Hedge funds initially suffered on counterparty concerns as a result of the Lehman Bros failure but funds had moved swiftly to limit their exposure and consequently damage was very limited. Concerns over regulatory changes followed, in particular those designed to curb short selling. Again the impact on the asset values was slight. However this is only half the story.Much of our structured product exposure is through defensive autocalls with good long term downside protection, however the widening of credit spreads due to concerns over the financial stability of the banks has impacted prices as has the increase in volatility which reached levels higher even than the Great Depression.Again we see outstanding value.ZDPs have behaved as expected given widening credit spreads and reduced asset cover. Most investments have held up well and are trading at, or around, the levels of a few weeks ago. Gross redemption yields have risen and cover has fallen but in most cases zeros remain covered. The falls in interest rates, which we view as inevitable, combined with a narrowing of credit spreads would produce useful returns from our investments.The recurring theme is uncertainty. Worries over further banking collapses, widening credit spreads, hedge fund exposure and leverage are all worsened by the prevailing clouds. As these clear we expect to make good money and unlike equity investors, this expectation is not built on an equity market recovery, merely some stability. This would allow pulls to redemption, defensive autocall kick outs, falling interest rates, and hopefully narrowing credit spreads to do the trick.
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