Thursday, March 20, 2014

The Hedge Fund Curse?

Matt Phillips of Quartz reports, Hedge funds bet big on GM and now the stock is getting creamed:
Not long ago, hedge fund managers were deeply in love with General Motors.

Goldman Sachs equity analysts said the stock appeared the most frequently among the largest 10 holdings of hedge funds it examined, making it a more important position than Google or Apple. At the end of 2013, nearly 200 hedge funds owned GM, more than any other stock held by the nearly 800 hedge funds Goldman analysts looked at.

And then this happened (click on image).

The underperformance of GM shares isn’t a big mystery. An unsettling recall that the automaker issued in February is largely to blame. But it’s a useful reminder that even financial titans don’t call everything right.

Now, we should point out that the stock is still up about 25% over the last 12 months, slightly better than the 21% gain the S&P produced. So how funds fared on their GM bets depends a lot on when they got into the stock. For instance, David Einhorn’s Greenlight Capital built the bulk of his position back in late 2011, when the shares were much lower. As of Dec. 31, Greenlight held a roughly $600-million position in GM. Meanwhile, Kyle Bass’s Hayman Capital didn’t even have a position in GM until the fourth quarter of 2013, when the fund bought roughly 4.6 million shares of GM, a position valued at $162 million, according to FactSet data. The price of the stock is down sharply since then.

In other words, even the big boys lose a few now and then.
The "big boys" most certainly lose money. Even Soros, the undisputed king of hedge fund managers, has made some terrible calls, like buying J.C. Penney in Q3 2013 and boosting his stake in GM in Q4 2013. Of course, Soros is a global macro guru, so he doesn't really care about a few losing positions in stocks. He made a cool $1 billion shorting the yen in 2013 and probably made more shorting the Canadian dollar recently (if he was smart and took my advice to short Canada).

As far as GM, I have no stake and don't plan on initiating one. The only thing I know about the car market is that crossborder business from Canada to the U.S. is booming. My buddy, Johnny, is the undisputed king of car auctions in Quebec and maybe Canada. He has secondary progressive MS, has difficulty walking, but still wakes up at 5 a.m. every morning and works a full 14 to 16 hours a day, six days a week. And they say disabled people don't work, what a bunch of ignorant nonsense! (as a side note, I called him this morning to tell him about a new study on how statins may help patients with progressive MS. I also told him to get his ass in the gym and come train with me and Big Lloyd).

Johnny's business is booming these days and he can hardly keep up with demand. I warned him last November the Canadian dollar was going to fall and to get ready to ramp up operations, buying all the used cars on the market which he resells down south for a nice profit. Interestingly, he lives on Gordon Fyfe's street but unlike Gordon and most of the pension plutocrats reading this blog, he earned his millions the old fashion way, through blood, sweat and tears. I know, I spent a day with him in Quebec city buying GM trucks at an auction and saw the entire operation firsthand and was completely blown away and wiped by the end of the day (I don't know how he does it!!).

Back to the topic at hand. I was in Toronto earlier this week for a HOOPP conference on DB pensions. I hooked up with Ron Mock, president and CEO of Ontario Teachers' Pension Plan, prior to the conference for a quick chat. I reminded Ron that I was among the first to invest in Bridgewater back in 2002 when I was working at the Caisse (h/t to Simon and Alan of McGill Capital) and then told him to take a look at them. Bridgewater was managing roughly $10 billion back then but it wasn't the juggernaut it has become now.

I told Ron, however, when I wrote my comment a couple of years ago on Texas Teachers losing its Bridgewater mind, I raised several yellow flags and would have likely recommended pulling money out. In fact, one year ago, I revisited Bridgewater and said the world's biggest hedge fund is in trouble, but I didn't sound the alarm because I know Ray Dalio, Bob Prince and their process is still one of the best in the world even if they're way too big now.

Still, too many institutions fall in love with their hedge fund managers and they blindly follow bad advice from their useless investment consultants. It's truly pathetic. I told Ron: "I don't care if your name is Ray Dalio, Ken Griffin, Dan Loeb, or Stevie Cohen, I'll grill your ass just as hard as I'd grill any new or less well known manager." In fact, the more arrogant you are with me, the more intense pleasure I get in grilling your ass. That goes for hedge fund, private equity or pension fund managers (ask Mario Therrien and Gordon Fyfe, they were in meetings with me and famous hedge fund gurus. In fact, I got under Dalio's skin, pounding the table on deflation, and he blurted out: "Son, what's your track record?!?" Gordon kept bugging me all day after that meeting).

In Toronto, I also met Heather Cooke who is now the Director of Institutional Sales at Unigestion, a well known Swiss asset manager specializing in hedge funds, private equity and low vol equity strategies.  Heather is extremely sharp and has extensive experience with multi-manager platforms. She worked many years at Northern Trust Global Advisors before moving on to RogersCasey and Mercer. She's also very nice, not your typical institutional salesperson. I love speaking to sales people who actually know what they're talking about (she is research focused; I highly recommend you contact her at to learn more about their low vol strategies and process which focuses on risk management).

Heather told me Unigestion is looking to hire someone in Quebec. I told her I know people and I might even be interested but there's a catch. "Some people love me, most people hate me, but they all read me and desperately want me to stop blogging and exposing the pension fund industry's dirty little secrets. They'd love for you to hire me so I stop blogging but truth is I'm having fun blogging and making money trading." She laughed and said she will keep that under consideration.

I also met up with one of Canada's sharpest hedge fund talent in Toronto. This is a guy who I would seed in a heartbeat and unlike all of Quebec's hedge funds, which I foolishly keep promoting, he would have no problem obtaining money from Julian Robertson if the Tiger fund was a true seed fund, not an accelerator fund. HR Strategies is currently looking at him for their SARA Fund but I put him in touch with a few U.S. funds of funds and raised concerns with HR Strategies and their SARA Fund (will they survive in the next three years??).

Anyways, we talked about markets and the entire culture of hedge funds. He told me flat out that he's happy to benefit from the 2 & 20 model (it's more like 1.5 and 15 now) but he thinks it's nuts to pay an established hedge fund manager managing billions a 2% management fee. I agreed and even wrote about how some smart managers are now chopping their fees in half. As I told him: "Why should Ray Dalio or any mega hedge fund 'guru' collect billions in management fees for turning on the lights? It's absolutely nuts!!" (if the ILPA had any balls and clout, they would pressure their established managers to only get paid on performance! I talked about this ten years ago at an ILPA meeting in Chicago but people looked at me like I was from Mars)

We also talked about culture at hedge funds. I told him I liked to meet with senior managers and then randomly meet with a junior analyst when doing due diligence. If the senior managers asked me why, I'd tell them flat out "because they carry the weight of your hedge fund" so I want to gauge their level of engagement and happiness and see how well they are treated.  (He told me Dan Loeb has a terrible reputation for not paying his senior analysts and managers the terms of their contract, something which if true, would make me pull out of his fund pronto, no matter how good he is)

In terms of compensation, he told me analysts and managers at hedge funds should be paid "a direct share of the total P&L with their swing factor determined by 1) quality and quantity of their research and 2) making other analysts better at their jobs." Right on!

We also talked about markets and his strategy. He told me his strategy "doesn't fit with funds of funds that look for guys hitting home runs every year because they charge an extra layer of fees" but he's confident in his research, process and ability to mitigate downside risk. In fact, he told me the put-call parity arbitrage presents interesting opportunities right now and shared this with me:
In the great wide world of theory,

Put + Stock = Call + RFD
where RFD = Risk free debt equal to face value of stock.

This assumes vol = vol and all units of vol are priced similarly. In the real world that never happens. Down vol is almost always more dear to buy than up vol sometimes it is not, but mostly it is.

As such this theory is routinely incorrect which should provide arbitrage opportunities.

Check the bid ask spreads on options and the borrow rate on most stocks. Sell put at the bid, short stock, buy a call at the ask, and invest your short proceeds at the RF rate (zero).

The bid ask spreads and borrow rates are what kill it.

If they don't, and you try to move any size, whatever bank you are trading with will collapse it and tell you they couldn't get it done. Seen it happen lots of times.

What I do is different. Picture it as buying insurance.

When the market is go go go go go, upside vol actually gets priced a little higher than downside vol. In that market you buy an at the money or near money put and sell an out of the money put (choose whatever spread you want).
If you are moving small to medium size you split that two part trade across two brokers. If you are moving big, you need a bank to take all the risk in one whack.

When the market collapses, downside vol is much more dear than upside vol. In that market you short the index and buy an out of the money call.

Very similar payoffs, very different cost structures. WIDELY divergent delta exposures when you flip one out for the other and it depends highly on how wide the spread between rungs on your put ladder are.
Very sharp guy who really knows his stuff. He told me his net exposure is zero and his biggest personal holdings are one year put LEAPs, betting the market will get clobbered in 2014.

I told him that I think his timing is off. As I explained in my outlook 2014, the liquidity party will continue but you have to choose your stocks and sectors right. I reminded him of Keynes' famous quote: "Markets can stay irrational longer than you can stay solvent."

But once this liquidity party ends, watch out, global deflation will set in, which is why Soros is asking Japan's leaders to put the pressure on their giant pension fund to crank up the risk.  Soros isn't stupid, he sees the writing on the wall, and it ain't pretty for the financial elite.

By the way, did you notice how many times Fed Chairman Yellen kept referring to the "2% inflation target" during the press conference yesterday? All these dummies are getting their panties tied in knots, fearing Fed tapering, but the reality is if inflation expectations don't pick up considerably, I wouldn't be surprised if Yellen et al. reverse course in six months. Stay tuned. Those who warn you about inflation are on the wrong side of the trade.

Below, the Atlantic Group's John Ricco and Training the Street President Scott Rostan discuss how private-equity firms and hedge funds are offering bigger salaries and more incentives to lure young bankers. They speak with Pimm Fox on Bloomberg Television's "Taking Stock."

"A great time to get into the industry?" I beg to differ. Good luck starting a hedge fund in this environment and make sure you don't work for some arrogant hedge fund manager with his head up his ass (and most of them have their head up their ass!). This clip proves to me there are way too many overpaid, over-privileged analysts working on Wall Street, profiting off dumb pension money.