Rekenthaler Report: The Future of Hedge Funds
With the boom over, what will coming years hold for hedge funds?
The Future of Hedge Funds?
With a presentation on this very subject beckoning in late November, I'd better get cracking.
Where better to start than with speculation from the Oct. 25th-31st issue of The Economist, in the richly titled article, "Hedge funds in trouble: The incredible shrinking funds," which carries the subhead, "High borrowing and the credit crisis are bad enough for hedge funds. Panicky clients are worse." That's a lot of nutrition for a mere headline, enough in fact that I wonder if I need bother reading the article.
However, I soldiered onward. The article does not start well. The unsupported statement that "industry executives predict that assets could fall 30-40%, as clients stampede for the exit" gives me little comfort. Being something of an industry executive myself, I am keenly aware of how little value one should place in anonymous statements from such people. Industry executives have a regrettable habit of pulling numbers out of thin air when attempting to impress listeners, and the even worse habit of mimicking what other industry executives have said. When this is immediately followed a note that the number of hedge funds "climbed to over 7,000," the article's credibility hits its low point. There are many, many more than 7,000 funds in existence.
But things improve. The author cites a Merrill Lynch study stating that the 30 largest holdings of the biggest hedge funds trailed the stock market from the end of August through mid-October. I have no idea whatsoever how Merrill Lynch could possibly learn what the stock positions of the biggest hedge funds might be, but it's certainly an interesting thesis, this notion that the hedge-fund giants have been on the wrong side of the recent trades, and I can hunt down the Merrill study for more information. Perhaps fuel for a future Rekenthaler Report.
Then the author shows, fairly convincingly, that hedge funds are deleveraging mostly because of client redemptions, not because their lenders are withdrawing credit. This thesis corroborates a recent discussion I have had with a hedge fund manager who has suffered redemptions of 15% of assets this year despite "OK numbers," and who says that many of his peers have shared similar fates. (This manager also says that he is only "in process" of deleveraging and selling off assets, which implies more problems for the upcoming stock markets.)
The article concludes with the provocative notion that hedge funds may emerge from the wreckage better off than they were, because no longer will so much money be chasing the same trades. Which raises the questions: How can we know when the industry has become too large? How can we predict when hedge funds might be prone to "contagion"? I do not know the answers, but I am glad to ponder the questions. Thanks, The Economist. Job well done.
False Profits
Inevitably, those who "called the market crash" become famous after the market does indeed crash. Morningstar is not alone in devoting attention to GMO's Jeremy Grantham (although it's fair to point out that Jeremy did receive some of Morningstar's cyberink when the markets were riding high, too), and longtime bear Robert Schiller has never been so widely quoted. At least those two offered trenchant critiques of fundamental weaknesses in the U.S. economic structure. Others who were expecting the worse from stocks, but without the same quality of criticism, have also come to the fore.
My advice is simple: Don't listen. With apologies to Monsieurs Grantham and Schiller, it's hard to find success stories with investors who publicly predicted a market decline, and who positioned their portfolios accordingly. I can recall only Stanley Druckenmiller, who hit a rough patch shortly after he dodged the 1987 crash, but who then enjoyed great success at hedge fund Quantum during the 1990s. Those odds don't strike me as appealing.
The Decline of Modern Society, #4675
From a no-doubt pricey advertising campaign, appearing on aol.com's coveted home page: Less Wrinkles in Only 60 Minutes. Such writing gives me fewer happiness.
