Fund Managers: The Unhedgable Risk

Teresa, May 12, 2008 @ 3:11PM ET | Link | RSS | Read via Email | Start a Discussion

A couple of weeks ago, we wrote an article called Hedge Fund Manager: First Shot, Second Chances. This morning, there was a priceless quote in WSJ:

Rebounds by Hedge-Fund Stars Prove ‘It’s a Mulligan Industry’
Wall Street likes to consider itself a strict meritocracy, but hedge-fund managers who fail in ugly ways often convince investors to hand them piles of cash so they can give it another go.

Says Ken Phillips, who runs RCG Capital Partners, a Boulder, Colo.-based firm that invests in hedge funds: “It’s a mulligan industry,” referring to the golf term for a second chance after a poorly played shot. “That’s what makes America great.”

. . . It can be helpful to have lost loads of money, rather than a smidgen of cash.

“It’s crazy, but the guy who’s down substantially often will have a lot more options versus someone smaller who hasn’t lost much money,” says Neal Berger, who runs Eagle’s View Asset Management, LLC and invests with funds. “Some investors will say ‘lightning doesn’t strike twice in the same spot,’ or, ‘there must be something smart about him that someone gave him the opportunity to lose so much money in the first place.”‘

It will not be different this time or any other time, because the risks inherent in a manager’s approach to investing or trading remain the same: concentrated bets (go big or go home), high leverage (small setback = wipeout), arbitrage (works until it doesn’t), and the classic, simply reject reality. These are what all the losing funds have in common…

Unregulated OTC derivatives steady in credit crisis
[Editor: Bet you didn’t know this!] Banks worldwide have suffered billions of dollars in losses on complex mortgage-related bets in recent months, but the similarly complex off-exchange derivatives market, whose notional value of $516 trillion is nine times that of global economic output, has performed well during the upheaval. The OTC derivatives market is where businesses, pension funds, hedge funds and other professional investors go to hedge against and bet on changes in interest rates, currency values and just about any commodity from oil to oranges. For years, the sheer size of the market has fueled calls for oversight, but U.S. officials believe the hands-off approach has worked and that the market has helped fend off what could have been worse losses.
Amaranth Founder Sets Up New Hedge Fund
Nineteen months after his Amaranth Advisors collapsed under more than $6 billion in losses, Nicholas Maounis is back. . . . Maounis is offering something of an olive branch to his former Amaranth clients, who saw more than two-thirds of the once-$9.5 billion multi-strategy shop’s assets disappear when natural gas trades made by trader Brian Hunter went bad to the tune of $6.6 billion in losses. Investors who still had money with Amaranth when it went under in September 2006 will pay no incentive fees for three years, Bloomberg reports. In addition, the fund will charge no management fees, although all investors will share in paying the fund’s expenses.
Downhill ride in 1st quarter
Miller’s Value Trust portfolio reads like a roadmap to the hardest-hit segments of the economy. The fund trailed all but four of 660 funds that buy stocks of large companies, according to Morningstar data. . . . Sprint, Miller’s seventh-largest holding, turned out to be another tough loss, falling 50 percent as a worsening economy and the loss of customers to rivals hurt profit projections. Communications and technology stocks, which account for about a third of Miller’s holdings, were laggards among industry sectors. Ever the contrarian, Miller also has invested heavily in financial and housing stocks — both of which have been hammered.
Former Shooter Employees Seek $200 Million for Currency Fund
[Editor: So they made money when currencies were trending…] Four former employees of Shooter Fund Management LLP, the London investment manager that lost 40 percent last year, are starting their own firm to trade currencies. Founded by Mark Shooter in 2004, Shooter Fund lost money last year on equity-index trades. Its foreign-exchange portfolio, which relies on computers to buy and sell contracts, returned 34 percent in 2007 and 10 percent this year through April, according to Dacharan marketing documents. “It’s clearly not a positive to be associated with the losses, but it won’t be impossible for them to raise cash,” said Patrik Safvenblad, head of hedge-fund research in Stockholm for DnB NOR ASA, Norway’s biggest bank. “They are just going to have to work harder at gaining trust among investors,” said Safvenblad, whose company is based in Oslo.
Hedge fund investors increase focus on risk management
Risk management has joined the performance, philosophy and pedigree of hedge fund managers among the key criteria for investors in manager selection, according to the sixth annual Alternative Investment Survey undertaken by Deutsche Bank’s hedge fund capital group. According to Sean Capstick, the London-based global co-head of the group, risk management has been gaining in importance as an investment criterion since 2005 but its displacement of manager pedigree from third place marks the first time since 2002 that the so-called ‘three Ps’ have been joined by another key selection factor.
Lampert, Wood Show Risk of ‘Concentrated’ Hedge Funds
When Jon Wood opened his Monaco-based hedge fund, the former UBS AG trader told investors he’d beat the market by buying stakes in no more than 40 companies — the same way he made $2.4 billion in six years for his old employer. Instead, holdings such as failed U.K. bank Northern Rock Plc and Calabasas, California-based Countrywide Financial Corp., the largest U.S. mortgage lender, imploded. From its start in late 2006 with $3 billion, Wood’s SRM Global Fund lost about 70 percent through March 31, said two investors, who asked not to be identified because the firm doesn’t publicly disclose returns. “These concentrated funds scare the hell out of me,” said Brad Alford, head of Alpha Capital Management LLC, an investment consultant based in Atlanta. “Either the manager knocks it out of the park or he strikes out.”
Falling Off an ETF Seesaw
It sounded like a can’t-miss idea: a pair of exchange-traded funds developed by a celebrity economist to track crude-oil futures. One lets investors bet oil prices will rise, the other that they will fall. But in recent days, creator MacroMarkets LLC announced the funds would terminate at the end of June, cashing out shareholders. This fizzle, after a year-and-a-half run, is one of the highest-profile embarrassments for the growing ETF industry over the past year. Turns out the funds, the brainchild of famed Yale economist Robert Shiller, were too smart for their own good.
State Street Subprime Damages May Surpass Reserve
State Street Corp., the largest money manager for institutions, may have to pay more than the $625 million it set aside for damages from lawsuits over losses from subprime-mortgage investments made for pension funds.

In an attempt to diversify risk, the industry steers investors toward funds of funds. But the question is this: what’s left for investors after fees paid to fund managers and fund of fund managers?

Hedge Fund Fees Shrink as U.S. Pensions Make Direct Investments
A fund of funds generally charges 1 percent of assets and 10 percent of any investment profits for selecting managers. That comes on top of the 2 percent of assets and 20 percent of profits the underlying managers collect. Hedge funds are private, largely unregulated pools of capital that can buy or sell any assets, betting on falling as well as rising prices.

It seems like people are catching on and going back to basics.

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