Alpha - September 2007 - (Page 36)

Market Turmoil meaningless by massive, recurring liquidations — quantitative managers’ trading models go haywire. The pain caused by those malfunctioning models was felt by some of the biggest names in the business, including Bruce Kovner at Caxton, Paul Tudor Jones II at Tudor Investment and Clifford Asness at AQR. Goldman Sachs, which injected $2 billion of its own money into its Global Equity Opportunities Fund as part of a $3 billion bailout in August, revealed that the fund was down some 23 percent that month. Worse, a handful of blue-chip funds went out of business entirely, including Sowood and Bear Stearns Asset Management’s High-Grade Structured Credit Strategies Master Fund and its counterpart, the High-Grade Structured Credit Strategies Master Enhanced Leverage Fund. A few managers, like New York–based Paulson & Co.’s John Paulson, successfully anticipated the subprime meltdown. Paulson had already been shorting various housing sector companies and structured credit products when disaster struck (see box, below). But a vast number of able managers never realized that their funds — which may have had little or no credit exposure — would prove to be so vulnerable. For those managers, the next few months will be a time of reckoning. For their investors it will be a time of critical reassessment, and redemptions are sure to climb. One of the problems of illiquidity is that it makes certain securities next to impossible to value — and investors will need to pay close attention to the ways in which their hedge fund managers mark their portfolios now that many complex derivatives, like CDOs, have been rendered virtually illiquid by ratings downgrades and thin trading. The U.S. Securities and Exchange Commission has sent out teams to talk to investment managers about correct valuation procedures. But even hedge fund managers who are working overtime to accurately and fairly value their portfolios may have considerable difficulty, because their fund administrators and prime brokers don’t all think alike. How the accountants and auditors make sense of the morass will have an enormous impact on investors’ confidence — or lack thereof — in hedge funds. On the positive side, however, investors will be able to use the recent upheaval as a means of differentiating among their hedge funds. As the disparity of returns increases among managers, it will soon become obvious who is genuinely generating alpha. The process of reallocation is under way. Kenneth Heinz, president of HFR, says that individual fund flows reveal that investors are already moving money away from losing strategies. In July, 29 of the more than 5,000 funds tracked by HFR each experi- Storm Beaters: Tracking the Hedge Fund Winners B y now everyone has heard of the breathtaking results at Paulson & Co. The New York–based hedge fund firm’s assets have doubled to more than $20 billion this year on the strength of a welltimed bet against the subprime mortgage market. By shorting the ABX subprime index, as well as shorting credit default swaps of companies like Countrywide Financial Corp., whose fortunes are tied to the subprime market, manager John Paulson’s Credit Opportunities Funds I was up 26.7 percent in August — and a whopping 410 percent for the year. His Credit Opportunities Fund II was up 32 percent in August and 230 percent for the year. But Paulson wasn’t the only manager that was on the right side of the credit trade. A small troop of hedge funds came through the difficult summer unscathed and are up well into double digits for the ﬁrst eight months of 2007. For MKP Capital Management, with $5.5 billion in assets across five fixedincome strategies, 2007 has been a very good year. The New York–based relative-value fixed-income firm’s MKP Opportunity Fund was its top performer in August, up about 4 percent for the month. With $285 million in assets, the fund is up 32 percent for 2007. “We’re excited about the results and hard work of our team this year,” says Patrick McMahon, co-head of investing and risk management at MKP. McMahon, who has been trading fixed-income securities for 20 years, co-founded the firm in 1995. Three years later MKP was one of several fixed-income hedge funds caught in a credit squeeze by prime brokers, which pulled back in fear of an industrywide contagion from the blowup of LongTerm Capital Management. This year MKP avoided similar problems by being net short credit, especially subprime. MKP’s bearishness on subprime goes back to early 2006, when it began deleveraging credit risk in its other specialized credit funds. “If we had not lived through 1998 and other difficult markets, we would not have done as well,” McMahon says. Subprime credit protection accounted for only some of the outsize returns at Harbinger Capital Partners in New York, an absolute-return ﬁrm within the portfolio of Harbert Management Corp., an alternatives manager headquartered in Birmingham, Alabama. Harbinger’s Capital Partners Fund I and Special Situations Fund both employ similar strategies, using a long-short approach to event-driven situations. The $10 billion Fund I was up 49.5 percent through July with an estimated 4.9 return in August. Special Situations, which takes moreconcentrated, long-term, activist positions in companies than Fund I, has $2.1 billion in assets and was up 76.6 percent through July and an estimated 2 percent in August. Like Paulson, Harbinger made money shorting CDSs, but also did well with long investments in metals, mining and electricity companies. The multibillion-dollar synthetic corporate collateralized debt obligation market is where London-based Credaris Structured Credit Fund has generated its returns this year, according to portfolio manager Gennaro Pucci. The fund, which takes long, leveraged positions in the equity portion of CDOs and shorts the underlying credit market, has beneﬁted from the widening of spreads in the corporate credit market. Credaris was 36 • INSTITUTIONAL INVESTOR’S ALPHA • SEPTEMBER 2007

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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