Archive for the 'Hedge Funds' Category

Is Another Hedge Fund In Trouble?

Kurt Brouwer March 31st, 2008

Is another hedge fund in trouble? This piece from the Wall Street Journal tells the tale. For the full piece, free registration may be required [emphasis added]:

Activist Hedge Fund Pardus Halts Investor Redemptions (Wall Street Journal, March 31, 2008, Joseph Checkler)

New York-based activist hedge fund Pardus Capital Management said it’s halting investor redemptions, at a time where many of its holdings are plummeting in value.

Pardus, which manages more than $2 billion, is currently seeking changes at several companies whose stocks it holds, most notably Delta Air Lines Inc. and UAL Corp., the parent company of United Airlines. Pardus has for months been trying to get the two airlines to merge, and both investments have been significant losers.

Pardus, which does not use leverage, is down 40% from its high-water mark in early 2007, said a person with knowledge of the fund’s performance.

“The actions we have taken will allow us to protect the funds and their investors from the external short-term pressure of the broader financial markets and focus on realizing value on our portfolio companies for investors over an extended period of time,” Pardus said in a statement. The firm is run by Karim Samii.

A person close to Pardus, which holds large positions in the 10 or so companies it invests in, said that while the fund will not be making any new investments from its current funds, it would not immediately be selling out of everything, either.

“For the portfolio companies themselves, this is good news because it reduces any market anxiety that we might have to sell shares as we will be able to maintain our investment horizons on our core positions and complete our strategies,” Pardus said in the statement.

“They don’t want to be forced to have to bail out,” the person close to Pardus said…

I hate to say it, but I imagine other hedge funds and trading desks on Wall Street may be gunning for this hedge fund’s holdings in a manner reminiscent of Hemingway’s book, The Old Man and The Sea.

In that classic, an old fisherman caught a huge fish that was too big to fit in his boat. So, he towed it behind him. All the local sharks smelled blood in the water and they pretty much ate the entire fish before he could get it to shore.

Like the sharks in that fictional account, real life traders have to know about this fund’s positions and they too must smell blood in the water. Assuming they feel that these holdings are vulnerable, they may be shorting them with a view towards forcing Pardus’s hand.

For more on hedge funds, see Hedge Fund Woes Worry Pension Plan Managers and Hedge Fund Losses Lead To Redemptions and Drake’s Halt On Withdrawals Underscores Hedge-Fund Risk.

Greenspan — We Will Never Have a Perfect Model of Risk

Kurt Brouwer March 18th, 2008

In a piece written for the Financial Times, former Fed Chairman Alan Greenspan admitted that the Fed does not always know what is going on. And, he acknowledged that ultimately the markets have to deal with financial problems such as the subprime lending mess.

Mr. Greenspan also tacitly acknowledged that he did not have a perfect — or even a good — model of risk in the housing markets. This then is probably the closest we will come to a mea culpa from the former Fed chairman [emphasis added]:

We Will Never Have a Perfect Model of Risk (Financial Times, March 16, 2008, Alan Greenspan)

The current financial crisis in the US is likely to be judged in retrospect as the most wrenching since the end of the second world war. It will end eventually when home prices stabilise and with them the value of equity in homes supporting troubled mortgage securities.

Home price stabilisation will restore much-needed clarity to the marketplace because losses will be realised rather than prospective. The major source of contagion will be removed. Financial institutions will then recapitalise or go out of business. Trust in the solvency of remaining counterparties will be gradually restored and issuance of loans and securities will slowly return to normal. Although inventories of vacant single-family homes – those belonging to builders and investors – have recently peaked, until liquidation of these inventories proceeds in earnest, the level at which home prices will stabilise remains problematic.

…The problems, at least in the early stages of this crisis, were most pronounced among banks whose regulatory oversight has been elaborate for years.

…The essential problem is that our models – both risk models and econometric models – as complex as they have become, are still too simple to capture the full array of governing variables that drive global economic reality.

I believe he meant something like this: the models we were using failed because the information that went in was of limited value so the output was not reliable. In computer programming, I believe the phrase is GIGO — garbage in/garbage out.

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JP Morgan, Fed Move To Bail Out Bear Stearns

Kurt Brouwer March 14th, 2008

It appears that Bear Stearns’ attempts to stem the tide of capital fleeing the venerable investment bank may have failed. As in other recents cases such as Thornburg Mortgage, this appears to be driven more by liquidity needs than anything else. The investment bank apparently borrowed short-term and invested or lent over the long-term.

Now, its creditors are calling in their loans and the company is scrambling to find other sources of capital. JP Morgan apparently is stepping in with guarantees of some sort from the Feds [emphasis added below]:

JP Morgan, Fed Move To Bail Out Bear Stearns (New York Times, March 14, 2008, Landon Thomas Jr.)

Bear Stearns, facing a grave liquidity crisis, reached out to JPMorgan on Friday for a short-term financial lifeline and now faces the prospect of the end of its 85-year run as an independent investment bank.

With the support of the Federal Reserve Bank of New York, JPMorgan said in a statement that it had “agreed to provide secured funding to Bear Stearns, as necessary, for an initial period of up to 28 days.”

For the next month, JPMorgan will work with Bear Stearns to reach a solution for its financing crisis. Options could include organizing permanent financing or, according to people briefed on the discussions, buying the bank for a discounted price.

“JPMorgan Chase is working closely with Bear Stearns on securing permanent financing or other alternatives for the company,” JPMorgan said in its statement.

This is not the outcome Bear Stearns shareholders would seek, but it is an example of the creative destruction of capitalism (see Paul Krugman — Capitalism’s Mysterious Triumph). Though they are different types of companies, this type of lack of liquidity led to the sale of Countrywide Mortgage (see Bank of America Snaps Up Countrywide) and no doubt it will happen again.

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Hedge Fund Losses Roil Muni Bond Market

Kurt Brouwer March 3rd, 2008

In this topsy turvy market, the historic relationship between muni bond yields and taxable yields is upside down. This article from the Wall Street Journal [emphasis added] points to hedge funds as the primary culprits for the turmoil in the municipal or tax-exempt bond market. Typically, muni bonds yields are lower than taxable bonds because they are exempt from Federal income taxes and, in some cases, from state income taxes:

Hedge Funds’ Fire Sales Send Muni Bond Yields To Historic High Levels (Wall Street Journal, March 1, 2008, Michael Aneiro, Tom Lauricella and Liz Rappaport)

“Months of turmoil in the municipal-bond market, long a placid haven for individual investors, reached a boiling point Friday — as hedge funds were forced to unwind complicated bets and in the process dump billions of dollars of the securities.

As a result of that surprising forced selling, yields on debt from municipalities and other tax-exempt issuers jumped to their highest levels in history, when compared with safe debt issued by the U.S. government. The average AAA-rated, 30-year municipal bond yielded 5.14% Friday afternoon, compared with 4.42% on a U.S. Treasury 30-year bond.

In normal times, municipal-bond yields are much lower than Treasurys, because investors don’t have to pay taxes on municipal bonds…

We previously wrote about this imbalance in the muni bond markets (see Tax-Free Muni Bond Yields Now Above Taxable Treasury Yields). Muni bonds yields have bounced above taxable bond yields a couple of times since 1990, but the situation did not last long. If history is any guide, the situation will not last that long this time either because, as we are seeing, bargain hunters are coming into the market.

“The muni market is at relative values that I have not seen in my career before,” said Evan Rourke, municipal-bond portfolio manager at MD Sass in New York. At current valuations, he said, investors can earn 5% or more on tax-exempt municipal bonds, roughly equivalent to an 8% taxable yield. “At this point, you’re approaching long-term [stock] returns.”

Brokerage firms issued all-points bulletins to their sales forces Friday suggesting they send clients into municipal bonds. One Morgan Stanley strategist described it as “the dislocation of a lifetime.” Bill Gross, managing director of Allianz SE’s Pacific Investment Management Co., or Pimco, said Friday the bond titan is moving out of Treasurys and corporate debt into the muni market…

This last part about Pimco and Bill Gross is quite interesting because it appears they are buying municipal securities in accounts for tax-exempt investors such as endowments and retirement plans. Normally, you would not do this because these entities cannot take advantage of the tax-exempt yield because these entities do not pay taxes. However, the folks at Pimco are well-known as bargain hunters and opportunistic investors (see PIMCO Buys Citigroup Bonds). So, for those investors who pay income taxes and are seeking income, this really does appear to be a buying opportunity.

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Yale Investment Pro Says, Keep It Simple

Kurt Brouwer February 18th, 2008

This piece set forth the views of the Yale University Endowment Fund’s Chief Investment Officer, David Swensen. Swensen has produced a sterling record of solid investment returns over more than 20 years at Yale. In addition, he has written a couple of interesting books — Pioneering Portfolio Management (Free Press, 2000) and Unconventional Success (Free Press, 2005). I read the first book when it came out and have read parts of the second one.

In this interview, Swensen lays out solid strategies for investing. He also contrasts the techniques Yale’s multi-billion endowment fund uses with strategies he thinks are more suitable for investors with more modest portfolios [emphasis added]:

Keep It Simple, Says Yale’s Top Investor (New York Times, February 17, 2008, Geraldine Fabrikant)

…For most individual investors, he said, copying the strategies of institutions like Yale is virtually impossible: big investors have access to fund managers and arcane strategies that are beyond the reach of most people.

“The only people who should get involved are sophisticated individuals who have significant resources and a highly qualified investment staff,” Mr. Swensen said.

This is an important point. Yale’s endowment fund has resources that most investors simply do not have — $22 billion in assets and a full-time staff of investment professionals. The article continues,

“Most people do not have the resources and time to pick market-beating managers” of hedge funds, private equity funds or funds of funds, he said. And he said that the techniques used by hedge funds often result in higher taxes than those of index funds.

So he advocates another approach, which he outlined in the book “Unconventional Success: A Fundamental Approach to Personal Investment” (Free Press, 2005). He proposes a portfolio of 30 percent domestic stocks, 15 percent foreign stocks, and 5 percent emerging-market stocks, as well as 20 percent in real estate and 15 percent each in Treasury bonds and Treasury inflation-protected securities, or TIPS.

The real estate investment can be made through real estate index funds. Though the real estate market has declined and your portfolio is below its target allocation to it, he said, don’t try to time the market. Go ahead and rebalance because no one really knows where the market’s bottom is.

Diversification will buffer a portfolio from declines in specific asset classes. For example, he said: “If the dollar declines dramatically, you have foreign and emerging-market equities. And a declining dollar may well be associated with inflation, but a diversified portfolio would include TIPS,” to provide a hedge. “That means if any of these scenarios play out, an investor has sizable chunks of his portfolio that protect against them,” Mr. Swensen said.

What he is outlining is a portfolio with 50% in stock mutual funds plus 20% in real estate funds and the balance of 30% in Treasury bonds. To put this in perspective, think in terms of the four major assets classes (stocks, real estate, bonds and cash).

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