What would you think if you discovered your mutual fund manager had turned over his portfolio almost 3 times? No, not in a year, in a day. Every trading day for a month. At any long only institution I know, men in white coats would within days have bundled the clearly demented portfolio manager away for some much needed downtime. But hedge fund managers are made of sterner stuff, and their wealthy investors don’t ask too many questions but just pay their 2 + 20 (at least until it all blows up). Greg Coffey, the soon to depart star fund manager at GLG, one of the worlds most prominent hedge funds managing $24bn, runs an Emerging Markets fund with $4.6bn in assets. He returned 5.1% in May as he turned over the portfolio 56 times in the month, or on average 2.8 times a day. In total this one fund manager traded $255bn of emerging markets instruments in a month to make 5%. Ask yourself: is that a strategy of genius or lunacy? Is this healthy or sustainable for those investors, the individual concerned or markets in general? Remember this is not some black box quantitative trading fund like those run by Renaissance Technologies, just a plain vanilla equity fund. No wonder emerging markets have been so volatile recently. As for his investors, perhaps they should reflect on the $500m-700m in broking commissions paid out in that single month. Bet the guy’s in line for a few great broker lunches, if he ever gets away from his trading screens. And despite this frenzied activity, the fund has lost 13.4% YTD, worse than the MSCI emerging market index as at end June. At the same time details are emerging of the $270m option profit garnered on an extreme option bet in March that Bear Stearns would more than halve within a couple of weeks, an utterly irrational bet on the basis of time decay and implied volatility unless the buyer could destabilise the bank and make success self-fulfilling. If the SEC can’t prosecute activity so destructive to the stability and integrity of the US financial system, then anything is fair game for these hustlers. I stated back in March in Bear Stearns: Hubris begets Humiliation… that ‘hedge funds abandoning BS as too risky a prime broker were the death knell; rumours that many of the self same funds were short Bear stock are all too credible and as with the wild speculation in commodities indicate the destructive influence funds are now having on broader market stability.’ The increasingly desperate and reckless tactics undertaken by a small but dangerous minority of hedge funds to earn their 20% plus performance fees are one of the biggest systemic risks as we head into the Autumn. The shadow financial system of which they are a key component remains largely opaque and unregulated. I believe the risks of an LTCM style disaster in the hedge fund industry, with spiralling collateral damage via prime brokerage activities at investment banks and liquidation upheaval, are now better than evens, and may trigger a renewed slump in the market. I compared the activities of some hedge funds previously to Crackheads in a Casino, but actually, with the benefit of hindsight, that’s a little harsh. On both drug addicts and Las Vegas, that is.

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Commodities, Market Commentary