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Monday 22 September 2008
Last week was too wild even for hedge funds with a taste for risk
For the very best hedge fund managers, who reap rich fees and laurels for making bold, counterintuitive bets, the furious rally late last week in financial stocks was - in theory - a golden moneymaking opportunity. More in comments...
Last week was too wild even for hedge funds with a taste for risk
By Landon Thomas Jr. 21 September 2008
LONDON: For the very best hedge fund managers, who reap rich fees and laurels for making bold, counterintuitive bets, the furious rally late last week in financial stocks was - in theory - a golden moneymaking opportunity.
Just before the rally took off on word that the U.S. government was leaning toward a giant bailout for holders of bad mortgage debts, fear and desperation were paramount. Morgan Stanley and perhaps even Goldman Sachs could lose their independence, traders sensed, forced to sell to an established commercial bank at a price so low that shareholders would lose billions of dollars.
It was a moment of supreme panic and pessimism, that fleeting moment of capitulation when investors give up all hope and when the few who dare jump into the fray.
One major hedge fund investor said that he had started to buy Morgan Stanley at $23 on Wednesday, convinced that the rumours of Morgan Stanley’s demise were unfounded. But as the stock began to plummet, he cancelled his trade and watched with amazement as the stock sunk to a low of $12 on Thursday.
And he stayed on the sidelines as the stock more than doubled that day and ended the week at $27.
Volumes were high, fear was higher - but conviction, the final and most crucial ingredient, was lacking.
“With this kind of fear you can’t do anything,” he said. “You never have heroes when you get these kinds of violent moves. The heroes only come out when the stock is down and stays down.”
While it is too early to know for sure, interviews with industry experts and investors suggest that few hedge funds had the foresight, dexterity and most of all the courage to counter conventional wisdom and go long on financial stocks last week.
On the other side of the equation, various large funds - no names have yet surfaced - appear to have been hit hard by having bet against financial stocks. Market participants say it was the frantic short-covering of these funds that propelled stocks upward late last week.
Insiders say that many funds lost money last week and in London some have whispered that they may sue the Financial Services Authority for temporarily outlawing short-selling against financial firms, one of their basic investment approaches.
But hedge fund investors also point out that with many funds nursing negative returns of as much as 40 percent this year, the appetite for taking bold, risky bets and losing everything has waned.
“Why would you take the risk of not getting paid 2 and 20 percent next year,” asked a hedge fund executive, referring to the lush pay scheme of 2 percent of fees and 20 percent of profits that successful hedge funds award themselves.
A hedge fund manager in New York was even blunter in conveying the sense of panic that has coursed through Wall Street in recent weeks.
“Essentially work has been like living through a financial version of ‘A Nightmare on Elm Street,”‘ he said. “There’s lots of panic, blood and screaming. You slay the evil monster, and everything is O.K. But then you wake up and there’s lots of panic, blood and screaming. Rinse and repeat.”
So, while many funds may have been hurt badly by the ban on short-selling, it is also true that the size of investments and the amount of leverage used has come down markedly in recent months. These steps may well prevent a large scale implosion, but they are unlikely to stem investor defections as well as a growing notion that the fat times for hedge funds and their investors are coming to an end.
Hedge fund investors are critical of the short-selling ban - saying that it will take liquidity out of the market and asking, sarcastically, if a prohibition on buying financial stocks will follow during the next bull market.
But it is also worth asking why so few were in a position to benefit from the recovery last week.
Partly this is due to an increasing propensity of funds to hunt in large packs. The strategy of betting against financial stocks had been an established money winner for so long that few funds seem to have made a countermove.
Some point to another factor: The collapses of Bear Stearns and Lehman Brothers cut close to bone. Many hedge funds had been customers and trading partners of the fallen companies and had close friends there, too, overwhelming the critical ability to think with dispassion that characterizes elite investors.
Accepted wisdom in hedge fund enclaves like Greenwich, Connecticut, and the Mayfair district of London contends that hedge fund operators benefit from volatility because they can use their smarts, flexibility and access to borrowed funds to take advantage of sharp dislocations in the market.
But what the past week has shown is that some dislocations are too much for even the best minds in finance to capitalize on.
Investors say this is because the most violent moves came in the middle of the week, catching many by surprise and laying ruin to carefully cultivated investment strategies. Indeed, the 30 percent to 40 percent increases for many financial stocks was evidence that the quick change in sentiment - the hint of a bailout fund and the ban on short-selling - caught many hedge funds with short positions, forcing them to become instant buyers.
And even many hedge funds that do not short stocks had long ago pared their holding in financial stocks. They quickly reversed course when they sensed they were moving upward.
It remains decidedly uncertain that the U.S. Treasury bailout plan and the ban on shorting financial stocks will result in a long term recovery. The financial environment for banks and brokers remains sickly - with past profit generators like trading, underwriting and advising all slumping. A new climate of regulation and increased government participation in the markets will also staunch the freewheeling actions of bankers.
“Anyone who borrows short and lends long does not have a friend these days,” said Andy Brown, chief executive officer of Cedar Rock Capital, a money management firm that does not invest in investment banks due to their use of leverage. “Has that changed? I just don’t know.”
1 comment:
Last week was too wild even for hedge funds with a taste for risk
By Landon Thomas Jr.
21 September 2008
LONDON: For the very best hedge fund managers, who reap rich fees and laurels for making bold, counterintuitive bets, the furious rally late last week in financial stocks was - in theory - a golden moneymaking opportunity.
Just before the rally took off on word that the U.S. government was leaning toward a giant bailout for holders of bad mortgage debts, fear and desperation were paramount. Morgan Stanley and perhaps even Goldman Sachs could lose their independence, traders sensed, forced to sell to an established commercial bank at a price so low that shareholders would lose billions of dollars.
It was a moment of supreme panic and pessimism, that fleeting moment of capitulation when investors give up all hope and when the few who dare jump into the fray.
One major hedge fund investor said that he had started to buy Morgan Stanley at $23 on Wednesday, convinced that the rumours of Morgan Stanley’s demise were unfounded. But as the stock began to plummet, he cancelled his trade and watched with amazement as the stock sunk to a low of $12 on Thursday.
And he stayed on the sidelines as the stock more than doubled that day and ended the week at $27.
Volumes were high, fear was higher - but conviction, the final and most crucial ingredient, was lacking.
“With this kind of fear you can’t do anything,” he said. “You never have heroes when you get these kinds of violent moves. The heroes only come out when the stock is down and stays down.”
While it is too early to know for sure, interviews with industry experts and investors suggest that few hedge funds had the foresight, dexterity and most of all the courage to counter conventional wisdom and go long on financial stocks last week.
On the other side of the equation, various large funds - no names have yet surfaced - appear to have been hit hard by having bet against financial stocks. Market participants say it was the frantic short-covering of these funds that propelled stocks upward late last week.
Insiders say that many funds lost money last week and in London some have whispered that they may sue the Financial Services Authority for temporarily outlawing short-selling against financial firms, one of their basic investment approaches.
But hedge fund investors also point out that with many funds nursing negative returns of as much as 40 percent this year, the appetite for taking bold, risky bets and losing everything has waned.
“Why would you take the risk of not getting paid 2 and 20 percent next year,” asked a hedge fund executive, referring to the lush pay scheme of 2 percent of fees and 20 percent of profits that successful hedge funds award themselves.
A hedge fund manager in New York was even blunter in conveying the sense of panic that has coursed through Wall Street in recent weeks.
“Essentially work has been like living through a financial version of ‘A Nightmare on Elm Street,”‘ he said. “There’s lots of panic, blood and screaming. You slay the evil monster, and everything is O.K. But then you wake up and there’s lots of panic, blood and screaming. Rinse and repeat.”
So, while many funds may have been hurt badly by the ban on short-selling, it is also true that the size of investments and the amount of leverage used has come down markedly in recent months. These steps may well prevent a large scale implosion, but they are unlikely to stem investor defections as well as a growing notion that the fat times for hedge funds and their investors are coming to an end.
Hedge fund investors are critical of the short-selling ban - saying that it will take liquidity out of the market and asking, sarcastically, if a prohibition on buying financial stocks will follow during the next bull market.
But it is also worth asking why so few were in a position to benefit from the recovery last week.
Partly this is due to an increasing propensity of funds to hunt in large packs. The strategy of betting against financial stocks had been an established money winner for so long that few funds seem to have made a countermove.
Some point to another factor: The collapses of Bear Stearns and Lehman Brothers cut close to bone. Many hedge funds had been customers and trading partners of the fallen companies and had close friends there, too, overwhelming the critical ability to think with dispassion that characterizes elite investors.
Accepted wisdom in hedge fund enclaves like Greenwich, Connecticut, and the Mayfair district of London contends that hedge fund operators benefit from volatility because they can use their smarts, flexibility and access to borrowed funds to take advantage of sharp dislocations in the market.
But what the past week has shown is that some dislocations are too much for even the best minds in finance to capitalize on.
Investors say this is because the most violent moves came in the middle of the week, catching many by surprise and laying ruin to carefully cultivated investment strategies. Indeed, the 30 percent to 40 percent increases for many financial stocks was evidence that the quick change in sentiment - the hint of a bailout fund and the ban on short-selling - caught many hedge funds with short positions, forcing them to become instant buyers.
And even many hedge funds that do not short stocks had long ago pared their holding in financial stocks. They quickly reversed course when they sensed they were moving upward.
It remains decidedly uncertain that the U.S. Treasury bailout plan and the ban on shorting financial stocks will result in a long term recovery. The financial environment for banks and brokers remains sickly - with past profit generators like trading, underwriting and advising all slumping. A new climate of regulation and increased government participation in the markets will also staunch the freewheeling actions of bankers.
“Anyone who borrows short and lends long does not have a friend these days,” said Andy Brown, chief executive officer of Cedar Rock Capital, a money management firm that does not invest in investment banks due to their use of leverage. “Has that changed? I just don’t know.”
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