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Hedge Funds Unravel

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CDO's, currencies and carry trades a risky game.

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Hedge fund fears are mounting over the Collapse of Focus Capital.

Focus Capital, a $1bn New York hedge fund, has been forced to liquidate its portfolio after missing margin calls from banks, it told investors yesterday. The fund, which had produced strong returns by investing in Swiss mid-cap stocks since starting in 2005, is now expected to shut down after losing about 80 per cent of its value.

In a letter to investors, the founders of Focus, Tim O'Brien and Philippe Bubb, said it had been hit by "violent short-selling by other market participants", which accelerated when rumours that it was in trouble circulated.

"It was like an avalanche," a spokesman said. He said the fund started in February with just over $1bn under management
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The Hedge Fund Lotto

Focus Capital had $1 billion under management and made 33% in 2007. Let's do the math:

  • $1 billion in assets
  • 33% return in 2007
  • 20% of the gains go to fund management.
  • 6.6%
  • 2.0% management fee is on top of that
  • 8.6% total
  • $1,000,000,000 * 0.086 = $86,000,000


$86 Million is not a bad sum of money to make for turning $1 billion into $200 million. Clearly this is the advantage of leverage (at least for those running the fund). All you need is one big year. Who cares after that? I think I could almost retire on $86 million.

VCG Special Opportunities Fund Sues Citigroup

VCG Special Opportunities Master Fund Ltd., formerly known as CDO Plus Master Fund Ltd., is sueing Citigroup (C) and Wachovia (WB). The suit alleges false claims on CDO defaults.

VGC has sued Citigroup Inc. and Wachovia Corp., alleging that the banks improperly collected the value of collateralized debt obligation (CDO) write-downs from the hedge fund by falsely claiming that the CDOs had defaulted. Citi and Wachovia had insured the CDOs by buying credit default swaps (CDS) from the hedge fund.

According to VCG, Citibank was 'more likely in a panic over recent turmoil in the debt markets connected to the sub-prime mortgage lending crisis, and because of that sped up demands for additional margin.' Soon thereafter, the fund said, because of an 'implied writedown' of the value of the collateralized debt obligations (CDO) it had insured via the CDS agreement, Citi claimed that a credit default had taken place. As a result, Citi said VCG owed the full $10 million. VCG argued that a default had not place, and said the demands for and seizure of its collateral were baseless.

The hedge fund made the same claims against Wachovia for breaching the CDS agreement they made on May 30
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No CDO Recovery in 2008

Moody's foresees No CDO Recovery in '08

Moody's Investors Service does not expect a recovery in the market for collateralized debt obligations - complex pools of debt that have fallen victim to the credit crisis in 2008, the ratings agency said Tuesday.

After issuance of CDOs peaked at nearly $350 billion in 2006, volume slowed down last year. The newfound distaste for risk investors developed scared buyers away from the CDO market.

A spike in payment defaults on home loans prompted Moody's to downgrade 1,655 tranches of CDOs last year, 10 times the number of downgrades in 2006. Moody's said it does not foresee a rebound this year
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Peloton Partners Liquidates Funds

Peloton Partners, a $3 billion hedge fund run by former Goldman Sachs (GS) star traders, was forced to liquidate its two investment funds. And margin calls at the Bank of Montreal recently went unanswered. Fingers are all pointing in the wrong direction. Please see Margin Calls Force Selling of Assets for more on those stories.

Hedge funds are supposed to make money no matter which direction the market goes. Clearly some don't. Excessive leverage and illiquid bets are frequently the reason. Expect to see more hedge funds blow up over CDOs, CDSs, CLOs, and CMOs. Still more will blow up over currencies and various carry trades.

The party has just started. I suspect 30-50% of the hedge funds in existence today will not be around several years from now.

No positions in stocks mentioned.
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