Thursday, September 21, 2006

Get Rich Funds vs. Stay Rich Funds

Are you a "Get Rich Fund" or a "Stay Rich Fund"?!??, I recall him asking. "You're a "Stay Rich Fund", which is all very nice and I am sure you're a nice girl, but, I only invest in "Get Rich Funds. Perhaps, you should talk to Izzy...since he's sweet on "Stay Rich Funds...." . Yup, that was a "potential investor meeting" following the LTCM debacle in late 1998. It followed a meeting in which the short, cigar-chomping Jewish allocator screamed "Dammit, Leverage is POISON!!". That of course followed the guy who said: "...only 20% pa and Sharpe of 2x?!?? You'll be lucky to raise a two dimes...I saw three guys this morning doing 35% with Sharpe's of 12..."

Such were the dark days in 1998 following LTCM's mere hiccup in comparison to the heaving technicolour yawn of the Amaranth Fund's demise. What will be the fallout for the street, hedge funds and hedgefund investors?

At $9bn, everyone who could, seemingly did have a piece of Nick Mouanis' Amaranth. Every Fund of Fund, family office, and large pension fund will have got stung. Many, will make public pronouncements, because they have to, though others -particularly in Switzerland - will be either more discreet or too embarassed to admit association. And surely the Japanese were there. Maybe that's why Mouanis let it happen: in response to the pathetically selfish neo-mercantilism of Japanese monetary policy? OK, probably not. And surely some of the Petro-dollars got "recycled" from Russian & Middle-Eastern owners to CTA's and the investment banks shorting Natty (who must have been the big winners), in their pursuit of putting the wounded holder of "The Ill-Fated Long Position", out of their margin-call misery.

LTCM was a capital dislocation event. It widened spreads of all variety across all credit-sensitive markets. And they stayed divergent or distended for a reasonably long period because LTCM was pari-passu with every prop-desk and Wall Street firm inventory position (and they had eaten their fill and weren't taking any more). The heightened perceived risk caused capital to pull in its horns, making it difficult for anyone to raise equity let alone think about dramatically increasing leveraged exposure to risk. Eventually it dissipated as the Fed ill-fatedly open the spigots in fear for the Y2K bug-a-boo. And the pain of investor losses faded.

But make no mistakes: the demise of Amaranth IS a capital dislocation event. Fortunately for the markets, their leveraged exposure was concentrated in Energy, and zero-sum. And though its zero sum, this is a dramatic destruction of equity, is not entirely offset since the short-Natty "winners" are not necessarily levered Spec Funds, per se. But more imtportantly, like in 1998 there will be ripples, and these ripples will cause risk-reduction, meaning position reduction in anticipation of year-end redemptions. Risk-spreads will widen, even though this was not a credit event. Christmas in Greenwich will not be as gluttonous as it might otherwise have been.

For the real economy, global imbalances (and the median US stock), Amaranth and its fallout is probably good news (for the moment). That there was excess speculation by all manner of Macro, Strategi, and Trend-Following investor in energy (and other commodities) as well as their stocks is obvious. Kicking the shit out of Natty validates the reality that there is plenty of supply (for the moment). Copper & Nickel are probably next. Maybe the whole real-asset complex. The net result will improve sentiment across the board by taking the heat off rising goods & service prices, the Fed, and especially the US's massive trade and current a/c deficits. PCE will take that much longer to roll over, and Nouriel Roubini's bold recession call, may prove to a quarter or two too-premature.

In the meantime, for hedge fund principals, and marketers alike, it is worth rehearsing your investor explanation for why you are no longer (and never really have been) a go-go "Get Rich Fund", but in fact are (and always have been) a conservative "Stay Rich Fund", irrespective of your momentum-humping pursuits, and envelope-pushing leverage. Just hope and pray that they do not demand to "look under the hood"...


pi said...

Is Amaranth a 6 sigma event? Was Refco a 6 sigma event? Was 9-11 a 6 sigma event (Some would argue market was already on it's way to being decimated regardless of 9-11.)? Was LTCM a 6 sigma event? Was '87 crash a 6 sigma event? Seems to me, only way to know is by the length of post-mortem recovery. Like the snow packed mountains, only a Cassandra would know the timing of avalanche. But as they say in comedy, timing is everything.

Cassandra said...

Refco was "Fraud" and that is simply part of the distribution. LTCM was "6-sigma" from an impact point of view as was '87. Amaranth will prove to havce a greater impact as ordinary investors (read: athletes, CEOs Trustees) RE-discover the risk in Funds' ordinary course of business. "You mean I could lose EVERYTHING??!!

pi said...

Speaking of fraud, I agree that Refco is par for the course. But LTCM also was a fraud, not on a conscience level, on an intellectual level. The principles of LTCM were arrogant and intellectally dishonest about the limits of their models.

Amaranth may or may not have far reaching effects. But there's a bigger elephant waiting in the room to which you have posted numerous times: the carry trade and everything related to it. Of course timing is uncertain, but 6 sigma event it will be.

Cassandra said...

I concur on the carry trade. But that will happen only when Japanese authorities voluntarily do away with ZIRP, the7y are strongarmed unvoluntarily into doing the same, OR things get bad bad bad in teh USA and the interest differentials diminish killing the carry itself.

One of the most nagging questions I had in 1998 was: did a BoJ of MoF (or a Fed) official give an ultimatum to HFs to unwind parasitic carry trades, or was it simply the magic of the market and pari passu risk? I really wondered about that for a long time, but subsequent behaviour by BoJ and MoF convinced me that it was the freak nature of pari passu insofar as LTCM had the same position as the street and they had some of it against all their lenders so when it went "POP!", there was no one who would dare bid and do more of the same once they found themselves proud owners of LTCMs carry positions. See Ben Carliner's last piece in Cynic's Delight about the impending end of the Carry Trade.

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