Tuesday, February 7, 2012

'MCM' Capital Management?

A follow-up on my previous comment on why it's time to pull the plug on hedge funds. Ever wonder how those super secretive, 'elite' hedge funds make a killing? I'll go through it with you below, poking some fun at the hedge fund industry.

Let's say we wanted to start a hedge fund. First, we'll choose a name. Since we know the industry is full of malakes (malakas Greek word for 'wanker'), we'll call it MCM, short for Malakia Capital Management. We'll fill out all the paper work, rent some fancy offices, hire some cute administrative assistants to get things off the ground.

Then, we'll hire a couple of Russian physicists, Igor and Yuri, to program malakies all day and help us out with our marketing material. They are used to make our hedge fund look legitimate and sophisticated so when institutional investors come around, we pass their due diligence and bombard them with all sorts of fancy risk metrics and eye-popping risk-adjusted 'pro forma' returns.

Speaking of eye-popping, we'll also hire Yuri's cousin, Tatiana, a smart and sexy Russian salesperson (that is her above). Tatiana is polished, highly educated, very sharp, and very hot. She knows all the hedge fund 'lingo' and more importantly, she's a shark. We'll send her off to all those silly hedge fund conferences in London, New York and Geneva where she'll work the crowd, targeting lonely institutional investors horny for hedge funds.

She'll peddle our "niche strategy" and "high Sharpe ratio". Hell, as long as the suckers show interest, she'll peddle any ratio they want over dinner and drinks. She's very cunning and can charm the toughest client. And if things get sticky, she can play dirty (bribes, prostitutes, whatever it takes to close the deal).

If things go well, our assets should be mushrooming in no time. We choose to run a legitimate operation. No Bernie Madoff scams for us. We'll get a reputable hedge fund administrator and hire some more quants to help Igor and Yuri 'reverse engineer' the portfolios of all the elite hedge funds (more malakies).

Except we won't be doing any reverse engineering at our shop. Instead, we're going to track the 13-F filings of elite hedge funds and try to go long or short their holdings. The data is delayed, typically coming in 45 days after end of quarter, but if you use the information wisely, you can make money leeching off these top funds.

To illustrate, let's take the institutional holdings of Peak 6 Investments, one of the best multi-strategy hedge funds. You'll notice at the end of Q3, they reported holding 1,684 positions with a total market value of $3.5B.

Admittedly, these are only their equity positions with a delay. Some large hedge funds do all sorts of complicated strategies using OTC derivatives, high-frequency trading and churn their portfolios many times in a quarter, but we'll keep things simple just to illustrate.

First, look at their top holdings (click on image to enlarge):

Then, click on the top of the second column (value of shares) twice to get their top dollar-weighted positions (click on image to enlarge):

Lo and behold, sometime in Q3 2011 when the shit hit the fan, this elite fund cranked up the risk, went long the market (bought a ton of S&P 500 ETF) and bought sizable positions in tech shares of Ciena (CIEN), Akamai Technologies (AKAM), NetApp (NTAP), Microsoft (MSFT) and other "high beta" stocks which handily outperformed the overall market since the end of September.

That, in a nutshell, is how 'elite' hedge funds make money. That's why while most hedge funds are mediocre, the top funds are worth tracking closely. Here I used Peak 6, but we can track many more funds, including hedge funds that are closed and top long-only funds, and cross reference their holdings.

Importantly, forget what Bill Gross, George Soros, Jim Rogers and other 'gurus' are saying on CNBC and focus on what top funds are actually buying and selling. Words mean nothing, show me their actual book!

It's not perfect, there are lags, but if you track the right funds, you'll get plenty of ideas on where you should be taking opportunistic risk and you don't have to pay 2 & 20 to any of them!

Ok, now that I shared some insights with you, who wants to invest in Malakia Capital Management? Too late, most of you are already investing in them, getting eaten alive on fees. Funny thing is that the world's best hedge fund is actually a pension and they're wisely avoiding all these malakies.

Below, a classic scene from Boiler Room. Unfortunately, it's not just unsuspecting doctors that are getting scammed. In these markets, the biggest sharks are charging 2 & 20, ripping off institutional clients in all sorts of hedge fund strategies.

Buyers beware, when the next crisis hits, you don't want to end up being the biggest malaka on the block
, left holding your nuts!