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Stock Ideas Investors Daily Edge Hedge Fund Inferno: September Swoon?
Stock Ideas Investors Daily Edge Hedge Fund Inferno: September Swoon? 
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| As I arrived into Heathrow Airport this Tuesday, the front page of the Financial Times was dominated by headlines trumpeting the collapse -- and subsequent bailout -- of | |
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| Hedge Fund Inferno: September Swoon? |
| Wednesday, 05 September 2007 | ||||||||
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With one trading day left in the month, the average hedge fund was down 3.2%. That put hedge funds on course for the worst month since November 2000, when they fell 3.5% in a month and came within striking distance of April 2000 when the index plummeted 3.9%. As one observer noted: "A manager who is flat in August looks like a hero at this point." For an industry that prides itself on its ability to make money in all markets, the fact that no hedge strategies performed as advertised is acutely embarrassing. Over the span of a few trading days, many computer-driven quantitative equity funds plummeted 30% or more, though the sector staged a strong comeback in the past two weeks.
Other badly hit strategies included equity long-short hedge funds, funds focused on Japan and statistical arbitrage -- the latter described as "an absolute blood-bath." Merger arbitrage and event-driven strategies, which aim to make money by betting on takeover deals, were also hard-hit as the credit crunch made it difficult for bidders to raise financing. Yet again, Mr. Market was painfully indifferent to pedigree and the prestigious marquees on the door. The biggest names in the hedge fund universe -- Goldman Sachs, DE Shaw, Tudor, Blackstone and Caxton -- all suffered. Goldman Sachs Global Equity Opportunities -- bailed out with a cash injection of $3 billion three weeks ago -- was still down 22.5% a week ago.Goldman's flagship Global Alpha was close behind at 21%, and its North American Equity Opportunities was down 15.7%. Super-quant fund, Renaissance Technologies' Institutional Equities Fund, was one of the few that redeemed itself, recovering all of its losses by the end of the month. Couple the hard times faced by the high and mighty with a handful of high-profile blow-ups, and August put the entire hedge fund industry on slippery footing. In the tradition of the Internet crash, a Web site has even sprung up to cover the travails of the hedge fund industry. While one tough month does not a meltdown make, the danger is that market mood swings can morph into financial contagion. If investors head for the exits all at once, highly leveraged funds forced to unwind their positions can trigger a fire sale of assets. Luckily, there has been little sign of widespread panic thus far. Blame for the current predicament of so many hedge funds has been sprinkled liberally from subprime lending in U.S. mortgage markets to the fundamental architecture of hedge funds that rely on statistical models that fail to acknowledge that 1,000 year storms, called "Black Swans," occur about every six or seven years.But attempts to divine the future always make for more interesting reading than those dissecting the past. Stephen Eckett, editor of The UK Stock Market Almanac 2008, recently calculated that the 36th week of the year, which started yesterday, is the single worst-performing week of the year for the share prices of top U.K. companies. Mr. Eckett calculated that since the creation of the FTSE 100 -- an index of top U.K. companies first compiled in 1984 -- the index has lost an average of 1.1% of its value in Week 36. Put another way, the index has risen in just six of the past 23 years during this week of the year. Citigroup Foreign Exchange also recently published a report in which it parsed data surrounding the crashes of 1987, 1990 and 1998. Eerily enough, it turns out that the markets all peaked on July 17. Ditto for 2007. For those inclined to accept Nostradamus-style divination. Citibank concluded that with the market averaging a drop of 21.7% during 47 trading days on two prior occasions, the sweet spot -- if this correction goes according to plan -- would be to see the DJIA at just below 11,000 on or about Sept. 19, 2007, and no later than Oct 11, 2007.And in an analysis reminiscent of the parallels between Presidents Lincoln and Kennedy, the Citibank report also highlighted commonalities between today's market and 1987: The last two years have been very good for the stock market in an extremely strong bull market that began five years ago; there is a leverage buyouts/merger mania; massive amounts of money have been raised by packaging low quality, fixed-income securities that have high interest rates due to high risk of loss; there is a new leader at the helm of the Federal Reserve; and the U.S. dollar has been declining amid concerns about the trade and budget deficits. Hedge Fund Inferno: Much Ado about Nothing? Say you were a French government official and went on vacation six weeks ago (July 23) and you got back to your desk yesterday. Glancing at your portfolio, you'd not have guessed it was a particularly difficult month for friends who, unlike you, weren't prohibited by their employer from using a Blackberry. Some stock markets in August moved around by up to 4% in a day but, by the end of the month, most markets ended little changed. The Dow Jones actually finished August higher, while European equities were pretty much flat. Most markets in Asia fell between 1% and 3% -- well within the swings of a single day's trading. Even currencies finished the month just about where they started. All the action was confined to the unwinding of short positions in the yen, pushing the Japanese currency higher across the board. Fixed income was the asset class where vestiges of the dislocation are still apparent. As investors piled into cash, yields dropped the most at the short end of the curve. Three-month Treasury yields plummeted almost 200 basis points on a single day and are now 60 basis points lower than when our iconic Frenchman went on holiday. So why the abysmal performance of hedge funds? The short answer is market panic and a jump in volatility that led to one of the many one in 1,000 year storms that pepper financial history with maddeningly unpredictable regularity. The good news? Savvy investors know that it's in these moments of dislocation that the biggest fortunes are made. And here's a tip of the hat to our not so mythical French government official. He may have just gotten it right this time. Sincerely,  Nicholas A. Vardy Editor, The Global Guru P.S. For all the hand-wringing about surrounding hedge funds, the long-term fundamentals of global megatrends sweeping the world remain intact. The global cell phone boom, the explosion in infrastructure, and the commodities supercycle are all terrific ways to boost the returns of your portfolio. Our current watch list of picks in my monthly investment service, Global Stock Investor, is packed with money-making ideas that can double or even triple the returns on your U.S. portfolio. Sign up for a 90-day trial subscription to Global Stock Investor today .
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