Tokyo Eifuku Hedge Fund Collapses

NEW YORK, Jan 24 (Reuters) - A $300 million Japanese hedge fund is being closed after losing almost all its capital in just seven trading days in early January, the Wall Street Journal reported on Friday.

An earlier report that the Eifuku Master Fund, run by a former Lehman Brothers Tokyo-based trader and which was up 76 percent in 2002, was closing hurt Japanese stock market sentiment at the beginning of this week.

"Substantial trading losses have consumed nearly all the fund's capital," John Koonmen, the manager, wrote in a letter to investors, dated January 15, the article said. While the fund's actual capital was down to almost nothing as of January 15, it still had long positions valued at $80 million and short positions at $117 million, the letter said.

Citing people familiar with the situation, the report said Koonmen borrowed funds from three securities brokerages that multiplied the equity capital by a factor of at least three. When positions started going wrong they demanded and got their money back. Koonmen declined to comment, the Journal said.

In early January, Eifuku made massive wagers on three trades, according to the letter to investors, the report said.

The largest of those trades, involving a total of $1 billion, included a bearish position in NTT DoCoMo Inc. <9437.T> and a long position in its parent, Nippon Telegraph & Telephone Corp. <9432.T>, people familiar with the trades told the newspaper.

Another one involved a tech stock Koonmen did not name in the letter but which people familiar with the trades say is Sega Corp. <7964.T>, the newspaper added. The third trade involved both long positions and short positions in Japanese bank shares, the report said.

Let's say you have 100 bucks. You borrow 300 from a bank. You now have 400 in your pocket. You invest it in Microsoft.

When you had 100, a 10% loss in Microsoft leaves you with a net worth of 90.

When you have for hundred, the 10% loss brings you down to 360. Only, the banks now want some more collateral, but you don't have any. So you pay back the banks 300, and are now left with only 60.

In other words, the leverage greatly increases the risk/reward. You can clearly see that with a loss of 30 percent, you would be wiped out.

Can you explain what this transaction is and how it works?

Basically, an investor/speculator borrows money from the broker and uses it to purchase stocks or deal in other capital instruments, hoping to make a profit. The stocks purchased are used as collateral for the loan.

If things go your way, you sell the stocks purchased with the broker's money at a profit, pay back the loan and pocket the difference as pure profit.

BUT--if the stock's price goes against you, this means your collateral's value can't cover your loan--so the broker(lender) gives you a call to put more cash into your margin account. If you can't come up with the cash, your broker will simply pick and sell items in your account until you have proper coverage of the loan. If neccesary, your broker will clean out your account.

Sounds like John Koonman used margin on a vast scale--probably doing some kind of speculative dance in the current markets--and got caught with his ducks all in the wrong row.

He didn't have enough in his managed accounts to cover the gigantic margin calls--and the party was over.

Here's a link that does a good job describing this somewhat complicated investment topic.

Imagine this, you're sitting at the blackjack table and then the dealer throws you an ace. You'd love to increase your bet, except that you are a little short on cash. Luckily, your buddy offers to spot you $50 and says you can pay him back later. Sounds tempting, doesn't it? If the cards are dealt right you can win big and pay your buddy back his $50 with profits to spare. But what about the downside? If you lose then not only are you down your original bet, but you still owe your friend $50. Borrowing money at the casino is like gambling-on-steroids. The stakes are high and your potential for profit is dramatically increased, consequently your risk is also increased.

Now, investing on margin isn't necessarily gambling. However, you can draw some parallels between margin trading and the casino. Margin is a high risk strategy that can yield a huge profit if executed correctly. The dark side of margin is that you can lose your shirt and any other assets you’re wearing. One of the few things riskier than investing on margin, aside from attending a soccer game in England, is investing on margin without understanding what you are doing. This tutorial will teach you what you need to know.

Buying on Margin

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