When the bellboy gets in, get out
Mar. 10th, 2005 01:49 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
peterbirksThere is a famous story, probably apocryphal, that JP Morgan knew that the 1929 stockmarket crash was coming, and decided to sell all his shares, when the elevator boy mentioned to him that he was thinking of buying some shares, as they seemed to be a one-way bet.
When I read in this morning's Financial Times that a retail "hedge fund" was going to be started in the USA, with a minimum investment of just $5,000, it struck me that now was definitely the time to be getting out. Superfund Asset Management, formerly Quadriga Asset Management, will have an investment office on Fifth Avenue in New York (to be opened this week by Bill Clinton), where retail turkeys can head down to vote for Christmas. Its founder is an Austrian, Christian Baha, and it claims to be the world's largest provider of "managed futures" funds to private investors. Baha wants to offer "people with a lower income the opportunity to benefit from successful investment models with double-digit returns".
Well, maybe they will benefit, but that is nowhere near as certain as the fact that Superfund Asset Management will benefit.
Thankfully the US has actually stopped SAM from calling itself a hedge fund. It would be a good idea if 95% of the so-called hedge funds around today were stopped from doing so. They are people punting with institutional investors' money at odds-on shots that they hope will not get beat. When they get their 20% return on a year, they take a vast commission. Eventually it all goes belly up, but the commission doesn't then get paid back.
What kind of punting are these hedge funds up to? Well, they are buying corporate bonds that probably have a 10% chance of defaulting before 2010, but they are accepting interest rates such that the chance is put at less than 5%. They are shorting the dollar through carry-trades. They are taking risk from banks, from insurers, from anyone who wants to give them risk, and they are asking for too little money to take that risk. The yield world is, as a result, turning topsy-turvy in a land where rational assessment of likelihoods has no place.
This basically comes down to the principles of big and small numbers -- that being that once a number gets very big it becomes incomprehensible. So it doesn't matter that you are paid odds of only 4 million to 1 on a 13.5 million to one shot. The numbers are too big. With small numbers, the same applies. If there is a
less than 1% chance of something happening in a year, people function as if it is certain not to happen. See the cries of wrath every time that Aces gets cracked in Hold'em.
Anyone who mentions "double-digit returns" at the moment, as Christian Baha does, should have a wealth warning stapled to their forehead. And if I had a tenner for every "successful investment model" that had ended in tears then, well, I'd definitely have over a hundred quid.
I don't know what institutions are ploughing money into these hedge funds, but I fear that they are playing with pensions, or with local authority funds, or with anything where they are being pushed by their bosses to squeeze that extra 1% out of returns. Fund managers being fund managers and most middle managers being wimps, we need people to say that no extra return comes without extra risk, and that the demand for that extra return means that at the moment you are taking on a LOT of extra risk, for not very much extra return.
I predict that the end, when it comes, will be very bloody indeed. And I am reminded of that elevator boy. All it will need is one bad corporate default, followed by the failure of five or six significant hedge funds, which will be followed by the news that these failures have brought down a significant investment operation and then, well, a vicious circle of defaults. Me. My money's all tied up at the moment, in the mattress.
When I read in this morning's Financial Times that a retail "hedge fund" was going to be started in the USA, with a minimum investment of just $5,000, it struck me that now was definitely the time to be getting out. Superfund Asset Management, formerly Quadriga Asset Management, will have an investment office on Fifth Avenue in New York (to be opened this week by Bill Clinton), where retail turkeys can head down to vote for Christmas. Its founder is an Austrian, Christian Baha, and it claims to be the world's largest provider of "managed futures" funds to private investors. Baha wants to offer "people with a lower income the opportunity to benefit from successful investment models with double-digit returns".
Well, maybe they will benefit, but that is nowhere near as certain as the fact that Superfund Asset Management will benefit.
Thankfully the US has actually stopped SAM from calling itself a hedge fund. It would be a good idea if 95% of the so-called hedge funds around today were stopped from doing so. They are people punting with institutional investors' money at odds-on shots that they hope will not get beat. When they get their 20% return on a year, they take a vast commission. Eventually it all goes belly up, but the commission doesn't then get paid back.
What kind of punting are these hedge funds up to? Well, they are buying corporate bonds that probably have a 10% chance of defaulting before 2010, but they are accepting interest rates such that the chance is put at less than 5%. They are shorting the dollar through carry-trades. They are taking risk from banks, from insurers, from anyone who wants to give them risk, and they are asking for too little money to take that risk. The yield world is, as a result, turning topsy-turvy in a land where rational assessment of likelihoods has no place.
This basically comes down to the principles of big and small numbers -- that being that once a number gets very big it becomes incomprehensible. So it doesn't matter that you are paid odds of only 4 million to 1 on a 13.5 million to one shot. The numbers are too big. With small numbers, the same applies. If there is a
less than 1% chance of something happening in a year, people function as if it is certain not to happen. See the cries of wrath every time that Aces gets cracked in Hold'em.
Anyone who mentions "double-digit returns" at the moment, as Christian Baha does, should have a wealth warning stapled to their forehead. And if I had a tenner for every "successful investment model" that had ended in tears then, well, I'd definitely have over a hundred quid.
I don't know what institutions are ploughing money into these hedge funds, but I fear that they are playing with pensions, or with local authority funds, or with anything where they are being pushed by their bosses to squeeze that extra 1% out of returns. Fund managers being fund managers and most middle managers being wimps, we need people to say that no extra return comes without extra risk, and that the demand for that extra return means that at the moment you are taking on a LOT of extra risk, for not very much extra return.
I predict that the end, when it comes, will be very bloody indeed. And I am reminded of that elevator boy. All it will need is one bad corporate default, followed by the failure of five or six significant hedge funds, which will be followed by the news that these failures have brought down a significant investment operation and then, well, a vicious circle of defaults. Me. My money's all tied up at the moment, in the mattress.
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no subject
Date: 2005-03-10 03:48 pm (UTC)I lost a really enjoyable job (probably the last such I've had) as IT manager at a hedge fund when the Russian and Brazilian economic crises triggered the LTCM collapse in 1998 (?). We got caught in the systemic disappearance of liquidity (and the 6 standard deviation market shifts) and found ourselves, trapped by redemption calls, having to close out positions in the worst possible conditions.
Part of the potential problem - and hence the unquantified risk - is that all (OK, most) of the funds are making the same bets with the same underlying assumptions. So when some generally but not specifically predictable cataclysmic market event occurs, there is carnage. Except for Nicholas Nassim Taleb's clients, who benefit at that time through his betting on things going wrong more often then people would like, which they tend to do. Smart bloke.
There is a possible exception to this, although it's irelevant to the private individual. Several (many?) investment banks have unrolled part, or all of their proprietary trading desks into one or more single-client hedge funds. This has several advantages, two obvious ones being that the traders get to operate with fewer constraints and the banks get to be "investing" rather than "punting".
Absolutely agree that when the small punter starts to get a sniff of the gravy then it's time to start thinking about your next meal.
I thought all your money was in Neteller?
It already happened,
Date: 2005-03-12 10:43 am (UTC)LTCM was eaxctly the 'major default leads to hedge-fund-meltdown leads to systemic-meltdown' event that Pete originally forecast. What happened then was that the central banks, led by the Fed, moved to plug the hole as far upstream as possible, by arranging for LTCM losses to be covered directly instead of letting the credit event ripple through the market.
In response to this one event, it may been the right decision. It does however raise the 'moral hazard' issue; and leave one wondering what's going to prevent it happening again. Central Banks will reply that lessons have been learnt in banking supervision, so that, for example, hedge funds cannot leverage as highly as LTCM did; also that the commercial banks will have had a shock, and be more careful in future. The problem with the latter is that in the seven years since the Russian meltdown (August 1998 - I was there too), the collective memory of investment bankers has been wiped out by staff turnover. As a species, investment bankers are no better than any other group at understanding the history of their trade/culture/environment. (Modern British politics rant deleted here.)
Re: It already happened,
Date: 2005-03-12 11:32 pm (UTC)Re: It already happened,
Date: 2005-03-13 10:20 am (UTC)That said, the way traders are trained and evaluated is a major problem in investment banking. The Bank of England issued a report years ago (possibly around 1998, I really don't remember) wherein it was pointed out that the way traders' bonuses are calculated effectively gives the traders call options on the trading profits. As we all know, option value is positively correlated with the volatility of the underlying. The report stated that this encouragement of volatility of trading results by the banks themselves is a systemic risk in the banking system. I have seen no report of anyone doing anything serious to address this.
BTW Why do traders buy I/L Gilts? Because they know that you only make money trading when it's a full-time job, and the bank won't let you trade your money and theirs at the same time (you get the bonus instead). At least, that's what the smart ones do. The not-so-smart ones give it all back to other providers of secondary market liquidity; or providers of primary market liquidity in the case of alcohol and fast cars ;-).
no subject
Date: 2005-03-10 09:29 pm (UTC)While I know practically nothing about the financial world, it's nice to hear someone who does know backing up my "mattress plan" as the way forward. I was thinking about buy to let about 18 months ago but I ended up thinking "Come on, it just can't be that easy". Once everyone's doing something, it must be time to change direction.
Andy.
no subject
Date: 2005-03-13 02:36 pm (UTC)I'm trying to think where the market opportunity here is. Surely, people should be "shorting" houses and renting? "Sell-to-rent", to coin a phrase.
Building seems a bit risky, due to startup costs, and likelihood of crash.
Build to sell
Date: 2005-03-13 02:47 pm (UTC)I see no easy money in the UK at all. Patience is the watchword. Wait until no-one has money to invest, and then you can move in and clean up. At the moment everyone has money to invest, meaning that the returns are pathetic relative to the risk. I read the Economist article. Most of this was well-known to most readers. However, it missed one interesting point about the benefits of house-ownership (rather than renting) and that is the ease with which you can get credit (if you want it!) if you are a house owner, and the difficulty in obtaining credit if you are not. Most loan application forms ask you whether you own your home and how long you have lived there. It's no use pointing out that you are a fan of Adam Smith and that you have moved home five times in the past five years because that made economic sense. As far as the munchkin at the Halifax is concerned, you might as well be a tinker traveller living in a caravan.
"Shorting" the market is very difficult because of the frictional cost involved. Anyway, if you plan to buy a bigger place, you WANT the market to fall. How come falling house prices is bad, but falling car prices is good?
no subject
Date: 2005-03-13 08:02 pm (UTC)Andy.
Congrats
Date: 2005-03-13 08:20 pm (UTC)Pete
Re: Congrats
Date: 2005-03-13 09:47 pm (UTC)My inner child is very happy to accept congratulations even though my outer adult knows it's a bit like being congratulated just because it's payday after working hard all month ;-)
Andy.