Phuket Post :: Article :: MONEY MATTERS

"Pension Fund Trustees are planning legal action against several London Hedge Funds in a desperate bid to salvage investments threatened by the recent credit crunch".

What on earth were pension funds doing putting their money into Hedge funds in the first place?

Well, Al Van Den Berg, a legendary U.S. investor in the Warren Buffet mould, and C.E.O. of Century Asset Management (one of the most prestigious old style value orientated fund managers who have steered their clients' money successfully through all the big market setbacks of the last thirty years) wrote in his annual letter of April 2004 (no less):

�Pension funds are the last to get sucked in but when they do, boy does the money gush in.�

He goes on:

� Let me tell you something about pension funds � because they are a wonderful indicator.

�Pension funds are designed to protect you, so they have the most conservative laws

�So whenever a new fad starts they never get involved -because they are prudent men and women. And they are not going to get sucked into a fad. So they always resist new ideas. Then a little time goes by - and then they get pressure from the people they manage the plan for. They say "Look, stocks haven�t done well, bonds haven�t done well but Gold and Diamonds are up� - so they have meetings. However nothing happens; they vote it down.

�But eventually pressure becomes irresistible.

�Then the pressure gets greater. More people come in, brokerage houses reports start to pour out - and universities start looking at new ideas and see how well they have gone, and how poor the old ones have done.
And now it just keeps going and going. Once it becomes a mania, all bets are off. There is no way that the trustees of the pension fund can resist.

�And that is why these pension funds get in at the tail end of �whatever it is� - because they are the last ones to be converted�

He goes on:

�The latest big idea? �Hedge funds� - (this was written in 2004).

�Its an idea that has been around for 50 years, but its only gotten a new lease of life in the last 5 years.

Basically what a hedge funds can do is use any conceivable speculative idea known to man. And they can make huge amounts of money. And they can lose huge amounts of money.

The great thing about hedge funds is that they are not regulated, and do not have to report to governments. So they can do what they want.

So you can just imagine what these things are invested in. And because of their track record (they did well in 2000 to 2003 when stock markets collapsed), these pension funds are moving into them in a big way."

Well it has taken just three short years from what Van Den Berg called "the tail end of whatever it is " - during which incidentally Funds of Hedge Fund returns have been abysmal, and have been outpaced by the indices of almost all major stock markets - for the chickens to come home roost in the Hedge Fund sector.

And with a vengeance, because, having swollen from 2000 to 8000 players, and funds having soared from $600 Billion to $1.8 Trillion invested; the quality has slumped; the competition in the different strategies has soared, leading to extra leverage to try to make the same returns; and the consequence is now there to see.

As Christopher Fildes, City editor of the Daily Telegraph commenting on a hedge fund collapse in Florida two years ago, stated:

�They were trying to do something that couldn�t be done in the first place:�

VIZ trying to permanently 'Outwit Markets'. (I refer of course to those Hedge Funds playing the Long / Short game, or the �Quants� - computer driven market bets basically - and refer not to many that exist under the Hedge Fund brand who run excellent and responsibly managed value funds, etc like Thames River Capital, Sloane Robinson, and many others - mostly the old originals - and who redeem at three days notice, contrasted to the opaque ones that only redeem up to 8 weeks after the order has been passed).

Either the new Hedge Fund managers had not read it, or certainly did not tell their clients to read a well known investment book written by Nicholas Taleb, a professor of mathematics at Yale, entitled: �Foiled By Randomness�.

Computers can only programme what has happened in the past. But by definition, what always moves financial markets unexpectedly is what has NOT happened before.

Trying to permanently outwit markets is like trying to beat the Roulette wheel. Many have claimed to have created a fool-proof mathematical system to do just that, and then have ended as �waiters� in the casino where they tried it.

Unfortunately, in the case of Hedge Funds it is more likely the investors end up as �waiters� because the managers have stacked up so much in fees, they can probably walk away unscathed.

In a lifetime of involvement with financial markets, I cannot remember a bigger �Con� that has been visited on the investment community than that claim:

�We can make you money whether markets go up or down�.

It is a fundamentally flawed argument. Nobody has ever done it for any length of time, and probably nobody ever will.

Luckily this myth has now blown up, at least before the small retail investors got sucked in. A dedicated website:
WWW .HEDGEFUNDIMPLODE.COM now exists to enable anyone to track the fall out.

Reverting to the recent stock market storm, which actually visited London worse than anywhere else (250 point fall last Thursday - all recovered now), the real meteorological low was not so much in the markets as in the level of media commentary on them.

This reached a seismological bottom even by their low standards, turning a foothill of problems into a mountain of hysteria.

The notable exceptions were the excellent leaders throughout in both the Financial Times and The Times, which basically advised people not to lose their heads and to keep a sense of proportion.

The problem with the financial press and media is that they also suffer from the same syndrome as computers used by �Quants�. They, by definition, are only programmed on past knowledge. But every new event creates new circumstances. This credit crunch has come from the new event in markets, which has been the slicing up and packaging of mixed debt portfolios stuffed with so many different bits it was difficult to analyse quite what was in it and the buyers - mainly smaller banks seeking better short term returns for their deposits than the low interbank rates available during a very low interest period - just relied on the RATING given to the package.

When a bit of the package imploded, and in global money market terms it was pretty tiny - the SUBPRIME market in America represents less than 2% of the U.S. mortgage market. Nobody is suggesting it is all DUD > perhaps at the worst 20%, and then that is still backed by real estate which in turn may be 40% down in the case of a fire sale - so the actual loss could be as little as 40% of 20% of 2% = 0.16% of the gross U.S. mortgage debt.

Where it becomes much more toxic is that some of the Hedge Funds had geared up the packages they had bought by a factor of 10 times or so. So a minute reduction in value of what they thought was a safe product wipes out their capital.

And one must add that all this happening in AUGUST, when anyway European market liquidity simply dries up because all the big hitters are away on holiday and many financial centres, particularly in Continental Europe, are practically ghost towns, has certainly made the short term liquidity problem much worse.

Actually equities were not directly involved in what was a fixed interest bond credit crisis - (indeed never has the corporate sector, almost worldwide, been more flush with its own cash and less in need of borrowing). However, the fear that world economy�s current robust growth would be hit, if the problem did not get solved, became an immediate concern for equities.

Also, as it happened, �equities� were where the best immediate liquidity still existed when the credit markets seized up - you could sell vast chunks of SHELL or VODAFONE or EXXON, and so forced sellers had to sell what was liquid. So equities took the hit. But don�t forget there were as many buyers as panic sellers, and among these was the highest proportion of INSIDER buyers (corporate bosses and directors) since 2003 - 10 buyers here to one seller.

The central bankers will, and indeed already have, done their utmost to see that the credit market liquidity seize up does not feed through to the underlying economies, just as in 2003. They should succeed, especially as the underlying economic and corporate situation is much stronger today, particularly in the FAR EAST where confidence remains much more robust than in pessimistic Europe.

And now the U.S. plus the Far East represents 66% of the world economy. The Pacific is now the economic epicentre of the global economy. On top of that there remain huge reserves of money in the cash-rich energy and commodity countries still seeking investment opportunities.

The U.S. probably needs a growth pause anyway to redress some of the imbalances that have developed within the $ ZONE (U.S.A., Japan, China, Taiwan, Hong Kong, Singapore, India and smaller Asian countries). But these countries look as if they can easily absorb the U.S. slackening.

The medium term outlook for world continuing growth remains promising.

Current equity valuations now anticipate much worse.

Robert Skepper