Hedge funds lose 1% in April - Worst month since July 2002, tracking group

[UpInArms]

http://www.marketwatch.com/news/story.asp?guid=%7BFC98B193%2D9EE8%2D442C%2DA4E8%2D96A546675249%7D&siteid=mktw

SAN FRANCISCO (MarketWatch) -- Hedge funds turned in their worst performance in more than two years in April as concerns about U.S. economic growth hit several strategies.

The CSFB Tremont Hedge Fund Index, which tracks the performance of more than 400 managers, fell 1.04% last month, leaving it down 0.11% for the first four months of 2005.

The index hasn't lost more than 1% in a month since July 2002, when it fell 1.35%.

"April was a difficult month for hedge funds," George Van, chairman of Van Hedge Fund Advisors International LLC, a consultant that also tracks performance in the industry. "Only one-third of managers who reported to VAN were profitable."

Van's Global Hedge Fund Index, another closely watched measure of the industry's performance, fell 1.4% in April, leaving it down 0.6% so far this year.

Convertible bond arbitrage funds lost an average 3.13% in April as positions continued to be liquidated in the market, said Oliver Schupp, president of Credit Suisse First Boston Tremont Index LLC and senior member of the hedge fund investments group at CSFB (CSR: news, chart, profile) .

...more...

[KoKo]

1. Should I be concerned that only the very wealthy are probably in these

funds and that if they lose their millions and the Hedge Managers reaps the rewards and cut out of town with the bags of $$$$$$$$$$$$$$$'s(well out of the Caymen's and elswhere) that I should be shedding tears about these folks?

Or, is the bigger problem that we, taxpayers will be left footing the bill for the failed Hedge Funds along with the Corporate Pension Funds which have no funds...and that this might end up being bigger than the Savings and Loan Crisis in the early 90's.

I just don't see that we taxpayers being "Home Equitied and Mortgaged to the hilt with our Vacation Homes and other Luxuries bought at Walmart will really be able to "Bail Out" these folks one more time.

But, then, everything's possible in this "Topsy-Turvy" world. :shrug:

[FogerRox]

2. the notational value of Hedge Funds worldwide is well over 200

trillion.

A crash would fuck you up like yoda in star wars.

AMerican banks have IIRC over 70 trillion in loans to hedge funds.

See the light now?

[KoKo]

13. I think I saw the light in my post...

:D

[UpInArms]

4. it impacts the dollar - which will reverberate throughout

everyone's wallet

Hedge Fund Worries Pressure Dollar

http://smartmoney.com/bn/ON/index.cfm?story=ON-20050510-000547-1020

NEW YORK (Dow Jones) -- The dollar dipped against the yen and euro in New York Tuesday, pushed down by talk in the market of troubled hedge funds.

Action Economics said the talk may have been sparked by a press report suggesting the rapid expansion of the hedge fund industry has made it difficult to make profitable trades, as evidenced by the Hennessee Hedge Fund Index registering a 1.6% drop for the year on Monday.

Speculation in Europe and New York trading rooms suggested that some funds may have been caught out by exposure to General Motors bonds following their credit rating downgrade last week. There was also talk of funds taking a hit from exposure to scandal-tainted American International Group.

...more...

[Lucky Luciano]

7. Any insitutions short

a lot of credit derivatives contracts on GM got hurt badly.....

Probably anyone who sells credit derivatives (read: insurance on corporate debt) got hurt badly.

[UpInArms]

8. hedge funds are dancing around like chickens with their heads

cut off.

http://www.thestreet.com/_googlen/comment/nickgodt/10223739.html?cm_ven=GOOGLEN&cm_cat=FREE&cm_ite=NA

excerpt:

But even as hedge funds faded from the headlines -- at least for one day -- it appears that their current positions are behind market developments in oil, Treasuries and tech stocks.

Hedge funds are rumored to be behind ongoing weakness in the price of crude oil as they unload long positions in crude to make up for losses related to the trades they placed on General Motors (GM:NYSE - commentary - research) stock and bonds. On Monday, crude oil touched $48 a barrel earlier in the session, before bouncing back and closing down 6 cents at $48.61 in Nymex trading.

Perhaps of more direct interest to investors, hedge funds also could involuntarily push a short-term rally in tech stocks, which are poised to rally "more than investors may expect," according to Merrill Lynch strategists.

Why? Just like the "crowded trade" over General Motors that led to some massive movements in GM stocks and bonds, there is currently another "crowded trade" in tech, says Mary Ann Bartels, global equity trading strategist at Merrill.

The sector, for starters, is smack full of short positions by hedge funds. Recent indications show the net long position in Nasdaq 100 futures by large speculators -- i.e., hedge funds -- are in fact at historical lows.

...more...

[Rockerdem]

11. Does that mean that they are betting on a bad economy & wrong?

If they are too pessimistic about tech and oil, that must mean things are better than they think, right?

[UpInArms]

12. here are the basics on shorting stocks

http://beginnersinvest.about.com/cs/newinvestors/a/022703a.htm

The Basics of Shorting Stock
I own 10 shares of company ABC at $50 per share. You believe the stock price of ABC is grossly overvalued and is going to crash sometime soon. You are so convinced that the stock will crash, you come to me, and ask to borrow my ten shares of ABC and sell them at the current market price for $50. I agree to lend you my shares as long as you pay me back ten shares of ABC at some point in the future. You take the ten borrowed shares, sell them for $500 and pocket the money (10 shares x $50 per share = $500).

The following week, the price of ABC stock falls to $20 per share. You call your broker and tell him to buy 10 shares of ABC stock, at the new price of $20 per share. You pay him the $200 (10 shares x $20 per share = $200). A few days later, you pick up the shares of ABC and bring them by my office. "Here are the ten shares I borrowed," you say as you put them on my desk.

Do you see what happened? You borrowed my shares of ABC, sold them for $500. The following week, when ABC fell to $20 per share, you repurchased those ten shares for $200 and gave them back to me. In the mean time, you pocketed the difference of $300.

The Speculative Nature of Shorting Stock
What if the price of ABC stock had risen? The person shorting stock would have had to buy back the shares at the new, higher price, and absorb the loss personally. Unlike regular investing where your losses are limited to the amount of capital you invest (e.g., if you invest $100, you cannot lose more than the $100), shorting stock has no limit to the amount you might ultimately lose. Famed investor Ben Graham told us there is nothing stopping an overpriced stock from becoming more overpriced. In the unlikely event the stock had shot up to $1,000 (which actually happened to shares of Northern Pacific during a short squeeze in 1902), you would have had to purchase ten shares at $1,000 a share for $10,000. Taking into account the $500 you received from selling the shares earlier, you would have lost $9,500 on a $500 investment.

Some investors practice shorting stock as a hedge to protect their portfolio. In most cases, this is not required nor recommended for individual or institutional investors. If you have selected a company you believe has excellent prospects for the next decade, you should view a declining market as an opportunity to purchase more of a good thing, not something to be dreaded.

...more...

[UpInArms]

9. also wanted to add one more paragraph

from the article referenced above:

That means the U.S. trade deficit is now being financed in large part by hedge funds -- not a very reassuring trend, if the recent impact of the GM story is any indication of the destabilizing impact that hedge funds can have on markets.

[K-W]

5. If the corporate sector cant produce a profit, it shuts down.

It is depression we are talking about here.

If the wealthy divest from production the wheels fall off the truck.

[Lucky Luciano]

6. Long Term Capital Management

was of course one of thie biggest debacle for hedge funds a few years ago. The Fed *HAD* to bail them out.

The fund was run by Nobel Laureates Scholes and Merton and so people trusted they would do a good job...they did not....

They placed far too many bets on emerging market debt (Their Russian debt defaulted - Argentinian debt went to hell...European bonds did not converge on the introduction of the Euro as quickly as they had expected and in fact they divereged viciously before converging -all of this done with derivatives too which made the moves that much mroe vicious)....they were in fact correct about some of their ideas in the long term (not with Brazilian, Argentian, or Russian debt though!), but their bets were so big in the short term that they could not weather the storm....an even bigger problem was that their brokers, in order to attract their business, did not require them to put up margin on their highly leveraged bets....They leveraged 4-5 billion into well over a trillion bucks! They had 5% of the notional amounts in interest rate swaps in their portfolio!!!!!!!!!!!!!!!!! (The total market for swaps is about $25T in notional amounts).

When they made bets, many other large institutions folowed suit because they wanted to be on the same side as the Nobel Laureates...The end result is that they had all cornered many markets....which is bad....As Paul Wilmott said, "It is one thing to corner the market in something that is a necessity like beer, but when you corner a much more obscure market, you are a sitting duck when you want to sell."

With all those depending on LTCM to be able to pay them for being on the opposite side of their derivatives and swaps trades this could have been a disaster....a chain reaction would have started where those *needing* LTCM to pay them and not paying them would have forced those expecting to be paid to not be able to meet their obligations - etc etc etc...it would have hurt the average person eventually....The Fed had to bail them out.

Those responsible should have been jailed though - not the Nobel Laureates, but the brokers that allowed these bets to be made without margin.

[Lucky Luciano]

3. It really is hard to be a hedge fund these days

Gone are the days of Ed Thorpe's revolution when he started the first quantitatively based hedge fund in 1969 doing convertible arbitrage.

There are just too many hedge funds and proprietary trading desks for large banks with zillions of math, physics, comp sci PhDs writing great programs to find - and thereby eliminate arbitrage opportunities immediately. The market is too efficient now with all these computers constantly running to price derivatives and what not.

Now they do a lot of statistical arbitrage - a fancy word for technical analysis if you ask me - albeit with mroe significant mathematics behind it.

Market inefficiencies still exist but it is buried deep in the mathematics of derivatives. I think there are still a lot of opportunities in credit derivatives because these are still poorly modelled. Another area on a more fundamental scale could be to do a significant revision of the Black Scholes model for options pricing. It is based too heavily on modeling stock pirce movements by a concept known as geometric Brownian motion - which is flawed as it does not account for the frequent crashes (frequent relative to what a log-normal distribution would lead you to believe)....However, even if GBM is a good enough model, we still suck at modeling volatility and if you do not get volatility right, everything gets fucked up - unless you hedge your volatility risk well with a varaince swap or an option to purchase a variance swap...


All that said, the big reason for hedge funds not performing well is the lack of volatility in the markets. The SP500 has options trading at 13% implied volatilities which is definitely very low and hedge funds feed off of volatility.

[AP]

10. What do you do for a living?

Just curious.

[Lucky Luciano]

15. You can probably guess

I do a lot of quantitative work in finance. The sort of stuff you might find over at:

http://www.nuclearphynance.com

or

http://www.wilmott.com

I like the first site better because there is a good noise to signal ratio over there and the people on that phorum are of the rebellious nature - along with there being more PhDs to talk on a very high level.

[KoKo]

14. But our markets HAVE been very volatile...are you saying the spread is

still too thin for the Hedges to make money off? I thought Hedges made money off of the "thinnest to the most wide swinging" and that was the purpose of "hedging" in the first place. :shrug:

[Lucky Luciano]

16. Hedge fund is somewhat of a misnomer

The markets have not been volatile. How long has the Down been stuck between 10,000 and 11,000? How long has the NASDAQ been near 2000? There has been very little variance....back in 1999-2001 the volatility was through the roof though....too bad I was not finished with my degree to play back then!


************************************


The perfect hedge is one in which you are guaranteed to earn a certain return. In order for arbitrage to be eliminated, that return has to be the risk free interest rate....so one might as well just buy government treasuries if they want to do that. Arbitrage opportunities do pop up where one can make more than the risk free rate without taking any risk. In these situations, it is best to borrow money at the risk free rate and squeeze out the maximum profit you can - and then returning the borrowed money plus interest - keeping the profit. The process by which you form the position that earns this greater than risk free rate will eliminate the arbitrage as you should continue to set up the position with a lot of buying and selling of the related securities until the arb opportunity is gone. I have obviously left out a lot, but this is what large hedge funds try to do.

Also, they do speculate by temporarily removing their hedges sometimes.

e.g.

You could be short a call option to buy 100 shares of IBM for $75. IBM is just under $75. This means (I am leaving out a lot here) that for every dollar that IBM goes up, the call option will go up about 50 cents - we would say the "delta" is 0.5. So, you would lose $50 by being short the call for every dolalr that IBM goes up. You hedge that risk by being long 50 shares of IBM. This strategy - along with the appropriate premium received for the option is a perfect hedge, but there are a lot of assumptions made that make it less than perfect...for example the delta changes continuously, so you have to continuously rebalance your portfolio of hedged securities which is obviously impossible - plus transaction costs are tough to deal with, the model completely screws up with stock price movements that are discontinuous - big jumps or crashes for example etc...plus the stochastic model for stock price movements, while being pretty good, is definitely flawed. I could go on and on and on because the stuff is fascinating to me. I love mathematics and there is some very deep math in finance, particularly as it relates to derivatives....

Sometimes traders remove these hedges to speculate.

[KoKo]

17. When it's that complicated though, it does mean that a "deviance" like

GM's and United's Pension Funds getting passed over to the Government can cause variables to mess up the models.

Thanks for your analysis. And, I can see you love the math and modeling of the data. But, "variables and vagaries" of events out of one's control can always come in and mess up even the most perfectly managed mathematical models. I would assume that "hedging" is supposed to take care of this those variables beyond control but often can't anticipate
a "curve ball."

:shrug: