Privileged Investors - BNP Paribas Investment Partners

Privileged Investors
Investment Manager’s Report
Market Review
Although only six months ago, the first half of 2008 seems like a lifetime ago. With so many major events occurring
during the last six months of 2008, perspectives and perceptions over the last year have changed massively. The first six
months saw many interesting developments that were leading indicators on what was to come. We saw continued
volatility in equity and credit indices around the world, from spikes first witnessed in the second half of 2007. The
Federal Reserve Open Market Committee started the year by cutting U.S. interest rates aggressively in an attempt to
pump liquidity back into the system. However, this wasn’t enough to dampen fears of recession, and volatility remained
dominant. The discovery of a rogue trader at Société Générale and the huge potential losses this could mean for the
bank was the first major incident followed very closely by the collapse of Bear Stearns and JP Morgan’s subsequent
Fed-induced purchase. As a result financial stocks were hit hard. Credit spreads displayed high levels of volatility,
widening rapidly through March, contracting in April and May, and jumping back out again in June. Weak economic
data from the U.S. and Europe in June meant that any rally in equities was relatively short-lived and lead to heightened
volatility again. Currency markets displayed less volatility, the yen fell against the dollar initially, but then appreciated
on speculation of the potential need to raise rates later in the year. The pound remained unchanged against the dollar as
the euro gained significantly after the Fed’s aggressive rate-cutting. There was plenty of speculation in commodity
markets and gold continued its strong run on the back of concerns with the global economy and the dollar’s weakness.
Oil and natural gas also continued to rise sharply over fears of lack of supply.
The second half of 2008 seemed to be a turning point. Looking back, there were many warning signs of the problems
which lay ahead and the subsequent large scale deleveraging which was to follow. The foundations for this
deleveraging were laid in 2007 when we first encountered the sub-prime debacle in the U.S.. July saw growing concerns
over the state of U.S. mortgage lenders Fannie Mae and Freddie Mac, and it was also the turning point for commodity
prices. Oil had nearly hit $150 a barrel but with signs of an impending global recession the upward trend of the previous
18 months started to reverse. By the end of the year the price of a barrel of oil had fallen over $100 to around the $40
mark. The collapse of Bear Stearns earlier in the year and growing fear that banks’ exposures to sub-prime would lead
to large write-downs, led to the financial sector being heavily punished. This culminated in the collapse of Lehman
Brothers. The absence of a government rescue package meant the fallout from this was on a scale that most had never
witnessed. Suddenly many financial institutions were on the brink of collapse as widespread panic selling set in. As a
result regulators around the world introduced new rules regarding a ban on the short selling of certain types of stocks,
namely financials. Hedge funds were blamed for this phenomenon but as events unfolded and many banks continued to
suffer after the imposition of these new regulations, it became clear the hedge fund industry was being used as a
scapegoat. This turmoil has subsequently led to high levels of consolidation, Fortis has not been immune to this and at
the time of writing the BNP Paribas deal is still pending. The latter part of the year saw continued deleveraging in the
financial system, and although equity markets stabilised towards the very end of the year, credit markets continued to
suffer as credit spreads widened to historic levels. Concerns, which were initially limited to the equity and credit
markets started to spread to the broader economy as a series of data releases painted a decidedly negative picture. The
hope was the emerging world would decouple from the developed world and help provide some level of support
through a period of recession. As things stand it looks as if the emerging world is also falling into recession which could
mean the impact is felt for longer and is more severe for those countries involved. One of the by-products of this has
been central banks’ moves to counter the effect of slowing economies by aggressively cutting interest rates. The Federal
Reserve cut rates from over 4% to between 0% and 0.25% at the end of December, similar moves were made by the
Bank of England, where the interest rate stands at 2%, and the European Central Bank which is at 2.5%. All this has
resulted in large moves in the currency markets with the U.S. dollar strengthening, especially against the pound which
ended the year at $1.46 having started the year at around $1.98.
Cadogan Market Neutral Fund
Portfolio Review
Performance at the beginning of 2008 was an indication of what was in store later on in the year. Continuing volatility
in the global market place was reflected in the performance of the fund through the first quarter. Returns were mostly
negative but there was a fairly high level of dispersion from month to month. The Bear Sterns debacle in March had
knock-on effects on performance as investors were forced to deleverage as liquidity dried up. One fixed income fund
lost 35% of its value through March as a result of unprecedented moves in the Japanese fixed income markets. Credit
funds underperformed over the quarter as credit markets continued to experience difficulties. The one beacon of light
was the global macro strategy which was able to identify macro trends in the uncertain environment. Although the
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