Hedge Fund Heave-Ho?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

A
buddy of mine who is a broker typically calls me after the close to ask me my thoughts on the markets. "So what do you think?", he
asked, to which I replied "as long as they keep buying the dips, this
market is heading higher."

Fellow bloggers, you know I admire
you, but sometimes I read stuff that makes my eyes roll back and want
to hurl. While part of me agrees that this bear is not for turning,
the world is awash with liquidity. I am not a perma bear or a perma
bull, I just concede to the fact that the banksters on Wall Street -
the very same ones that manufactured this crisis - are printing money
and they are flush with liquidity which they are using to trade away in
their capital markets operations.

Apart from the banksters, you
got their favorite clients, the Masters of the Universe, the elite hedge
funds that are also making a killing in these volatile markets. They
are buying the dips too, knowing full well there is a lot of performance anxiety out there.

So where did the top hedge funds make money? Where else? According to Reuters, hedge funds bet big on Bank of America:

At
least 20 top hedge funds boosted their positions in financial
institutions in the latest quarter in a sign that Wall Street is ready
to bet on more risky sectors in the hope of longer-term rewards.

The
push into financials indicates that fund managers including Steven
Cohen and John Paulson, who are watched closely as barometers of risk,
have shifted from routine merger arbitrage plays to directional bets
that have more potential.

The
aggressive switch was given credence by stress tests conducted by U.S.
regulators that underscored the underlying health and viability of
banks -- if they could raise capital.

Low
stock prices also made banks a safer play, even if their profitability
was still in question, said James McGlynn, manager of the Calvert Large
Cap Value fund.

"It's a
fundamental bet that they won't go to zero, and that liquidity will
come into the system" over time, said McGlynn, whose fund owns shares
in Bank of America(BAC) and JPMorgan (JPM). Big banks have "breathing room," he said.

Positions
in big financials such as Bank of America and JPMorgan Chase stood out
among the holdings of hedge funds in the second quarter, according to a
Thomson Reuters analysis of regulatory filings.

The
group of 30 hedge funds in the analysis increased their exposure to the
financial sector by 56 percent to $59.5 billion (36.9 billion pounds)
in the second quarter compared to the first.

Filings
showed at least five of the top funds bought into Bank of America, led
by Paulson's purchase of 168 million shares. Shumway Capital Partners,
run by Tiger Management alum Chris Shumway, bought 24.1 million shares
and Timothy Barakett's Atticus Capital bought 26.9 million.

Notice
that these hedge funds did not "hedge" in the second quarter; they took
directional bets and bet on financials in a big way. Keep that in mind,
because when I tell you most of them are charging alpha fees for beta,
that's exactly what they're doing.

The top hedge funds, like Soros Fund Management, are soaring while rival firms shrink:

Soros
Fund Management had $24 billion in assets at the start of July, up more
than 14% from the end of 2008 and more than 41% from a year earlier.
That made the firm the fifth-largest in the hedge fund industry, up
from sixth at the end of 2008, AR said.

Soros was one
of the few investment managers to foresee the global financial crisis
that erupted last year. As markets collapsed, he stepped back into
trading, helping the firm's flagship Quantum Endowment fund gain almost
10% in 2008. This year, the fund was up almost 19% through the end of
July, AR reported.

Another manager who saw trouble
ahead was John Paulson, head of Paulson & Co. After generating huge
gains in 2007 from bets against mortgage-related securities, Paulson
continued his winning streak in 2008, partly by betting against
financial institutions.

This year, Paulson bet big on
gold and has taken large stakes in Bank of America and Citigroup . His
funds were up as much as 16.38% through the end of July, AR said.

Despite
those gains, Paulson's assets under management still dropped more than
6% to $27.2 billion this year as investors redeemed some of their money
to rebalance portfolios to avoid being too concentrated in certain
funds and strategies, AR said.

Paulson is the third-largest hedge fund firm by assets, maintaining its position from the end of 2008, AR noted.

Bridgewater Associates, run by Ray Dalio, remains the largest hedge
fund firm in the world, overseeing $37 billion in assets at the start
of July. That was down more than 4% from the end of 2008, AR said.

The asset-management division of J.P. Morgan Chase remains the
second-largest hedge fund business, with $36 billion in assets, up 9.4%
from the end of 2008, AR said.

D.E. Shaw Group
remains in fourth place with $26.7 billion in assets. That was down
6.6% from the end of 2008, AR said.

The
asset-management division of Goldman Sachs ranked sixth, up one place
from the end of 2008. Assets under management inched up to $20.8
billion, AR said.

Och-Ziff Capital Management was
seventh in AR's rankings. The firm, run by Dan Och, lost 6.33% of
assets in the first half of 2009, bringing its total to $20.7 billion,
AR said.

Baupost Group, run by Seth Klarman, became
the eighth-largest hedge fund firm, with assets of $19 billion, up 13%
in the first half of 2009, AR said.

Farallon Capital
Management, headed by Thomas Steyer, saw assets fall 10% to $18 billion
in the first half of this year. That left the San Francisco-based firm
ninth in AR's rankings.

Angelo, Gordon & Co.,
Avenue Capital Group and Renaissance Technologies tied for tenth in
AR's rankings, which $17 billion in assets.

Interestingly, Reuters reports that Och-Ziff funds have recouped most of 08' losses:

Hedge
fund firm Och-Ziff Capital Management's funds are delivering
double-digit returns and have mostly recouped last year's heavy losses,
allowing the industry titan to soon begin charging incentive fees again.

The New York-based firm's flagship OZ Master Fund, Ltd gained 17.06
percent in the first eight months of 2009 after having lost 15.9
percent last year when most hedge funds suffered heavy losses during
the financial crisis.

But not all large hedge
funds are doing well. In fact,last year may have been the worst ever
for the global hedge fund industry, and it’s doubly true for the funds
of hedge funds who suffered huge outflows:

The
redemption crises that struck many single-manager funds were amplified
by the run on funds of funds, which in turn filed their own withdrawal
requests with their underlying manager. It’s no surprise, then, that 42
of the 50 largest fund of funds firms in the world saw their assets
drop, some dramatically so.

Amidst the carnage, UBS’ Alternative
and Quantitative Investments remained the largest fund of funds shop
with $31.4 billion, according to the Hedge Fund Journal’s
Fund of Hedge Funds Global 50. While it holds the top spot, 2008 was
not a good year for the UBS group, as its assets under management
plummeted 32.6%.

One of the six funds that actually reported an
increase in assets—two declined to provide earlier figures—Blackstone
Alternative Asset Management was second, adding $5 billion in new
assets since Sept. 30 to reach approximately $25 billion.

As
for the rest of the top five, it was a bloodbath representative of what
the rest of the industry suffered. Union Bancaire Privée shed 27.8% of
its assets, leaving it with $23.8 billion. Man Investments dropped
46.3% to $23 billion, while HSBC Alternative Investments dropped 51.9%
to $22.27 billion.

(click on image below)

Another well known hedge fund that suffered massive redemptions, Cerberus Capital Management, is looking to start two new funds with a three-year lock-up:

Cerberus
Capital Management is making sure it never again suffers a redemption
crisis like the one in which it is currently enmeshed. The New
York-based alternative investments firm will impose a three-year lockup
on two new hedge funds it aims to launch later this year.

Cerberus
hopes to raise several billion dollars for its Cerberus Partners II and
Cerberus International II, successors to its current hard-luck funds.
Investors in the existing funds are pulling more than 70% of their
assets after they lost nearly 25% last year on bad bets, including
Cerberus’ ill-fated takeover of Chrysler.

The long-term lockups are Cerberus’ way to make sure that never happens again, according to the Financial Times.

But
many of the firm’s redeeming investors balked at a lockup, demanding
quarterly liquidity to join the new funds, Cerberus said last month.
Mark Neporent, the firm’s chief operating officer, said investors
holding about 60% of the fund’s total assets were moving their money
into a liquidation vehicle that will return capital over the next three
years. The rest are moving to the new fund, lockups and all.

Investors
are right to balk at any three-year lock-up. In these markets, I
wouldn't lock my money up for three months, let alone three years.
Cerberus is one of the best distressed debt funds, but if they want a
three-year lock-up, they should dicusss this with the private equity
managers at the large pension funds, not the external hedge fund
managers.

Right now, investors are clear of what they want from hedge funds, and it looks like transparency is surpassing performance as a criterion for choosing a hedge fund:

Despite
hedge funds returning to positive performance, we believe investors
will be looking at more than just returns in the future. The recent
market crisis highlighted four factors of increased importance.

Most
rated hedge funds with a 10-plus year history have generally understood
that they can succeed or fail by leverage -- borrowings or embedded
leverage in instruments that can magnify both gains and losses -- and
have accordingly used it sparingly. Some funds have come to shun the
use of leverage altogether because of its inherent risk. We have seen
funds with historically low leverage [1 to 2 times total assets to risk
capital] reduce it even further as a result of the experience of the
past 18 months. As we note in our rating criteria, with high leverage
comes the high likelihood that cash flow will be insufficient to cover
costs and adequately compensate key employees, leading funds
potentially to close, if not default.

We
evaluate the level of leverage in a fund from an absolute basis -- the
debt-to-equity ratio -- but also adjust this ratio based on several
factors, including embedded leverage of the instruments and the
volatility of the asset values. In general, we believe investors will
be more attracted to hedge funds that use low to modest balance-sheet
leverage relative to their investment strategy in conjunction with a
strong risk management system, which should enable them to respond to
market changes more promptly.

Building Investor Goodwill

As with leverage, investors will likely increasingly judge a hedge fund
based on the transparency of its dealings with all its business
partners. As we note in our criteria, the highest-rated funds are those
that provide the greatest transparency and demonstrate the most
developed infrastructure and culture of risk controls. At the most
basic level, we look for management's willingness to communicate and
seek ways for investors or service providers to attain the assurances
they need. In some instances, managers have achieved this by engaging
agreed-upon procedures with an independent third party such as an audit
firm. Where a sensitive matter such as investment strategy is
concerned, funds may use dated examples to bring across the relevant
points in public statements. In some cases, we've observed funds create
investor letters with sufficient detail that investors can adequately
judge the merits of performance and risk attribution.

Many
funds have realized that the benefits of being transparent outweigh the
potential cost from the outset, enhancing investor goodwill. After all,
during times of uncertainty, such as the recent financial crisis,
investors' focus seems to shift to return of capital from return on
capital.

Investors
have become wary of hedge funds' use of gating, which can limit the
amount of total outflows that can occur at a given time. Historically,
gates were used to benefit investors by preventing them from exiting en
masse, which could cause the fund either to collapse or to sell assets
in a down or illiquid market. Investors understood that management
would only gate if it intended to regain its prior years' losses, or a
"high water mark." It expected the fund to make the money back or shut
down and pay it back to investors. However, some hedge fund managers
used gates because in the lead-up to the crisis, what they believed to
be liquid investments turned out to be less so, and that caused
managers and investors great losses. Funds also used gates to provide a
safety net for the fund's own liquidity shortfalls.

Whatever the reason, when hedge funds closed the gates of hedge hell, they lost a lot of good-will. Moreover, the flip-side of transparency is liquidity, which is why 2008 spelled the death of highly leveraged illiquid strategies.And mark my words, the brutal shakeout in the hedge fund industry is not over.

For
those investors who were caught out by the lack of liquidity and
transparency in their holdings in 2008, managed accounts can address
these issues, as well as the more publicized fraud concerns. But I
agree with Christopher Rose of Clear Lake Consulting Group, managed accounts for hedge funds are not a panacea.

Some
large investors are opting for the traditional fund of funds route.
According to Bloomberg, China Investment Corp. (CIC), the country’s
sovereign wealth fund, is continuing to shift its investments away from
cash and is investing billions in hedge funds and private-equity funds:

China
Investment has invested “many times” the $500 million that CIC was
reported to have placed in hedge funds and private-equity firms in
June, Lou said today in an interview in Beijing. He said China
Investment was also investing in fund-of- funds.

Lou
said Beijing-based CIC’s performance this year “has not been bad”
following last year’s 2.1 percent decline in its global investments. He
didn’t elaborate. China Investment Corp. had $297.5 billion in assets
and had 87.4 percent of its global portfolio invested in cash and cash
equivalents at the end of last year, the fund reported earlier this
month.

In December, Lou said he didn’t “dare to invest
in financial institutions” after losing money on investments in
Blackstone Group LP and Morgan Stanley. CIC raised its stake in Morgan
Stanley in June by buying an additional $1.2 billion of shares.

CIC aims to allocate $6 billion to hedge funds by the end of 2009, company adviser Felix Chee
said in June. Chee, who is a special adviser to the chief investment
officer of CIC, said he will initially run CIC’s hedge fund and
proprietary trading effort.

According to Dealscape, In June, CIC put $500 million into a Blackstone hedge fund unit and bought another $1.2 billion of Morgan Stanley's stock.Moreover, according to Reuters, the CIC will increase new overseas investment this year by around 10 times from the previous year
on signs the global economy has bottomed out, one of the organization
top managers said in an interview with Japan’s Asahi newspaper.

Like
I said at the start of this post, the world is awash with liquidity, so
keep buying them dips and pay attention to the hedge fund heave-ho. It
looks like things are getting bubbly all over again.

Comments

[walküre]

from REUTERS:  Speculators trim short dollar positions-CFTC

NEW YORK, Sept 4 (Reuters) - Currency speculators trimmed
their bets against the dollar in the latest week, according to
Commodity Futures Trading Commission data released on Friday.

The value of the U.S. dollar's net short position edged
down to $12.31 billion in the week ending Sept. 1, from a net
short position of $13.8 billion the prior week.
Bets in favor of the euro were cut nearly in half while
bets against sterling were increased sharply. However,
speculators also more than doubled their long yen position.

Being long a currency is a bet it will go up, while being
short is betting on a decline.

The aggregate U.S. dollar position is derived from the net
positions of International Monetary Market speculators in the
yen, euro, British pound, Swiss franc, Canadian and Australian
dollars.

********

Take it for what its worth.

This action despite a "run on gold".

How much paper debt is on the table going forward this year?

About one trillion or so in Treasury debt alone?

Bullish on Dollar, bearish on Euro, long on Yen.

Boo-Yah!!!! /sarc

[walküre]

Labour Day weekend ahead.

Markets up on improvements in the economy that had been factored into the market since March.

Oil is not making higher highs although gold exposed weakness in the Dollar and a flight to quality. BDI index is depressed.

Call it what you want, I call bullshit.

Fool me once, shame on me.

Fool me twice...

Nothing has changed. The crooks are still in the game to fleece the dumb sheeple investors. Calling CNBC educated Americans "retail investors" is a joke.

Labour Day weekend ahead.

Dear Leader speaking to all school kids on Tuesday.

Happy thoughts, y'all

[Leo Kolivakis]

Daedal,

Go back to read my Outlook 2009: post-deleveraging blues. You will see that I was not recommending financials and I still have a hard time recommending them today. The thing I missed was that by lowering the interest rates to historic lows, and keeping them there for a long time, the Fed is giving the banks a license to print money. A buddy of mine who works in a treasury department tells me "It's all about spread". "Banks borrow at next to nothing and they trade away in their capital markets operations...they're printing money."

In that post, I also discussed the findings from Jonathan Nitzan and Shimshon Bichler in their paper called Contours of Crisis: Plus ça change, plus c'est pareil?. This is an excellent paper and shows you in real terms, the devastation that was done in the FIRE sector (finance, insurance and real estate) was unprecedented. It doesn't mean it can't go lower, but it tells you that we had a massive correction in that sector.

A few months ago, I wrote about why small is beautiful. I like to track what the top hedge funds are buying, even it is lagged data. It gives me clues into how they position their portfolios.

Nobody really knows where we are heading, but it's important to remember that we averted a "manufactured calamity" and the liquidity in the system has to show up somewhere.

I do not get too excited about one day selloffs. I need to see a really bad week before I get worried that something is up.

cheers,

Leo

[Leo Kolivakis]

What tells you this will not go exponential going into the new year? I have seen liquidity steamrollers before and they decimate value-minded portfolio managers. Be careful with all the gloom & doom because if you keep waiting for the BIG CORRECTION, you'll be left holding your balls.

cheers,

Leo

[Daedal]

TD posted a video of Bernanke yesterday, when talks of a housing bubble existed in 2005. It took several more years for the bubble to explode. No one knew when it would explode, and that's my point.

Bank shares may indeed keep going 'up', against their true valuations, until they don't. By all means, if retail investors have the delusion and/or the testicular fortitude to play that game, then by all means they should parttake. But before they do, perhaps they should revisit 1999, and remind themselves of important lessons learned, and now forgotten. Retailer investors chased returns, and got burned.

I see the same lunacy going on today, which I think is only being perpetuated by opinions similar to yours, which are circulating all over, and could even be classified as a 'self-fulfililng prophesy'.

Many casual acquintances I know are buying Citi, AIG, and the likes, for 2 reasons: these bank stocks keep making new highs and all news networks report great economic news on a daily basis. http://newsfrom1930.blogspot.com/

[i.knoknot]

"... you'll be left holding your ..."

hell, that's the only place where fundamental analysis has held out for me...

(good advice all the same - thanks for the article. :^)

[pm69]

I agree... the hedge funds may very well be selling now.
The average duration for holding securities now is less than 6 months.
Useless article.

[Daedal]

All those Hedge Funds piled into financials several months ago. Who's doing the piling in now? The 'dumb money' buying on dips? 

The problem with that advice is that when a dip turns into a fall, dumb money will be the last to get out. This 'buy on dips' advice would've been useful back in March. Whoever wants to buy financials now b/c some hedge fund manager bought them several months ago is a fool onto whom the aforementioned hedge funds will eagerly unload their positions.

Edit Addition:

The article above reminds me of the guy who collects Andy Warhol paintings and overbids by hundreds of percent above 2nd highest bid (http://www.artnewsblog.com/2008/01/art-collector-with-800-andy-warhols.htm), and then tries to convince himself, and others, that it's worth that much. He is his own 'greater fool' -- replace 'Warhol Paintings' with 'Bank Stocks', and I get the notion that the author and/or hedge funds are playing the same game with themselves, blog readers, and market participants.

[market folly]

Very prudent thing to highlight Daedal.  The time lag is a large detractor here and as such all these things should be taken with a grain of salt.  Undoubtedly, some hf's have at the very least taken some profits while others may have unloaded entirely.  Reason we monitor it though is that you see a fund like Paulson & Co who is buying & appears to be accumulating for more than just a trade.  If he's going long distressed securities and started a real estate recovery fund, I doubt he would be just purely trading those, no?  After all, in Q2 he was buying BAC and GS and all those other banks.  Then, just in the recent weeks it's rumored that he's apparently bought C and then bought into the BBT follow-on offering as well, even after the rise.  So while certainly some managers played it as a trade, it will be interesting to see who continues to hold.  It's all situational for each hf and we're just watching it out of sheer curiosity more than anything.

Completely agree though that those rushing in to buy purely after the fact could possibly regret their lemming behavior.

Jay

@marketfolly

[Anonymous]

you've been duped it's not a liquidity issue, it's a solvency issue.
no amount of printing money will change it, ever.

short XLF

[Groty]

Citi announced it would make a pre-provision profit in Q1, BAC followed a couple of days later, then Bernanke went on 60 Minutes and declared no big banks would fail AND he was seeing green shoots in the economy.    All those events happened in the first two weeks of March.  It took the nationalization risk being promoted by Ritholtz, Krugman, Roubini, and Stiglitz off the table. 

It was like ringing the proverbial bell at the bottom that everyone claims never rings.

[i.knoknot]

that was all only days from when Obama said 'looks like a good time to get into the markets to me...'. a few days later... it was. coincidence? i think not.

(it's killin me, not to mumble something about the 'messiah'... but i'll be strong and hold my tongue... this is a financial blog after all :^)

[Leo Kolivakis]

Thanks Jay,

I enjoy reading Market Folly too and made a mistake not seeing that the big hedgies were all going long financials in Q2. Going forward, things are getting tougher, however, and I suspect many will look into other sectors including tech and alternative energy.

cheers,

Leo

[Hephasteus]

They'll crash the financial stocks when the plug is pulled taking the rich people who give them money to the slaughter house. AGAIN.

[market folly]

We've noticed this phenomenon as well since we track hedge fund portfolios on our blog on a daily basis.  The amount of funds that entered BAC (and other financials in general) was truly astonishing.

While you can't track their shorts from SEC filings, you can at least get a glimpse at some of their longs and it's good to pay attention to when long US equity exposure levels rise and to which sectors they've allocated to.  The ripe buying in financials was a telling move since you saw so many funds flock to it.

Here's an example from our hedge fund portfolio tracking series for those interested: http://www.marketfolly.com/2009/08/dan-loeb-buys-bank-of-america-bac-add...

and also an interesting read from Goldman Sachs:  Their hedge fund trend monitor report where they aggregate what funds have been buying and guesstimate what they have been shorting: http://www.marketfolly.com/2009/08/hedge-fund-trend-monitor-goldman-sach...

Nice summary Leo, we've enjoyed reading Pension Pulse, thanks.

Jay

[Hephasteus]

Hedge funds are speculative tool during a bubble market used to create the eventual collapse. Once the collapse hits they have to either realize they serve no useful purpose to the powers that be and take thier shrunk worth home or find someplace else that is being bubbled. Hedge funds helped to create the collapse their job is done. Trying to run around get the money back is contrary to thier destructive purpose in the financial world.