| Paul Singer, Elliott Management (Bloomberg) |
Paul Singer’s Elliott Management Corp. is telling clients it is most concerned about accelerating inflation these days, according to its latest quarterly letter.
The hedge fund firm, which manages about $30 billion, warns in its third-quarter client letter that the tide toward inflation could turn rather abruptly, for a number of reasons. And this would not be good for the hedge fund firm, Elliott says, stressing that if inflation starts accelerating to an annual rate of high single digits or greater, “it will be quite difficult for the mix of strategies” the firm favors to “keep up.”
This fear seems odd since rising prices have not been a concern since at least the financial crisis eight years ago. In fact, until recently, some pundits were worrying about possible deflation, using that fear to explain the phenomenon of negative interest rates.
What would happen if we moved from a low- to high- inflation environment?
First, there would be a collapse of bond prices, and possibly a stock market crash. “This type of transition is something that we have seen before, and we think we are prepared for it,” Elliott assures investors. “We do not anticipate losing much money during such an episode, and afterward assets are typically ‘repriced’ (lower) to provide a new, higher expected forward rate of return.”
Elliott, founded nearly 40 years ago by Singer, is one of the oldest and most successful hedge fund firms.
Slow and steady has been the hallmark of the well-diversified firm, which is best known for its activist investments. Since its inception Elliott has generated a 13.5 percent net compounded annual return, suffering just two losing years during that time. This beat the overall market by 2.4 percentage points per year, but with much less volatility than the market in general.
What’s more, its performance has exceeded the returns of investment-grade bonds by 6 percentage points per year.
So it is not surprising that in a year when most hedge funds are struggling to keep up with the Standard & Poor’s 500 index’s 4 percent return, Elliott has more than doubled the benchmark.
In the third quarter, its flagship Elliott Associates domestic hedge fund and Elliott International posted gains of 3.1 percent and 2.9 percent, respectively. As a result, the domestic partnership is up 8.4 percent for the year.
Performance in the third quarter was driven by distressed securities, performing debt, event arbitrage, commodities trading, and portfolio protection trades related to interest rates, according to its third quarter letter to clients, obtained by Alpha. On the other hand, it lost money on equity-oriented trades and portfolio protection trades related to equities and credit.
Elliott spends a considerable amount of space in the client letter worrying about growing debt levels throughout the world, both on the individual level and corporate level. This could exert enormous pressure on bond prices, the firm contends, given that interest rates are at their lowest levels in history.
“Any retracement of bond prices will do far more damage to portfolios than one would expect,” Elliott states. “Any fall in bond prices will put every major central bank under water. It is not clear what that means in a world in which every developed-country central bank feels empowered to print money without limit, but it certainly suggests that the losses would represent additional debt on top of the already-gigantic levels of governmental debt and promises.”
Even as it is concerned about the prospect of rising inflation, Elliott stresses it won’t make “a significant bet” on the timing of inflation or a bond or stock market collapse. “However, we will do whatever it takes at all times to be really diversified, as hedged as possible and highly risk-conscious,” the firm’s letter states.
Otherwise, Elliott tells clients its mix of activities is providing “a steady stream — if not a flood — of interesting new opportunities.”
The firm seems intrigued about potential distressed credit opportunities in the energy patch. “While the ‘crash’ phase of the American energy industry bust happened months ago, and the prices of oil and gas have recovered significantly from the lows, the financial condition of many oil, gas and shipping companies continues to deteriorate, and fresh bankruptcies are occurring,” it explains. But Elliott does offer this caveat: “It is hard to tell whether any larger and more diverse pool of distressed securities will become available in the next few months.”
At the same time, the hedge fund firm says it is continuing to cut back on its real estate book, asserting, “for this cycle we are probably past the peak of capital deployment in that sector.”
“The current trading environment — while extraordinary — does not present unusual new risks to attaining the goals Elliott was founded to try to achieve,” the firm states in its client letter, stressing its goal is to limit losses to “manageable amounts” if there were a severe downturn in stock and/or bond prices.
