Friday, March 28, 2008

Founder of Long Term Capital Failing Again

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I have to say, when I read these type of stories (and it's not the first, not even the first this past month), I get inherently frustrated. I want to ask the type of people who entrust these people with their money, why do you go back to the same well over and over when there are other people (maybe writing a blog) who actually manage well? I know whenever a hedge fund blows up it says "well it's a Black Swan" - a once in a lifetime situation that caused it... just like the Asian currency crisis in late 90s, just like the tech bubble 4 years later, just like the real estate bubble 5 years later, just like (insert crisis here, they keep repeating every 4-5 years) - and each time the hedge fund manager says, well those are conditions we didn't model, we promise it won't happen again. Investors lap it up, give them money, and they blow up again down the road. Is having a "background" at the "right investment firm" all that is really needed to raise $500M or a few billion at a hedge fund? I openly wonder this because of the purpose of my blog... it is mind boggling to me. So easy to raise billions when you have the right access, but so difficult to raise money if all you are is a good investor... fascinating.

For those who were not around, Long Term Capital Management was a hedge fund that was a lot like Bear Stearns - it was so large, that it had its tentacles in so many pieces of the global financial world that it was not allowed to fail - so the Federal Reserve of NYC managed a bailout (sound familiar?) ... details here if interested.
  • Ten years after overseeing a hedge-fund collapse that buckled the world's financial markets, John Meriwether again is scrambling to stem losses and keep investors from jumping ship.
  • Mr. Meriwether is best known as a founder of Long-Term Capital Management, which in 1998 lost $4 billion. That helped foster a global financial crisis and triggered both a Wall Street-led bailout and congressional hearings on the dangers of hedge funds, the freewheeling pools for wealthy investors and institutions that often trade heavily and rely on borrowed money to bolster returns. (now remember, back in "those days" $4 billion was serious money - nowadays we write that off on a weekly basis and laugh it off, we are immune to numbers "that small")
  • Now, Mr. Meriwether's biggest fund, a bond portfolio, has plunged 28% this year; another, broader market fund is down 6%. Both had subpar performances last year.
  • Some investors in the funds are seeking to get their money out. Mr. Meriwether and his colleagues at JWM Partners LLC -- which he launched in 1999 with LTCM alumni -- are trying to reassure investors in the two funds that they have slashed risk and will use their experience to survive this market crisis, preserving about $1.4 billion in assets.
  • Mr. Meriwether, a 60-year-old former vice chairman of Salomon Brothers, has seen three decades of market zigzags, recessions and credit contractions. Yet he can't corral the risks of today's markets and is trying to play it safe, even though he believes he should be buying securities.
  • His funds' losing positions have included mortgage securities backed by Fannie Mae and Freddie Mac, trades tied to municipal bonds and triple-A-rated commercial-mortgage-backed securities, according to the letter. Those bets have eaten into his returns this year, particularly as hedge fund Peloton Partners LLP and Carlyle Capital Corp. unloaded many of the same securities as they spiraled toward demise.
  • His LTCM hedge fund, located in Greenwich, Conn., included Nobel Prize winners and math whizzes, but it was undone in 1998 by massive "leverage," or borrowing -- up to $50 for every dollar invested -- which amplified losses when the markets turned on him. (sound familiar? 40:1, 30:1, 20:1?)
Do you see the pattern of the systematic greed that is Wall Street? Take outsize risk, fight regulation, ride the train for a few years, build generational wealth through huge fees - then move on to next step.... blow up, get burnt, talk about how you "learned your lesson", Congressional hearings, someone is sacrificed to the gods (goes to jail), some regulation is introduced, everyone claps, then as things quiet down 2 years later, begin to lobby to unwind regulation, began levering again, take more risk, create a new round of transfer of wealth (generational wealth), rinse, wash, repeat - the game is the same, only the name of the crisis is different (except this current version is the worst ever in its reach) - thats why I keep saying we will have another crisis from today's slashing of fed rates, creating easy money, another bubble, which will end badly circa 2013... so the savers in this country get trashed (low interest), the common man gets trashed (rampant inflation through easy money) but there are some winners of course - and you can guess who. And then in 2013 we'll hear the same tired excuses of "this is a Black Swan event, once in a lifetime" and we "promise" it won't happen again - please don't regulate us, we mean it this time. If I'm still writing this blog at that bursting of the next bubble, begging for investment, while these fat cats get billions handed to them (again), just shoot me. But I digress, back to the shrewd Mr. Meriweather who because he was a VP at Salomon obviously knows how to run money (into the ground)....
  • Mr. Meriwether's recent troubles partly stem from borrowing. His bond fund had $14.90 in borrowed money for every $1 in equity at the end of February, according to the March 18 letter. Although far lower than at LTCM, the fund's risk level, which includes leverage, was still too much for this year's volatile environment, he and his fund managers have acknowledged in conversations with investors.
  • Mr. Meriwether marketed his bond fund as a lower-risk version of LTCM's core strategy, of identifying the next financial crisis and profiting from it by buying securities its managers consider underpriced. Investors were told that the firm would aim to keep borrowings below 15-to-1 even during less-volatile times. Mr. Meriwether and his colleagues promised to behave more conservatively, rebuilding their reputations with consistent returns. His bond fund hasn't had a money-losing year. (Editor note - see these are how these things work, devise a strategy - all the herd of hedge funds copy - they are all on the same side of the trade - and then when things turn "once in a lifetime" it blows them up across the board)
  • JWM's Relative Value bond fund, launched in December 1999, has lost 28% this year through last week after notching a 5.6% return in 2007, according to people familiar with the fund. The recent losses further weigh on the fund's average annualized return since inception of about 7% through February 2008. The Lehman Brothers U.S. Aggregate Index, a measure of investment-grade bond performance, has returned an annualized 6.5% during that period. (this is the hilarious thing - "sharp" investors pay these hedgie managers 2% annually plus 20% of profits to return 0.5% over what they could get by buying an index fund - what a scam. Yes there are the few bright minds out there who deserve that, or more - they return true value but when you have 6000-7000 hedge funds its a bunch of "me too" - just like the mutual fund industry, except more sexy because its "secretive")
  • Moreover, Mr. Meriwether's five-year-old macro fund, JWM Global Macro, which invests in broad trends through currencies, commodities, stocks and bonds, was down 6% through February after falling 5.6% in 2007. The fund has gained about 5.7% per year, on average, since it began trading in 2003. That record means the macro fund, too, trails its peers, which have gained twice as much a year, on average, during the same period. (probably 2/3rd of the readers of this blog have beaten that return - so apparently we can all be hedge fund managers - although they will claim "we reduce risk much better than peon individuals" - yes, they reduce risk until they blow up into shards)
  • Meanwhile, there is a big disadvantage to reducing how much money they borrow. Lower leverage cuts into the fund's chances of climbing back from losses. And it is a steep climb before JWM can start collecting its 20% performance fee again, in addition to the 2% of assets that the managers collect.
I would like to run a hedge fund someday too. Somehow, I think I can do better than these guys. And I won't need to lever 20:1 to do it. What a circus out there. And these are the people driving wheat up 25% 1 week and down 20% the next. Thanks locusts....

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