Hedge Funds: It's a Mulligan Industry

I've written on this subject a few times including [Mar 28: Founder of Long Term Capital Failing Again] and [Feb 28: London Hedge Fund Goes from +87% Return to Out of Business in a Span of Months] but frankly, for a person in my position with my goals, I have to say I get supremely irked each time I read another version of the same story. The Wall Street Journal has 2 stories on this subject - it seems like such a strange game. Take other people's money, devise a method to "beat the system" by a large amount, creating the ability to earn large sums of money in very short periods of time ('generational wealth' I like to call it), but opening yourself up to completely blowing up from the risks involved.

Then when it happens, you blame it on a "Black Swan" event - that once in a lifetime risk that you could never of foreseen.... wash your hands, close down your fund. (wait a while) And then go back to the market to raise funds for a new fund, now that your smarter and learned from your mistakes... and here is the kicker folks - there are tons of people willing to give it to you. But only if you have the right pedigree and have shown the ability to destroy wealth in a fabulous manner. Is that perverted or what? I guess I just don't understand since I am not part of that "sophisticated" system. Again, perhaps I am just bitter and that feeling does not allow me to see the brilliance in the investors who continue to shovel money in the direction of these "stars".

For those new(er) to the market, and wonder why stocks go in crazy directions that don't resound with logic these are illustrative stories of what goes on behind the scenes; think computer dominated trading, think huge leverage, think massive risks and the ability (in some cases) to group together to push a stock where "said group" would prefer it to go... this is not your momma and poppa market from the 60s or 70s. We are just minnows in shark infested waters. And leverage is everything - even our "conservative" investment banks are apparently leveraged 30+:1 (see Bear Stearns). And money is so pervasive in the invesment banking industry, that $30M is chump change - I don't know the conversion ratio but apparently $1 million investment banking dollars (easily earned through such great ideas as tech stock IPOs that value companies on "eyeballs" or say mortgage back securities - NEARLY risk free) is equivalent to a $10 bill for normal Americans.

WSJ: Rebounds by Hedge Fund Stars (Stars?) Prove it's a Mulligan Industry

• Jeffrey Larson lost $1.5 billion for his hedge-fund investors in a few painful weeks last summer. He shuttered Sowood Capital Management LP in July, one of the more embarrassing meltdowns in recent memory.
• So what are the 50-year-old Mr. Larson's summer plans this year? He is trying to raise money for a new fund, arguing that he has learned valuable lessons. And he is attracting some interest.
• Just over a week ago, Drake Asset Management announced that it was closing its $2.5 billion hedge fund after heavy losses. Executives say they already have more than $800 million committed to a new fund.
• Some investors in Daniel Zwirn's D.B. Zwirn & Co. fund recently received subpoenas from the Securities and Exchange Commission regarding an investigation into the fund, which is closing. But some already have told Mr. Zwirn that they would be interested in giving him money for a new firm he is considering.
• Traders sometimes even get third chances. Take Brian Hunter. After leaving Deutsche Bank amid a dispute, his trades led to $6.6 billion of losses for hedge fund Amaranth Advisors. He now is advising a new fund.
• Investors have a range of explanations for opening their wallets for failed managers. Sometimes, managers demonstrate that big losses made them smarter investors, or they offer to waive some of their hefty fees for those who got burned in previous funds. Some managers who had stumbled in the past, such as David Shaw of D.E. Shaw and William Ackman of Pershing Square, restarted their careers and generated big returns.
• It can be helpful to have lost loads of money, rather than a smidgen of cash. (aha! that's the secret - go big or go home)
• "It's crazy, but the guy who's down substantially often will have a lot more options versus someone smaller who hasn't lost much money," says Neal Berger, who runs Eagle's View Asset Management, LLC and invests with funds. "Some investors will say 'lightning doesn't strike twice in the same spot,' or, 'there must be something smart about him that someone gave him the opportunity to lose so much money in the first place."'

Back to Peloton which I wrote about in February - WSJ: Peloton Flew High, Fell Fast

• When hedge-fund chief Ron Beller's investments in U.S. mortgages turned against him, he got a rude awakening to Wall Street's unsentimental ways. Bankers who had vied for his business reeled in credit lines and seized the fund's assets. In a matter of days, Peloton Partners LLP, once one of the world's best-performing hedge-fund operators, lost some $17 billion.
• There is a widespread weakness in the hedge-fund business: Highflying managers sometimes fail to fully factor in broader risks, such as what happens when troubled banks pull back the borrowed money many funds need to make their investments. Peloton was particularly susceptible because it borrowed heavily to boost returns. For every dollar of client money, Peloton had borrowed at least another nine dollars to buy some bonds.
• A Long Island, N.Y., native, Mr. Beller made his career at Goldman Sachs Group Inc., netting a post as a top executive in London. (aha that explains it, right pedigree - please take all my money; what could go wrong - every Goldman guy is teflon)
• At a Goldman-hosted hedge-fund conference in a Spanish coastal resort, Peloton's team held court with potential investors, laying out the fund's strategy: Make money on global economic trends through bets on a variety of assets, including bonds and currencies. The partners kicked in $30 million to help start the fund. Goldman's asset-management arm invested $50 million, said people familiar with the situation. By that fall, Peloton's assets totaled $1 billion.
• He berated some investors who decamped, questioning why they would forgo Peloton's gains, which by November 2007 had reached a stunning 87.6%, largely on the bearish housing bet. In late January, Peloton won two awards at a black-tie ceremony hosted by trade publication EuroHedge. But by Monday, Feb. 25, further sharp drops had left Peloton scraping for cash to meet margin calls from lenders, including UBS and Lehman Brothers Holdings Inc. On Wednesday morning, Feb. 27, yet another sharp drop in Peloton's mortgage investments killed a rescue. Mr. Beller at one point collapsed on a couch in distress. The next day, lenders seized Peloton's assets, bringing a chaotic end to the fund.

So follow along at home; huge leveraged gain in 2007, accepting hedge fund awards in late January 2008, out of business by end of February 2008.

Since it is now May 2008, I can only assume he has a new fund or is fund raising and getting a ton of capital because "that could never happen again" and "he learned from his mistakes". :) There just must be more money than sense in this world. I look forward to the day I can blow up institutions money in my hedge fund and be lauded for my learning curve....