Archive for the 'Hedge Funds' Category

Momentum Investing & Mutual Funds

Kurt Brouwer August 31st, 2009

We have not written much about momentum investing, which is in its simplest form trend following.  Take a given index such as the S&P 500 and track it over time.  When it begins moving up, buy in.  When it begins falling, sell.

George Soros and Reflexivity

Perhaps the most famous proponent of momentum investing or trend-following investing is George Soros.  In his book, The Alchemy of Finance (Wiley Investment Classics), Soros wrote that markets are inherently reflexive.

That is, buying begets more buying until a peak is reached and then selling begets more selling until a bottom is reached. A market that is hot (say oil in early 2008) will continue to attract buyers who act under the belief that it will keep going higher and higher. A market that is cold (say financial stocks in January and February 2009) will continue to freeze out even the most patient buyers because most investors think it may keep going down. Of course, neither belief is correct. No market (such as oil) grows to the sky, but no market (such as financial stocks) falls to zero either.  Beginning in March 2009, we saw the turnaround.  All the sellers of financials had sold and some buyers came in.  Over time, financials moved up, attracting more buyers and so on.

In other words, though we do not know how far stocks or commodities will fall, but eventually all the sellers will have sold and the bottom will have been reached.  Then, inevitably, the market will rally. Similarly, at some point, the price of a stock or a commodity will falter due to a combination of weakening demand and increasing supply. Again, we do not know how far up it will go before that point is reached, but reached it shall be…

Now, Barron’s reports on a bevy of momentum-oriented mutual funds issued by hedge fund investor AQR.

Source: Barron’s

Preaching the Gospel of Momentum (Barron’s, August 21, 2020, Andrew Bary)

QUANTITATIVE INVESTMENT STRATEGIES ARE SHROUDED in mystery. Most investors don’t even try to understand them, and many practitioners won’t discuss them, fearing that doing so could cost them their competitive edge.

One of the largest firms in the field is AQR Capital Management of Greenwich, Conn. Founded in 1998, it oversees more than $20 billion, primarily for institutional investors. AQR, which stands for Applied Quantitative Research, seeks to use some of best ideas of academic finance in the real world. It applies its proprietary models across a range of assets, including stocks, bonds and currencies.

Backed by a wealth of historical data, the firm believes in often-derided momentum investing, which favors buying stocks that have been doing well, relative to their peers or the overall market, and avoiding those with poor price momentum. AQR calls momentum investing an “undiscovered style” and a better complement to value investing than growth-oriented strategies. The firm seeks to overweight cheap securities that have strong momentum and underweight expensive ones that have weak momentum. Unlike most investment managers, AQR employs no fundamental analysts to cover companies. Instead, it seeks to hone its quantitative models and develop new ones.

The firm last month started three momentum-oriented equity mutual funds.

The first, AQR Momentum (ticker: AMOMX), which invests in the third of the 1,000 largest U.S. stocks with the best total return over the preceding 12 months. It will be rebalanced quarterly. The other two funds, AQR Small Cap Momentum (ASMOX) and AQR International Momentum (AIMOX), are similar. The funds are up since their inception but trail the overall market.

Cliff Asness, one of the company founders described AQR’s general approach to investing this way in the Barron’s interview:

We use the best of modern portfolio theory techniques, not necessarily quantitative models, to help serve clients. It started back in 1994 when I was at Goldman Sachs, and they asked me to form a quantitative-research group. Where our process might have consisted of a few measures of value and price momentum 15 years ago, it now generally consists of many factors from more subtle measures of value and momentum to signals obtainable from the actions of management, short-selling activity and inventory changes for commodities. Our models form a diversified systematic opinion on what we like and don’t like in all liquid assets…

The problem with quantitative investment stratagies is that they are difficult to describe with any accuracy.  And, they are not purely quantitative, that is computer or model driven.  The managers still have a lot of leeway in what signals they follow and how they weight them.

I’m not knocking the momentum-investment approach because it makes use of very basic human psychology — the herd instinct.  As such, it can be very useful.  It will be interesting to see how well these momentum investing funds work.

Hat tip to Tadas Viskanta (Abnormal Returns) for helping me clarify the meaning of the last quotation.

Average Holding Period for Stocks — 6 Months

Kurt Brouwer August 8th, 2009

Source: Clusterstock

This chart covers stocks on the New York Stock Exchange.  As you can see, the trend has been towards more trading and speculation for many years.  I suspect much of this is driven by institutional investors rather than individuals.

Bonds Funds Gain on Hedge Fund Pain

Kurt Brouwer July 31st, 2009

Deleveraging Boosts Bond Fund Managers (MarketWatch, July 29, 2020, Sam Mamudi)

…Bond-fund managers say the exodus of leveraged hedge funds from their market pushed out spreads on debt securities to historic levels — a dramatic change from the middle of the decade.

In recent years, hedge funds were buying the securities at narrow spreads and making money by leveraging the trades. The spread represents the additional yield above U.S. Treasurys.

But as the credit market froze and access to leverage dried up, many of those trades ceased. What’s more, as panicked investors pulled their money out late last year, many hedge funds were forced to unwind positions to raise cash.

The combination of the two factors pushed down bond prices and raised yield spreads. As a result, mutual-fund managers are jumping back into the market.

“My environment as a non-hedge fund, cash-only manager is so much better now,” said Dan Shackelford, manager of T. Rowe Price New Income Fund .

…Hedge funds were making trades on debt securities that had fallen in price by fractions. They would make money on the deals by using leverage to magnify returns. But for mutual-funds, which are not allowed to use leverage, the small drops in price didn’t justify a purchase.

…But as hedge funds stopped buying — and were even selling — debt securities, prices fell, raising yields and widening spreads. Late last year, spreads spiked to more than 6%…

Fixed income mutual fund managers had a hard time competing with their highly-leverage counterparts at hedge funds until all of that unwound.  So far this year, bond funds have done pretty well.

California Pension Plan: Betting the house

Kurt Brouwer July 25th, 2009

From the New York Times [registration may be required] we get this report on the California Public Employees Retirement System (CalPERS), which is the largest pension plan in the nation.  CalPERS has struggled of late due to investment losses and funding issues.  It also has a credibility problem after helping bring about the current crisis in California public pensions.

Now, the investment chief for CalPERS is doing something that is quite unusual in that he is calling for the system to essentially bet billions on risky assets in the hopes of making a big gain [emphasis added below]:

CalPers Hopes Riskier Bet Will Restore Its Health (New York Times, July 23, 2020, Leslie Wayne)

Big as California’s budget woes are today, so are the problems lurking in its biggest pension fund.

The fund, known as Calpers, lost nearly $60 billion in the financial markets last year. Though it has more than enough money to make its payments to retirees for many years, it has a serious long-term shortfall. Meanwhile, local governments in the state are pleading poverty and saying they cannot make the contributions that would be needed to shore it up.

California’s public pension funding problem is one of the thorniest financial issues facing the state. The state made an unwise and almost certainly unsustainable deal to substantially raise public pension payouts approximately 10 years ago.  CalPERS played an important role in that disastrous decision (see Budget Busting Pensions).

The New York Times continues:

Those problems now rest largely on the slim shoulders of Joseph A. Dear, the fund’s new head of investments. He is not an investment seer by training, but he thinks he has the cure for what ails Calpers, or the California Public Employees’ Retirement System, the largest in the nation with $180 billion in assets.

Mr. Dear wants to embrace some potentially high-risk investments in hopes of higher returns. He aims to pour billions more into beaten-down private equity and hedge funds. Junk bonds and California real estate also ride high on his list. And then there are timber, commodities and infrastructure.

That’s right, he wants to load up on many of the very assets that have been responsible for the fund’s recent plunge. Calpers’s real estate portfolio has tumbled 35 percent, and its private equity holdings are down 31 percent. What is more, under Mr. Dear’s predecessor, Calpers had to sell stocks in a falling market last year to fulfill calls for cash from its private equity and real estate partnerships. That led to bigger losses in its stock portfolio.

CalPERS has made very significant investments in illiquid real estate and private equity partnerships.  Selling stocks last Fall to help keep those partnerships going may or may not have been a huge mistake, but it is certainly unusual behavior.

From the Sacramento Bee, here is a report on a billion dollar bust in CalPERS’ real estate portfolio.  The details do not sound encouraging:

…CalPERS made aggressive investments in real estate at the worst possible time, when inflated property values had peaked and were already beginning to decline.

As The Sacramento Bee’s Dale Kasler detailed in a recent article, one CalPERS real estate misstep stands out in particular. In February 2007, CalPERS invested $922 million in a deal with LandSource Communities Development LLC that involved thousands of homes and lots in seven states including Florida, Arizona and California.

A month before the investment was finalized, Lennar Homes, a principal partner in the LandSource deal, announced it was writing off $500 million in real estate assets because of deteriorating market conditions. That should have served as a clear warning to CalPERS, but it did not.

Sixteen months later, LandSource filed for Chapter 11 bankruptcy. Depending on what assets the partnership sells to pay off creditors, CalPERS could lose its entire investment, nearly $1 billion...

In fairness, CalPERS made lots of money from its real estate investments over the years, so a billion dollar writeoff won’t break the bank.  However, the bankruptcy of a private real estate deal like this one should be a warning light that the partnership investments the plan already holds may have other unwelcome surprises.

Joseph Dear, CalPERS’ new investment head seems to be a smart guy and he is certainly well connected in a political sense.  He also seems to be a gutsy guy in that he is definitely making a bet — in effect, betting the retirement future of many Californians  — that the private partnerships he likes will outperform more traditional investments.

…He [Joseph A. Dear] was hired in large part for his management skills and political savvy - honed in Washington, where headed the Occupational Safety and Health Administration in the Clinton years. He does not have an M.B.A. or any other advanced degree in finance. Harvard, Yale or Wharton is not on his résumé. Instead, his lone degree, in political economy, is from Evergreen State College in Olympia, Wash.

Most recently, Mr. Dear headed the Washington State public pension fund, which gained a reputation as a daring investor under his oversight. It risked more of its portfolio - 25 percent - on private equity than any other public fund. The bet pushed the Washington State Investment Board, which now has $67 billion in assets, into the top 1 percent of its peer group in performance during the boom years, according to Wilshire Associates. But in the fiscal year that ended last month, the fund lost 27 percent of its value, or $18 billion.

Calpers has a lot riding on Mr. Dear’s effort to achieve above-market performance. The fund just posted a loss of 23 percent, the worst in its history. That leaves it 66 percent funded, the lowest level in two decades, meaning it has only $66 on hand for every $100 in benefits promised to 1.6 million California public employees and their families.

… “Calpers is significantly underfunded, and they have decided that they will roll the dice,” said Edward A. H. Siedle, president of Benchmark Financial Services, which audits pension plans. “Is that appropriate if you have just lost 25 percent of your portfolio? These are high-risk, illiquid, unregistered products where there is tremendous valuation uncertainty. I would bet you any amount that five years from now, this plan will not have outperformed the market.”…

On one hand, I applaud CalPERS and its new head of investments for taking a bold and contrarian stand.  It may work and, if so, I will be very happy.  On the other hand, I question the motivation behind this move.  Is it the desire to follow a sound investment principle of adding to solid holdings when they have fallen in value? Or, is it a move like that of a gambler who suddenly decides to double down in order to erase a series of losing hands?

Via: Calculated Risk

See also:

Budget Busting Pensions

10 Rules for Investing

Oakland ‘Mulls’ Bankruptcy

Hedge Funds Cut Redemptions

Kurt Brouwer July 9th, 2009

Hedge funds have perked up a bit in terms of performance this year, but many are still suffering from the aftermath of last year’s financial panic.  A number of large and small hedge funds are limiting, restricting or delaying investor requests for a redemption.  That, of course, just makes investors more concerned about a return of their capital as this MarketWatch piece points out [emphasis added]:

Cerberus Restructuring Offers Investors Few Quick Exits (MarketWatch, July 9, 2020, Alistair Barr)

Cerberus Capital Management LP unveiled a restructuring of its main hedge fund that offers few ways for redeeming investors to get their money back quickly, according to two people familiar with the situation.

The plan, described in a Friday letter from the firm, means investors in Cerberus Partners LP will probably get about 5% of their money back by the end of 2009 at most, the people said on condition of anonymity.

Cerberus is offering investors in the hedge fund two main choices. One option involves shifting their stakes into a special-purpose vehicle which will be liquidated over two to four years, the people explained.

Or investors can stay in the current fund. As Cerberus sells assets and returns cash, these investors can either put the money into a new hedge fund that will be run by the firm, or they can reinvest it in the current fund, the people added. Investors have to vote on the plan, they noted.

…Cerberus, founded in 1992 by former Drexel Burnham Lambert banker Stephen Feinberg, is one of the largest private-equity firms in the world. It has also run a successful hedge fund business.

Cerberus International Ltd., the offshore version of the Cerberus Partners hedge fund, has generated annual returns of more than 11% since it started in 1993, according to industry performance data compiled by HSBC’s private bank.

Last year, the Cerberus hedge funds were hit hard by the financial crisis, partly because of a foray into mortgage securities in the first half of 2008, according to a former investor in the funds. Indeed, Feinberg said in a January 2008 letter to investors that the meltdown in mortgage markets was “overdone.”

…Cerberus Partners lost more than 20% from May 2008 through February 2009, its largest drawdown ever, according to HSBC data. The fund was up 1.12% during the first five months of 2009.

Cerberus limited withdrawals from the hedge fund in December after getting redemption requests totaling 16.5% of its net asset value. The firm planned to let investors withdraw 20% of what they requested, CNBC reported at the time.

Earlier this year, Cerberus suspended all withdrawals from the hedge fund. Since then, redemption requests have surged. A June 30 audit that was sent to investors showed withdrawal requests representing 50% to 60% of assets, according to one investor who didn’t want to be identified.

Many hedge funds suspended or limited redemptions in the wake of last year’s crushing financial crisis. By late November, at least 75 hedge fund firms, including GLG Partners , Deephaven Capital Management, RAB Capital and New Star Asset Management, had limited withdrawals in some way…

Via Shane Holt

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