The Case for Contrarianism

This article appeared this morning in HedgeWEEK.

Stephen BartholomeuszThe great shake out

Earlier this year the prestigious business magazine, Barron’s, listed its “top 75” hedge funds. If it were running the same exercise today the names would be somewhat different. Assuming it could find a fund worthy of the description.

The post-Lehman Brothers phase of the credit crisis has been horrible for the hedge fund sector.

There has been nowhere to hide since Lehman collapsed mid-September. Equity markets, credit markets, commodity markets and emerging markets all tanked. Bans on short-selling in some markets wouldn’t have helped. Their funding base, the investment banking sector, has virtually disappeared.

The Credit Suisse/Tremont hedge fund indices showed that virtually every type of fund suffered losses in September and that the sector overall was down about 10 per cent for the year-to-date. October would have provided no relief, with indications that the funds have been hit by large-scale redemptions and withdrawals of funds that are forcing liquidations of positions in declining markets.

When Barron’s compiled its list, in April, its best-performing fund was the San Francisco-based Passport II Global fund. That fund was down 27 per cent last month and 34 per cent for the year.

Another of Barron’s top 10 fund managers, Renaissance Technologies, saw the value of its flagship fund fall 8 per cent in October. Atticus European, a New York-based fund, was down 43.5 per cent for the year after a 15 per cent fall in September. The Children’s Investment Fund is down 26 per cent for the year. Philip Falcone’s Harbinger Capital, which has been very active in our resources sector, was down 18 per cent in September and had lost 5.4 per cent for the year-to-date despite having been up about 43 per cent in the first half of the year.

Sydney fund manager Phil Mathews made it to number 12 on the Barron’s list. His Sabre fund took long and leveraged positions in oil future and stocks, bets that appeared to have paid off spectacularly as the oil price soared.

About $6 million of units in the fund were issued at $100 each at its inception in 2002. By April this year they were valued at $1202. They then rocketed along to reach $2480 in June, giving the fund assets under management of more than $2 billion and making Mathews – who had a lot of his own money in the fund – momentarily one of the richest men in the country.

In July the fund lost 50.7 per cent of its value. It lost a further 6.7 per cent in August. Assets under management slumped to $984 million. At that point it stopped posting its returns amid reports that it was dumping its positions.

The funds are caught up in, not just extraordinary volatility, but what leading fund-of-funds manager Man Investments has described as “vicious de-gearing.” It compared the September quarter, during which the hedge fund sector lost more than 10 per cent of its value, to the period after the collapse of Long Term Capital Management 10 years ago.

George Soros last week predicted the hedge fund sector could be reduced to a third of its pre-crisis size by the “shake out” currently underway. Certainly, there will be a lot less leverage available to hedge funds in future and the cost of debt will be far more expensive than during their halcyon period of the credit bubble.

The remarkable returns posted by the funds during the bubble – Passport II returned 219 per cent in 2007 for a three-year annualized return of 65.5 per cent and the Sabre fund returned 105 per cent last year – are unlikely to be available again in the foreseeable future, which means it won’t be as easy for the managers to raise funds even if the post-crisis environment creates significant opportunities.

There is also likely to be far greater transparency imposed on a shrunken industry by shaken regulators. The leverage in the funds and a recognition that many of them were pursuing similar strategies, exaggerating both the booms and busts in various asset classes, has added to the extreme volatility and will add to the pressure to make their activities more visible and measurable.

In any case, a battered and down-sized global banking system is going to be short of capital and balance sheet capacity for some years to come. It won’t have any appetite for funding leveraged exposures to capital markets.


Today we will lighten up our stock portfolios by 50 percent  if the opportunity arises at the S&P 990 level.  The market is headed higher but election jitters may provide some trading opportunities to buy back lower at S&P 890 level.

7:29 AM CDT


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