An independent professional's take on the latest news and trends in global financial markets

Archive for the ‘Hedge Funds’ Category

A Struggle For Hedge Funds

This item from the Financial Times caught my eye today:

Paulson & Co, the world’s third-largest hedge fund manager, has seen another painful month thanks to growing fears over the health of the US economy. The firm’s $9bn Advantage Plus fund, which aims to profit from trading corporate events, lost 4.26 per cent in August, according to an investor, wiping out gains made in July. The fund, Paulson & Co’s largest, is down 11 per cent so far this year.

Paulson & Co is far from alone in having had a difficult year. Very few hedge fund managers have reported strong performance in the past eight months.  The average hedge fund manager made just 0.17 per cent in August, according to Hedge Fund Research, and has returned just 1.29 per cent so far this year. Pressure is now on for many managers to deliver stronger returns in the next four months.

My long-held sceptical views about hedge funds as a group have not, shall we say, been tested by this latest news. The very best hedge fund managers are terrific, but they are a small minority, so you have to pick them with care (if that is, they allow you to invest with them in the first place). There is sufficient academic evidence to show beyond reasonable doubt that many hedge funds are charging very high fees for performance that they don’t really earn, while the risk-reward structure is heavily weighted in favour of the manager at the expense of the client.

Read the rest of this entry »

Written by Jonathan Davis

September 9, 2010 at 9:10 PM

Should you laugh or cry?

This story from today’s Financial Times about Citibank’s hedge fund experience is one of of those that leaves you wondering whether to laugh or cry. It is only part of the bad news story that sent shares in Citibank plunging yesterday, following the discovery that it has effectively decided to dismantle the universal banking model that Sandy Weill put in train by merging Citibank with Traveller’s 10 years ago. But it certainly deserves its own small footnote when the story of the rise and fall of the hedge fund business comes to be written.

The story says that Citigroup’s Special Opportunities Fund, where investors’ funds have been frozen since January 2008, has finally disclosed how much money will be returned to investors following the decision to wind it up last year. The amount is a princely 3 cents in the dollar – the kind of special opportunity that most of us would not wish to be offered now or ever again, thank you very much!

The story also says that in addition to the investor’s losses, Citibank itself stands to lose hundreds of millions of dollars it provided by way of financing to the hedge fund – $450m in credit lines, $320m in equity and assets with a nominal value of $1 billion. The fund managed almost $4.2bn at its peak but had a net asset value of just $58m, with debt of $880m, when the winding up decision was made in November.

“Every fund that invested in bank loans in Europe and used leverage did not survive”, the story quotes someone from Citibank as saying. “At least we are giving investors cash”. It is good to see that the cult of relative performance is alive and well; who can deny that 3c in the dollar is a better result than getting nothing back at all? But it is not quite what the hedge fund proposition was popularly held to be about in days gone by, as I recall.

The cruellest part of the joke is that this dismal performance comes from a fund that was once part of the division run by Citibank’s current CEO Vikram Pandit, who with his colleage John Havens sold Citibank their Old Lane hedge fund business for $800m in 2007. Shortly afterwards Mr Pandit was chosen as the CEO in succession to the ousted former Citibank Chairman and CEO Chuck Prince (he of the infamous “dancefloor” metaphor that marked the start of the credit crunch). The Old Lane operation was shut down last summer and $9bn of its assets transferred to Citibank’s own balance sheet with a $200m writedown.

Would Mr Pandit have got the job if his fellow board members knew then what we know now about what was going to happen to hedge funds in general, and to Citibank’s alternative asset division in particular? It must be open to doubt, despite his evidently remarkable ability to sell a dud asset for a top of the market price, a quality that may well come in handy as Citibank “desizes”. I fear however that this will not be the strangest twist of fate that will be seen before the current cycle in hedge funds has run its course.

Written by Jonathan Davis

January 15, 2009 at 1:27 PM

Posted in Hedge Funds

Madoff and the Hedge Fund Business

Here is a statistic to make your eyes water. CSFB Tremont, keeper of one of the main hedge fund indices, has removed the track record of the feeder funds that channelled money towards Bernard Madoff‘s reported Ponzi scheme. As a result the performance of the market-neutral strategy in the Tremont index has been adjusted from a gain of 0.85% (as originally reported) to a loss of 40%% for the ten months to October 2008!

The overall return from the hedge fund universe this year, according to the same CSFB Termont index, has been restated from minus 14% to minus 17%, all the direct result of the Madoff scandal. Ironically one of the biggest losers is Tremont itself, which directed some $3bn of its clients’ money into his funds. Two other big feeder funds, Fairfield Greenwich and Kingate Global, constituted a large part of the funds that were the basis for the market-neutral segment of the hedge fund index.

I have argued for several years that most of the arguments hedge funds have used to justify their place in investors’ portfolios are intellectually bogus. There are a few very talented individuals who have produced good results over many years, but the industry has become bloated with mediocrity as it has expanded so rapidly and taken in, directly or indirectly, a new breed of investors whose demand has completely outstripped the industry’s capacity for excess returns.

Shorn of the ability to use leverage, the hedge fund concept has at last been shown up for what it is: a hollow vessel. Several academics have shown that hedge fund indices consistently overstate actual hedge fund performance, and the Madoff debacle will further invalidate the credibility of the statistics. While absolute returns are a fine idea, and consistent absolute returns are an even more splendid notion, they are rarely achievable in practice.

Increased regulation is not the answer. Hedge funds worked okay when they were private unregulated pools of capital and the managers had to answer to a small group of wealthy and self-certified sophisticated investors who were deemed to be able to look after themselves. Making them mass market investments was always asking for trouble. The hedge fund model has too many intrinsic flaws to make hedge funds suitable even for most institutional investors, let alone the general public.

Written by Jonathan Davis

December 23, 2008 at 11:04 PM