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The End of Hedge Funds? |
rffrydr
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 Posted: Sun Mar 23, 2008 4:30 am Post subject: The End of Hedge Funds? |
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Martin Wolf runs some numbers looking for what's real. --Maybe better not to look too deeply into the well....
| Quote: | Hardly a week goes by without the implosion of a hedge fund. Last week it was Carlyle Capital, with an astonishing $31 of debt for each dollar of equity. But we should not be surprised. These collapses are inherent in the hedge-fund model. It is even conceivable that this model will join securitised subprime mortgages on the scrap heap.
Getting away with producing adulterated milk is hard; getting away with an investment strategy that adds no value is not. That was the point made by John Kay, in a superb column last week (this page, March 11). With the “right” fee structure mediocre investment managers may become rich as they ensure that their investors cease to remain so.
Two distinguished academics, Dean Foster at the Wharton School of the University of Pennsylvania and Peyton Young of Oxford university and the Brookings Institution, explain the point beautifully*. They start by asking us to consider a rare event – that the stock market will fall by 20 per cent over the next 12 months, for example. They assume, too, that the options market prices this risk correctly, say at one in 10. An option costs $0.1 and pays out $1.
Now imagine that we set up a hedge fund with $100m from investors on the normal terms of 2 per cent management fees and 20 per cent of the return above a benchmark. We put our $100m in Treasury bills yielding 4 per cent. We also sell 100m covered options on the event, which nets us $10m. We put this $10m, too, in Treasury bills, which allows us to sell another 10m options. This nets another $1m. Then we go on holiday.
There is a 90 per cent chance that this bet will pay off in the first year. The fund then grosses $11m on the sale of the options, plus 4 per cent interest on the $110m in Treasury bills, for a handsome 15.4 per cent return. Our investors are delighted. Assume our benchmark was 4 per cent. We then earn $2m in management fees, plus 20 per cent of $11.4m, which amounts to over $4m gross. Whatever subsequently happens, we need never give this money back.
The chances are nearly 60 per cent that the bad event will not occur over five years. Since the fund is compounding at a rate of 11.4 per cent a year after fees, we will make well over $20m even if no new money is attracted into this apparently stellar enterprise. In the long run, however, the bad event is highly likely to occur. Since we have made huge profits, our investors have paid us handsomely for the near certainty of losing them money.
The immediate response may be that so naked a scam is inconceivable. Well, imagine a fund that leverages investors’ money by borrowing massively in short-term money markets in order to purchase higher-yielding paper. Assume, again, that the premium gives a correct estimate of the risk. With sufficient leverage, this fund, too, is likely to make profits for years. But it is also very likely to be wiped out, at some point. Does this strategy sound familiar? It certainly should by now.
We can identify two huge problems to be solved. First, many investment strategies have the characteristics of a “Taleb distribution”, after Nicholas Taleb, author of Fooled by Randomness. At its simplest, a Taleb distribution has a high probability of a modest gain and a low probability of huge losses in any period.
Second, the systems of reward fail to align the interests of managers with those of investors. As a result, the former have an incentive to exploit such distributions for their own benefit.
Professors Foster and Young argue that it is extremely hard to resolve these difficulties. It is particularly difficult to know whether a manager is skilful rather than lucky. In their telling example, the chances are more than 10 per cent that the fund will run for 20 years without being exposed. In other words, even after 20 years the outside investor cannot be confident that the results were not being generated by luck or a scam.
It is also tricky to align the interests of managers with those of investors. Obvious possibilities include rewarding managers on the basis of final returns, forcing them to hold a sizeable equity stake or levying penalties for underperformance.
None of these solutions solves the problem of distinguishing luck from skill. The first also encourages managers to take sizeable risks when they are close to the return at which payouts begin. Managers can evade the effects of the second alternative by taking positions in derivatives, which may be hard to police. Finally, even under the apparently attractive final alternative it appears that any clawback contract harsh enough to keep unskilled managers away will also discourage skilled ones.
It is obviously best not to pay the manager, as a manager, at all, but rather to invest alongside him, as at Berkshire Hathaway, Warren Buffett’s investment company. But we still have the challenge of knowing whether the manager is any good. We know this today of Mr Buffett. Fifty years ago, that would have been very hard to know.
What we have then is a huge “lemons” problem: in this business it is really hard to distinguish talented managers from untalented ones. For this reason, the business is bound to attract the unscrupulous and unskilled, just as such people are attracted to dealing in used cars (which was the original example of a market in lemons). The lemons theorem states that such markets are likely to disappear. The same may happen to today’s hedge-fund industry.
Now consider the financial sector as a whole: it is, again, hard either to distinguish skill from luck or to align the interests of management, staff, shareholders and the public. It is in the interests of insiders to game the system by exploiting the returns from higher probability events. This means that businesses will suddenly blow up when the low probability disaster occurs, as happened spectacularly at Northern Rock and Bear Stearns.
Moreover, if these unfavourable events – stock market crashes, mortgage failures, liquidity freezes – come in stampeding herds (because so many managers copy one another), they will say: “Nobody could have expected this, but, now that it has happened to all of us the government must come to the rescue.”
The more one believes this is how an unregulated financial system operates, the more worried one has to become. Rescue from this crisis may be on the way, but what about next time and the time after next?
*Hedge Fund Wizards, and The Hedge Fund Game, January 2008 |
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The End of Hedge Funds? Replies |
rffrydr
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| Posted: Tue May 05, 2009 9:34 pm Post subject: |
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Forced restructuring sole option for many hedge funds
Hedge fund redemption headlines may have fallen by the wayside in recent weeks as the market turns its attention to the implementation of new government initiatives. But, according to Houlihan Smith & Co, redemptions remain a significant overhang and will hinder any sort of recovery in the industry for some time to come.
“Redemptions are still a big issue,” confirms Karl D’Cuhna, senior md at the firm. “31 March was ugly. For some funds, I’d say 30 June will be a bottom, but for others the money is going to continue pouring out...”
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HenryTo
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rffrydr
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diesel
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| Posted: Wed Feb 18, 2009 4:31 pm Post subject: |
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Thats putting it gently! It is becoming increasingly obvious that from top to bottom, the entire hedge fund, investment banking and financial advising business is riddled with fraud, filled with crooks and a total disaster.
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HenryTo
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rffrydr
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HenryTo
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| Posted: Sat Nov 22, 2008 2:30 am Post subject: |
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rffrydr, thanks for the note.
I have the Goldman report in my possession. Note the 17% net long exposure is estimated based on September 30th data - right before the latest swoon in the US stock market. As you said, this is down from a 47% net long exposure from a year ago and 32% as of June 30, 2008. Since then, there has no doubt been further deleveraging by hedge funds, as exemplfied by the significant overperformance of Goldman's "least concentrated HF ownership basket" versus its "most concentrated HF ownership basket" (outperformance of 10% in 3Q and 9% during 4Q thus far).
Given the deleveraging during 4Q so far, my sense is that HF net long exposure of US equities is now at 0% or even lower. |
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rffrydr
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| Posted: Fri Nov 21, 2008 11:35 pm Post subject: |
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There was an interesting story on Bloomberg Friday highlighting hedge fund holdings. Net holdings of equities were said to be 17% compared to 47% of a year ago. This is a major shift to underweight and a sign of mass de-leveraging. Moreover, the sector is a net short in financials. Hedge funds were said to be long $85 bln in financials and short $109 bln in financials. The largest net positions are in healthcare and technology.
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HenryTo
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| Posted: Mon Nov 17, 2008 1:26 am Post subject: |
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Hedge fund liquidation update:
http://www.bloomberg.com/apps/news?pid=20601110&sid=a3VOHBm0mnLc
| Quote: | The story at Appaloosa, whose returns have dropped more than 20 percent this year, was repeated across the hedge-fund world in the quarter as managers were hit by client withdrawals, tumbling financial markets and tighter credit. Regulatory filings last week by 38 hedge funds with more than $1 billion in assets each show that selling and market declines cut the value of their reported holdings by about 30 percent to $273 billion.
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At Tudor Investment Corp., the Greenwich, Connecticut, hedge-fund group founded by Paul Tudor Jones, 13F holdings fell to $453 million from $5.7 billion. Jones said markets face more selling from managers.
``Our concern now is less over year-end fund redemptions, as record cash balances have already been raised in anticipation, but with prospective fund closures,'' Jones, 54, said in an Oct. 31 report to his clients. ``This latter event represents a tipping point at which a fund's call on the market for liquidity goes non-linear.'' |
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HenryTo
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| Posted: Sat Nov 15, 2008 2:02 pm Post subject: |
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Levered funds of funds have been forced to delever as well:
http://www.businessweek.com/magazine/content/08_47/b4109034618218.htm?chan=magazine+channel_news
| Quote: | The funds of funds were layering leverage upon leverage. They owned hedge funds already loaded up with debt, roughly $6 for each $1 of capital. When credit seized up, the process began to reverse. "Once things start to delever, everything contracts," says Andrea S. Kramer, a lawyer at McDermott Will & Emery who represents hedge funds.
To protect themselves, such big global banks as France's BNP Paribas, KBC Group of Belgium, and the Royal Bank of Canada are now charging higher fees on loans they extended to funds of funds, or pulling the loans entirely. The tight credit is compelling fund-of-funds managers to sell their holdings, which is driving individual funds to dump stocks, bonds, and commodities.
The situation shows no sign of stabilizing. Consider CMA Global Hedge PCC, a $360 million fund of funds. The portfolio, which over the years used financing from JPMorgan Chase (JPM), Société Générale, and HSBC (HBC), is currently relying on credit from Citigroup (C) . Its holdings—47 hedge funds—are down 11%. Add in leverage, which amplifies losses, and CMA Global is off 25%. |
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HenryTo
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| Posted: Thu Nov 06, 2008 9:47 pm Post subject: |
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To Cramer's (and others') point. Hedge fund redemptions have again been fueling the sell-off over the last couple of days:
http://online.wsj.com/article/SB122602205734807307.html?mod=testMod
| Quote: | Perhaps more than others on Wall Street, Mr. Griffin has actually tried to set up his fund so that it's prepared for a crisis. Most of his investors are locked up for an extended period, meaning they can't ask for their money back whenever they get jittery. The fund also sold $500 million of bonds to investors, becoming the first hedge fund to do a bond deal, to raise more-permanent capital.
Many funds are dealing with deep losses, and because some of them have barred or limited withdrawals, investors now are turning to healthier funds to get their hands on cash.
Plainfield Asset Management, a $5 billion fund down just 8% through October, has told investors that in just the past few weeks it's received withdrawal requests amounting to as much as one-third of its assets. About one-quarter of the investors in Blue Mountain Capital Management, which has lost less than 3% this year, have asked to yank their money from the fund. Trafalgar Asset Managers, which has seen redemption requests of about 25% of the firm's $3 billion assets despite gains in most funds this year, has moved some assets into a separate vehicle, to sell them over time. "The main pressure on the firm has been redemptions, not performance," said a Trafalgar spokeswoman. |
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rffrydr
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| Posted: Thu Nov 06, 2008 8:42 am Post subject: |
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The Madman says:
| Quote: | Expect More Hedge Fund Pressure
By Jim Cramer
Chairman
11/5/2008 4:38 PM EST
The letters go out at the first of the month for places we think of citadels and fortresses of capital. They read like this: "Our performance is X vs. the S&P, and we see multiple opportunities and we have lots of cash. We have never been in better shape, and we are excited about the great possibilities we see."
The letters go to sophisticated investors, institutions and funds of funds.
The first two pretty much take them in stride. They've made a lot of money with these hedge funds, and they aren't sanguine but they aren't panicked.
And then there are the funds of funds. These people are supposed to be the keepers, the shepherds of the money. They are desperate to try to keep their jobs and demonstrate that they are being fiduciaries. They are basically saying, "Our raison d'etre is on the line." That means they have to pull the money.
They have five days to notify the hedge funds they want their money out unless there is a lockup or if the hedge funds have decided to abrogate their contracts, which is completely on par with the nonsense of this industry.
That means that right now the hedge funds are getting the funds of funds' letters. There was so much marking-up going at the end of the quarter by these citadel/fortresses of brilliance that they might have escaped the worst of performance. And there might be funds of funds people dumb enough to buy the "opportunities abound" logic.
But to me, we are seeing some of that fund-of-funds action today, and I suspect a new round of redemptions is upon us without federal bailouts, although many of these hedge funds have convinced Treasury that they could be Lehman-like if they fail, and that they must be able to make a lot of money not to lose key talent if they are bailed out.
If I have one wish if it comes to the Obama campaign, it is that hedge funds won't be bailed out.
Wishful thinking?
I bet we shall soon see! |
He's really after Cerberus who slyly tucked themselves into the heart of the american heartland. Sounds like they pretty much wrapped up to the forced sales though I'm sure they'll be selling into decent bids thru christmas.
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rffrydr
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Rubedo
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| Posted: Sun Oct 26, 2008 2:04 pm Post subject: |
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http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3248965/GLG-chief-Emmanuel-Roman-w
arns-thousands-of-hedge-funds-on-brink-of-failure-financial-crisis.html
GLG chief Emmanuel Roman warns thousands of hedge funds on brink of failure
Emmanuel Roman, the co-chief executive of Europe’s biggest hedge fund GLG, has warned that thousands of hedge funds are on the brink of failure as the global economy contracts with unexpected severity.
By Rowena Mason
Last Updated: 5:50PM BST 24 Oct 2008
Emmanuel Roman, of GLG Partners, said 25pc-30pc of the world’s 8,000 hedge funds would disappear "in a Darwinian process", either going bust or deciding meagre profits are not worth their efforts.
"This will go down in the history books as one of the greatest fiascos of banking in 100 years," said Mr Roman, who with Noam Gottesman, co-runs GLG, a former division of Lehman Brothers Holdings with assets of $24bn (£14.8bn). "There need to be some scapegoats, and the regulators are going to go hunt people. That will be good in the long run."
His views were echoed by Professor Nouriel Roubini, a former US Treasury and presidential adviser known for his accurate prediction of financial crises, who estimated that up to 500 hedge funds would fail within months. |
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rffrydr
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| Posted: Sat Oct 25, 2008 8:48 am Post subject: |
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"Policy makers"? Really? I thought the markets and the CDS running hedge-funds made that choice. What then was left for policy?
"Winners"? Is that what the commerical banks are?
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