per cent to his returns year-to-date. "If everyone used the same pricing methodology, we might see a very different leader table than we do," he adds, albeit with the caveat that his one year track record would still be fourth quartile.
But even managers further up the current league tables complain the statistics misrepresent their work. Stephen Thariyan, head of credit at Henderson Global Investors, for example, claims the numbers do not do full justice to his strategy of underweighting certain crucial sectors that have been particularly hit in the sell-off.
"The inability of iBoxx to accurately reflect market levels is irksome since we do not see the benefit of our sector and security selection until the index catches up. We email them regularly to suggest they should re-examine a price," he says.
Bond pricing policy is not subject to regulation, so every fund house handles the problem in a different way. Needless to say, this only adds to the confusion. But most are reportedly still using the iBoxx index to value the vast majority of their holdings, suggesting there may be a considerable shake-up in the rankings when Markit reconfigures its algorithms in the New Year.
COPYRIGHT 2008 FT Business
0 comments:
Post a Comment