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Broadgate: Market News 8/8

8 August 2012

Stocks rose for a third straight day on Tuesday, pushing the S&P above 1,400 for the first time since early May, on growing optimism the European Central Bank would act soon to contain the euro zone’s debt crisis.

Trading was light, which could distort the level of optimism investors truly have that Europe will follow through with adequate measures. ECB President Mario Draghi boosted hopes last week when he spoke of restoring calm to the euro zone’s troubled bond markets.

Since then, good news from Greece and declines in borrowing costs for Spain and Italy from peaks above 7 percent have kept sentiment positive. The relative calm allowed the S&P to break through the psychologically important 1,400 level after trying unsuccessfully the past couple of sessions.

“If the ECB expands its balance sheet, it will keep pushing these bond yields lower, which can help these countries finance their debt, giving markets a bit of reprieve,” said Joseph Tanious, global market strategist at J.P. Morgan Funds in New York. “It’s likely we won’t get anything official for a few weeks, and until then investors are likely to be skittish.”

Summer holidays have added to light trading volume, which has contributed to volatility. Equities cut their gains just before the close on Tuesday, mirroring Monday’s late-day action.

About 6.39 billion shares traded on the New York Stock Exchange, the American Stock Exchange and Nasdaq, below last year’s daily average of 7.84 billion.

The real tests for markets may come in September. The ECB is expected to face decisions about controlling the euro zone debt crisis and the Federal Reserve could take stimulus actions to aid the flagging U.S. economic recovery.

The Dow Jones industrial average rose 51.09 points, or 0.39 percent, at 13,168.60. The Standard & Poor’s 500 Index was up 7.12 points, or 0.51 percent, at 1,401.35. The Nasdaq Composite Index was up 25.95 points, or 0.87 percent, at 3,015.86.

Despite worries over the economies of Europe and the United States, investors have pushed the S&P 500 up more than 11 percent so far this year. Yield-hungry investors have kept buying stocks as U.S. and German government bond prices soar and yields hit historic lows.

Tuesday’s advance was led by stocks in cyclical sectors like energy, materials and consumer discretionary, while defensive sectors like telecoms and utilities edged lower.

Energy stocks rose 1.3 percent, helped by Chesapeake Energy, which jumped after it said it would sell some assets and spend less on new properties. The stock surged 9.4 percent to $19.37 and was one of the top percentage gainers in the S&P 500.

Banking shares rose 0.5 percent, lifted by Morgan Stanley, which was up 2.5 percent at $14.50.

“Despite what seems like a weekly scandal of some sort, the banks have posted incredibly large profits. The Fed has made it very easy for them to take on very little risk and make very large profits,” said Randy Frederick, managing director of active trading and derivatives for Charles Schwab in Austin, Texas.

Watch and fashion accessory maker Fossil Inc soared 32 percent to $91.77 after it forecast growth in Asia and Europe.

With 82 percent of S&P companies having reported quarterly results, 68 percent have beaten profit expectations, according to Thomson Reuters data.

Pfizer and Johnson & Johnson scrapped further studies of an experimental drug for Alzheimer’s disease after the drug failed in a second trial. U.S.-traded shares of their partner, Elan Corp, dropped 0.9 percent to $11.15. Pfizer fell 2.1 percent to $23.74 and J&J edged 0.8 percent lower to $68.29.

A group of investors rescued Knight Capital Group in a $400 million deal that kept the market maker in business, but existing shareholders were nearly wiped out. Knight closed 0.3 percent lower at $3.06, erasing gains of more than 3 percent from earlier in the session.

About 62 percent of stocks on the New York Stock Exchange closed higher while 61 percent of Nasdaq-listed stocks finished up.

Emboldened by their success in bringing down boardroom pay in Europe and the United States, pension funds and other institutional investors are now attacking the fees charged by the once-booming private equity industry.

Private equity firms, which aim to buy and sell companies for vast profits, rode the crest of a cheap credit wave in the middle of the last decade, charging fees that make lavish banker bonuses pale by comparison.

But the biggest buyout funds raised in 2006 have so far yielded just under 3 percent each a year, data shows, well below returns of at least 20 percent which the dealmakers had persuaded investors they were able to deliver.

“A lot of investors are upset about the historic returns from their funds and attacking fees is one of the ways they are gaining retribution,” said one private equity executive at a leading firm, who asked not to be named.

Some big investors led the revolts over management pay at shareholder meetings this year at a wide range of companies, including Citi, UBS, Barclays, Air France-KLM, advertising group WPP and British insurer Aviva.

Meanwhile private equity pay and the low taxation rates on the partners’ bonuses have come under the political spotlight as a result of Bain Capital co-founder Mitt Romney’s bid to become the next president of the United States.

And institutional investors are piling on the pressure, with high fees now a reason for not investing with a private equity firm, said 87 percent of investors surveyed by publishing and data group PEI International.

DISCOUNTS

Investors have already begun chipping away at the once standard 2 percent annual management fee which they paid on the capital they give to private equity firms to invest over the duration of a 10-year fund, regardless of performance.

“To us the shoe really starts to hurt at 1.5 percent and we are looking to pay less than that,” said Katja Solvaara, a portfolio manager at Finnish pension advisory group Ilmarinen.

The biggest investors, with hundreds of millions or even billions to spend, often get a discount on the 2 percent fee, and the average annual fee is in reality already closer to 1.5 percent, private equity investors and the firms themselves say.

That is also the maximum level that 69 percent of investors think private equity managers should be charging for their management fee, according to PEI International research.

Private equity dealmakers are paid far better than their deal-making peers at investment banks, because of the “2 and 20” fee structure that the industry shares with hedge funds, and that guarantees income regardless of performance.

A hypothetical 5 billion-euro ($6.15 billion) fund with 20 partners who double investors’ money will have about 1 billion euros to share – or $50 million each – because of a 20 percent cut of the profits.

Should they miss the target, a 1.5 percent management fee means the dealmakers still get 75 million euros a year for costs and salaries.

TIME TO TALK

In comparison, a senior banker can expect to earn a fixed salary of 350,000 pounds ($546,000), which the best can supercharge through bonuses. For example some 238 senior Barclays staff earned about 1.5 million pounds each on average in 2011.

Having burned through the billions raised before the credit crisis many private equity firms that raise new funds every four or five years are back in the market asking for more money and finding more than ever that investors want to discuss fees.

“Since the financial crisis, it’s one of those rare windows that come along. There’s an opportunity for the pension funds, insurers and others that provide wholesale capital into private equity to sit down and look at these mechanisms,” said Alan Mackay, chief executive of private equity fund manager Hermes GPE.

There are also some signs that private equity houses are yielding to such ideas.

James Coulter, the co-founder of U.S. private equity group TPG, surprised many when he said that more than half the group’s investors thought the biggest of them should get a discount of 20 percent on the management fee, which could take a 1.5 percent charge down to 1.2 percent.

And Bain Capital – with which Romney now no longer has any involvement – is offering a range of fee options, including a higher performance fee of up to 30 percent in return for lower management fees.

“That would be preferable because it really shows that they believe that they can produce the top quartile returns and it’s not a management fee game,” said Klaus Ruhne, partner at Danish investor ATP Private Equity Partners.

Investors have already won a victory on the range of additional fees that sprung up unchallenged in the boom years of the last decade, when deals for food groups to drugs makers ran into the tens of billions of dollars.

They won concessions on deal fees charged to companies for being bought, on exit fees charged to list or sell companies and on monitoring fees for private equity executives to sit as directors on boards.

Those now flow back to investors, otherwise known as limited partners (LPs), rather than lining the dealmaker’s pockets.

“It is quite extraordinary that there has been so little dispersion between types of fees and fee structures. That can only go one way — there will be different models over time,” said Ilmarinen’s Solvaara.

Commodities

Brent crude dipped on Wednesday, coming off a 12-week top hit in the previous session, although worries about falling North Sea output and hopes for more stimulus measures from both sides of the Atlantic kept prices above $111 per barrel.

Brent crude fell 40 cents to $111.60 by 12.04 a.m. EDTafter touching a 12-week intraday high on Tuesday in its third straight day of gains.

U.S. crude was at $93.30, down 37 cents. It settled at its highest since May 15 in the prior session, partly supported by a fire at a U.S. refinery.

Gold was little changed on Wednesday, after advancing for three straight days on hopes that central banks in Europe and the United States will launch more stimulus measures to help shore up their faltering economies.

Spot gold was little changed at $1,610.31 per ounce by 0316 GMT, after rising more than 1 percent over the past three sessions.

The U.S. gold futures contract for December delivery also traded nearly flat at $1,613.10.

Shorter-term technical analysis suggested that spot gold could fall to $1,591 per ounce during the day, said Reuters market analyst Wang Tao.

Currencies

The euro held steady against the dollar on Wednesday, supported by persistent hopes for further action by the European Central Bank to lower the borrowing costs of Spain and Italy.

The euro held steady from late U.S. trade on Tuesday at $1.2395, not too far from a one-month high of $1.2444 hit on Monday on trading platform EBS.

The dollar slipped 0.1 percent versus the yen to 78.52 yen, but hovered near the top of a range between 78.80-77.90 that has largely held for past two weeks.

The Australian dollar dipped 0.1 percent to $1.0549, having hit a four-month high of $1.0604 on Tuesday.

Against the yen, the Aussie dollar eased 0.2 percent to 82.80 yen, but still remained near a three-month high around 83.22 yen hit on Tuesday.

Sterling held steady at $1.5615, its moves limited ahead of the Bank of England’s quarterly inflation report due later on Wednesday.

Source:  Reuters.com

The information set out herein has been obtained from various public sources and is by way of information only. Broadgate Financial can accept no liability of any sort in relation thereto and readers should obtain their own verification of any statement before making any decision which may have any financial or other impact.

Neither the information nor the opinions herein constitute, or are they to be construed as, an offer or a solicitation of an offer to buy or sell investments.

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