Saturday, May 28, 2005

A bubble for rich people beginning to burst?


After big losses by some funds and generally stagnant performance this year, more investors have begun asking for their money back, said several experts who track the vast, unregulated private investment groups that cater to the world's richest investors.

Redemption requests that may come due in late June or in early July are expected to undercut the performance of some already struggling hedge funds as managers unwind market bets so they can come up with enough cash to return to investors.

"People were sold on the idea that hedge funds were investment products that had no down months and would perform all the time," said Cyril Delamare, a director at Tara Capital SA, a Swiss advisory firm. "Now they're waking up to the reality that this isn't true."

Some hedge fund investors and brokers are talking of a less likely, but more worrying scenario: A wave of redemptions could force lots of managers in the same market to liquidate positions at the same time, sparking a chain reaction of sharp price drops that could force other investors to lose money.

Still, those same market professionals dismiss doomsday scenarios, including comparisons to the infamous collapse in 1998 of Long-Term Capital Management, the hedge fund whose demise prompted the Federal Reserve to step in to avert a full-scale market meltdown.

In recent years, wealthy people have herded into hedge funds at an unbridled clip, expecting steady returns irrespective of the market's usual peaks and valleys. These private investment partnerships are now estimated to oversee more than $1 trillion, after managing less than $40 billion in 1990.

Some of that enthusiasm may be beginning to wane.

The Hennessee Hedge Fund Index, a gauge of about 900 managers overseeing at least half of the capital in the industry, fell 1.62% in the first four months of 2005.

In April, the industry recorded its worst losses in more than two years, according to Tremont Capital Management, a Rye, N.Y.-based investment firm that tracks hedge funds. See full story.

This is problematic for the rest of us, because declines in prices of derivative securities must, at some point, due to a tendency towards efficient markets and the opportunity for arbitrage, affect the prices of the securities on which derivatives are based.

In short that means your IRA/401(k) is also vulnerable, thanks to people who thought that this type of security would always go up.

This is, I think traceable to the rampant innumeracy of Americans (and others?): no matter the gambling strategy, there's always the possibility of gambler's ruin.

Or, to put it another way: one guy making money on some long/short position means that there's a complementary position in which another guy's losing his shirt.

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