Friday, September 07, 2007

Hedge Funds - Confidence Trick or Genuis?

The White Tip Catfish is a scavenger. It roams the the bottom of backwaters looking for uneaten food and dead and dying fish. It is an excellent cleaner of the seas and is also an excellent analogy for what is going on the markets at the moment. Turning quickly from predator to scavenger some hedge funds are licking their lips at the prospect of picking up dead and dying funds assets at deep discounts and they are even taking advantage of the banks squeeze on credit by going into the loan business.

It is a testament to the shape shifting ways of hedge funds that in market turmoil they just change the focus and it's business as usual. Financial News Online reported that hedge funds and private equity groups are raising billions of dollars to buy leveraged loans in the belief that the banks will have to sell $250bn of debt on the cheap. Don't you just love the concept of that? Spend a few years leveraging the investments you make through the banks and then borrow or get investment from the banks to buy bad loans on the cheap from the banks. Genius!

Imagine if you were merely an equity player and not some high falutin' hedge fund and you could borrow stock from a company to sell short its own shares and then buy them back at a discount with money borrowed from that company. Unfortunately the pesky regulators would see that as market abuse and you would be acquainted with Mr Big in the showers for a while, but what a Utopian existence such freedom of the markets would least for hedge fund managers.

Consolidation also seems to be a word that is being banded around when it comes to hedge funds buying other hedge funds or their assets. I think we all know that 'consolidation' is just market speak, in this instance, for 'cannibalism'. It is the survival of the fittest at the moment. I recall the words of Gordon Gecko in Wall Street the movie when he said " either get it right or you get eliminated". This is certainly what is happening at the moment.

But it all could have been so different, oh yes!. Having graduated from the University of Life with a First Class Honours Degree in Hindsight, I am not averse to the odd "I told you so" as you may see from some of the wildey contradictory statements I make as my mood changes from bull to bear and vice versa, however, in a 'salt rubbing in' exercise of marvellous proportions Lipper published a report saying that investors shouldn't have redeemed their money in the recent volatility.

The Lipper study suggests that volatility is actually a good thing, so rather than pulling their money when the markets made its manic moves, hedge fund investors should have kept it in, and today perhaps a number of them and their hedge funds would have been better off.

“People assume that during periods of volatility, the overall hedge fund index is going to go down,” Lipper senior hedge fund analyst Ferenc Sanderson told Reuters. “But we’ve had lots of periods of volatility, and in more instances than not, the overall index has been up.” Apparently, according to Lipper, in volatile times, the spread between the best performers and the worst widens. According to Lipper, since 1994, in one-third of the months, volatility has been at its highest levels, meaning greater than 10%, while the hedge fund index fell only 11% of the time – an indication that for the most part, aggregate returns actually rose in those months.

“In more cases than not,” Sanderson noted, “performance is actually up” -- which means investors may have erred by pushing the redemption button too quickly. In an interview with Reuters, Sanderson surmised that a few fallen funds, albeit big ones, may have led to a rush to judgment that the entire hedge fund industry was in trouble.

The worst of volatility times, says Lipper, was during the Asian currency crisis in August 1998, when the spread between the winning and losing funds was 45.7%, and the Credit Suisse/Tremont Hedge Fund Index slumped 7.55%. On the other hand, in another volatile month, December 1999, when the performance spread increased to 21.9%, the HF index actually soared 8.53%. HSBC’s Private Bank Alternative FundInvest Group has published its list of current winners and losers, indicating dramatic spreads: The top performer through July 31 was 788 Asset Management’s 788 China Fund, recording gains of 61.43%, while at the opposite end is Tontine Associates’ TFP Overseas Fund Lt-Class A Fund,which lost -41.90% during the same period.

So there you have it, hedge fund redemptions probably exacerbated the situation in the market with TrimTabs Charles Biderman saying the redemptions "likely sparked the dislocation in the equity markets in the summer" and now Lipper is saying that the volatility created could turn out to be a good thing for the performance of funds... does any one else find this a little confusing?

Investors get jitters, redeem funds, causing hedge funds to sell position to fund redemptions, market falls further, some hedge funds can't afford redemptions and sell assets at a discount to those that can, banks panic and reign in credit and put scary loans up for sales at a deep discount, hedge funds lap them up, and make more money anyway...

Ever watched the TV show 'Lost'. I understand the basic premise, plan crash people survive, but other people living on the island as part of a long lost experiment, invisible creatures, flash backs trying to explain the unexplainable? I am getting the same confused feeling here...

It seems like some large confidence trick, like 'find the lady'. You know you should be able to spot the queen, but never seem to win.
This, to me, is as confusing, a little misdirection here, a few statistics there and someone walks away with a ton of money, while the majority of people are wondering where their portfolio value went.

I need to lie down.....

No comments: