NOVA did a show about it.
Posted on 05/11/2005 5:13:45 AM PDT by TigerLikesRooster
May 11, 2005
Hedge Fund Rumors Rattle Markets
By RIVA D. ATLAS
Long-simmering worries about the growing influence of hedge funds erupted yesterday in a wave of nervous selling on world stock markets after talk that hedge funds had suffered large losses tied to the debt of General Motors. Shares of banks with connections to hedge funds fell sharply, even though the rumors could not be substantiated.
Hedge funds, lightly regulated investment pools for the wealthy and institutions like pension funds, have been a source of concern for some investors because the recent flood of money into the funds appears to some to have the earmarks of an investment bubble.
For Wall Street, however, the funds have been a huge source of profits. Banks made an estimated $25 billion last year catering to hedge funds - lending them money, trading for them, helping to devise complex derivative transactions or lending them stock to bet against a company, according to a recent report by Credit Suisse First Boston. Some of the rumors yesterday involved hedge funds that have sold ownership stakes to the investment banks in recent months.
The increasing ties of hedge funds to Wall Street, the runaway growth of the funds and the relative secrecy of their operations have made a number of investors uneasy. At a time when stocks have been weak, and bond investors have been unnerved by last week's credit rating cut on two of the biggest issuers of bonds, G.M. and Ford, it is perhaps not surprising that the markets could be so easily rattled.
"No hedge fund declared bankruptcy during the day and no one could come up with the name of a hedge fund close to that status," Richard Bove, an analyst with Punk, Ziegel & Company, noted in a report yesterday. But "the rumor did stimulate a thought process," he said, "suggesting that there was vulnerability" in the business of catering to hedge funds.
Several large hedge funds fielded calls yesterday from investors worried that portfolios had taken big hits.
One firm that was the subject of rumors was Highbridge Capital Management, which oversees $7 billion in hedge funds. Highbridge sent a letter to investors yesterday noting that while its funds were down 3 percent through April, they are actually up modestly in May. An investor with Highbridge said that the fund had made an investment tied to G.M.'s securities but that an executive at the firm told him it had not lost money on the trade.
"In a difficult market environment it is not uncommon for rumors to circulate about market losses," Highbridge said in its letter.
Another large hedge fund manager, GLG Partners, which is based in London and is 20 percent owned by Lehman Brothers, had losses ranging from 2.5 percent to more than 8 percent as of last month on some of the portfolios it manages, according to a person briefed on the results. Officials at GLG did not return e-mail messages sent to their offices yesterday afternoon. A spokeswoman for Lehman declined to comment.
Yesterday's sell-off began on European markets amid a rumor that Deutsche Bank stood to suffer losses because of its exposure to a hedge fund that was caught wrong-footed by the recent cut in the credit rating of G.M.'s debt. Shares of Deutsche Bank fell 3 percent.
Traders said that many hedge funds were hurt by betting that shares of G.M. would fall and that the debt securities of the company would rise. Both sides of the bet went against the funds last week. First, the investor Kirk Kerkorian said that he planned to accumulate a stake of as much as 9 percent in G.M., and its shares rose sharply. The next day, Standard & Poor's cut G.M.'s debt to junk status, causing prices for one bond issue of the company to fall as much as 7.6 percent.
Some hedge funds, and some brokers' trading desks, may also have lost money on complex, highly leveraged derivative contracts tied to the correlation in prices of corporate bonds. That trade also fared poorly in recent weeks, after prices fell on the debt of some industries, like retailers and auto companies, with the debt of those companies weakening more than the broader market.
Some traders speculated that losses by hedge funds tied to G.M.'s securities might have been behind an announcement yesterday by S.& P. that it was downgrading or placing on watch several derivative contracts, known as synthetic collateralized debt obligations, that were arranged by Deutsche Bank.
The value of these contracts can be linked to the prices of an underlying portfolio of securities. The contracts are popular with hedge fund managers because they can be purchased for as little as 10 percent of the value of the underlying securities, traders said. The contracts affected by yesterday's action appeared to be relatively small, with S.& P. placing a value of about $150 million on a majority of them. A spokesman for S.& P. said the agency would not comment on whether its action was linked to the decline in G.M.'s bonds.
A spokesman for Deutsche Bank declined to comment on rumors that the bank was exposed to losses from a hedge fund, saying that was market speculation.
Executives at the bank said that they had not turned up evidence of major losses from hedge funds. The rumors emerged a day after the top leaders of another prominent German company, Deutsche Börse, were forced out by pressure from United States and British hedge funds, which had opposed the leaders' effort to take over the London Stock Exchange. Such a shareholder uprising is almost unprecedented in German industry, and it clearly rattled the markets.
The selling spilled over into New York, where shares of Wall Street firms with significant ties or relationships to hedge funds - J. P. Morgan Chase, Morgan Stanley, Lehman Brothers, Bear Stearns and Goldman Sachs - also fell sharply. The major stock market indexes fell about 1 percent.
The big worry, one money manager said, is "if some fund had big losses and multiple banks were lenders to that fund." Such a possibility scared global markets after the near collapse of Long-Term Capital Management in 1998.
Last fall, the Federal Reserve set up a group to look at what systemic risks had been created by the explosion of entrants into the hedge fund market and the aggressiveness with which Wall Street was welcoming them. It also encouraged the revival of a high-profile watchdog group formed in the wake of the Long-Term Capital crisis. Called the Counterparty Risk Management Policy Group II, it will examine everything from narrow credit spreads - a result of low perceived risk - to concerns that Wall Street may be cavalier in its lending to hedge funds.
A spokeswoman for the Federal Reserve Bank of New York declined to comment yesterday.
The worries about hedge funds come at a time when the performance of many funds has slumped. After record flows into the funds in recent years, many of these portfolios are suffering losses this year.
Although most funds' returns are down by a few percentage points through April, the weak results to date have caused some worries that performance may have peaked. With interest rates rising, some investors could be tempted to shift their money out of the funds and into the bond market as a safe haven, said Antoine Bernheim, publisher of the U.S. Offshore Funds Directory. Funds specializing in everything from junk bonds to commodities have suffered poor results in recent weeks.
"It has been one of those periods where there is no place to hide," he said. "There are no land mines, but there are plenty of potholes."
Mark Landler contributed reporting fromFrankfurt for this article.
Ping!
means...?
Something which can bring down the entire financial system.
Long-Term Capital Management - LTCM: A large hedge fund comprising Nobel Prize-winning economists and renowned Wall Street traders that nearly collapsed the global financial system in 1998 as a result of high-risk arbitrage trading strategies.
http://www.investopedia.com/terms/l/longtermcapital.asp
NOVA did a show about it.
long term capital management
Thanks for the post. Interesting. Thanks for the links.
An analyst on Cavuto yesterday said the market could lose 1,000 over this. Minimum.
That is big.
Is there a danger they could ALL go belly up?
sw
Anyone with savings in mutual funds should be concerned. If GM does go bankrupt, thousands of suppliers are going to take a hit.
Debt derivatives: the only five hundred year flood plain that floods every five years.
And wanna figuratively bet that one George Soros may be trying to deliberately engineer a crash of the US economy because he has considerable short positions on stocks and US currency and considerable long positions on commodities such as gold and crude oil?
Real or tin foil hat time?
LTCM (already defined by several) was the attempt by alot of VERY bright guys to build a whole series of "riskless" hedges, arbitraging one market against another in a very complicated sequence of interlocking, intermarket, international offsetting trades. It was NOT an attempt to do "high risk" arbitrage, like when you plunk down money on a futures contract leveraged at 20:1 or better. It was rather an attempt to build a network of one contract against another, so that the profits are smaller, but the risk is minimized, like doing a covered call, or a calendar spread. The problem was that "no one anticipated"(DUH, it is called "market risk", you dolts!) the collapse of the Russian Rouble or its consequent effect on several markets. The firm went bust, and came close to pulling the whole shebang down with it.
Thanks...bump!
Yes. Stock options are one form of derivatives.
I have read that one organization controls most of the derivative creation and has large poisitons in them.
All the large banks and brokerage firms use derivatives.
To the point where the government can't let them fail or they will bring down the world financial system.
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