Saturday, November 10, 2007

Exit Games

We are early November, and getting closer by-the-day to the close of the Calendar Year. Imagine yourself a hedge-fund manager. Maybe you're a long vs. short HFM who shorted oil and commodity stocks too early, or went long domestic drillers, or didn't own foreign stocks, favoured financials, or shorted the f*ck out of ISRG, RIMM, AAPL, CROX, DECK or some other momo shite with disastrous effect. Or perhaps you were a value manager who thought there was solid opportunity in all things mortgage, or worse, you were a way-to-leveraged quant-manager who unwound with the crowd in August and missed the sharp recovery bounce in a double-whipsaw body-slam. Whatever the case, you hoped for the best, pleaded, even made the pilgimage to your investors head-offices, but after all that, they apologized, sent you a pink-slip en-masse, for value Dec 31st, and will subsequently be shipping the money - in Darwinian-style - to those who've done well, or simply better than you. Or maybe they'll just give it all to Steve Einhorn. And as result, you now have to think about precisely what strategy to employ in order to take a large part of your still-leveraged and probably still-losing portfolios down to cash in order to repay investors their dosh, and thereafter think about swapping that NetJets Gold Package for regularly scheduled air travel.

What are your options? How do they differ? What are the benefits and drawbacks of your respective choices? Do you have D&O insurance? What does the CFA handbook say you should do? What does that little red devil that keep apparating on your left shoulder suggest? Let's take a look...

Option A - Be a Fiduciary.
I must tell that boring as it is, this is my preference. For I am at once, a poor liar, and as bad holder of untruths. And its a small world of investors and allocators, and one never whether what's gone around might come around. In any event, it's not personal (unless your are Dan Loeb or Tom Hudson). And in any event, maybe the redemptions are not terminal, and you'll live to fight another day so there's no point in ticking off remaining investors. So be a stand-up guy, take your position down in the context of the market, taking advantage of liquidity and shorter-term price aberrations pacing yourself to arrive at your desired leverage at the end of the year. It yields in effect under-leveraged, "lame-duck" management until the redemption date, but most allocators and would prefer this, I think, since they never know what side of the share register they'll be own.

Option B - Wish, Pray, Hope
Maybe you've had a spell of bad luck: long some earnings torpedoes, short some momentum upward revisions, but you convinced your positions are sound and right. You've looked at them upsides-down, sideways, you've asked Cramer on The Lightning Round and consulted the Ouija Board, Runes and your Eight Ball from sixth grade. You still think you;re right. Well, there is always a chance something awful might happen to market between now and then and THAT would cause temporarily bad positions to come good. There is also the chance that the January effect will come early and reward you, bailing you out with some roaring returns that will allow you to phone investors and suggest "all is now well" and that they pull theirredemption requests. Yes. it's possible. Not probable, but still possible. Unfortunately, if you've good sucky positions at this point of the year, the odds are (from the Trading Calendar) that November and December remain tough for fortune reversal, and that they historically have been rewarding for momentum, or precisely the opposite of what you require. And to boot, the Darwinian redemption cycle this Q4 looks vicious, so others like you will be pondering precisely the same question. Bit of a mind-fuck actually...but if you get it wrong, then you can certainly kiss your investment career bye-bye.

Option C - Unwind Now, Go Play Golf
You must ask yourself: "How bad is it?" If its really really bad, then you might as well just call up the GS portfolio-trading desk, gt a principal bid, do a program-trade and spend the next six weeks management fees to go to Vegas, Bali, Cabo and party. Unless your substance-abuse oriented, and you can behave like Nicholas Cage in "Leaving Las Vegas"? I actually suggest that like David Weill you could use the time to go to an Ashram somewhere in India and get on with the spirtitual repair that will undoubtedly be setting in when your ego faces the reality that you are Master Of The Universe, no longer.

Option E - PIK or Suspend Redemption
Now if you've been emulating Lancer's Michael Lauer (as was ex-Absolute fraudster FLorian Homm) you might not be able to exit at all, so IF the authorities haven't already gotcha, you could suspend redemptions, or choose to pay-in-kind which is SOP to almost all by-laws of Funds, at the sole disrection of the directors. Usually its reserved for illiquid and unmarketable securities, or those caught in litigation (quite common in reg-D funds). It's a shitty option, but if your portfoilio is micro-cap or worse, nano-cap, it is always option. The downside of course is that you'd better have a "Plan B Career" (do you Cook or Dog-Walk?), and a way of ensuring "Bubba" is not your cellmate, and doesn't take a fancie to you.

Option D - Leverage Up & Shoot the Moon
Nothing says you must unwind. Depending upon how clever you wrote the docs, you might not need to pay redemptions for several weeks, maybe even months if your lawyers were really goood, and the investors really desperate to throw money at you. This way, you'll be earning interest and the Prime won't know you've got to pay redemptions so your leverage won't look awry (to them). There are times when the January effect is vicious and pays huge. This could be it. But then again, maybe it won't be. Maybe whatever mortally-injured your portfolio continues, and you still have the full position, on a tiny veneer of capital. IF things went really wrong of course, the remaining investors could easily be obliterated in a morning. It's a high stakes game, but if you are in possession of non-public information about yourr positions, or the macroeconomy that carries a high degree of certitude, it just might worth the punt. It's "all in" as they say in poker....just make sure you've some cash and property ringfenced and secure, becuase if you get it wrong, you will have some irate folk at your door, even more so if you've got some of the pilfered billions from Russia.
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Option F - Screw the Bastards
OK, lets blame your investors. They shouldn't have redeemed YOU in favor of some Frat-boy with a trophy wife who was "lucky". How stupid of THEM! IF only they'd waited...the positions would have come good. But you can get revenge. What IF you unwind all of the redeemed positions on the last day? Perhaps even in the last hour of the last day? What would happen? Well you and your remaining investors would experience a large negative return, But you could choose NOT to slam all the positions, but slamming some, and leveraging up for the balance is a market impact trade that transfers YOU the positions at the extreme-best prices. Maybe if your positions are really rather large, you can wait until the last few days of the year and really lean on the stocks your selling and jam-up the stocks your buying so that you do not attract the undue attention of the SEC. How much can you move prices? Hmmm, when Highbridge started the puke in July and August, they moved it 10%. With the end of the year being really thin, and the last day off the year being a half-day, something like 5 to 10% might be entirely possible if you tried really hard. So ideally, you'd double or triple your post redemption leverage on Jan1st, turning the 5% drawdown into 15% profit on the January bounce at +3x leverage. Remember that you need to inject some plausible deniability into your explanation or else you might be subject to lawsuit (which you might in any event). Some good examples might be: "Mea culpa, I underestimated the market impact, but it was YOUR decision to redeem." Or "I didn't want to disadvantage remaining investors (mostly YOU) by lowering their leverage diluting performance before the end of the year." Or "Tough luck, sue me (that'll teach you to f*ck with The [Former] Master of The Universe".

Option G - Screw the Bastards Royally
DO the same as the above, but the interesting thing to contemplate is that as the manipulator, YOU are privileged to material non-public information. While everyone else is scratching their heads wondering WTF is going on and why and who, YOU know, and there is no doubt. This allows YOU, in addition to the significant additional leverage. to trade options directionally on the last day or two. You could sell puts on the things you're liquidating and sell calls on the shorts your covering, or buy puts on things your covering and buy calls on names your liquidating. Or both. The point is: YOU finally have an edge, one that is apparently better than your stockpicking or asset-allocation or else you would be in your position in the first place. So heroic will your January post-redemption performance be that your former investors will be kicking themselves and flogging the analyst who made the redemption call on you, and you will have some new "I told them so" talking points in which to entice some new suckers into your fund.

For allocators, it is worth having this discussion with your HFMs to try to ascertain precisely what their exit strategy is. You might even want to ask them for a written legal representation, just in case they decide to Shoot The Moon or Screw You...

2 comments:

Jeremiah said...

"momo shite"

gotta love it. well.. sort of
if you were trying to be 'right' the last 2 years, than calling a number of currencies, commodities, stocks..etc (it turns out artefacts too) "momo shite" has a much deeper meaning than one would think.
but would not pronounce the "momo shites" dead yet, but many of its followers will hopefully have a much smaller saying in market movements in the years to come.
i would welcome that

Anonymous said...

I wonder if this will be required reading at Goldman Sach's Global Alpha fund this holiday season?
clare