Investor Essentials Daily

This hedge fund could not have asked for a better time to expand

September 22, 2023

Macro hedge funds look for opportunities to profit from significant political or economic trends. Bets are then made based on the movement or development of these large events.

As we discussed a few years ago, Brevan Howard is among these hedge funds that has garnered a reputation as one of the smartest macro investing shops.

Last time, we mentioned how the fund may have mistimed the opportunity to capitalize on market volatility through credit default spreads. However, recent signals suggest the current market environment may be favorable for their credit strategy.

On a different front, the fund has also expressed interest in a presence in the United Arab Emirates.

The UAE’s reputation has transitioned to an industry powerhouse cemented by the region’s wealthy investors and the allure of low taxes. Thus, there has been an increase in the number of top hedge funds establishing offices there.

Brevan Howard is among the bunch.

That said, let’s analyze these recent developments and see if Brevan Howard is positioned to take advantage of its new geographical exposure and credit market favorability.

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In the aftermath of the pandemic, Dubai authorities have significantly pushed its effort to become the central hub for the hedge fund industry. So far they’ve been very successful.

Forty funds have been registered as of July 2023 in the Dubai region. Of those, one-third have arrived within the last twelve months.

Its absence of personal income taxes is an eminent driver for talent amidst the escalating search for portfolio managers, who are beginning to record millions in bonuses.

In terms of industry appeal, the sovereign wealth funds of Saudi Arabia and the United Arab Emirates (“UAE”) are rapidly expanding thus acting as an important source of capital for hedge funds.

Dubai is not the only area benefiting from the hedge fund rush in the nation, macro fund Brevan Howard announced that they will be opening an office in Abu Dhabi.

To establish their presence, the firm’s co-founder Trifon Natsis and COO Ryan Taylor have both moved to the city. Additionally, the fund anticipates hiring 100 employees over the next twelve months.

Evidently, the fund is rushing to establish itself in hopes of grabbing a share of the massive developing sovereign wealth funds the UAE prides itself on.

This move could not be more calculated.

Brevan Howard rarely invests in equities, in fact, its top two holdings are bond-related ETFs.

The firm’s focus is on interest rate swaps, currencies, commodities, and other assets. It focuses on taking advantage of broad macro trends.

While Brevan Howard’s internal procedures aren’t entirely obvious, the fact is the fund devotes a noteworthy amount of time to credit markets. Credit market cycles are what drive the economy as a whole, and one of the core drivers of Valens’ Market Phase Cycle™.

We can better understand the credit cycle by taking a look at the corporates’ cost to borrow. The chart below shows how the credit cycle moved in the last decade.

The chart has two key components: the risk premium a company pays on aggregate and the risk-free rate.

The risk premium is based on the stated risk of default of a company, which is usually expressed by credit default swap (“CDS”) spreads.

On the other hand, the risk-free rate refers to the interest rate at which an investment can be made with no risk of financial loss, and 10-year US Treasury yields are typically used as a proxy for this rate.

As the chart shows, the Fed significantly reduced the risk-free interest rate in 2020 to help reduce the negative impact of COVID-19 and took aggressive actions to provide liquidity to the market.

This significantly reduced the base for the corporate cost to borrow through much of 2020 and 2021. Thus led to a low volatility in the credit markets, which wasn’t beneficial for Brevan Howard at all.

Take a look…

The chart also shows that since the Fed started to aggressively raise rates last year to combat inflation, credit spreads reached their highest levels in the last decade in all different categories of credit risk.

These high levels of credit spreads suggest that the market is in a volatile state. Brevan Howard benefits from these mass fluctuations, even more favorable when considering its expertise in credit markets.

So, while the fund may have missed its chance back then, the past two years provided the ideal environment for its success.

With that said, Brevan Howard’s expansion to the UAE is much more thought out than meets the eye. The fund is trying to grow aggressively as the market environment is currently in its favor.

Its strategy to improve the capital base by getting closer to sovereign wealth funds would allow it to capitalize on the current credit market conditions on a much larger scale.

Conditions may change in the future, but the fact of the matter is that Brevan Howard is in a good position to do what it does best.

It’s important that investors continue to watch our Market Phase Cycle to see if things begin to signal change. But as it stands, there doesn’t seem to be much concern for the fund.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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