Quantum Endowment Funds Group Members: Kunqi Bai; Heng Zhao; Shengnan Zhang; Zhe Li; Kailai Xu; Benchen Huang: Junyu Xiao.

Quantum Endowment Funds

Group Members:

Kunqi Bai; Heng Zhao; Shengnan Zhang; Zhe Li; Kailai Xu; Benchen Huang: Junyu Xiao

IntroductionSuccessful case

Failure cases

Invest theory

Successful cases

Current News

Agenda

George Soros, born August 12, 1930, is the chairman of Soros Fund Management. He is known as “the Man Who Broke the bank of England” because of his short sale of 10 billion worth of pounds, giving him a profit of 1 billion during the 1992 “Black Wednesday UK currency crisis.”. Also, Soros is one of the thirty richest people in the world.

introduction

Soros Fund Management• Soros Fund Management is a privately held American investment

management firm currently structured as a family office but formerly a hedge fund.

• The firm was founded in 1969 by George Soros and in 2010 was reported to be one of the most profitable firms in the hedge fund industry, averaging a 20% annual rate of return over four decades.

• It is headquartered in New York City.

• In July, 2011, The Quantum fund announced that they would be ending the fund, and will return all the outside money and exclusively manage Soros’s family money.

introduction

Quantum FundQuantum Fund is one of five funds belongs to Soros Fund Management and is one of the most famous hedge fund in the world.

· Founded in 1969 with 4 million registered capital.

· 4 years later, Quantum Fund had more than 12 millions.

· All the investors are from outside the U.S. in order to avoid the supervision of SEC.

introduction

What makes Soros and his Quantum Fund so famous?

· Quantum Funds earned 1.8 billion by shorting British pounds and buying German marks. This famous battle earned Soros the title of “ the Man Who Broke the Bank of England.”

· In 1997, Soros shorting Thai baht, causing the economic crisis in Southeastern Asia.

How does it work

Reflexivity

The market is made up of people.

People have a conception of the economic reality (which is inevitably false or incomplete) and base their actions on these conceptions.

These conceptions then have a feedback loop with "economic fundamentals"

In certain historical circumstances this feedback loop leads to outcomes that are initially self fulfilling but inevitably self defeating in a boom/bust sequence.

Generally this reflexive boom/bust sequence initially builds on a pre-existing trend based on sound economic fundamentals.

X=knowledge

Y=action Y=F1(x) ①

X=F2(y) ②

①, Y=F② 1[F2(y)]

X=F2[F1(x)]

▪Reflexivity is inconsistent with equilibrium theory.

▪Reflexivity asserts that prices do in fact influence the fundamentals and that these newly influenced set of fundamentals then proceed to change expectations, thus influencing prices.

▪The process continues in a self-reinforcing pattern. Because the pattern is self-reinforcing, markets tend towards disequilibrium.

• The market is made up of people.

• People have a conception of the economic reality (which is inevitably false or incomplete) and base their actions on these conceptions.

• These conceptions then have a feedback loop with "economic fundamentals"

• In certain historical circumstances this feedback loop leads to outcomes that are initially self fulfilling but inevitably self defeating in a boom/bust sequence.

• Generally this reflexive boom/bust sequence initially builds on a pre-existing trend based on sound economic fundamentals.

a. Lenders began to make more money available to more people in the 1990s to buy houses.

good?

Thus they lent out more money because their balance sheets looked good, and prices went up more, and they lent more, etc. Prices increased rapidly, and lending standards were relaxed.

Increasing lending against appreciating assets without understanding that one of the main reasons for the increased asset price is the increased lending.

b. Ever larger numbers of potential investors in housing markets grew increasingly confident that house prices would continue to increase based on their past experience (i.e. adaptive expectations) and thus scrambled to bid up the prices of houses.

the trend-following habits of investors or speculators (including adaptive expectations formation).

Unchecked credit expansion

An explosion in the value and type of unregulated financial instruments (derivatives, leveraged instruments etc.)

Globalization of financial markets with the financing of US consumption (private and government) by foreign lenders (China etc.)

How does it work

Strategy to Arbitrage

A: buy stocks

B: short sell

C: sell stocks

P

t

B

AC

Quantum Fund VS Quantum Endowment Fund

Higher leverage Lower risk with lower return

The War with Pound: Break the Bank of England

Origin of 1992 Pound Crisis

European Exchange Rate Mechanism (ERM)

• Introduced in 1979 with the goals of reducing exchange rate

variability and achieving monetary stability within Europe

• Prepare for the Economic and Monetary Union (EMU) and ultimately

the introduction of a single currency, the euro

• This process was seen as politically driven, attempting to tie

European countries together

• The United Kingdom tardily joined the ERM in 1990 at a central

parity rate of 2.95 deutsche marks to the pound


The sign of Maastricht Treaty in 1992

• In February 17, 1992, the European Community signed the "Maastricht

Treaty“

• Treaty requires that the European Community countries should complete

the single currency in three phases

• First stage: intensify “European exchange rate mechanism” role to

achieve free flow of capital;

• Second stage: establish a “European Monetary Institute” to coordinate

national monetary policies;

• Third stage: establish a unified European currency (euro) and

found“European Central Bank”for the EU to develop a unified monetary

policy.


Imbalance economic development in EU countries

• Germany has a prosperous economic due to the integration of East

and West Germany and Germany dominates the economic

development of the whole of Europe

• UK is caught in the mire of recession

• The economic situation in southern Europe, such as Italy, was

inferior to the United Kingdom

• Unified European currency will only exacerbate the economic

imbalance between EU countries

• the UK government was required to keep the pound in a trading

band within 6 percent of the parity rate. An arguably artificially

strong currency in the United Kingdom led the country into a

recession

• Despite a recession, the United Kingdom was forced to keep

interest rates artificially high, in line with German rates, in order to

maintain the currency regime

• These two action can not stimulate the economy and rescue the UK

from depression.

• Meanwhile, Germany was suffering inflationary effects from the

integration of East and West Germany, which led to high interest

rates.

Soros got “the UK economy can not support the strong pound,

pound must devalue in the future” conclusion and took following

specific strategies to make profit:

• Short positions strategy: buy dollars or imminent revaluated

Mark, short selling (borrowing) devalued pound

• Arbitrage strategy: devalued pound may cause serious impact on

the UK financial markets, certain financial assets on the UK

market may temporarily fall below the proper value; buy low and

sell high

September 16,1992, British government was forced to withdraw

the pound from the European Exchange Rate Mechanism

(ERM), which send the currency into a free fall

September 16, 1992 also is called Black Wednesday

$950 million was earned by Soros

Figure: Pound/Mark and UK Base Rates, 1992

Black Wednesday,September 16, 1992

Sniping Baht in Thailand

Good Side In the early 1990s, when Western countries were in the stage

of recession, the economy of the Southeast Asian countries develop rapidly, the economic outlook is very good.

Strategy------- become the New World Financial Center.

relaxed financial regulation, implement the financial liberalization

The background of sniping Baht

Potential Risk

Economic growth of Asian countries is not based on the rise in productivity, but mainly dependent on the increase of the foreign investment.

Target : Thailand, is the most vulnerable to the impact of international capital

International trade surplus baht exchange rate is significantly overestimated

maintain the dollar's exchange rate, sold a lot of foreign exchange

How Endowment Fund made money Interest rate: Thailand >U.S.

borrow money from the U.S., and then deposited in the Bank of Thailand money flowing into Thailand

baht & US dollar exchange rate is fixed no depreciation and appreciation

the assumption is 1:25, Soros borrow 250 billion baht from Bank of Thailand then exchange $10 billion let their baht depreciate

Borrow money from Thai banks and buy dollars from Thai government resulted in a panic

How Endowment Fund made money

Dollar is so hot all of a sudden, all together to sell baht and buy dollars

Thai government: not so much foreign exchange reserves, the dollar has been depleted quickly

floating exchange rate and let the baht devaluation, only the baht devaluation, the dollar is enough to sell

sharp depreciation of the baht, from 1:25 to 1:50 , $10 billion worth 500 billion baht pay back $250 billion baht and earn $250 billion baht

Timeline of sniping Baht---first battle In March 1997, when the Bank of Thailand

announced that nine domestic financial companies and the one major housing loan company have liquidity shortage problem.

Soros and other hedge funds Managers sell baht in large amount

Timeline of sniping Baht---first battle

Three tricks---- transaction costs surge, all of a sudden loss of $300 million

Joint Singapore spent $ 12 billion reserve to absorb the baht

Prohibit lending

Raise interest rates

Timeline of sniping Baht--- Second battle

In late June 1997, former Thai finance minister resigned. Soros ordered to sell bonds to raise funds and short selling again

July 2, the Thai government as a result of no longer able to compete with George Soros, implement a floating exchange rate system.

Quantum Fund in

Hong Kong

Quantum Fund’s strategies

Stock market

Futures and Option market

Currency market

Linked Exchange Rate System

A system of managing a nation's currency and exchange rate by linking the national currency to another base currency that is held at a fixed ratio in deposit at domestic banks.

Hong Kong Dollar is linked with UD dollar.

In Hong Kong, the monetary regulator is Hong Kong Monetary Authority (HKMA).


Short HK Dollar

HKMA increase Interbank

lending rate

Negatively effect the

stock market

Value of stock index

futures decrease

Speculators

benefit

• HKMA: Hong Kong Monetary Authority


Quantum Fund focus on two markets: currency market and stock market

Currency market stock market

1 •Borrow the HK dollar from currency market

2 •Exchange the HK dollar to US dollar

3 •HK dollar depreciate

4 •Use the dollar to buy the HK dollar and pay back

1

• Short the stock index futures and the stock

2• stocks price

decrease

3• benefit from

the short position

When the hot money flow into Hong Kong…

Hang Seng Index (HSI)

10/20/1997 12860

10/21/1997 11700

10/22/1997 10600

10/28/1997 9060

Exchange rate:

10/20/1997 1USD=7.75 HKD

10/29/1997 1USD=7.73 HKD

Reaction of Hong Kong government

Protect the stock market by capital injection

Increase the margin of the stock index by 50%,from 80,000HKD to 120,000HKD.

Request the registration of holding more than 250 index contracts.

.

Result

Quantum Fund loss 900 million

HK stabilized its Linked Exchange Rate System, however it went through a 10-year regression resulted after this crisis.

Per Capital income from 1997 to 2007

Year Per capital income(USD)

1997 27,055

1998 25,352

1999 24,600

2000 25,144

2001 24,744

2002 24,340

2003 23,428

2004 24,393

2005 26,000

2006 27,466

Quantum Fund In Russia

In 1998, Soros's Quantum Fund Losses in Russia

Loss:

One of the main reasons Soros ended the Quantum Fund

$2 Billion, 80%


Why Quantum Fund invested in Russia?

1995, suggested by QFII, Russia Government gradually opened up its capital market to foreign investors.

1997, Russian economy rebounded, GDP had a positive growth, inflation rate declined.


Treasury Bond: 3-6 months

Stock Price low:$0.5 - $5

Annualized Bond Return>30%

Average Return>100%

Bullish

Why Quantum Fund invested in Russia?

Quantum Fund was Bullish on Russian Market


Why lose?- The financial crisis in RussiaIn the first half of 1997, the Russian economy showed some signs of improvement. However, soon after this, the problems began to gradually intensify. Two external shocks:

The Asian financial crisis that had begun in 1997 and the following declines in demand for (and thus price of) crude oil and nonferrous metals, severely impacted Russian foreign exchange reserves.

A political crisis came to a head in March when Russian president Boris Yeltsin suddenly dismissed Prime Minister Viktor Chernomyrdin and his entire cabinet on 23 March 1998.


Why lose?- The financial crisis in RussiaOn 17 August 1998, Russian government and the Central Bank of Russia issued a "Joint Statement" announcing, in essence, that:

The ruble/dollar trading band would expand from 5.3–7.1 RUR/USD to 6.0–9.5 RUR/USD;

Russia's ruble-denominated debt would be restructured in a manner to be announced at a later date; and, to prevent mass Russian bank default,

A temporary 90-day moratorium would be imposed on the payment of some bank obligations, including certain debts and forward currency contracts.


Why lose?- The financial crisis in Russia The effects of Crisis

Exchange rate •Exchange rate had reached 21 rubles for one US dollar, lost two thirds of its value in less than one month

Treasury Bond •Treasury bond price declined to less than 50% of the face value

Stock market •Stock market dropped 75% than beginning of the year


The big loss

When the crisis began, Soros appealed to other western countries to help Russia, the banks used to support Quantum Fund refused and ask for early loan payment.

In the crisis, the market broke down, stock, bond, ruble-dollar were terminated trading once.

Foreign investors lost $33 billion in this crisis.

Current News about Quantum Fund

Return Money to Outside Investors

Time: 2011

In order to avoid regulation under Dodd-Frank Act

1. Not need to register with SEC

2. Avoid handing over data to the Financial Stability Oversight Council

Now a family office operating approximately $25 billion family wealth

Current Performance

Earned $5.5 billion in 2013, best return since 2009 (Financial Times)

Ranked No. 1 hedge fund with the greatest net gain for investors (LCH Investment NV,2014)

Started to focus on China and warned China’s rate of credit growth and leverage

The world’s most successful hedge fund

Won the battle against the Bank of England

Generated more than $40 billion to its investors since its foundation (LCH Investment, 2013)

Annual return is more than 30% (LCH Investment, 2013)

Quantum Endowment Funds Group Members: Kunqi Bai; Heng Zhao; Shengnan Zhang; Zhe Li; Kailai Xu; Benchen Huang: Junyu Xiao.

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