From Alan Abelson column:
The torrents of cash pouring into hedge funds are themselves an evident and mounting problem. To put all this fresh capital to work in an increasingly crowded arena, the funds, Seth relates, are more and more piling into the same trades or abandoning their narrow areas of expertise for seemingly more exploitable markets, or even taking a fling at activities wholly alien to them like making corporate loans. In investing, unfamiliarity breeds risk, and the greater the unfamiliarity, the greater the risk.
There's also, he points out, a "change in the very nature of hedge funds -- from nimble vehicles focused almost exclusively on investing to marketing organizations with well-staffed investor-relations teams." What that means, among other things, is that where once hedge funds accepted new capital pretty much only when they spotted reasonable opportunities to put it to profitable use, today, all too often, marketing is the driver and the hope is that somehow the new money will be fruitfully employed down the road.
By no means do these snippets, however germane, do full justice to Seth's incisive survey of the hedge-fund scene. But they're nonetheless, we think, a decent sampling of an unusually provocative and knowledgeable, yet concise, commentary on a slice of the investment world that for all its importance is largely shrouded in myth and obscurity.
Seth concludes that the mania to invest in hedge funds is destined to end badly, and the only question is how it will end: "with a bang or whimper, with some sort of crash and panic, or years of disappointing results, unjustifiably high fees and eventual capital outflows."
As we said, the remarks are a year old. But, if anything, they strike us as even more pertinent today.
WHAT SPARKED OUR INTEREST in hedge funds and jogged our memory about Seth Klarman's piece, prompting us to go back and dig it out of our files, was a recent issue of MacroMavens in which proprietor Stephanie Pomboy described the big impact the hedgies have had on recent markets and what it possibly portends
More specifically, Stephanie noted that sometime around the end of October hedge-fund managers realized they were in dire peril of ending 2005 with truly crummy performance. No performance, no profits and, pretty soon, no investors. So, predictably, they decided to throw caution to the wind, banish risk and fear from their vocabularies and, as she puts it, "take their standard recipe for generating returns and kick it up a notch."
First they slathered "on an extra layer of leverage -- the secret sauce in the hamburger of hedge-fund returns." Which is why borrowing in yen, their favorite source of capital, in the past several weeks went from ''heady to parabolic." Next, they piled into an assortment of high-risk, high-return investments. And, finally, "washed it all down with lemonade."
Working on the premise that the fastest way to put some numbers on the board was to squeeze the shorts, "they set to work turning their performance lemons into lemonade." Their kill-the-shorts buying, moreover, was not confined to equities like down-in-the-dumps tech and telecoms, but reached out to such commodities as natural gas and copper.
And it worked like a charm. As Stephanie reports somewhat dryly, in terms of performance, in just a couple of months, the hedge funds may even have caught up with their mutual-fund competition.
Come the New Year, Stephanie speculates, the hedgies may resolve to reduce their leverage, unwind their bets and allow the markets to follow their natural inclinations. But if, more likely, they decide to continue their feckless ways, she reasons, their risky behavior is bound to come home to roost and their positions will be unwound for them the "hard way."
One market where they could especially come to grief is oil, which sports a record high short interest. As Stephanie notes, forecasts that the largest marginal buyer of oil -- China -- will slow (a notion that certainly helped spur short selling in crude futures) "continue to come up empty." Although the Chinese economy is woefully unbalanced and conceivably more than a little overheated, recent riots underscore that for the powers-that-be in Beijing, "an economic slowdown is simply not an option."
Stephanie divines premonitions of a credit crash, triggered by a collapse in mortgage-backed securities. On the latter score, she points out that mortgage originators are securitizing low-quality loans as fast they can; subprime lenders are shedding jobs; and insiders in both the homebuliding and mortgage sectors "are quietly streaming through the exits."
If such early tremors do, indeed, presage a serious quake, anyone leveraged to the hilt stacks up as a prime casualty. And leveraged to the hilt describes many a hedge fund perfectly. |
