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Hedge Funds: "It’s a bloodbath"

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A colorful story in the Telegraph, “Hedge fund legends hit by financial crisis,” tells of the fall from grace of many former hedge fund stars. And the worst is yet to come.

While the broad outlines of the story are well known – many formerly successful strategies are doing badly, with highly levered funds suffering the most – the Telegraph story gives it a great deal of color via lively anecdotes and quotes. Most US readers do not realize that London is the world’s hedge fund center and the excesses make Steve Schwartzman’s 60th birthday party look tame.

From the Telegraph:

Even for the affluent residents of London’s Holland Park, the arrival in the area last year of Gerard Griffin, head of Tisbury Capital, was big news. Curtains twitched as a multi-million-pound refurbishment of his house began…

To the neighbours, the house had been “hedged” – snapped up and spruced up by a rich hedge fund manager. These flash Wunderkinder are branching out, and surpassing toffs, lawyers and even footballers’ wives with their reputation for ostentatious opulence.

As head of Tisbury, a $2.7bn (£1.35bn) event-driven fund founded in 2003, Griffin was the archetypal hedge fund manager: aggressive, arrogant and nearly always right. He audaciously took large positions in big public companies including ICI, J Sainsbury, EMI and Alliance Boots, and was listened to by their managements despite being smaller than other shareholders.

But just a year on from the refurbishment of his Holland Park house, this pillar of London’s hedge fund industry is on shaky ground. The latest bite of the credit crunch has caught Griffin offguard….The fund was down 8 per cent in the first two months of the year, according to Tisbury’s monthly letter – and losses are getting worse.

…. Griffin has had to negotiate new terms with his prime brokers, beg for patience from investors and offered his business for sale to bigger rivals, including GLG Partners.

One insider said: “Tisbury has gone from darling to disaster is a short space of time. Griffin is losing staff and probably won’t get much for the sale. It’s been amazing turn of fortunes.”

Griffin is not alone. Some of the most successful players in the industry also have serious problems. The past month has been littered with high-profile calamities.

At the end of February, Peloton Partners, the award-winning fund run by ex-Goldman Sachs star Ron Beller, imploded. Focus Capital, another EuroHedge fund of the year, wound up days later. Then came the biggest casualty so far: the spectacular collapse of Carlyle Capital Corportation after a $16bn debt default.

Last week, it was the turn of John Meriwether, the man behind the collapse a decade ago of Long Term Capital Market. His bond fund at JWM Partners is struggling with losses of 28 per cent this month.

One industry expert told The Sunday Telegraph: “This is just beginning. Somewhere been 40 and 100 hedge funds will liquidate shortly. It’s a bloodbath and it will get worse.”

Already investors are showing their fury. One said: “I thought volatility was what hedge funds lived for? Making money, or at least preserving cash, during volatile times is certainly what we pay them for. They have been poncing around during the good times and are now found wanting at the first sign of trouble. It’s a debacle out there.”….

Suddenly, there’s a new fear surrounding the sector. Just a few months ago these were the best brains in finance. Now they are being exposed as average fund managers at best, and potential market manipulators at worse. How many more pretenders are there out there and how much more chaos will their demise bring to the rest of the markets?….

Hedge funds morphed from being American, secretive and peripheral to becoming one of the most important influences on global markets. Assets grew from about $200m in 1998 to an estimated $1.5 trillion at the end of last year. Mayfair became the new hedge fund capital….

At the same time, hedge funds shed their pariah image and developed cult status. With legendary brains – and pay packets to match – they started attracting celebrities and politicians….

With their dominance came increasingly displays of hubris and extravagance. Two years ago Albourne Partners, a hedge fund adviser, hired Knebworth and staged Hedgestock – the “alternative conference for the alternative investment industry” – one of the most extravagant and bizarre business meetings ever organised.

There were talks and meetings like any normal business conference, except the grounds were decked out as if it were a 1960s music festival, with the additions of a polo field, laser clay pigeon shooting range, hot-air balloon station and remote-controlled duck racing, while 4,000 delegates were dressed as hippies and danced to a live performance by rock giants The Who.

Meanwhile, London’s annual Ark dinner, the industry charity night, became the biggest fund-raising night in the world. Organised by Arpad “Arki” Busson, the multi-millionaire French financier and former boyfriend of supermodel Elle Macpherson, more than 1,000 hedge fund managers and celebrities, including Jemima Khan, Bob Geldof and Liz Hurley, paid up to £50,000 for a table. Last year, a speech by Bill Clinton, a private concert by Prince and an appeal from Madonna helped raise a record of £28m.

Even when the markets turned last year, the hedge funds’ high jinks continued. Stephen Partridge-Hicks, the former Citibank debt guru and head of Gordian Knot, one of the big credit hedge funds and so hit first, tackled the crisis by splurging thousands of pounds on a show-stopping party. In October, as his fund tanked, he chartered a plane to fly 150 mates to Morocco where he had hired Marrakech’s upmarket Amanjena hotel for a James Bond-themed party. On top of the usual champagne and haute cuisine, Patridge-Hicks staged a James Bond scene – complete with actors, stunts, a real submarine and a fly-by from two Mig jets – starring himself as 007.

At the start of this year, hedge funds had been protected from the full impact of the credit crunch. While private equity houses experienced a sudden severance from lending, investment banks largely kept open for the hedge funds….In recent weeks, this has changed….bank bosses ordered their prime brokerage and repo departments to comb through their books again and slash risk exposure.

Lending lines have been cut, just as the funds needed them most to cope with the volatility….

A new view of hedge funds has been revealed, particularly with regards to borrowing levels. In recent years, leverage in the funds has spiralled. While hedge funds have traditionally used two or three times leverage in their funds, this figure has been multiplied to eight or nine times in many cases – and even more in some.

One prime broker said: “Hedge funds have had it easy. Every man in a pink Cadilac has been able to raise money, start a fund and do really well. Frankly, those who have taken the biggest risks have come off best because markets have been so extraordinarily kind.”

The leverage that magnified gains in the rising markets has had the same impact on the way down. Weaker funds were the first victims. But now the squeezing by the lenders has meant that a far bigger number have had no cushion or protection against short-term swings.

[Ron] Beller [of failed hedge fund manager Peloton] wrote to his investors: “Because of their own well-publicised issues, credit providers have been severely tightening terms without regard to the creditworthiness or track record of individual firms, which has . . . made it impossible to meet margin calls.”

In the aftermath, others have a different view. One observer says: “The only way to generate 90 per cent returns off AAA-rated bonds is if you are taking too much risk. Simple as that.”

Another friend says that he often boasted that Peloton was sailing close to the wind. “I once asked Beller how he would cope if the market suddenly turned and he was forced to mark to market. He said he’d be in trouble but that would never happen.”

Focus Capital, the fund that liquidated two weeks ago, was managed by Tim O’Brien and Philippe Bubb, who formerly worked at Pictet & Cie in Geneva. Focus won a EuroHedge industry award after returning more than 100 per cent in 2006. O’Brien and Bubb told investors that they had been the victims of the credit crunch and short selling. But observers disagree: “Focus took large stakes in very small, illiquid companies. In these markets that’s a dangerous position to be in.”….

Meanwhile, Platinum Grove, the $5.5bn New York-based hedge fund set up by former Long Term Capital Management co-founder Myron Scholes, fell 7 per cent when Japanese prices moved suddenly….

Prime brokers say that the survivors are big funds with diversified portfolios and are not overleveraged. One said: “Over the next few months, there will be a shake-up of hedge funds and the ones that survive will be stronger and more robust – essentially, the new breed of hedge funds that take the sector to the next stage of development.”….

One said: “Hedge funds got carried away. Benevolent markets meant that anyone could be a superstar which couldn’t be true. The current crisis will quickly show the pretenders and leave behind those that are genuine hedge funds – that can make money whatever the weather.”

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10 comments

  1. Anonymous

    Why would any rational human being invest in something that is highly leveraged, illiquid and non-transparent? It is investing on pure faith to enhance one’s own self-image (sense of status).

    I think there will be a massive run on the entire hedge fund complex.

    Any excess returns that hedge funds have previously earned are usually the result of leverage (which are not employed by regular mutual funds). Hedge fund investors are paying a 20% performance fee for the privilege of having someone employ leverage on their assets (which they could have done themselves). That on top of being potentially subject to being cut off from withdrawals. Really smart move.

  2. Francois

    The most remarkable feature here is HUBRIS: “I’d be in trouble but it’ll never happen.”

    F*ck me plenty!

    Didn’t ANY of these guys read the chapter about Larry Hite in Market Wizards? Hite was legendary for is risk/return ratio precisely because, like the seasoned alpha wolf of the clan, he respected RISK.

  3. vlade

    The usual story – first people in the industry were good, even exceptional. The next generation was more lucky and arrogant than good, and the current generation is just arrogant.
    A curse of any (originally) new and successfull idea (first HF was a wealth-protection fund founded in 1947 IIRC)

  4. Richard Kline

    *hahahahahaha* “I thought volatility was what hedge funds lived for.” *HAHAHAHAHAHA* Look, Mr Well-heeled Schmuck, none of these ‘speculation funds’ have ever, EVER been put to the test in hard-down and dirty market conditions. You knew that when you gave them your dough. Now, it is obvious that you allowed yourself the fantasty that these self-declared alpha predators ‘worked for you,’ that is that you had been invited to share a place with them on the ‘above market return’ gravy train and not as a menu item because, well, you’re special. They were especially bright for knowing how to beat the game, and that made you, well _extra_ special for getting them to work for you. That worked for you, I’ll bet. You were there, brother, for your dough. Which they took to speculate with. For a fat man’s fee, and a rake off. _You_ worked for _them_ because they were ‘working’ you. Every dime in profits they, purportedly, earned for you is gone, and you will be lucky to get back half your principal.

    “Does that work for you?” *HAHOHAHOHAHOHAHO!*

  5. Richard Kline

    Vlade, Ibn Khaldun observed that it took four generations from creation to dissolution. The one your missing is the first one, that actually accumulated the ‘wealth’ to protect in the first place. But, yeah.

  6. RK

    Please correct me if I’m wrong, but aren’t we ordinary
    schmucks limited to margin requirements of 50%, or
    a 2 to 1 ratio of asset value to initial cash? Isn’t one
    of the great attractions of hedge funds the knowledge that they are allowed to lever way beyond those limits
    the “little people” must live with? Didn’t the clients
    of hedge funds understand that it was exactly that leverage which was responsible for their outsized returns. And did they fail to notice that the quarterly redemption request rules rather closely
    resembled the check-out notice at the ROACH MOTEL?

  7. atlasapple

    “The current crisis will quickly show the pretenders and leave behind those that are genuine hedge funds?”

    P.T Barnum knew decades ago that there would always be a market for scam artists. Being rich doesn’t mean your not a sucker.

  8. Anonymous

    What I find interesting is that people still have the rather quaint idea that the “markets” are independent and free. It is my sense that the markets are completely synthetic and gyrating around as a result of hedge fund and investment bank ownership and trading.

    All they need do to goose the market is launch another ETF. Seems to work every time.

  9. Anonymous

    Running a hedge fund is the best deal in the world. 2 and 20 and you get to play with other people’s money.

    But investing in a hedge fund? Pure stupidity. The only possible valid reason for a hedge fund is that it allows you to go short, a unique feature absent of mutual funds due to over-regulation. But most of these funds weren’t even short funds. They were equity long, or, even more absurdly, they were long a bunch of bonds, collecting the yield spread, somehow convinced there was no risk in that spread.

    The guys who got paid got lucky. The trades were stupid from the get-go.

    I also find the use of the word “victim” by any of these guys to be appalling. Perhaps the investors could classify for that term, but the traders. Gimme a break.

  10. Yves Smith

    I don’t like deleting comments, but the one expunged was an excessively long rant (the substance wasn’t terrible, truth be told) that was made on six separate posts. I haven’t published a formal policy re comments, but if in doubt, look here and here to get an idea of what will get your comment deleted. Multiple listings of the same content is one of them.

Comments are closed.