HedgeSpeak

Outsourced Ops Due Diligence? Really?

2012-02-20T09:36:00.002-05:00

July 2009

"... bolster our capabilities as we will be able to perform some functions in house, such as Operational Due Diligence, which were previously run through an outsourced service provider."

This simply underscores the inefficiencies of the Hedge Fund of Funds industry pre-Madoff and the apparent lack of operational due diligence for many firms. The good news is that the industry has upgraded this area since 2009.

HedgeSpeak: Side Pockets Anyone?

2012-02-09T09:23:00.003-05:00

December 2005

"These adjustments are designed to provide additional comfort to investors. First, we are committing that no side pocket investment will have a duration of greater than 10 years."

No comment.

Fund of Fund-Speak

2010-06-10T10:05:00.001-04:00

"Yes, I’m a buyer, but I am a parasite on other people’s genius"

David Smith, GAM

One of my favorite quotes that best describes the Hedge Fund of Fund industry.

More Footnote-Speak

2010-05-28T12:16:00.003-04:00

March 31st 2010

“(1) 1. ...Performance data pertaining to periods after 12/31/06 relates to investors that are charged a 2% management fee and a 20% performance fee. Performance data pertaining to periods prior 12/31/06 relates to investors that are charged a 1.5% management fee and a 20% performance fee Fees applicable to certain investors may be different."

It is always worth the time to peruse the footnotes which is why I am posting another footnote comment.

Clearly the relevant fund manager increased their management fees when business was booming (consistent with the rest of the industry), but I remain curious how long before we see reversion to pre-2006 fee levels.

Anyone? Separately, in case you were wondering... the typo is from the managers letter.

Footnote-Speak Mr. Mauldin?

2010-05-20T10:46:00.004-04:00

May 18th, 2010

"...I will focus on another issue close to my heart – commodities.

In last month's Absolute Return Letter I raised a yellow flag concerning the short term outlook for commodities[1]."

"Footnotes:[1] There is no denying that the long term outlook for commodities continues to be bullish, mainly driven by the strong growth in emerging market economies."

Source John Mauldin JohnMauldin@InvestorsInsight.com

For those that have received Mr. Mauldins recent (relevant) letter discussing a a yellow flag relating to Commodities, I urge everyone to absorb its contents and possible importance. He is often 6 to 12 months premature, but he has clearly flushed out (no pun intended) issues relating to the evolution of commodities within our modern financial markets. Buyers beware.

That said, his careful phrasing and protective footnote illustrate how investors may choose to carefully read all documents from start to end.

FedSpeak

2010-04-19T18:17:00.002-04:00

April 2010

"I Saw the Crisis Coming. Why Didn’t the Fed?

By MICHAEL J. BURRY
Cupertino, Calif.

ALAN GREENSPAN, the former chairman of the Federal Reserve, proclaimed last month that no one could have predicted the housing bubble. "Everybody missed it," he said, "academia, the Federal Reserve, all regulators."

But that is not how I remember it. Back in 2005 and 2006, I argued as forcefully as I could, in letters to clients of my investment firm, Scion Capital, that the mortgage market would melt down in the second half of 2007, causing substantial damage to the economy. My prediction was based on my research into the residential mortgage market and mortgage-backed securities."

This appeared as an Op Ed in the New York Times earlier this month and the author calls out former Fed Chairman Greenspan for being asleep at the wheel. He along with several other hedge fund firms (and broker dealers) were actively informing the world of their "contrarian" views. One of these views even emanating from one of Deutsche Banks own traders who was ridiculed with the nickname "chicken little (as in the sky is falling)."

As an investor, one should be listening to the herd (as in sheep), but more importantly, pay constant attention to the "nay sayers" in order to better understand the risk of what could go wrong. It is odd that Mr. Greenspan did not have an entourage that employed similar strategies.

Has anyone asked whether there have been changes to the process within the Fed?

Mr. Soros speaks Greek

2010-02-22T10:56:00.003-05:00

February 21st 2010

"The situation is aggravated by the market in credit default swaps, which is biased in favour of those who speculate on failure. Being long CDS, the risk automatically declines if they are wrong. This is the opposite of selling short stocks, where being wrong the risk automatically increases. Speculation in CDS may drive the risk premium higher."

"So makeshift assistance should be enough for Greece, but that leaves Spain, Italy, Portugal and Ireland. Together they constitute too large a portion of euroland to be helped in this way. The survival of Greece would still leave the future of the euro in question. Even if it handles the current crisis, what about the next one?"

Channeling an old TV commercial:"When Soros speaks, people listen."

Most managers have been positioned on the PIIGS for the past 2 years and simply waiting for events to unfold. Was Europe not listening?

Enemy of the State?

2010-02-16T17:24:00.003-05:00

August 2009

"Nevertheless it features one of the most formidable new buildings that I have ever come across. I would estimate the build cost must be in the hundreds of millions of dollars. And it wasn't located in Hong Kong or even Shanghai or Shenzhen, but in the decidedly less glamorous Wuhan in the centre of the country. And to make matters worse it was completely empty..."

"I learned recently that the building now has a tenant, the $20bn Minsheng Bank, but I suspect they lent the money to the developer in the first place."

"Adding to the intrigue, I have subsequently been informed that our video has now been blocked in China by the authorities. Who would have thought that I would become an enemy of the state?"

We read regularly in the media about how hedge fund managers are the bad guys always looking to make a profit. I would argue that in most cases these same managers are simply correcting (exploiting) certain market inefficiencies or simply going against the herd. Examples would include Mr. Chanos and Enron and this manager asking some basic questions.

The real question should be to ask other managers why they are not asking similar questions?

It's Greek to me...

2010-02-13T15:32:00.000-05:00

Feb. 12th 2010

"Path dependence explains how the set of decisions one faces for any given circumstance is limited by the decisions one has made in the past, even though past circumstances may no longer be relevant. In essence, history matters."

"With regard to the future, the choices we make determine the paths we will take."

"As I have been writing for a long time, we have made a series of bad choices, often the easy choices, all over the developed world. We are now entering an era in which our choices are being limited by the nature of the markets. Not only are we in a path-dependent world, but the number of paths from which we may choose are becoming fewer with each passing year."

John Mauldin's most recent note manages to reduce all the noise into a simple hum. He discusses the mess in Europe. His next conference is April 22-24 in La Jolla CA

ShortSpeak

2010-01-15T16:25:00.003-05:00

Dec 2009

"On the short side, opportunities remain scarce, and we are not surprised by this. Clearly the abnormality of returns in 2007/2008 from our short positions were such that capital deployed in here is unlikely to be productive for some time.

The nature of the corporate reaction to the downturn amplifies this point. Generally a good short position stems from an over optimistic investment decision by corporate management.

The combination of limited finance and corporate prudence of the last couple of years has inevitably meant that examples of this are few and far between."

I would love to simply insert the entire letter. The manager produced 30 pages of detailed review of his past predictions with half dedicated to his outlook for the future.

His entire letter is filled with similar quotes which explain realities in the simplest of terms.

It is all too rare to find a hedge fund manager willing to take the time to explain and share his thoughts.

Well done and an example for others to follow.

2010-01-13T10:16:00.002-05:00

Excerpt from HedgeSpeak:

I saw the green light flicker on my phone and answered. A quiet voice with a German accent stated: “I voot like to speak vit “Bob Picard.” He immediately took on a menacing voice saying that he had heard that I was bad mouthing his hedge fund and that he had no choice but to personally sue me, my firm, and my family. He added that he would make sure that "my team would not work on Wall Street again." He then hung up the phone. As the line went dead, I started immediately thinking about my on site due diligence visits and what information I may have shared with anyone. All this was done in seconds and immediately turned to my “desk counsel” who was never more than 3 feet away at any given time of day.

“Kev, we have a problem. I was just personally threatened by Michael Berger, one of those managers who did not make it through our screening.”

Too often we forget that Wall Street and its Hedge Fund industry is about people and trust. In the hedge fund world, reputation and trust are seeded, grown and nurtured for years at a time

Let’s back up 6 months. The Fund was called Manhattan Capital, managed by an Austrian national named Michael Berger. The fund was brought to our attention from investors who claimed that Manhattan Capital Management was the ultimate Long Short equity hedge fund. It would make money during market rallies and would protect capital and make even more money in down markets. His track record included returns over 30% per annum regardless of the year and the market direction.

We met in beautiful offices in mid town. Surprisingly, he did not bring us to a conference room, but sat us down in an area off the reception area adorned with couches.

Michael was a low talker quietly smoking a cigarette throughout the meeting...

Around the World...

2010-01-06T16:20:00.004-05:00

November 26, 2009

"We’ve spent two weeks traveling almost 20,000 miles and visiting three cities: Tokyo, Hanoi & Singapore. Meetings included quality time spent with central bankers, investors, pension fund managers, academics, commercial bankers, and others. It has been a whirlwind and well worth the fatigue.

We will summarize the observations with some key points.

Our trip confirms that the Asian emerging-market story is real and is likely to accelerate..."

It is all too rare that managers actually travel the world in order to get first hand knowledge. It is also rare for managers to get access to the right people. It is all too often that managers accept second hand information as gospel. Clearly in today's central bank (IE Government) driven economy, managers recognize the potential impact of government intervention as it relates to company fundamentals.

You need to ask your manager: "Where have you been lately and who did you talk to?"

Wall StreetSpeak

2009-10-20T10:38:00.002-04:00

Again, a letter that no investor wants to receive:

October 19th 2009

Dear XYZ Employees, Clients and Friends:

During this challenging time, I wanted to take a moment to address you directly. As I am sure you understand, I am not able to respond in detail to the charges recently brought against me. But let me be clear: they are, without exception, entirely baseless. I am innocent and will vigorously defend myself and our firm.

As I move forward on my defense, I want to assure you that our commitment to our investors and employees will remain unwavering. I will continue to be here working for XYZ, and the firm will continue to serve its clients with effectiveness and integrity. Thank you for your ongoing support.

This letter is of course sent out after wide press coverage in the WSJ. Most likely, it has been reviewed by attorneys and PR firms. The question that most investors are now asking is who is next? Who in their portfolio may also be under investigation? The institutional allocators need to revise their investment processes to screen out the potential reputational risk associated with an investment with an alleged "cheater."

On the other side, how many hedge fund firms called a Monday morning meeting to discuss potential impact and isolate any potential issues in their own firms. Lastly, how many shorted names in the portfolio of the alleged "crooked manager" who will be hit by redemption's.

For $1,000: What is suspend redemption's?

RegulationSpeak.... Forty Years Ago!

2009-09-15T14:30:00.005-04:00

Fortune Magazine 1969

"Probably the hedge funds deserve to be regulated in some way, but whether they should be ravaged is another question. If wealthy, sophisticated investors wish to pay 20 percent of their profits for investment management or, as one dejected investor put it, are "foolish" enough to pay 20 percent-then quite possibly they should be allowed to do so. Anyway...after 1969, not so many will be in that magnanimous a mood. For as every hedge-fund manager knows, without a good product at a good price, you don't get far in the market."

Just when you think there is something unique about your "epoch" you realize that the same issues and problems have existed for years. It helps to have historical persepctive which can only be gained through: "Experience"

How many investors today were allocating to hedge funds in 1969? 1979? 1989?

More relevant, the debate continues on regulation 40 years later...

Side Pockets anyone?

2009-09-11T08:58:00.002-04:00

December 2005

These adjustments are designed to provide additional comfort to investors. First, we are committing that no side pocket investment will have a duration of greater than 10 years.

For those that were surprised by side pockets (in 2007 and 2008), I would simply suggest they look back over the past 10 years. Anytime a manager is confronted with large redemptions in a "long term" investment strategy (i.e. credit, private equity, real estate), they will either suspend redemptions, side pocket or distribute securities in kind.

Unfortunately, many allocators preferred to simply ignore this possibility (risk) as "improbable."

10 Years ago...

2009-09-03T09:48:00.003-04:00

January 6, 1999

“Be that as it may, we are not paid to pass judgement on Fed policy. That is best to think tanks. Nor are we in the business of market timing. While we do have certain macro-economic views, we are primarily in the business of managing a portfolio of individual investments. In so doing we lost you a meaningful amount of money last quarter.”

“Essentially, having what appeared to be a number of separate moderate bets, our portfolio was really exposed to one growing bet on the internet.”

It may be time for investors to watch carefully where their investment managers are drifting in order to generate competitive returns. As the "herd" mentality develops managers often find themselves allocating ever more money to (temporary) winning trades and forgetting about the patience required to manage a diversified long term portfolio.

It begs the question: "Have investors become more patient after the recent correction or will they return to short term rewards."

Lastly (and I'm just throwing it out there), is the aging demographics for the US and Japan actually encouraging more short term risk since older investors do not have the time for a long term view...

HedgeSpeak: I give up... really?

2009-08-11T12:37:00.004-04:00

August 2009

"My decision is solely a personal one. After fifteen years of being singularly focused on building and managing XYZ Fund, I believe it is time to reassess my future. I intend to spend more time with my family, pursue my philanthropic interests and establish a family office to manage my own capital and charitable foundation."

This decision to return over USD 3 Billion to investors represents another large firm choosing to liquidate Vs. deal with the ever changing landscape in hedge fund land. Simple questions should come to mind relating to rationale and timing...

Thoughts anyone?

Consolidation? Anyone? Anyone?

2009-08-05T07:39:00.003-04:00

"We are very pleased to announce that on July 9, 2009, XYZ Associates and 123 Management entered in to an agreement under which 123 Management will take over the investment management duties....

"...We believe that this combination will greatly bolster our capabilities as we will be able to perform some functions in house, such as Operational Due Diligence, which were previously run through an outsourced service provider."

A positive sign within the industry that demonstrates certain benefits of hedge fund (in this case fund of funds) consolidation. The seller recognizes the need to provide additional services to investors in order to remain competitive and hold on to investors/assets.

There remains a large amount of smaller (and mid size) firms that have outsourced compliance, legal, technology, marketing and even trading execution in order to save costs and infrastructure.

Clearly, the above example of consolidation and rationalization will be beneficial and help the industry emerge stronger.

HedgeSpeak: What is he talking about!?

2009-08-03T18:13:00.004-04:00

February 2000

“…..Years ending in “O” have an average loss of -8.17%; the Dow gains only an average of only 0.85% during the last year of a second term President and loses an average of -7.0% for the last year of a second term Democrat; and the results from XYZ Study forecast prices going down -9.3%. Since the release of that letter, the Dow’s performance has provided further evidence that Dow prices may continue to deteriorate.”

I recall my colleague Patrick throwing up his arms and saying: "What is he talking about!?"

This manager spent significant time analyzing the more obscure aspects of technical market analysis in order to gain an investment edge.

Apparently there was no edge. By the end of 2000, his business was shuttered.

Conventional wisdom is that if it doesn't make sense... Do not invest.

RealSpeak

2009-07-26T22:06:00.002-04:00

July 2009

"We are now in the early stages of a depression..."

"...the only thing propping up this market is investor sentiment. Earning have not improved. Keep it simple, stupid-investing is and has always been about the real economy, and this market is ignoring the hard data."

No hedgespeak here, only realspeak.

HedgeSpeak and Timing is Everything...

2009-07-21T11:24:00.003-04:00

July 8, 1998

“As opportunities in convertible hedging dried up, a synthetic put program was implemented. This proved too costly and has been terminated.”

Focus on the date. The all too common cycle of a manager becoming frustrated by the cost of maintaining his hedge, and the investors frustration and pressure to generate competitive returns. Are investors really using "apples to apples" comparisons? Are they simply comparing to another manager who is not hedging consistently.

The irony in this case, is that the manager chose to terminate his hedging program one month prior to Long Term Capital Managements failure and the subsequent large market drop.

Top Down, Bottom Up?

2009-07-14T15:08:00.002-04:00

June 2009

"The XYZ Fund (the 'Fund') seeks to achieve long term capital appreciation utilising a top down active asset allocation policy ...

...Stock selection provides the core to the investment process."

I just noticed this basic strategy description in a recent monthly snapshot. You do not need to look far to pick up on basic inconsistencies.

If "Stock Selection" is the core of the investment process, shouldn't the marketing team state that they use a "bottom up" approach to investing? I know, I know... there is room for debate, but it does appear that some managers still engage in certain hedgespeak in order to cover all investor types. They try to be everything to everybody.

At least they didn't write "bottoms up."

Efficient Markets anyone?

2009-07-06T16:35:00.002-04:00

June 2009

“Unfortunately, there’s lack of consistence of what’s happening. I am wondering how stupid the market can be for how long.”

One difficulty confronting managers (and their investors) is maintaining conviction no matter how great the head winds or how inefficient the markets.

What separates one managers brilliance from another managers stubbornness?

I many cases, simply timing and their tolerance for risk.

HedgeSpeak: Fear of Melt Down or Melt-Up?

2009-07-02T09:29:00.003-04:00

May 2009

"Rather than fight the riptide we decided to go with it until it ebbed. We reduced a number of our short positions and covered our index shorts that had served us so well in the market meltdown, reducing our notional short exposure in the process. We also bought high yield indices to hedge out our remaining short exposure and to cover our portfolio for a further melt-up."

General consensus is that hedge funds make money in all market environments. It remains a naive statement with limited appreciation for the actual market realities and the difficulty to continuously manage short positions. Very few appreciate the maddening aspect for a hedge fund manager to maintain hedges throughout a rally. Managers will often second guess themselves, and in some cases be influenced by (frustrated) investors demanding performance on during rallies. Often, the manager will have doubt and reduce those hedges just as the market reverses and then lose the benefit of those same hedges.

The manager has to weigh the pros and cons: Do I hold steady? Do I shift? Is a Melt Up worse than a Melt Down?

Anyone? Anyone?

Climb every mountain...

2009-06-25T16:31:00.004-04:00

May 31st, 2000

“Within a month of the stroke, I had regained most of my motor skills and although still unable to speak properly, I was able to follow the markets and our trading program and to put in my two cents on occasion, for whatever it was worth.”

This is an actual quote from a manager letter back in 2000. This is not intended to poke fun, but simply to expose the "key man" risk with many hedge funds and the way they are managed.

It is remarkable that this manager, who suffered a tragic health set back was able to not only pen (dictate) this missive, but also take over ongoing management of the portfolio and actually return redeeming investors capital with an 80% net return for the year 2000.

This actually illustrates the courage and perseverance often present in great leaders.

No excuses. Just results. Anyone else worthy?