Minyan Mailbag: Hedge Funds
Fool me once, shame on...you're not gonna fool me again
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.
Your mailbag comment about convertible bond funds calling you to try and unload their entire book was enlightening, and points out an interesting effect of hedge fund compensation systems: If a fund is underwater enough for a given year, then at some point it becomes clear that they won't be able to earn their 20% of profits because there won't be any profits. In this situation can make sense for managers to close their fund and start a new fund or join forces with another fund hoping to generate profits for the remainder of the year.
With so many types of hedge funds deeply underwater already this year, are you seeing a significant percentage of funds trying to close up shop? Do you think we'll see much of it in the months ahead if the market continues the way it has been going? How likely would exploitation of the fund closing option be to sour investors on hedge funds in general? Could the closing of enough hedge funds result in credit contraction as their massive borrowings are returned to the banks?
Thanks for all your insights,
You accurately describe a process that can occur, and has in selective cases. The frequency of such actions, at least so far, is very small since it is so egregious and would/could ruin the reputation of the manager.
I think if and when such occurs it is very messy and normally forced. Essentially the managers of LTCM did this; they were forced but the result is the same. The marketplace for some reason let these managers get away with it. Fool me once, shame on you; fool me twice, shame on me.
Hedge funds are an intricate part of the system and much money is being lent to them. A systematic unraveling could occur for example if the carnage in convertible bonds spills over as suggested it might. I have described a "correction" in the hedge fund industry that would weed out over-leveraged, poorly risk-managed funds. This will be a painful process and I believe it already has begun.
But what will emerge is a system with a smaller number of well-run hedge funds.
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