15 August 2007

How To Speak Hedgie: What hedge-fund managers mean when they talk about challenges.

In these days of market volatility, hedge-fund managers and executives at all types of money management firms have been forced to explain why their funds are shutting down, losing money hand over fist, and freezing investors' funds. When they do so, however, they frequently lapse into a strange euphemistic dialect. And so we thought it would be helpful to provide a handy Hedgie-English glossary.

Hedge-Fund Phrase: Challenging
Translation: Run for the hills!

Hedge-fund managers never piss away money. They just face challenges. "We sincerely appreciate your patience and understanding during this challenging period," Jeffrey Larson, founder of Sowood Capital, told investors last month, as he explained why the $3 billion hedge fund, having lost half its capital, was selling off its remaining positions and closing up shop. As two of its large hedge funds that invested in mortgage-backed securities were going down, XXX XXX CEO XXXXXXXX XXXX told investors that "the sub-prime mortgage market has been challenging for a number of months." More recently, Monday's Wall Street Journal quoted giant asset manager Barclays as saying that performance in its 32 Capital Fund had been "challenging."

Hedge-Fund Phrase: Unprecedented, unique circumstances
Translation: Shit happens. But we had no clue.

Anyone who read the best seller The Black Swan knows that random geopolitical, financial, and economic events can cause the prices of assets to move in ways that defy history and sophisticated computer models. But it comes as a shock to the brightest minds on Wall Street, especially those who run quantitative-based funds. "Wednesday is the type of day people will remember in quant-land for a very long time," Matthew Rothman, head of quantitative equity strategies for Lehman Brothers told the Wall Street Journal last week. "Events that models only predicted would happen once in 10,000 years happened every day for three days." Strangely, these same models failed to predict the once-in-10,000-year events that roiled the markets in 1997, 1998, 2001, and 2002.

Hedge-Fund Phrase: Market volatility has produced unfair, unrealistic prices.
Translation: The market is efficient only when it works in our favour.

Several money managers blamed their temporary problems on investors' irrational collective behavior. "Investor fear has overtaken reason and has induced a period in which most securities have simply ceased to trade," said Sentinel Management, which sought to halt redemptions of some of its funds this week. And such conditions make it "virtually impossible to properly price securities or to trade them." Goldman Sachs CFO David Viniar noted that the firm's decision to inject $2 billion into its ailing Global Equity Opportunities fund "reflects our collective belief that the value of this fund is suffering from a market dislocation that does not reflect the fundamental value of the fund's positions." In other words, the losses shown by these funds isn't the fault of the managers, it's the fault of a market that just won't value assets properly. Ironically, you never hear fund managers say that their gains have been unwarrantedly large due to the market's failure to reflect stocks' fundamental value.

Hedge-Fund Phrase: Our results were affected by the selling behavior of other firms.
Translation: We made the same dumb trades as everyone else.

"We have been caught in what appears to be a large wave of de-leveraging on the part of quantitative long/short hedge funds,'' James Simons of Renaissance Technologies said in a letter to investors last week, which sought to explain losses in his highly regarded hedge fund. He also noted that the methodology used by his fund was "undoubtedly shared by a number of long/short hedge funds." Goldman Sachs similarly blamed other funds' behavior for its own losses. Of course, the premise of high-end money management is that you don't simply mimic the same investment strategy of 30 other hedge funds. That why Simons was paid $1.7 billion in 2006.

Hedge-Fund Phrase: We just want to protect investors.
Translation: We just want to cover our asses.

Declining performance frequently leads investors to withdraw their funds, which can, in turn, force hedge funds to sell securities to raise cash. To forestall the ensuing death spiral, funds sometimes lock the door. French bank BNP Paribas last week froze redemptions of three funds that held mortgage-backed securities. BNP said it was limiting the liberté of its investors for the sake of protecting the Gallic virtues of égalité and fraternité. Locking up the funds temporarily is the best way "to protect the interests and ensure the equal treatment of our investors." Sentinel used the classic American trope of aligning the interests of the owners with those of the shareholders. "We don't believe it is in anyone's best interest if a run on Sentinel took place and we were in a forced liquidation mode."

Hedge-Fund Phrase: This isn't a rescue.
Translation: THIS IS TOTALLY A RESCUE!!!!!!!

Goldman Sachs' GEO fund lost 30% of its value in a week and was leveraged at a rate of 6-to-1. But to hear Goldman tell it, the cratering of its own fund simply presented an irresistible buying opportunity. "We are investing not because we have to, but because we want to," said Viniar during a conference call. At another point, he noted: "No, let me just clarify. This is not a rescue." And if you believe that, I've got some subprime debt I'd like to sell you.

By "Oh, that" Daniel Gross

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