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Quantum Endowment Funds Group Members: Kunqi Bai; Heng Zhao; Shengnan Zhang; Zhe Li; Kailai Xu; Benchen Huang: Junyu Xiao Agenda Successful case Introduction Invest theory Successful cases Failure cases Current News introduction George Soros, born August 12, 1930, is the chairman of Soros Fund Management. He is known as “the Man Who Broke the bank of England” because of his short sale of 10 billion worth of pounds, giving him a profit of 1 billion during the 1992 “Black Wednesday UK currency crisis.”. Also, Soros is one of the thirty richest people in the world. introduction Soros Fund Management • Soros Fund Management is a privately held American investment management firm currently structured as a family office but formerly a hedge fund. • The firm was founded in 1969 by George Soros and in 2010 was reported to be one of the most profitable firms in the hedge fund industry, averaging a 20% annual rate of return over four decades. • It is headquartered in New York City. • In July, 2011, The Quantum fund announced that they would be ending the fund, and will return all the outside money and exclusively manage Soros’s family money. introduction Quantum Fund Quantum Fund is one of five funds belongs to Soros Fund Management and is one of the most famous hedge fund in the world. · Founded in 1969 with 4 million registered capital. · 4 years later, Quantum Fund had more than 12 millions. · All the investors are from outside the U.S. in order to avoid the supervision of SEC. What makes Soros and his Quantum Fund so famous? · Quantum Funds earned 1.8 billion by shorting British pounds and buying German marks. This famous battle earned Soros the title of “ the Man Who Broke the Bank of England.” · In 1997, Soros shorting Thai baht, causing the economic crisis in Southeastern Asia. How does it work Reflexivity The market is made up of people. People have a conception of the economic reality (which is inevitably false or incomplete) and base their actions on these conceptions. These conceptions then have a feedback loop with "economic fundamentals" In certain historical circumstances this feedback loop leads to outcomes that are initially self fulfilling but inevitably self defeating in a boom/bust sequence. Generally this reflexive boom/bust sequence initially builds on a preexisting trend based on sound economic fundamentals. X=knowledge Y=action Y=F1(x) X=F2(y) ①,② Y=F1[F2(y)] X=F2[F1(x)] ① ② ▪Reflexivity is inconsistent with equilibrium theory. ▪Reflexivity asserts that prices do in fact influence the fundamentals and that these newly influenced set of fundamentals then proceed to change expectations, thus influencing prices. ▪The process continues in a self-reinforcing pattern. Because the pattern is self-reinforcing, markets tend towards disequilibrium. • The market is made up of people. • People have a conception of the economic reality (which is inevitably false or incomplete) and base their actions on these conceptions. • These conceptions then have a feedback loop with "economic fundamentals" • In certain historical circumstances this feedback loop leads to outcomes that are initially self fulfilling but inevitably self defeating in a boom/bust sequence. • Generally this reflexive boom/bust sequence initially builds on a pre-existing trend based on sound economic fundamentals. a. Lenders began to make more money available to more people in the 1990s to buy houses. good? Thus they lent out more money because their balance sheets looked good, and prices went up more, and they lent more, etc. Prices increased rapidly, and lending standards were relaxed. Increasing lending against appreciating assets without understanding that one of the main reasons for the increased asset price is the increased lending. b. Ever larger numbers of potential investors in housing markets grew increasingly confident that house prices would continue to increase based on their past experience (i.e. adaptive expectations) and thus scrambled to bid up the prices of houses. the trend-following habits of investors or speculators (including adaptive expectations formation). Unchecked credit expansion An explosion in the value and type of unregulated financial instruments (derivatives, leveraged instruments etc.) Globalization of financial markets with the financing of US consumption (private and government) by foreign lenders (China etc.) How does it work Strategy to Arbitrage A: buy stocks P B: short sell B A C: sell stocks C t Quantum Fund VS Quantum Endowment Fund Higher leverage Lower risk with lower return The War with Pound: Break the Bank of England Origin of 1992 Pound Crisis European Exchange Rate Mechanism (ERM) • Introduced in 1979 with the goals of reducing exchange rate variability and achieving monetary stability within Europe • Prepare for the Economic and Monetary Union (EMU) and ultimately the introduction of a single currency, the euro • This process was seen as politically driven, attempting to tie European countries together • The United Kingdom tardily joined the ERM in 1990 at a central parity rate of 2.95 deutsche marks to the pound Origin of 1992 Pound Crisis The sign of Maastricht Treaty in 1992 • In February 17, 1992, the European Community signed the "Maastricht Treaty“ • Treaty requires that the European Community countries should complete the single currency in three phases • First stage: intensify “European exchange rate mechanism” role to achieve free flow of capital; • Second stage: establish a “European Monetary Institute” to coordinate national monetary policies; • Third stage: establish a unified European currency (euro) and found“European Central Bank”for the EU to develop a unified monetary policy. Origin of 1992 Pound Crisis Imbalance economic development in EU countries • Germany has a prosperous economic due to the integration of East and West Germany and Germany dominates the economic development of the whole of Europe • UK is caught in the mire of recession • The economic situation in southern Europe, such as Italy, was inferior to the United Kingdom • Unified European currency will only exacerbate the economic imbalance between EU countries • the UK government was required to keep the pound in a trading band within 6 percent of the parity rate. An arguably artificially strong currency in the United Kingdom led the country into a recession • Despite a recession, the United Kingdom was forced to keep interest rates artificially high, in line with German rates, in order to maintain the currency regime • These two action can not stimulate the economy and rescue the UK from depression. • Meanwhile, Germany was suffering inflationary effects from the integration of East and West Germany, which led to high interest rates. Soros got “the UK economy can not support the strong pound, pound must devalue in the future” conclusion and took following specific strategies to make profit: • Short positions strategy: buy dollars or imminent revaluated Mark, short selling (borrowing) devalued pound • Arbitrage strategy: devalued pound may cause serious impact on the UK financial markets, certain financial assets on the UK market may temporarily fall below the proper value; buy low and sell high September 16,1992, British government was forced to withdraw the pound from the European Exchange Rate Mechanism (ERM), which send the currency into a free fall September 16, 1992 also is called Black Wednesday $950 million was earned by Soros Black Wednesday, September 16, 1992 Figure: Pound/Mark and UK Base Rates, 1992 Sniping Baht in Thailand Good Side In the early 1990s, when Western countries were in the stage of recession, the economy of the Southeast Asian countries develop rapidly, the economic outlook is very good. Strategy------- become the New World Financial Center. relaxed financial regulation, implement the financial liberalization The background of sniping Baht Potential Risk Economic growth of Asian countries is not based on the rise in productivity, but mainly dependent on the increase of the foreign investment. Target : Thailand, is the most vulnerable to the impact of international capital International trade surplus significantly overestimated baht exchange rate is maintain the dollar's exchange rate, sold a lot of foreign exchange How Endowment Fund made money Interest rate: Thailand >U.S. borrow money from the U.S., and then deposited in the Bank of Thailand money flowing into Thailand baht & US dollar exchange rate is fixed no depreciation and appreciation the assumption is 1:25, Soros borrow 250 billion baht from Bank of Thailand then exchange $10 billion let their baht depreciate Borrow money from Thai banks and buy dollars from Thai government resulted in a panic How Endowment Fund made money Dollar is so hot all of a sudden, all together to sell baht and buy dollars Thai government: not so much foreign exchange reserves, the dollar has been depleted quickly floating exchange rate and let the baht devaluation, only the baht devaluation, the dollar is enough to sell sharp depreciation of the baht, from 1:25 to 1:50 , $10 billion worth 500 billion baht pay back $250 billion baht and earn $250 billion baht Timeline of sniping Baht---first battle In March 1997, when the Bank of Thailand announced that nine domestic financial companies and the one major housing loan company have liquidity shortage problem. Soros and other hedge funds Managers sell baht in large amount Timeline of sniping Baht---first battle Three tricks---- transaction costs surge, all of a sudden loss of $300 million Joint Singapore spent $ 12 billion reserve to absorb the baht Prohibit lending Raise interest rates Timeline of sniping Baht--- Second battle In late June 1997, former Thai finance minister resigned. Soros ordered to sell bonds to raise funds and short selling again July 2, the Thai government as a result of no longer able to compete with George Soros, implement a floating exchange rate system. Quantum Fund in Hong Kong Quantum Fund’s strategies Stock market Currency market Futures and Option market Linked Exchange Rate System A system of managing a nation's currency and exchange rate by linking the national currency to another base currency that is held at a fixed ratio in deposit at domestic banks. Hong Kong Dollar is linked with UD dollar. In Hong Kong, the monetary regulator is Hong Kong Monetary Authority (HKMA). Quantum Fund’s strategies Short HK Dollar Speculators benefit Value of stock index futures decrease • HKMA: Hong Kong Monetary Authority HKMA increase Interbank lending rate Negatively effect the stock market Quantum Fund’s strategies Quantum Fund focus on two markets: currency market and stock market Currency market stock market 1 • Borrow the HK dollar from currency market 1 2 • Exchange the HK dollar to US dollar 2 • Short the stock index futures and the stock • stocks price decrease • 3 4 • HK dollar depreciate • Use the dollar to buy the HK dollar and pay back 3 benefit from the short position When the hot money flow into Hong Kong… Hang Seng Index (HSI) 10/20/1997 12860 10/21/1997 11700 10/22/1997 10600 10/28/1997 9060 Exchange rate: 10/20/1997 1USD=7.75 HKD 10/29/1997 1USD=7.73 HKD Reaction of Hong Kong government Use foreign exchange reserve to intervened currency market Protect the stock market by capital injection . Increase the margin of the stock index by 50%,from 80,000HKD to 120,000HKD. Request the registration of holding more than 250 index contracts. Result Quantum Fund loss 900 million HK stabilized its Linked Exchange Rate System, however it went through a 10-year regression resulted after this crisis. Per Capital income from 1997 to 2007 Year Per capital income(USD) 1997 27,055 1998 25,352 1999 24,600 2000 25,144 2001 24,744 2002 24,340 2003 23,428 2004 24,393 2005 26,000 2006 27,466 Quantum Fund In Russia In 1998, Soros's Quantum Fund Losses in Russia Loss: One of the main reasons Soros ended the Quantum Fund Quantum Fund In Russia Why Quantum Fund invested in Russia? 1995, suggested by QFII, Russia Government gradually opened up its capital market to foreign investors. 1997, Russian economy rebounded, GDP had a positive growth, inflation rate declined. Quantum Fund In Russia Why Quantum Fund invested in Russia? Treasury Bond: 3-6 months Stock Price low: $0.5 - $5 Bullish Annualized Bond Return>30% Average Return>100% Quantum Fund was Bullish on Russian Market Quantum Fund In Russia Why lose?- The financial crisis in Russia In the first half of 1997, the Russian economy showed some signs of improvement. However, soon after this, the problems began to gradually intensify. Two external shocks: The Asian financial crisis that had begun in 1997 and the following declines in demand for (and thus price of) crude oil and nonferrous metals, severely impacted Russian foreign exchange reserves. A political crisis came to a head in March when Russian president Boris Yeltsin suddenly dismissed Prime Minister Viktor Chernomyrdin and his entire cabinet on 23 March 1998. Quantum Fund In Russia Why lose?- The financial crisis in Russia On 17 August 1998, Russian government and the Central Bank of Russia issued a "Joint Statement" announcing, in essence, that: The ruble/dollar trading band would expand from 5.3–7.1 RUR/USD to 6.0–9.5 RUR/USD; Russia's ruble-denominated debt would be restructured in a manner to be announced at a later date; and, to prevent mass Russian bank default, A temporary 90-day moratorium would be imposed on the payment of some bank obligations, including certain debts and forward currency contracts. Quantum Fund In Russia Why lose?- The financial crisis in Russia The effects of Crisis Exchange rate • Exchange rate had reached 21 rubles for one US dollar, lost two thirds of its value in less than one month Treasury Bond • Treasury bond price declined to less than 50% of the face value Stock market • Stock market dropped 75% than beginning of the year Quantum Fund In Russia The big loss When the crisis began, Soros appealed to other western countries to help Russia, the banks used to support Quantum Fund refused and ask for early loan payment. In the crisis, the market broke down, stock, bond, rubledollar were terminated trading once. Foreign investors lost $33 billion in this crisis. Current News about Quantum Fund Return Money to Outside Investors Time: 2011 In order to avoid regulation under Dodd-Frank Act 1. Not need to register with SEC 2. Avoid handing over data to the Financial Stability Oversight Council Now a family office operating approximately $25 billion family wealth Current Performance Earned $5.5 billion in 2013, best return since 2009 (Financial Times) Ranked No. 1 hedge fund with the greatest net gain for investors (LCH Investment NV,2014) Started to focus on China and warned China’s rate of credit growth and leverage The world’s most successful hedge fund Won the battle against the Bank of England Generated more than $40 billion to its investors since its foundation (LCH Investment, 2013) Annual return is more than 30% (LCH Investment, 2013)