You probably caught the news that a hedge fund called Amaranth got caught on the wrong side of a natural gas traded and that the loss YTD for their two main funds may be as large as 35%.
I do not know how important this story really is but I do think the episode is very constructive for anyone trying to manage their own portfolio. Earlier this year during the emerging market selloff there were a few comments left by people with, as it turned out, too much emerging market exposure.
I imagine this selloff in materials and energy has taught a few people they had too much exposed to those sectors. I have continually preached moderation in portfolio construction this current and now very popular idea that oil and gold will keep going down might be an example of the concept.
Materials, of which the mining stocks are a part, only comprise 3% of the S&P 500. Materials make up a similar percentage of most other broad benchmarks. I think 20% in gold stocks a huge bet. If an investor merely doubled up on materials and his picks doubled in value he would have added six percentage points of return to his portfolio which I think is substantial. If from there he sold nothing and those same picks are down 1/3 from there high he has only taken a 4% hit to his portfolio and is probably still close to the market for the year.
For anyone that now finds themselves with a lot of commodity holdings and lagging the market badly I think you need to consider changing how you do things.
This will no doubt fall on some deaf years as many people like the idea of chasing big returns but where possible I do what I can to smooth out the bumps that come along the way and one way to that is not go 20% into a narrow, volatile theme.
Wikinvest Wire
13 comments:
The idea of diversification while simple in concept, is quite difficult in practice...especially in that environment. The fact that every 100 bps of return adds a new Rolex to the collection can drive these guys to make stupid decisions (with someone else's money). And while a few will inevitably lose/lost their jobs, it can in no way make up for the hundreds of millions of dollars lost.
DL
Keep up the good work Roger!
How do I ask a question of Roger about a Stock CTIC?
just post the question and I will attempt to answer it.
CTIC what do you think this deal that was announced today with Novartis will effect stock price. Have a few shares should I hold'em or let them ride now. This has been a very volatile stock?
OK, well I did not see that type of question coming on CTIC. With a $227 million cap it probably fits the label of micro cap.
I know nothing about the company or the stock any sort of opinion about what to do would be a guess. Apologies but I am not smart enough to give advice about stock I don't know.
Doesn't Buffet ( or someone...) call it Deworsificaton?
...little joke there....
Interesting to note that between 1978 and 2004 the Materials averaged 6.5% of the S&P500.
g
Further evidence that trying to run a global macro hedge fund out of your ETrade account is a bad idea.
I read the WSJ article. It seems to be of two minds as to what Mr. Hunter's strategy was.
Using arbitrage on "mispriced" options is one thing. But it really sounds like he either misidentified the arbitrage or (more likely IMO) was making one-sided bets.
I can make one-sided bets all day and nobody is going to notice. But with a few billion dollars in the pot (or blind?), it seems like it starts becoming a game of poker with the rest of the table ganging up on you.
I do not have this problem.
Russell
hi roger, when i read that brokerage firms invest in hedge funds i begin to worry that if some meltdown would occur a brokerage firm find itself in difficult straits. so i wonder if you think diversification extends to institutions as well? in other words, do you think it is wise to not keep all your portfolio with one firm and instead spread it among a few? keep up the good work. thanks, mpk
They should have learned from the Long Term Capital Management fiasco. Clasic example of too many Ivy League financial wanabees with other's cash at their fingertips.
Hedge funds the next .com
As investors hurt by Amaranth this month sort through the damage, here are some principles they may want to have in mind:
It goes without saying that a good hedge fund investor has to pick good funds to invest in. The key, though, to success in this business, is not to choose the best performing managers, but actually to evade the frauds and blowups.
Frauds in this business can take on the form of a misappropriation of funds, as in the case of Cambridge, run by John Natale out of Red Bank NJ, or a misreporting of returns as in the case of Lipper, or Beacon Hill, or the Manhattan Fund, or a host of others.
Blowups usually occur when a single person at the hedge fund has the power to become desperate and "bet the ranch" with leverage. The classic example of this week of Amaranth. Amaranth’s investors will be seeking answers to questions including: to what extent did leverage and concentration play a role in recent out-sized losses.
With both frauds and blowups, contrary to public opinion (and myth), size does NOT matter: Beacon Hill was $2 Billion, Lipper was $5 Billon, Amaranth was $9 Billion).
How do we avoid these two pitfalls of investing in hedge funds?
The answer is long and complex. It takes years to walk on the high wire and not fall off. If you're a long term hedge fund investor and you haven't been burned by one or both of these, you've been either incredibly skilled or incredibly lucky. I should know, for I have been burned by both of these. We have invested billions of dollars in hedge funds over the last ten years in this business. We have done well despite our battle scars and thankfully we have been blessed with a lot of good luck from above.
Suffice it to say that this should be the main question investors should be focused on as they interview and select hedge funds to entrust their dollars to.
Jack Doueck
Stillwater Asset Backed Strategies
Stillwater Capital
thanks for sharing your insight, Jack.
Jack's comment dovetails neatly w/Rogers good advice regarding limiting your exposure to a narrow sector, or in the case of Amaranth, an illiquid investment. The problem with trying to avoid fraud is that it's darn near impossible to predict that a partner(s) of a perfectly legitimate appearing firm, with a respectable track record, will risk jail time to defraud you.
An interview of the LTCM partners would have uncovered a collection of some of the smartest people on the planet. Without access to the daily p&l's and position reports, an investor wouldn't have had any idea of the size of the looming disaster.
The only true defense is to limit your exposure. I assume this is why the burns Jack has suffered have not been fatal.
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