French funds add fuel to sub-prime fire

Just when you thought the markets were looking up, along comes another financial bombshell that has sent global stock markets spinning lower. On Thursday BNP Paribas, a large French bank, announced that it could no longer calculate the net asset values of three asset-backed securities funds.

The news hit North America just before the opening bell in New York and Toronto, and both the Dow Jones Industrial Average and the S&P/TSX Composite Index opened with triple-digit losses.

BNP Paribas says the “complete evaporation of liquidity in certain market segments” in America — namely the sub-prime market — has made it impossible for the company to accurately value certain assets.

Paribas is suspending NAV reporting for the Parvest Dynamic ABS, the BNP Paribas ABS Euribor and BNP Paribas ABS Eonia funds.

“In order to protect the interests and ensure the equal treatment of our investors during these exceptional times, BNP Paribas Investment Partners has decided to temporarily suspend the calculation of the net asset value as well as subscriptions/redemptions, in strict compliance with regulations,” says a statement on the bank’s website.

Philip Lee, an analyst at Morningstar Canada, says Paribas’ announcement, coupled with hedge fund blowouts at Bear Stearns, raises questions about the impact of the credit market, and that has scared people off of risk. “All of this uncertainty creates liquidity in the market,” he says. “Investors aren’t looking for any type of risk, even high-quality equities and bonds.”

There are fears that more companies could release similar announcements. “There’s a general feeling in the market that more of these stories are popping up,” says Lee. “Clearly, a lot of the firms are working around the clock, trying to figure out what type of exposure they have to these types of securities.”

Suspending NAV reporting is likely a result of difficulties Paribas is having determining exactly what is driving its asset-backed securities. “There could be high-quality mortgages and low-quality mortgages wrapped together, but how do you decipher that?” Lee asks.

He points out that Paribas hasn’t released much information about the suspension, so it’s difficult to predict what exactly the long-term effects of this will be on the market.

But there is some good news, especially for hedge fund investors. Most experts predicted that hedge funds would lose significant ground in July due to their exposure to the sub-prime mess, but according to the Barclay Group, hedge funds actually gained 0.62% last month.

“I was as surprised as everyone else,” says Sol Waksman, president of the Barclay Group.

He says the small gain was a result of hedge funds short on sub-prime exposure, which helped counterbalance funds with a more direct exposure. “When you average in a plus 100 and a minus 100, those two balance each other out,” he says.

Out of 18 of Barclay’s hedge fund indexes, 11 improved their performance in July. Specifically, the Equity Short Bias Index climbed 6.56%, Emerging Markets jumped 3.19%, Pacific Rim Equities rose 1.67%, and Technology increased 1.66%.

But while this is positive news, Waksman points out that there were far more losers than usual last month. Normally, the ratio of winners to losers is 80 to 20, but in July that figure was about 55 to 45.

Waksman adds that it’s not just the hedge fund sector that the sub-prime market is affecting — everything’s in turmoil. “Equity markets in the developed world were all down in July,” says Waksman. “The sub-prime problem exposed weaknesses in the fixed income sector in general, and you see credit tightening across the board.”

The greatest threat to market volatility might not be sub-prime woes, though. It’s fear. “It’s a very emotional time right now,” says Waksman. “Fear is in the driver’s seat.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com