Wednesday, 16 December 2009
Side pockets - The new Investment Opportunity
Every night has a day lying ahead. Similarly, every financial crisis leads to the huge investment opportunities. Sometimes it is done by the development of new financial instruments. Side pockets is one such form of investment that has, of late, been used by the Hedge Funds and large financial institutions.
Let’s say a hedge fund had some investments that were not yielding good returns, courtesy the financial crisis. The company that were otherwise fundamentally sound, but had become victims of the financial crisis had almost become dead investments. As a risk averse investor, you were not interested in such investments and thus found no incentive to invest in the hedge fund. On the other hand, the hedge fund manager knew that the investment was good, but was only a matter of time and didn’t want to sell off the investment to book huge losses.
How does the hedge fund attract investors then? Assuming it has enough cash (or liquidity) to invest in new investments it would set aside these dead investments in a separate class as designated investments of the fund and would classify them as illiquid (for practical purposes, Long term) investments.
Since these investments have been removed from the normal class of the fund, this does not affect you as you won’t invest in dead investments and would have fresh investments for the fund.
But what does it do with these dead investments then. Say I am an risk aggressive investor and share the same view that these investments would give high returns in the future. I would then invest in these investments (which are classified in a separate class) and look forward for high returns in the long term. These are called Side Pockets.
Once designated, distinct valuation, allocation, withdrawal and distribution provisions are applied to such designated investments without affecting the general portfolio of the fund (and its applicable terms)
Since the markets have started recovering, Hedge Funds have started reporting huge unrealized gains on these side pockets and the risk aggressive investors (in our example, me) are getting better fund returns. Obviously, since these were a separate class, the risk averse investors (you) are not sharing these unrealized gains with me.
Side pocket provisions typically permit a fund manager to create a side pocket, if the fund manager feels it to be in the best interests of the fund and its investors. Generally, only investors that are investors at the time the side pocket is created are allocated a participating interest in such investments. Accordingly, investors that become investors after a side pocket is created will have no interest in such designated investment.
Monday, 14 December 2009
Carbon markets, invest for the short term only
The influence of the current environmental lobby ensures that there will be a thriving short term market for carbon avoidance and carbon fixation schemes as well as markets related to carbon trading. However, I am increasingly convinced, having read a lot of the science on all sides of the debate, that the quality of climate models is low in that they ignore major components such as the impact on cloud formation of cosmic rays. By contrast, evidence from research centres such as CERN, in which I have much higher confidence, especially Jasper Kirby, suggests that this may be able to account for the bulk of the warming we have seen so far, backed up by analysis of good proxy data going back millions of years (I am familiar myself with some of this data).
If you want to read Jasper's paper it is at: http://arxiv.org/PS_cache/arxiv/pdf/0804/0804.1938v1.pdf or you can watch him present similar material at http://cdsweb.cern.ch/record/1181073. He isn't the only scientist saying this sort of thing, but he is pretty convincing, for me anyway, and when you put it all together, it makes a lot of sense.
Although CO2 may well also still be shown to be a significant contributor, I believe that we will find that current climate science bodies such as the IPCC have over-stated its importance in dealing with climate. The Cloud experiments at CERN (along with their collaborators at a number of other prestige labs) will investigate the cosmic radiation related mechanisms for cloud formation and will produce results over the next two or three years. Based on what I consider to be well-informed hypotheses by Kirby et al, I expect him to be shown to be correct. By contrast, recent evidence indicates that some of the most influential temperature records appear to be corrupted, data and models tweaked to fit hypotheses rather than the reverse, and worse still, group-think seems to have severely polluted the quality of application of the scientific method in large parts of the field. So while I have little confidence in the IPCC and some other climate bodies, I still have great confidence in the quality of basic science at a large number of sites, and CERN probably comes at the top of my list in that regard.
In my view therefore, it is highly likely that over the next few years, results from CERN will show that most of the climate change being experienced can be explained by variation in solar activity. Science will win out and most scientists will change their positions to adapt to this new knowledge - that is the nature of science when it is at its best - theories are changed to fit the data, not the other way around.
Even though limiting ocean acidification will also require management of CO2, the public understanding and support for carbon taxes is based on its impacts on climate. Consequently, it will be very difficult then to persuade people to back another reasoning base for the same taxes and governments will be accused not unreasonably of crying wolf. Due to decline in support, they will be very reluctant then to pour any more funding into schemes for carbon trading or fixation, and large corporations will also largely abandon their support for carbon markets and taxes.
Although it may take some time for schemes such as carbon trading to be dismantled, long-term valuations for any companies involved in CO2 reduction will fall very quickly once the science changes. Many green companies will go bust. Problems such as ocean acidification will be considered a lesser problem, solved on the fly by slow changes in carbon output that will happen in any case via technological change in energy and transport sectors.
The good news is that as the sun returns to 'normal', so will our climate and not for the first time, doom mongers will be shown to be wrong. The money we have already spent in green energy will not all be wasted, it will have accelerated development of cheap solar and wind power that will still have a market, (although subsidies will no longer be justified and will stop as contracts terminate).
Related to this, the CLOUD team is looking at a number of factors in cloud formation. The list is long but includes particulates and other aerosols, aircraft contrails, and various gases. They will investigate a range of atmospheric altitudes and temperatures and vary the kinds of radiation. I am confident we will know a great deal more about how our environment works as a result, and once the physics is understood, it can be factored properly into climate models, which will of course benefit from parallel development in many other branches of science. Since the 'climategate' affair, we can be reasonably assured that scientists will be more careful to do their work properly.
Summarising: strong short term market in carbon reduction and fixation technology due to what is likely to be shown as misunderstanding of climate science, but many companies in the carbon reduction sector will die in a few years when better science shows that CO2 is not the main problem. If you must buy now, get ready to sell quickly. The carbon band-wagon might well crash any time between the end of 2010 and 2012.
If you want to read Jasper's paper it is at: http://arxiv.org/PS_cache/arxiv/pdf/0804/0804.1938v1.pdf or you can watch him present similar material at http://cdsweb.cern.ch/record/1181073. He isn't the only scientist saying this sort of thing, but he is pretty convincing, for me anyway, and when you put it all together, it makes a lot of sense.
Although CO2 may well also still be shown to be a significant contributor, I believe that we will find that current climate science bodies such as the IPCC have over-stated its importance in dealing with climate. The Cloud experiments at CERN (along with their collaborators at a number of other prestige labs) will investigate the cosmic radiation related mechanisms for cloud formation and will produce results over the next two or three years. Based on what I consider to be well-informed hypotheses by Kirby et al, I expect him to be shown to be correct. By contrast, recent evidence indicates that some of the most influential temperature records appear to be corrupted, data and models tweaked to fit hypotheses rather than the reverse, and worse still, group-think seems to have severely polluted the quality of application of the scientific method in large parts of the field. So while I have little confidence in the IPCC and some other climate bodies, I still have great confidence in the quality of basic science at a large number of sites, and CERN probably comes at the top of my list in that regard.
In my view therefore, it is highly likely that over the next few years, results from CERN will show that most of the climate change being experienced can be explained by variation in solar activity. Science will win out and most scientists will change their positions to adapt to this new knowledge - that is the nature of science when it is at its best - theories are changed to fit the data, not the other way around.
Even though limiting ocean acidification will also require management of CO2, the public understanding and support for carbon taxes is based on its impacts on climate. Consequently, it will be very difficult then to persuade people to back another reasoning base for the same taxes and governments will be accused not unreasonably of crying wolf. Due to decline in support, they will be very reluctant then to pour any more funding into schemes for carbon trading or fixation, and large corporations will also largely abandon their support for carbon markets and taxes.
Although it may take some time for schemes such as carbon trading to be dismantled, long-term valuations for any companies involved in CO2 reduction will fall very quickly once the science changes. Many green companies will go bust. Problems such as ocean acidification will be considered a lesser problem, solved on the fly by slow changes in carbon output that will happen in any case via technological change in energy and transport sectors.
The good news is that as the sun returns to 'normal', so will our climate and not for the first time, doom mongers will be shown to be wrong. The money we have already spent in green energy will not all be wasted, it will have accelerated development of cheap solar and wind power that will still have a market, (although subsidies will no longer be justified and will stop as contracts terminate).
Related to this, the CLOUD team is looking at a number of factors in cloud formation. The list is long but includes particulates and other aerosols, aircraft contrails, and various gases. They will investigate a range of atmospheric altitudes and temperatures and vary the kinds of radiation. I am confident we will know a great deal more about how our environment works as a result, and once the physics is understood, it can be factored properly into climate models, which will of course benefit from parallel development in many other branches of science. Since the 'climategate' affair, we can be reasonably assured that scientists will be more careful to do their work properly.
Summarising: strong short term market in carbon reduction and fixation technology due to what is likely to be shown as misunderstanding of climate science, but many companies in the carbon reduction sector will die in a few years when better science shows that CO2 is not the main problem. If you must buy now, get ready to sell quickly. The carbon band-wagon might well crash any time between the end of 2010 and 2012.
Thursday, 3 December 2009
Carbon trading v R&D investment
Carbon trading won't save our environment. As Dr James Hansen (one of the world's leading climate scientists) says http://www.timesonline.co.uk/tol/news/environment/article6941974.ece, it would be better that the Copenhagen conference fails than that a carbon trading scheme be locked in as the solution to climate change. Carbon trading has already been shown to be deeply flawed. It has encouraged fraud, especially in the offset area, with payments for schemes that would have happened anyway, phantom forests, multiple sales of the same trees, and poor monitoring or maintenance of planting schemes. It has also enriched the more imaginative criminal fraternity via intricate tax avoidance scams. Even on the legitimate market, it has perversely incentivised the destruction of forests and peat bogs since countries that weren't covered by Kyoto restictions could still sell carbon offsets and biofuels, so cleared forests and bogs to allow them to capitalise on planting new trees and plantations. And as Hansen says, it is really little different from the Catholic Church's indulgence scheme, where forgiveness for sins was sold for cash.
Carbon trading obviously needs a profit motive to work at all, and to do so it also needs a lot of administration. Yet there is little evidence that it significantly reduces CO2 production. This money could instead be spent on either improving climate science, filling in the remaining gaps, or accelerating the production of cheaper alternative energy sources, such as solar.
Wind power uses a fundamentally mechanical system, which limits the potential cost reductions. Solar uses either indirect production using sunlight concentration via mirrors or direct electricity production using photovoltaics. Solar power using photovoltaics offers a lot more potential for cost reduction and conversion efficiency improvement. It is already clear that in sunny areas, solar power will become cheaper than using energy from the grid (grid parity) by 2015. That will enable those regions to greatly reduce their fossil fuel use. Other areas that are less sunny will eventually be able to import energy from sunnier areas as technologies such as supercables develop. Europe could get much of its energy from the Sahara desert for example.
In parallel, development of electric vehicles and electronic driving technology will allow much greener transport solutions.
These areas will now develop anyway, there is already enough momentum in their markets to guarantee that. I certainly wouldn't argue for any subsidies on the products, which would disincentivise improvements. But increasing research funding would accelerate their development. That would be a much better use of the money that will be wasted in futile carbon trading schemes.
If Copenhagen results in governments agreeing targets and using carbon trading schemes as their mechanism for achieving them, the environment will suffer, because CO2 emissions will not be reduced sufficiently. Economies and quality of life will suffer due to extra costs, without significant benefits. People will become opposed to environmental taxes and it will be harder to solve the problem by more effective means later. We will be locking in a solution that won't work at the expense of ones that might. I fully agree with Hansen. If the climate scientists are right and CO2 is the problem they tell us it is, carbon trading will not solve it, and because this is being pushed as the main measure for solving CO2 emissions instead of incentivising R&D on alternative energy sources, Copenhagen will fail.
Carbon trading obviously needs a profit motive to work at all, and to do so it also needs a lot of administration. Yet there is little evidence that it significantly reduces CO2 production. This money could instead be spent on either improving climate science, filling in the remaining gaps, or accelerating the production of cheaper alternative energy sources, such as solar.
Wind power uses a fundamentally mechanical system, which limits the potential cost reductions. Solar uses either indirect production using sunlight concentration via mirrors or direct electricity production using photovoltaics. Solar power using photovoltaics offers a lot more potential for cost reduction and conversion efficiency improvement. It is already clear that in sunny areas, solar power will become cheaper than using energy from the grid (grid parity) by 2015. That will enable those regions to greatly reduce their fossil fuel use. Other areas that are less sunny will eventually be able to import energy from sunnier areas as technologies such as supercables develop. Europe could get much of its energy from the Sahara desert for example.
In parallel, development of electric vehicles and electronic driving technology will allow much greener transport solutions.
These areas will now develop anyway, there is already enough momentum in their markets to guarantee that. I certainly wouldn't argue for any subsidies on the products, which would disincentivise improvements. But increasing research funding would accelerate their development. That would be a much better use of the money that will be wasted in futile carbon trading schemes.
If Copenhagen results in governments agreeing targets and using carbon trading schemes as their mechanism for achieving them, the environment will suffer, because CO2 emissions will not be reduced sufficiently. Economies and quality of life will suffer due to extra costs, without significant benefits. People will become opposed to environmental taxes and it will be harder to solve the problem by more effective means later. We will be locking in a solution that won't work at the expense of ones that might. I fully agree with Hansen. If the climate scientists are right and CO2 is the problem they tell us it is, carbon trading will not solve it, and because this is being pushed as the main measure for solving CO2 emissions instead of incentivising R&D on alternative energy sources, Copenhagen will fail.
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