For Private Use Only
(C) NY Times
By REED ABELSON
he roiling of global markets continues to claim its victims among the most sophisticated money managers, the people who manage hedge funds. While some of these managers escaped and even profited from the damage done by falling stock markets and the rush to safer investments, many are telling their investors that their funds have racked up huge losses.
John Meriwether, the former vice chairman of Salomon Inc., who founded Long-Term Capital, a Greenwich, Conn., hedge fund that employs highly specialized trading techniques, is the most recent casualty. The fund, whose partners include two Nobel prize winners and a former vice chairman of the Federal Reserve, told its investors Wednesday that its bets had wiped out about half of its net asset value so far this year.
Hedge funds, aimed at wealthy individuals or institutions to pursue a variety of investing strategies, have become increasingly popular. Despite their name, many of these funds involve substantial risk because they borrow money to leverage their investments. If those investments prove ill-fated, whether they are in Russian bonds or technology stocks, the losses can be sizable.
According to Hedge/MAR, a New York publishing company that specializes in hedge funds, preliminary results from 155 hedge funds suggest that roughly three quarters lost money in August. About 42 funds had losses exceeding 10 percent. The funds that were hardest hit, according to Lois Peltz, the managing editor, were those invested heavily in emerging markets, especially Russia.
Long-Term Capital, which now has about $2.3 billion under management, appears to have incurred the bulk of its losses when bond spreads widened between Treasuries and the rest of the market like corporates and convertibles. Those losses seem to have been magnified by the fund's use of heavy borrowing. The fund was also hurt through its exposure to emerging market bonds.
Long-Term Capital, which issued a press release, would only say that August's losses "occurred in a wide variety of strategies," involving bonds in the major industrial countries, equity-related instruments like derivatives and emerging market debt, including holdings related to Russia.
"Losses of this magnitude are a shock to us as they are surely are to you," Meriwether said in a letter sent out Wednesday to his investors. "The losses arising from the event-driven major increase in volatility and the flight to liquidity were magnified by the time of the year when markets were seasonally thin."
According to the letter, the fund is down 44 percent for August and 52 percent for the year. Meriwether assured investors that the fund "is quite liquid" and is taking steps to reduce its risk.
In addition to the high profile of some of its partners, Long-Term Capital had impressed investors with spectacular returns in 1995 and 1996. At the end of last year, saying investment opportunities were not sufficiently attractive, the fund returned about $2.7 billion in capital to investors.
"We expected that sooner or later that this good fortune could not continue uninterrupted and that we as a firm would be tested," Meriwether told investors. "I did not anticipate, however, how severe the test would be."
Including the losses this year, the fund is estimated to have had yearly returns of about 20.8 percent, net of fees, since it started in 1994. Those results are about in line with the overall market's performance.
Meriwether also emphasized that the fund believes that the current market environment is "unusually attractive." Since the fund has not bailed out of many of its positions, it could profit handsomely if its bets end up proving right in the longer term. The fund is now raising additional capital, according to the letter.
As Meriwether was also quick to point out in his letter to investors, Long-Term Capital is hardly alone in its suffering: "Investment funds widely, many Wall Street firms, and money-center banks have reported large trading losses with resulting sharp declines in their share prices."
Several large and high-profile hedge funds, including George Soros' Quantum Fund and Leon Cooperman's Omega Advisors, have publicly acknowledged losses from exposure to the Russian markets. Soros' fund, for example, said it had lost $2 billion through its investments there.
"There is a lot of blood in the streets," said James R. Hedges 4th, the president of LJH Alternative Investment Advisors in Naples, Fla.
The types of funds that appear to have done well emphasized such strategies as short selling, in which investors are betting on a drop in the price of a stock. Other funds that appeared to hold up in the current market were Julian Robertson's Tiger Fund and Bruce Kovner's Gamut Investments, according to MAR/Hedge.
The lesson to be learned, according to advisers, is for investors to understand the risks of these funds and their individual strategies. "Many of the hedge funds managers are individuals who have been successful in a bull market only," said Donald Herrema, the chief operating officer of Bessemer Trust, who advises many wealthy individuals on where to put their money.
It's the same lesson investors learned in 1994, when some of the macro funds betting on global shifts posted sizable losses, according to E. Lee Hennessee of the Hennessee Hedge Fund Advisory Group. The funds most badly hurt were those investing in the least liquid securities and using the most leverage.
And investors, many of whom have found access to these funds easier, may be a little more cautious in the months ahead."It should dampen the frenzied fascination" with hedge funds, Hedges said.
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