Australia's financial services regulator, ASIC, has extended the ban on covered short sales of financial stocks until March 6th, 2009. The ban, which was due to be lifted on 27th January, was extended due to renewed volatility in financial stocks in the US and Europe.

ASIC's decision will no doubt please some, and disappoint others, including those investors who have sold stock ahead of the expected lifting of the ban and in anticipation of further price weakness. However, the renewed volatility in bank and financial stock prices overseas has probably had more to do with additional and continuing bad news in the sector than the resumption of short selling.

In their statement released on 21 January, ASIC said:

'ASIC today said it would keep the ban on covered short selling of financial securities in place until Friday, 6 March 2009.

ASIC advised the market on 13 November 2008 that the current ban on covered short selling of financial securities (as defined in ASIC’s release of 13 November 2008) would remain in place until at least 27 January 2009.

This approach was consistent with many other jurisdictions, including the UK, where the Financial Services Authority (FSA) planned to lift its short selling ban on certain financial securities on 16 January 2009.

The FSA lifted its ban on 16 January 2009 and ASIC expected to then lift its ban, so as to be in line with the other major markets.

ASIC, however, noted the recent increase in volatility in financial stocks in overseas markets. ASIC is not at this stage in a position to assess if the resumption of short selling in the UK was coincidental or contributed to this volatility and if so, to what extent.

As many factors are at play in these overseas markets, ASIC needs time to examine these latest developments. ASIC will therefore, over the next few weeks, assess the markets more carefully to determine the role of short selling and aggressive or predatory practices and whether there are similar risks for Australia when the ban is lifted.

ASIC believes that in the context of the renewed volatility affecting banking stocks in many markets, including the UK and USA, this cautious approach is warranted. ASIC believes that any possible loss of market efficiency or price discovery as a result of this additional short period of review is therefore justified.

ASIC’s decision to extend the ban on covered short selling of financial securities is also in the context of a legislative framework that recognises short selling as a legitimate mechanism of price discovery and liquidity, subject to disclosure and subject to intervention by ASIC in exceptional cases.

ASIC’s intention is and remains to keep its intervention to an absolute minimum. ASIC will continue its consultations with relevant stakeholders and other regulators in Australia and overseas.

ASIC will keep the position under review, and might decide it has sufficient information to be able to lift the ban earlier than 6 March, and will make a decision for 6 March closer to that date.'

Australia's Sydney Morning Herald (SMH) has reported that the Westpac controlled BT Investment Management wrote to investors before Christmas advising they were freezing redemptions on its $1.2bn Global Return Fund.

The SMH article cites BT believing that "unstable market conditions ... assets cannot be realised at prices that would be obtained in a stable market."

Management of the Global Return Fund was apparently outsourced to Grosvenor Capital Management in Chicago who are claimed to manage US$23bn. Grosvenor had taken action to segregate a portion of the less liquid assets.... and as a result are not currently available to meet redemptions in the fund. However, Grosvenor itself has not suspended redemptions from its own master fund.

Australian based Fund of Funds HFA Asset Management has suspended redemptions from a number of its underlying funds including the HFA Diversified Investment Fund, and the HFA Octane and Octane Series 2 Fund, effective December 22nd.

Citing deteriorating liquidity in the underlying funds in which it invests, HFA also announced limited liquidity in their US based Lighthouse Diversified Fund, by establishing a special purpose vehicle (commonly referred to as a "side pocket") to hold and isolate the redemptions in illiquid investments until such time as they are liquidated.

HFA are not the first, and are unlikely to be the last Fund of Funds to halt or limit redemptions due to lack of liquidity in underlying funds. In October Everest Babcock and Brown announced that it would freeze redemptions in their Income Fund, and earlier this month Macquarie announced a halt to redemptions in their Equinox Series of funds. Prior to this there were wide ranging redemption freezes in many Australian based mortgage funds.

To date single manager Australian Funds have avoided freezing redemptions in spite of being subjected to significant and widespread redemptions from investors, particularly Fund of Funds, who in turn have been subjected to a wave of redemptions from their own investors. However, the redemptions to date are having a domino effect as investors redeem from otherwise well performing funds due to the lack of liquidity in others. The liquidity issues are also primarily based on the larger overseas managers, although the flow on effect has certainly reached Australian funds and their investors.

With the S&P500 and the ASX both down around 7%, and energy and commodities in disarray, it seems strange to be saying that November saw some improvement and signs of stability. With 70% of funds reporting to date, the average November return of Absolute Return funds in AFM’s database was minus 2.81%.

The debate in the media continues as to whether Absolute Return Funds as a whole should be reporting negative results, but a more careful analysis shows that strategy selection has determined investors’ returns in 2008.

Once again the best performing strategies were non-equity based (i.e. Global Macro, Commodities, Currencies and Managed Futures). Equity based strategies suffered but still on average outperformed the underlying equity benchmarks with the S&P/ASX200 Accumulation Index ending down 6.2% for the month, the S&P500 Total Return Index down 7.18%.

Click on the link below for the full report.

Although too early to say definitively, it is hoped that direct repercussions (i.e., Investments) by Australian hedge funds, fund of funds and other local investors in former US "Investment Guru" Madoff's so called "Ponzi" scheme will be minimal.

As of 15th December, two local Fund of Funds, Everest, and Select/Gottex have categorically denied having any investment or exposure to Madoff's extraordinary US$50 billion fraud.

However, there is no doubt that further confidence will be eroded in the eyes of ordinary investors in the top end of town, with this scam following on a series of disasters involving both overseas and local former high flying names.

Equally expect the surveillance of unregulated funds (a greater issue in the US than Australia) by the authorities to increase significantly.

Macquarie has written to investors with the news that as of 28th November, redemptions in their Equinox Series Fund of Funds have been suspended until further notice. Redemptions for 31 October will be processed, but all others, including those for November 28th, are included in the suspension.

Macquarie's letter to Equinox shareholders cited difficult (but now well known) issues affecting underlying managers, who themselves have been limiting or freezing redemptions. This poses a major issue for the Fund of Funds model with liquidity dependent on underlying assets which are themselves illiquid.

As a result there is, and will continue to be, a "cascade" effect as investors seek liquid assets, which in themselves are becoming an increasingly rare commodity.

Macquarie also noted other reasons for the problem, including falling interest rates damaging the mechanism for capital protection, and a falling Australian dollar affecting the value of predominantly US$ underlying investments, as well as impacting the A$/US$ currency hedges employed. Finally, the portfolio employed leverage between 10% and 20% of NAV, and this loan facility had been withdrawn and in current conditions was unable to be replaced.

Absolute Return funds surveyed by Australian Fund Monitors (AFM) that have reported November results indicates it was a
much improved month for the industry with quite diverse results. To date the average return for the month is negative 2.51% with 37% of funds in AFM's database having reported.

The best performing strategies have again been non equity based (i.e. Global Macro, Commodities, Currencies and
Managed Futures). Equity based strategies have suffered less than in September and October, significantly outperforming
the S&P/ASX200 Accumulation Index and the S&P500 Total Return Index which fell 6.20% and 7.18% respectively for the
month.

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In a statement to the ASX, the listed absolute return fund HFA Accelerator Plus Limited (HAP) has announced an Asset Realisation Program in which it will redeem all of its leveraged instruments (i.e. notes and swaps). HAP is undertaking the program in order to protect shareholder value in the current environment.

HAP stated: "The HAP investment model is predicated on leveraging HAP's capital 3 times as an investment in the Lighthouse Diversified Fund, a diversified offshore fund of hedge funds.

The HAP model was designed to provide superior returns in a wide variety of hedge funds with different investment strategies. The model was successful during periods of high capital market liquidity and market confidence in the global economy. However, the HAP model has underperformed during the sustained deterioration of global capital markets over the past 12 months."

HAP is listed in the AFM database under a Global Diversified strategy and recorded a return of negative 20.89% in October bringing its year-to-date (YTD) return to negative 52.79%.

To read the full statement, click here.

The Reserve Bank issued the following statement at 14:30 AEST Tuesday 2nd December 2008:

"At its meeting today, the Board decided to reduce the cash rate by a further 100 basis points, to 4.25 per cent, effective 3 December 2008.

Recent actions by governments and central banks to stabilise their respective financial systems have begun to take effect. Nonetheless, financial market sentiment remains fragile, as evidence accumulates of weak economic conditions in the major countries and a significant slowing in many emerging countries. Commodity prices have fallen further. This, combined with the likelihood of below-trend growth in the global economy, suggests that global inflation will moderate significantly in 2009.

The Australian economy has been more resilient than other advanced economies, but recent data nonetheless indicate that a significant moderation in demand and activity has been occurring. With confidence affected by the financial turbulence and a decline in the terms of trade now under way, more cautious behaviour by both households and businesses is likely to see private demand remain subdued in the near term. With that outlook, and with capacity pressures now easing, it is likely that inflation in Australia will soon start to fall. Global disinflationary forces will assist in this regard, though the depreciation of the exchange rate means that the decline of inflation to the target could take longer than would otherwise have been the case.

Weighing up the international and domestic developments of recent months, the Board judged that a further significant reduction in the cash rate was warranted now, to take monetary policy to an expansionary setting. As a result of today’s decision, the cash rate will be at its previous cyclical low point. Given trends in money market yields, most lending rates should fall significantly and will also reach below-average levels.

There has now been a major easing in monetary policy over the past few months. Together with the spending measures announced by the Government, and a large fall in the Australian dollar exchange rate, significant policy stimulus will be supporting demand over the year ahead. The Board will continue to monitor developments and make adjustments as needed to promote sustainable growth consistent with achieving the 2-3 per cent inflation target over time."

October was another difficult month for Australia's Absolute Return and Hedge Fund sector with widespread deleveraging across the globe and across almost every investor group and asset class.

The average October return of single managers across the sector was negative 5.04% with 86% of single managers’ funds having reported to date. This made October the worst month this year for the sector. On a year-to-date (YTD) cumulative basis the performance of the average Absolute Return fund in the database is negative 12.30%.

Positive returns were achieved by 28% of the sector while 81% of the sector outperformed the benchmark S&P/ASX200 Accumulation Index. The ASX200 fell 12.61% for the month, and according to Mercer Investment Consulting the median Long Only fund lost 11.3% in October, and 35.7% over the past 12 months.

To read the full report download the file below.