August 2007
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August 23, 2007
Hedge funds profit from sub-prime collapse, says Hennessee
Last October Hennessee reported that hedge funds had been using credit default swaps in several ways, including purchasing CDS on sub-prime mortgage-backed fixed-income securities and indices intended to profit from deterioration in credit quality among mortgage borrowers.
In what has been the best short sale theme since 2002, Hennessee says, many hedge funds have greatly benefited from the collapse in sub-prime mortgages through their short exposure to mortgage lenders and sub-prime mortgage-backed securities and indices. While some have focused on shorting mortgage lenders and buying credit default swaps on specific mortgage-backed bonds, others have purchases CDS on indices of these securities, the ABX series, with most focused on those securities issued in 2006 under more relaxed lending standards.
The ABX-HE-BBB- 06-2 Index (ABX Index of BBB-rated tranches issued in 2006) is now down by 60 per cent for the first seven months of the year. Several managers think there is still more downside for the lowest-level tranches, as they believe cumulative losses for sub-prime mortgage securities could potentially cause the value of the BBB-tranches to be worthless.
However, as has been widely publicised, several hedge funds with leveraged long bets on bonds backed by sub-prime mortgages experienced significant losses in the first half of the year. According to reports, these funds leveraged investor capital between 10 and 20 times, and held a collection of collateralised debt obligations and mortgage-backed securities, some of which were illiquid and 'marked to model'.
As the value of the underlying bonds fell, funds faced margin calls from lenders, which forced them to sell assets, further exacerbating losses. While BBB tranches have garnered the most coverage, even more senior tranches have been affected by the collapse, as the AAA tranche has declined by 1 per cent, the AA tranche by 2 per cent and the A tranche by 20 per cent up to the end of June. While many recent news stories have publicised hedge fund failures related to the sub-prime collapse, Hennessee says, in reality many hedge funds were expecting such an event and were able to profit from the decline.
Hennessee Group is a registered investment adviser that advises direct investors in hedge funds on asset allocation, manager selection, and ongoing monitoring of hedge fund managers. It compiles the Hennessee Hedge Fund Indices to benchmark individual hedge fund manager performance, but does not sell a fund of hedge funds product nor market individual hedge fund managers.
-Hedgeweek.com-
Posted by su at 11:58 AM | Comments (0)
August 17, 2007
Investors should look to funds of hedge funds, says S&P
Funds of hedge funds are a good proposition for investors looking for long-term investment returns without excessive risk, according to Standard & Poor's Fund Services.
S&P says fund of hedge funds have been very successful at protecting investors from significant losses and S&P-rated funds of hedge funds have generally delivered positive returns during the first half of this year.
S&P fund analyst Randal Goldsmith says: “Our rated fund of hedge fund managers have done well so far this year despite the turmoil in equity and fixed income markets. Examples of funds of hedge funds, as opposed to individual hedge funds, getting into trouble are extremely rare.
“A number of the funds we rate have invested in short-biased credit funds, which have benefited from falling values in the US debt markets - Thames River, Absolute and RMF are some examples.
“They have generally maintained or increased their exposure to short-biased credit, which should see them continuing to do well in the more turbulent market conditions of the second half of the year.”
-Money Marketing-
Posted by su at 2:13 PM | Comments (0)
August 15, 2007
Culross July estimates - the development of a theme
Culross funds are about to be ranked as No.1 again in Global Multi-strategy FoHF databases.
Performance estimates:
Fund Name/ July Return/ YTD
Culross Global Fund/ 8.3%/ 21.90%/ Unleveraged
Culross Global H Fund/ 8.6%/ 29.51%/ Unleveraged
To explain these extraordinary numbers we need to recap and look at this really good example of Culross’ themed approach:
Theme name - ‘Short sub-prime borrowers’
- October 2005: Culross closed out all managers with any exposure to credit across all funds
- January 2006: Culross recognised that Sub Prime was an extreme credit problem and was rapidly becoming excessively over extended. Goal – find a manager to fill the new Theme.
- July 2006: found a hedge fund manager launching a “Short Sub Prime Fund”. “H” immediately builds a 12 % exposure. (Bear Stearns simultaneously raises two funds to invest long in Sub Prime!)
- Enjoy strong performance over following 12 months as underlying Sub Prime market starts to deteriorate (See HSBC et al)
- May 2007: Culross warns again of increasing risk in Sub Prime and clearly warns that the market is misunderstanding contagion risk
- July 1 2007: the “Short Sub Prime Borrowers” theme evolves to become “Widening Sub Prime and Credit Spreads”.
- July 1 2007: Culross double their theme exposure to 23% in Global and 30% in “H” Fund
It is clear that Culross Funds generate Alpha by successfully using complimentary themes. This approach is intellectually traceable back over 10 years and will continue to be the unique and distinctive hallmark of the investment manager Culross.
-Culross Global Management Ltd-
Posted by su at 2:47 PM | Comments (0)
Managers 'suffering' as quant similarities revealed
Computer-driven funds, including Renaissance Technologies, considered one of the best in the world, are believed to have lost heavily almost across the board this week.
Bankers said quantitative funds run by Tykhe Capital, another US hedge fund manager, are down 20% for August so far, while JP Morgan's Highbridge Capital Management has lost 6% in its statistical arbitrage fund. Bankers said DE Shaw is down 5% while State Street Global Advisors has also lost money in its quantitative equity strategies this week. Renaissance is down 3% so far this month.
Tykhe, Highbridge, DE Shaw and SSgA were not available for comment.
A spokesman for Renaissance, whose institutional fund is one of the largest quantitative hedge funds with $27bn (€20bn) of assets under management, said: "Markets have been up and down and a lot of people are deleveraging. It has not been pleasant but it is not a disaster."
A hedge fund manager specialising in managed futures, which relies on computer models to make investment decisions in the commodity and currency derivative markets, said: "Quantitative equity managers are being massacred this month, losses are 5% to 10% and more. I'm told someone has been liquidating positions in one of their funds, but these quant managers are all supposed to be doing different things and now they all appear to be correlated."
Goldman Sachs' flagship global alpha fund is down 16% for the year to date, bankers said, after continuing a run of losses. The firm's North American equity opportunities fund, which had $767m (€560m) in February, was down 15% for the year to the end of July, bankers said.
A quantitative manager said: "The falls are across the quant management board and that shows that, although the equity models may be superficially different, really they are variations on the same theme. Everyone has been taking long positions on value stocks and short positions on growth stocks, and now they are all making losses."
-Financial Times-
Posted by su at 2:46 PM | Comments (0)
Another day, another hedge fund implosion
GOLDMAN Sachs Group's $US8 billion ($9.5 billion) Global Alpha hedge fund has fallen 26 per cent this year, a decline that may prompt more investors to withdraw their money, people familiar with the fund say.
Goldman's largest hedge fund, managed by Mark Carhart and Raymond Iwanowsk, has dropped almost 40 per cent since July 31, 2006, said the people, who declined to be named because the fund is private. The Standard & Poor's 500 Index of the biggest US stocks has returned 16 per cent during the same period.
Virginia Parker, who helps oversee about $US1.8 billion at Parker Global Strategies LLC, said it was hard to imagine how investors could maintain confidence. "There has been a broad range of market climates and the fund has not demonstrated the ability to excel in any of them," she said.
Quantitative hedge funds - including those run by Goldman, Highbridge Capital Management LLC, AQR Capital Management LLC and Tykhe Capital LLC - have lost money in August as credit spreads have widened and stock-price volatility has jumped, jarring the computer models the managers use to make their bets.
The $US1.7 trillion hedge-fund industry has been roiled by declines in the credit and equities markets during the past two months. Two hedge funds managed by Bear Stearns Companies collapsed and Sowood Capital Management LP, run by a former manager of Harvard University's endowment, is shutting down after a 60 per cent loss.
James Simons's $US29 billion Renaissance Institutional Equities Fund has fallen 8.7 per cent this month, hurt by swings in securities prices, the 69-year-old told investors. The two-year-old fund has fallen 7.4 per cent since January.
A Goldman spokesman, Peter Rose, declined to comment.
Global Alpha losses may lead to more redemptions. Withdrawals for its $US6.2 billion offshore version were $US394 million in the month ended June 30, an investor who declined to be identified said. That was almost three times the $US142 million in new money added.
Global Alpha decreased 8 per cent during the last full week of July and was down 16 per cent from the beginning of January through August 3. There is an August 15 deadline for Global Alpha investors who want to redeem money on September 30.
-Bloomberg-
Posted by su at 2:43 PM | Comments (0)
Structured investment vehicles’ role in crisis
Policymakers and investors have been obsessed in recent years about the potential for a hedge fund collapse to spread financial panic. But it seems one of the biggest threats to stability is coming from the age-old risk of short-term borrowing to fund investments in illiquid long-term products.
In a corner of the market few people knew existed, regulators are scrambling to understand what is happening in structured investment vehicles (SIVs), a breed of often huge, mainly bank-run, programmes designed to profit from the difference between short-term borrowing rates and longer-term returns from structured product investments.
These have proliferated in recent years and control assets worth hundreds of billions of dollars. Depending on whether they are fully rated by credit rating agencies and on how strictly they have to conform to certain rules, they are known as SIVs, SIV-lites, or conduits.
They are typically quite opaque, invest in complex securities and often do not need to be displayed on a bank’s balance sheet.
It seems they have played a key role in last week’s liquidity crunch.
“We are in the middle of a mini-crisis in the commercial paper market, at least half of which is related to the SIV conduits,” says Robert McAdie, global head of credit strategy at Barclays.
These programmes typically invest in credit market instruments, such as US subprime mortgage-backed bonds and collateralised debt obligations. These assets tend to be the highly rated, supposedly safe versions of such debt, but in the recent fear-driven turmoil have shown just how illiquid and hard to value they can be.
The profit for those who run such programmes comes from the fact that the assets pay fairly high yields, while the conduits and SIVs fund their purchases with short-term borrowings in which interest and principal payments are backed by financial assets that are deemed to have stable cash flow. Collectively this so-called “asset-backed commercial paper” – or ABCP – lasts for anything between a few days and a few months before needing to be refunded.
The problem could be thrown into relief when billions of dollars of ABCP mature today and on Wednesday, with great uncertainty as to whether this can be refinanced.
Everything in this market depends on investors in the ABCP market maintaining their faith in the programmes and the assets they hold. With the current rush for the exits in many structured credit markets, this faith has been evaporating wholesale. No investors are sure exactly what assets SIVs and conduits are holding, or how damaged those holdings might be.
While many non-SIV funds – such as those run by BNP, Axa and others that have hit trouble recently – were able to stop investors pulling their cash out, SIVs and conduits who see their funding expire on a regular basis have no such luxury.
In the case of a blip in the market, SIVs and conduits are supported by liquidity facilities from highly rated, mainstream banks. This means banks must step in to provide finance if the SIV cannot raise commercial paper in the normal way, unless the SIVs’ assets suffer significant ratings downgrades. Typically, the credit line provided by the sponsoring bank and a group of others in a syndicate must cover 100 per cent of outstanding commercial paper.
These funding lines have rarely been drawn in recent years, because liquidity has been abundant in the ABCP market as almost everywhere else in the financial world. As recently as mid-June, the European commercial paper market was seeing records levels of issuance.
However, what sparked last week’s turmoil – and the dramatic intervention by central banks – was a pernicious chain of events. As it became apparent this summer that the US subprime problems were worsening and infecting a broader range of structured products, some investors in the ABCP market started to worry about whether SIVs were also sitting on losses.
The rush to sell structured products by hedge funds facing redemptions and other investors meant those market values that could be ascertained were being marked down heavily. As a result, by mid-July some investors decided to stop buying ABCP paper from SIVs suspected of subprime exposure.
The German bank IKB was an early victim. Like many local peers, it had a conduit – called Rhineland Funding – which had expanded rapidly and had almost €20bn ($27.3bn, £13.5bn) worth of outstanding commercial paper in the markets in July. In mid-July, ABCP investors refused to roll over some of these notes.
Rhineland asked IKB to provide a credit line, as the rules of SIVs require. But it appears the German bank did not have enough cash to meet this request and was unable to liquidate enough assets to plug the gap. This threatened to trigger IKB’s collapse, until KFW, the state-owned German bank, stepped in and offered an €8bn credit facility.
German officials hoped this action would stop growing panic in the sector. But it may have had the reverse effect: investors started to shun almost all commercial paper issued by SIVs.
“This is an environment where there has been a big loss in confidence and nobody is distinguishing between apples and oranges,” notes Mr McAdie.
By early August, the problems in the ABCP market had become so serious that some European banks were preparing for additional calls on credit lines to SIVs. But the banks are also grappling with a backlog of unsold leveraged loans, which is placing additional pressure on their balance sheets.
So early this month some European banks – and a few US institutions as well – quietly started trying to raise new credit lines themselves. That, however, triggered additional alarm, as rumours spread about the potential losses at SIVs – on top of problems in other corners of the financial world.
Consequently, by the middle of last week, some banks started shutting credit lines to a sweeping list of institutions. “Commercial paper is now being funded on an overnight basis. The banks will not roll paper for three months,” says Dominic Konstam, head of interest rate strategy for Credit Suisse.
And while it seems that European financial institutions were particular victims of this credit squeeze, the problems – perhaps ironically – were extreme in US markets, since SIVs typically raise a large proportion of their finance in dollars. One banker admitted last week: “The attitude is ‘Don’t show me anything east of a [New York] 212 area code’. If you lend to [those banks] it could be a career-ending experience.”
Policymakers hope that some of this panic will dissipate this week following the massive emergency injections of liquidity by the ECB and US Federal Reserve. And indeed, by the end of last week, borrowing rates were stabilising. There were signs vulture funds were circling, ready to pick up ABCP paper at bargain prices.
“What some people are hoping is that the bottom fishers will appear and help the market self-correct,” says one big ABCP issuer.
However, nobody close to this sector expects to see a quick solution soon. Commercial paper interest rates have not yet fallen, irrespective of central banks’ actions. In New York on Friday, they closed at their highest level for six years.
There is deep uncertainty about what the central banks will do next – making ABCP players even more reluctant to start issuing and trading again. “Nobody is going to handle commercial paper if they think the Fed could be about to cut rates or do something else completely unexpected overnight,” explains one.
However, the third, most pernicious problem is that it is becoming clear central banks cannot resolve the biggest problem – a lack of clarity about valuations in structured credit markets and the almost complete loss of confidence that is infecting even the biggest and most diversified of conduit-type programmes.
-Financial Times-
Posted by su at 2:39 PM | Comments (0)
Pack Mentality Among Hedge Funds Fuels Market Volatility
On Wall Street, there is a rage against the machine.
Hedge funds with computer-driven or quantitative investment strategies have been recording significant losses this month.
The managers of these funds are the products of the trading desks of the big investment banks, like Goldman Sachs and Morgan Stanley, both of which have investment operations that use computer models.
The cross-fertilization has raised fears among some analysts that it is not only the hedge funds that are being hit, but the trading desks at the banks as well.
“These guys all know each other, and they all have the same strategies,” said Ernest P. Chan, a quantitative trading consultant who has done computer-driven research at Morgan Stanley and Credit Suisse. “They came from the same schools, and they get together for drinks after work.”
As the quantitative system has come to underpin the investment approaches of some of the largest hedge funds, its use has grown sharply.
Moreover, bankers and investors say, the strategies employed tend to be not only duplicable but broadly followed — the result being a packlike tendency that has helped increase market volatility and, for some hedge funds, has led to losses in the last month.
Wild swings in stock prices have become the norm as fears about the mortgage securities market have expanded into the broader markets. Last week, the Dow Jones industrial average was sharply higher on Monday and Wednesday, only to drop 387 points on Thursday, eventually ending the week about where it began.
A common thread has often been a rise or fall in prices late in the day, a pattern that many analysts attribute to computer models, which are driving a much larger volume of the trading.
Mr. Chan said this predilection for lemming-style buying or selling from investors using similar computer models could turn what would normally be a market setback into a wider contagion.
“If all the models say buy, who is going to say sell? There is just not enough money on the other side,” he said.
The problems of these quantitative funds mirror those of the hedge fund industry as a whole — many funds have seen sharp declines in the last couple of months as the credit markets have dried up. Some quantitative funds could potentially have their worst year on record.
Despite the large sums of money involved, ranging from $250 billion to $500 billion, according to industry estimates, the club of quantitative investors is a small, exclusive one that bridges the trading desks of investment banks and some of the country’s largest hedge funds.
One might call it six degrees of quantitative investing.
Clifford S. Asness, who has a Ph.D. in finance from the University of Chicago, is the founder of AQR Capital Management, a quantitative hedge fund that, according to investors, has had a 13 percent loss so far this month.
Mr. Asness is also a founder of Goldman Sachs’s troubled Global Alpha fund, which controls about $9 billion. The Alpha fund has suffered an 11 percent reversal this month, giving it a decline for the year that is approaching 30 percent, sparking speculation that Goldman would liquidate the fund. Goldman calls the speculation “categorically untrue.”
On a smaller scale, Tykhe Capital, another hedge fund that uses quantitative techniques, was down 19 percent in August. The founders of Tykhe are from D.E. Shaw & Company, the giant hedge fund that manages $35 billion via a broad reliance on quantitative, as well as other, strategies and whose founder, David E. Shaw, who has a Ph.D. from Stanford, originally came from Morgan Stanley.
Hedge funds as a whole have grown exponentially and now manage about $1.7 trillion, more than double the amount five years ago.
In one respect the swoon of these computer-reliant funds is the result of managers, who are faced with a deluge of investor money seeking accelerated returns, using their models to make higher risk market bets by following day-to-day trends. It is an approach that seems to run contrary to the original philosophy underlying a quantitative approach, called statistical arbitrage.
Narrowly defined, statistical arbitrage involves a fairly straightforward investment strategy, like the rapid-fire buying of one stock and the selling short of another so as to use the computer’s speed to identify and make money from even the most minute price discrepancies. Such a strategy will generally provide liquidity to the market by buying stocks on the way down and selling them short on the way up. In so doing, it provides a dose of calming, computerized sang-froid to markets in the grip of panic or euphoria.
But such strategies rarely promise high returns, so quantitative investors have broadened their computer models to include strategies for investing in more risky areas like mortgage-backed securities, derivatives and commodities.
“You can build a computer model for anything that is tradable,” Mr. Chan said. To some extent, that explains the outbreak of losses in these funds.
With many of these new assets being highly illiquid and with the funds themselves having used considerable amounts of borrowed money to enhance their returns, losses have been magnified as worried investors have demanded to pull their money out.
In a letter to investors this week, James H. Simons, the founder of Renaissance Technologies, the most highly regarded of the quantitative funds, gave voice to what he described as “unusual” market conditions. Mr. Simons, who received a Ph.D. in mathematics from the University of California, Berkeley, acknowledged what a difficult month August had been, with his RIEF down close to 9 percent for the month.
For an investor who reportedly earned $1.6 billion last year and whose flagship Medallion fund had an average annual return of over 30 percent since 1988, it was a surprising reversal.
“We cannot predict the duration of the current environment,” Mr. Simons wrote. “But usually such behavior causes first pain and then opportunity. Our basic plan is to stay the course.”
-New York Times-
Posted by su at 2:38 PM | Comments (0)