Hedge funds: now it’s shark eat shark
The share price of Man Group, the giant of the sector, is driven down relentlessly as rivals scenting blood are selling the company short. By Louise Armitstead
LEWIS BACON, head of Moore Capital and one of London’s most successful hedge-fund managers, once described the opaque world of investment management as a game.
Hedge-fund managers, he said, fall into three groups. Those who know they are in the game, those who don’t, and those who have unwittingly become the game themselves. The last is to be avoided at all costs.
When shares in Man Group, the hedge fund-of-funds company, began to fall in April, commentators shrugged off concerns by blaming difficult market conditions. Share-price volatility was to be expected from a hedge-fund group, they said.
Six months on, with the shares down from their high of £18.51 to £13, experts say Man’s stock is suffering rather more than cyclical volatility.
It seems the world’s biggest quoted hedge-fund manager has become the victim of its own unforgiving and relentlessly competitive industry. Its share price is being driven down by a large number of short sellers.
Almost all hedge funds have suffered recently from a lack of volatility in global markets and the proliferation of new funds. As such they have been best placed to predict the downturn in Man’s fortunes. Astute managers have taken short positions to cash in on their quoted rival’s sliding share price.
Industry insiders said more and more hedge funds have been jumping on the bandwagon in the past year. According to Data Explorer, a company that gathers intelligence about short selling, more than 16% of Man’s market value is now on loan. In the past few months it has been the most consistently borrowed stock in the British market. Since hedge funds have to borrow stock to cover short positions, these figures give the clearest insight into short-selling activity.
Jason Street, an analyst at UBS, the investment bank, said: “There’s huge short interest in Man Group. It’s the most shorted stock in the UK market.”
To use Bacon’s analogy, Man has become the latest — and most lucrative — game in the hedge-fund playground despite the company’s vast size and importance.
James Chanos is the founder of Kynikos Associates, a New York hedge fund with $2 billion under management. Chanos, one of the first to spot the accounting irregularities at Enron and Tyco, was also one of the first to take a big short position in Man Group.
At first it looked like an embarrassing mistake. Man’s shares rose steadily in subsequent months from about £15 to a high of £18.
But three months ago things changed. In April, Man’s shares began to plummet. Although Kynikos’s position would have been expensive to maintain, Chanos’s firm and other hedge funds that foresaw Man’s demise were richly rewarded as Man’s stock fell.
The share-price collapse has puzzled both analysts and the group itself. Man said: “The company doesn’t know why the share price is going down.” And analysts at Merrill Lynch wrote in a recent note: “We’re somewhat bemused by Man’s recent share-price fall.”
Both analysts and Man’s management blame the poor performance of the AHL fund, the company’s core product. The fund has a trading strategy based on a “black box” system that produces data from which market trends are predicted. AHL generates more than 13% of Man’s profits, said Merrill Lynch, the house broker.
In recent years AHL has been phenomenally successful, generating annualised returns of more than 15% that have fuelled the growth and reputation of Man Group as a whole.
But in the past few months the lack of volatility in global markets has meant that AHL and other trend-spotters and statistics-driven strategies have suffered because there have been few trends to follow.
Roderick Campbell, manager at London’s Cross Asset Management and an industry veteran, said: “The black-box systems point to times when the market is likely to go up, and the traders buy, but the trend hasn’t gone very far. Then the line is crossed again the other way and traders sell, but again it doesn’t go far. Managers are paying the trading fees without benefiting from the long trends. This is not only unprofitable but also expensive.”
In the three months to the end of June, AHL lost more than 10% of its value. As with most of Man’s products and funds, a large part of the revenues generated by AHL stems from management and performance fees. As well as high front-end and exit fees, AHL charges performance fees of up to 20%. These fees have dried up recently because performance has been poor and this, in turn, has hit the share price.
AHL’s impact on Man’s share price is obvious. But it does not offer a complete explanation. Despite the drama, this is not AHL’s darkest moment. Between October 2001 and April 2002, the fund suffered a far worse collapse when it shed more than 20% of its value. Man’s share price fell, but not as much as it has this time.
Likewise, there are shortcomings in Man’s explanation that a high proportion of its stock is on loan because of “hedging arrangements used by investors in our convertible bond” and “option arrangements by long-term shareholders”.
Man admitted that its stock was being sold short, but said it did not know the extent of it.
Experts said more hedge funds were piling in, encouraged by gloomy views on Man. While analysts had predicted half-year returns of about 6% for Man, many forecasts have been revised to losses of more than 3% as a result of continuing poor performance at AHL.
One industry observer said: “There’s a joke going around that the only trend worth trading is Man’s shares going down.” |
