Alpha - September 2007 - (Page 35)

Market Turmoil Greenspan has been making waves during the media blitz for his just released book, The Age of Turbulence, warning that lowering interest rates too aggressively could leave the U.S. economy vulnerable to a resurgence of inﬂation. By now, no one can claim to be surprised by the rapidity and ease with which the subprime contagion spread: Wall Street has been hooked on the profits. Until two months ago investment banks were able to package billions of dollars worth of subprime mortgages with other, higher-rated loans and bonds in structured credit products and derivatives, like CDOs, and sell them to investors: pension funds, mutual funds and non-U.S. banks. Hedge funds, keen to boost their returns, were avid buyers of some of the lowest-rated, highest-yielding U.S. mortgage paper. So when the subprime loans began to go bad, they exposed hedge fund managers that had been chasing high yields through esoteric mortgage-backed instruments without doing enough due diligence. “Many hedge fund managers have been much too dependent on rating agencies to do their credit analysis for them,” Makena’s Ross says. “They didn’t take the time to truly develop their own fundamental views on the intrinsic value and risks of these securities.” The U.S. subprime mortgage crisis bears many of the hallmarks of previous market dislocations. Just as in earlier episodes, the loss of liquidity in the markets trapped hedge fund managers between competing demands: On one side, many Wall Street banks and brokerage ﬁrms upped their margin calls, requiring more capital and collateral in payment for daily losses and restricting access to credit for managers that couldn’t provide it. On the other side, some skittish investors, spooked by poor performance in July — and leery of losing more money in August — tried to cash out. (See box below to find out what happened to 200plus managers who weathered the storm.) Some managers, particularly those running heavily leveraged portfolios, like Jeffrey Larson at Boston-based Sowood, were forced to raid their own portfolios to raise capital. Everything went cheap, including more stable, liquid stocks and bonds. Those fire sales exacerbated the problem: Share prices of many a good, high-quality company plunged and — paradoxically — share prices of many a lousy, underperforming company climbed. Hedge funds that pursue statistical arbitrage and other quantitative market-neutral equity strategies were hit especially hard. Stocks in these types of portfolios are often bought and sold based on a manager’s ability to determine the historical relationships of certain underlying factors, like valuation, quality and price and earnings momentum. When those relationships break down — or are rendered Market Monitor: An Exclusive Alpha Survey H edge fund managers don’t all view the recent market turmoil as a prognosis of doom. In fact, many spy the potential for future gains, according to an Alpha survey of more than 200 hedge funds conducted earlier this month. Although two thirds of the hedge fund managers we polled admitted to having suffered losses in August, nearly as many — or about 60 percent — said they were seeing more investment opportunities as a result of the downturn. And despite the talk of prime brokers getting nervous and clients pulling capital, only a small percentage of managers — less than 13 percent — admitted to experiencing an unusual increase in redemptions or having lenders tighten credit or margin requirements. “These are our kind of markets,” said one London-based global macro manager at the height of the August sell-off. In 1998 — arguably the worst year during the past two decades for the hedge fund industry — when a massive market correction caused many managers to shutter their ﬁrms, hedge funds returned, on average, 2.62 percent, according to Chicago-based data provider Hedge Fund Research. The next year, however, the average fund was up 31.29 percent. But even if hedge fund returns in 2008 rebound, most managers believe that the increased volatility is going to be here for a while. More than 60 percent of the managers we polled expect the volatility to continue at least through the end of the year, suggesting that there could be more pain ahead. — Imogen Rose-Smith Did the investment performance of any of your funds suffer from the market turmoil in August? Yes 67.7% No 29.7 Don’t know 2.7 Did your ﬁrm see an unusual increase in redemption requests from investors as a result of the recent turbulence? Yes 9.7% No 87.6 Don’t know 2.7 In the past two months, have any of your prime brokers tightened the credit and margin requirements for your hedge fund ﬁrm? Yes 12.8% No 77.0 Don’t know 10.1 Did you reduce the leverage in your portfolio during the recent market downturn? Yes 40.7% No 57.1 Don’t know 2.2 Has your ﬁrm put in place any measures to restrict the ability of investors to withdraw assets during periods of unusual market volatility? Yes 6.6% No 89.4 Don’t know 3.9 How long do you expect the recent market volatility to continue? Zero months 1.8% One to two months 18.1 Three to ﬁve months 36.3 Six to nine months 17.7 Ten months or more 10.2 Don’t know 15.9 Do you think that the Federal Reserve Board and other central banks should have stepped in to ease monetary policy and increase liquidity? Yes 45.6% No 43.4 Don’t know 11.1 Is your fund seeing more or fewer investment opportunities as a result of the recent downturn? More 60.2% Same 28.3 Fewer 7.1 Don’t know 4.4 Note: Responses may not total 100 percent because of rounding. SEPTEMBER 2007 • INSTITUTIONAL INVESTOR’S ALPHA • 35

Table of Contents Feed for the Digital Edition of Alpha - September 2007

Contents Letter from the Editor Longs & Shorts Pension Corner: Keeping the Faith The Good Guys: Going Public Interview: Barry Bausano - A Delicate Balance Cover Story: Cruel, Cruel Summer Profile: Phil Cooper - Alternative Flight Plan Strategies: Marshall Wace - TOPS in Its Field Profile: Fortis Investments - Banking on Alternatives Research Center: Top Equity Trading Firms Alpha Bytes: Desktop Duel Unhedged: Commentary - The Taxman Cometh

Alpha - September 2007

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