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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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 ;-).