HEDGE FUND NEWS
@ Tue 14 August 2007 : GMT

FINTAG COMMENT

Today's is a quickie.

Mrs Fintag has ordered me back to the South of France so today's review is fast and furious. I know that is how many of you like it.

We have been telling you for the last 3 days that Tewksbury / TCM had suffered from the tanking markets and exposure to illiquid assets that nobody wanted. It now confirms the rumors although we still haven't heard about DE Shaw's thumping great draw down? Or Permal's fixed income fund chaos?

[UPDATE - DE Shaw Composite down 9% MTD apparently .. tbc]

AQR come clean.

15th August is subscription / redemption day. We have lots of sweaty credit focused hedge funds praying that the former prevails.

Inflation in China hits a 10 year high - which means we will all soon be importing this and interest rates will have to go up to combat domestic inflation - not that anyone has noticed.

Goldman gets a few mates together and bails itself out. I don't get it. The masters of spin have confused the heck out of me. What have they actually done?

Quants are the new whipping boys (and girls).

As lawyers prepare briefs to fight over poor documented credit derivative agreements, operations staff are struggling to cope with the back log.

BGI admits it was caught with its trousers down.

Bear Stearns, renowned for its low staff turnover is petrified of defections so is offering them stock. Now that is a great comfort. Mind you, if you are a BS employee and fancy working for Merrills I would just stay where you are because we believe that they will be the new owners (or JP Morgan, Barclays, Lehman, etc) very soon.

The Nanny Central Banks feel smug that they averted a massive market crash - but can they keep it up?

The Fed get stuck.

RUBBISH NEWS

Asian stocks recover Monday; China's annual inflation hits 10-year high (finfacts)

Man CEO ups stake in Friday's share plunge (reuters)

The Bear Stearns Golfing Song (hereisthecity)

No Evil (breakingviews)

Iraq Hedge Fund Launches (finalternatives)

KKR warns on pending deals (financialnews-us)

Liquidity injections soothe nervous investors (ft)

Equity derivatives volumes soar (ft)

It's time for central banks to stop bailing out markets (ft)

BRIBES

Bear Stearns to offer stock to offset fall (financialnews-us)
Management of Bear Stearns said they would grant more stock to employees if the US bank's share price does not rise by the end of the year. It fell to $99.75 last week against its 52-week high of $172.61 and, on Friday, it was trading at about $110.

The bank issued several types of stock grants last year and all have seen their worth fall after its market capitalization dipped by nearly $2bn (€1.5bn) last week in the aftermath of its sub-prime troubles.

The price is 33% below the value of stock grants Bear Stearns issued last year, diminishing the value of employees' compensation. It issued 3.29 million capital accumulation plan units and 1.15 million restricted stock units last year at an average price of $165.32, according to its 10-K filing in December.

Executives may redeem the capital accumulation plan units after five years and the restricted stock vests over four years.

Banc of America analyst Michael Hecht said in a research report: “Employees who were issued shares at year-end are under water but the flip side is that they will be issued even more shares this year at lower average prices at which the stock trades today.”

The management's move may displease investors who are asking questions about the group's financial standing. The bank was forced to hold a conference call 10 days ago to explain that two imploded hedge funds had suffered from the worst credit environment in 22 years.

The bank also raised money through two debt offerings of $2.25bn each in the past two weeks to bolster its cash position by between $2bn and $3bn, raising its total cash from $11bn to $14bn.

CAGED ANIMALS

Hardly model behaviour from the guilty quants (telegraph)
Well-schooled investors woke up last week facing a new addition to their lexicon. After becoming versed in the vagaries of the "sub-prime" market, they now had another term to brush up on. "Quants".

The market meltdown that stunned traders last week was largely blamed on quantitative funds. Such funds trade on the recommendation of computer models based on years of market data.

Computer models using quantitative analysis plan investment strategies based on easily measured metrics that can have a numerical value assigned to them.

The computer models will crunch the numbers for any given company and come up with a recommendation based on whatever valuation ratio it has studied and how stocks with similar profiles have performed over the past ten years. The models will then trade on stocks based on how they stand relative to others.

The techniques emerged in the early 1970s and were popularised by the bank Wells Fargo. As computer processing power improved, models could examine many more stocks much faster than any human could dream of.

It seemed a perfect way to invest. Computer models could learn from the past to predict the future, and quantitative funds flourished. By removing human emotion from the equation and taking a market-neutral approach, the quants were designed to practically eliminate risk.

Such was their success that in recent years, as interest rates plummeted, many funds geared up heavily to take advantage of cheap money. By the beginning of this year, $1,500bn (£745bn) was said to be invested in quant funds.

But as the saying goes, history may repeat itself, but it rarely has the same ending. Last week stocks started moving not only in ways that the commonly used models didn't predict, but in the opposite direction to what was expected and the moves were far more volatile than algorithms used to design the models had factored in.

The models were unable to react fast enough, forcing fund managers to step in and trade in ways counter to the recommendations. With so many funds using similar models, the lemming mentality only exacerbated the problems. As a result, some funds recorded a 30pc drop in one week alone.

In 1998, Long Term Capital Management, a hedge fund that bet heavily on the predictions of its quantitative model, failed to predict that the Russian government would default on its debt. The result was the collapse of LTCM. A financial crisis was only averted when a number of banks and the Fed stepped in to prevent the rest of the market following suit.

Goldman Sachs' three funds are perhaps the most high-profile quants to feel the heat, but there are many more, as many large quant funds lost money in their fixed-income or credit positions on the back of a decline in the sub-prime mortgage market.

The firms had to sell more liquid stock investments to raise cash and reduce debt, says a report by Lehman Brothers analyst Matthew Rothman. The selling caused the models of quantitative funds to short-circuit. Stock positions expected to fall in price rose. Shares expected to rise, fell. "The models are behaving in the opposite way we would predict and have seen and tested for over very long time periods (45+ years)," Mr Rothman wrote.

SUMMER INTERNS

Back offices feeling the strain of credit crisis trading boom (ft)
The back offices of investment banks are struggling to cope with the recent surge in trading volumes in credit derivatives as investors sought protection designed to hedge against risk.

As voltatility rattled global credit markets throughout August, staff at investment banks across Europe and the US have been scrambling to keep on top of the requisite paper work, which is piling up in back offices.

"Volumes have exploded and we're struggling to keep up," said a person at a US bank.

Hedge funds said the delays in documentation and settlement are leading to unexecuted trades, difficulty in valuing assets in a timely manner and additional risk.

In New York, daily trading volumes for an index comprising credit default swaps on 125 investment grade North American companies reached some $221bn last week, while similar products in Europe attracted notional volumes of €200bn ($272bn), according to a straw-poll of dealer banks. Credit default swaps allow investors to take a view on the likelihood of a company defaulting on its debt.

Previous pile-ups have led to regulatory crackdowns: in 2003, the US Federal Reserve warned investment banks about both the slowness of their settlement confirmation and the accuracy of their data.

In response, banks cut the number of trades outstanding for more than 30 days by 80 per cent in the past two years and invested in electronic trade processing technology to reduce errors.

Now more than 90 per cent of trades are confirmed electronically. Large companies send out more than 70 per cent of confirmations within a day of the trade being agreed, according to data from the International Swaps and Derivatives Association.

The backlog of unconfirmed credit derivatives trades at large firms had fallen to the equivalent of 5.5 days of business, down from 16 days a year ago and 24 the year before, ISDA said.

Nonetheless, back office staff have been stretched to capacity this month and some banks have been tested more than others.

Data seen by the FT suggest that Credit Suisse, Goldman Sachs, Deutsche Bank and Merrill Lynch are among those to have seen delays.

"There have some been minor delays given the volumes, but these are well within the tolerances which we have established," Deutsche Bank said.

Citigroup said it had not received any complaints from clients. "Based on industry metrics, our credit derivatives trade confirmation and settlement activity is very much in line with the rest of the industry."

Goldman Sachs said it was not aware of any delays. Credit Suisse and Merrill Lynch declined to comment.

RUMORS

Tewksbury smashed...by its lofty standard (nakedshorts)
ewksbury Capital Mgt Ltd lost about 10 percent between Jul. 1 and Aug. 10, according to an investor who spoke with fund principals last Friday. While mild by the standards of other “quant crisis” losses, the decline was somewhat startling for investors used to the firm's rare monthly declines being measured in basis points.

Closed to new investors since long before Matthew Tewksbury took over from Monroe Trout in 2002, the firm had continued the Trout heritage of consistent returns with few losing months, and last year made more than 30 percent on its $3-billion-plus asset base.

The investor said that while the decline was out of Tewksbury's normal range, “the loss is relatively mild compared with some others, and I understand that investors are very supportive. They're still well ahead and this is hardly the sort of thing that can't be recovered. I don't think anybody's planning an exit.”

Tewksbury was said to have told investors that, apart from taking some defensive measures similar to those announced by its peers, the firm was sticking with its signals and, as it does anyway, “watching the portfolio very closely.”

BYE BYE ABN

Barclays Has `Significant' Loan Risk, Panmure Says (bloomberg)
Barclays Plc, the U.K. bank vying to buy ABN Amro Holding NV, may have ``significant'' risks from loans to hedge funds and private equity firms, said Panmure Gordon & Co., which rates the shares ``sell.''

In addition to holding asset-backed commercial paper, which may contain high-risk assets including subprime mortgages, the London-based bank's securities unit may be hurt by loans to hedge funds and private equity firms, Sandy Chen, a London-based analyst at Panmure, said in an e-mailed statement today.

``We think there is a material risk that some of Barclays Capital's counterparties may be in trouble,'' said Chen. ``What was previously a strong source of growth could turn into an area of weakness.''

Shares of Barclays, down 9.8 percent this year, rose 3.2 to 658.5 pence in London, valuing the bank at 43 billion pounds ($86 billon).

The nine-member FTSE All Share Banks Index fell 6.6 percent over two days through Aug. 10 amid concern that a crisis in worldwide credit markets may trigger losses on loans held by banks and hold back earnings growth.

``The events of the market are liquidity-driven rather than market driven,'' said Barclays Global Investors spokeswoman Melissa McVeigh in an interview. ``There are no fundamental changes to the market. We are maintaining the investment process that we have.''

`Challenging' Time

BGI, a San Francisco-based fund manager, will probably say one of its hedge funds has had a ``challenging'' time, the Wall Street Journal reported today.

Barclays's hedge-fund fee income, which represents more than 50 percent of its hedge fund revenue, may also be hurt as the value of assets in so-called quantitative funds falls on defaults in mortgage-backed securities and worldwide credit tightening, Chen wrote.

Revenue at the U.K.'s biggest banks, including Royal Bank of Scotland Group Plc, may fall as banks cut back on lending as defaults rise, Chen said in an interview. Simultaneously, smaller U.K. banks including Northern Rock Plc and Bradford & Bingley Plc, which rely on capital markets to fund lending, may see margins shrink and earnings slow as lending costs rise, Chen said.

While the drop in U.K. banking stock prices may be ``perceived as a buying opportunity,'' risks to earnings remain as they tighten lending, said Chen, who lowered his rating on British lenders including Barclays and HSBC Holdings Plc on Aug. 10.

SPINNING TOPS

Goldman Sachs: 'This Is Not a Rescue' (dealbook)
Goldman Sachs may be pumping billions of dollars in one of its troubled hedge funds, but don't call it a bailout. Or a rescue.

Speaking on a conference call, the securities firm faced many questions about Monday's announcement that it, along with C.V. Starr, Perry Capital and Eli Broad, was putting $3 billion into one of its hedge funds after it suffered big losses last week. Goldman, which is supplying $2 billion of the new equity itself, insisted that the infusion was an attempt to seize on an attractive investment opportunity — and not a move to shore up the fund or protect Goldman's reputation.

“This is not a rescue,” Goldman's chief financial officer, David Viniar, said on the conference call, an event that was unusual in itself because the firm rarely holds calls outside of its quarterly earnings reports.

Goldman said it was confident that the fund's assets were undervalued after last week's beating, in which many so-called quantitative hedge funds tried to unwind similar trades at the same time. The fund, called Global Equity Opportunities, is down more than 30 percent for the year, Goldman executives said Monday, with all of the decline happening last week. Before the new investment, the fund had $3.6 billion in assets under management.

But, one analyst wanted to know, would Goldman have ponied up $2 billion for any fund in a similar situation — even one that did not belong to Goldman? The executives replied that, depending on the particulars, yes, they would.

Two analysts asked whether Goldman might be setting a dangerous precedent by putting its own capital at risk to bolster a troubled hedge fund. One used the term “moral hazard,” a term that refers to the potential for bailouts to encourage inappropriate risk-taking in the future.

Bear Stearns's recent bailout of one of its hedge funds is fresh in Wall Street's memory. That fund, and another one run by Bear Stearns, later filed for bankruptcy protection.

To be sure, Bear's actions were quite different from Goldman's: Bear pledged loans to its ailing fund, while Goldman is investing equity alongside the fund's current investors.

“You should not take this as any sort of precedent,” Goldman executives said on Monday's call. Still, they did not rule out a similar move at other Goldman funds, including Global Alpha, its flagship hedge fund. Global Alpha is down 27 percent for the year, with about half of the loss occurring last week, executives said.

Goldman Conf Call (gs)

Q TIPS

AQR Blames Crowding For Losses, Says 'Severe' Rumors False (finalternatives)
It seems saying sorry isn't contagious.

As more and more hedge funds are forced to send mea culpa letters to investors assuring them that it only seems as though the sky is falling, few, if any, are taking the route of Sowood Capital Advisors' Jeffrey Larson, who told investors that he was “very sorry” that he lost upwards of 60% of their investments. Most, like Friday's missive from AQR Capital Management, accept a modest amount of blame, peppered with a heaping pinch of excuses.

“Many of you have heard rumors concerning us over the last few days,” founding principal Clifford Asness wrote. “If the rumors are that we've had better weeks, then they are accurate. If the rumors are that we are in some pain over the recent widespread quant stock selection woes, then they are accurate. If the rumors are more severe than that, then they are simply false.”

Of course, severity is in the eye of the beholder: Bloomberg News reports that investors in one of the Greenwich, Conn.-based firm's Global Stock Selection funds are saying it is down 21% year-to-date. But AQR, which manages about $10 billion in hedge funds, also has a bright side—one that it continually pointed to in its letter—as its asset allocation fund is up 3.5% in August.

AQR said it is in no danger of shutting down. “Our business is stable and healthy,” Asness wrote.

Still, he acknowledged that its quantitative stock selection strategy has proven “shockingly bad,” and that the firm “underestimated the magnitude and the speed with which danger could strike.” But he blamed crowding in the space for the declines, saying everyone suffers “when too many try to get out the same door.”

“This is decidedly not a regular drawdown,” Asness wrote. “It's a deleveraging of historical proportions.”

BACKROOM BOYS

The credit crunch and the quandary of the Fed (ft)
The events of the past week demonstrate how far the process of financial globalisation has gone. The European Central Bank injected more than €155bn (£105bn) of liquidity into markets because unemployed workers in Detroit are defaulting on home loans they ob-tained during 2006 that did not require any down payment, principal repayment or documentation of income. In the 1980s those defaults would have led to a run on the local bank. In the current decade the loans have been securitised, repackaged in a collateralised debt obligation bond and sold to a hedge fund that bought it on leverage.

The shutdown of several hedge funds has scared the markets. There is no way to predict how many will fail because the markets for securities with subprime loans are illiquid and non-transparent. Hedge funds have valued the securities using models that give them considerable discretion in when to recognise losses. The subprime market began to implode in late 2006 but hedge funds did not recognise any losses on their securities until June. The losses have been so shocking that asset prices have declined sharply even for higher-quality securities.

The subprime debacle resulted from excessive risk-taking by lenders. There was a US housing boom from 2001 to 2006. Lenders responded by sharply expanding loans to marginal borrowers. At the peak, six months ago, there were more than $1,300bn (£650bn) of subprime loans or about 13 per cent of the total mortgage stock. This recklessness was encouraged bygreat demand on Wall Street for low-quality loans to package in CDOs. The rating agencies facilitated the boom by giving high credit scores to securities with loans of dubious quality. The rating agencies collaborated with brokerage firms to produce high-risk securities, as they earned fees from structured finance deals three times higher than on conventional bonds. In the first quarter, structured finance products rose to46 per cent of Moody's revenues.

Ben Bernanke, US Federal Reserve chairman, has suggested the losses from the subprime fiasco could be $50bn-$100bn, or less than 1 per cent of US gross domestic product. Such a loss would be modest compared with 2.5 per cent of GDP lost in the savings and loan scandals of the early 1990s. The problem with the Bernanke forecast is that it will require some good luck. The final cost will depend on house prices. The credit crunch could cause house prices to fall by 10 per cent. In this case, the losses on subprime loans could be twice the Bernanke estimate.

As the US residential housing stock market is worth more than $20,000bn, the economy can cope with a $100bn- $200bn loss. The problem for the Fed is the shock waves from recent events. During the past four weeks, interest rates on conventional home loans have increased by 100 basis points and on subprime loans by 300 basis points to 11 per cent. This did not result from monetary policy but from lenders seeking to protect themselves from rapidly deteriorating credit quality. The rise in yields will further depress home sales and cause housing starts to fall further. Residential construction has already declined from 6.2 per cent of GDP in late 2005 to 4 per cent in the second quarter of this year. It could easily decline to 3 per cent by early 2008. Fannie Mae has said it is prepared to help lessen the risk of credit crunch by expanding its balance sheet. The Bush administration is reluctant to let it do so because of the accounting scandals that occurred two years ago, but the Democrats will demand that Fannie Mae increase its lending because it was created to play such a role.

The Fed is in a quandary. It is reluctant to ease because it thinks the US economy can still achieve 2-3 per cent output growth at a time when the core inflation rate is above 2 per cent. There had been no weakness in consumer spending until the second quarter and many analysts blame gas prices, not the slumping housing market. But with mortgage yields rising there is a risk of a prolonged housing downturn. The Chicago futures market is projecting that house prices could fall by 3-4 per cent over the next year. The risk is growing of a 10 per cent drop. There has been no national decline in US house prices since 1933. If they fall by 10 per cent in a presidential election year, the pressure on the Fed to ease could become irresistible. Presidential candidates could appeal for votes by promising to appoint a pro-housing Fed chairman when Mr Bernanke's term ends in 2009. If he wants a second term, he would then have to let home prices determine monetary policy.

The writer is is an economist and founder of Hale Advisors in Chicago

REDS

US hedge funds face D Day crisis (scotsman)
HUNDREDS of US hedge funds face a D-Day stampede for the exits tomorrow as investors, scarred by huge losses, look set to rush to demand their money back.

In what Wall Street traders describe as a "shoot first and ask questions later" mentality, "everyone from the wealthy to chief investment officers are now shunning risk and scrambling to get out".

Many hedge funds require a 45-day notice period for withdrawal. To pull out before the end of the third quarter, investors have to notify their managers by close of play tomorrow.

US investors are far from convinced the crisis in financial markets is over.

But London and continental markets rallied strongly yesterday. The FTSE 100 index of Britain's leading shares rose 180.7 points, just under 3 per cent, to 6,219 points, erasing more than three-quarters of the losses which put the world on alert on Friday. Leading indexes in Japan, France and Germany all rose.

But the mood on Wall Street was much more mixed as further hedge fund "skeletons" tumbled out. Large swings in the Dow Jones index throughout the day testified to fears that the "perfect storm" in financial markets has further still to rage and that more shocks lie in store.

Investors have been appalled at how some of the biggest names in the $1.75 trillion hedge fund industry have been brought down by exposure to US subprime mortgage debt and the subsequent flight from higher-risk assets.

David Jones, chief market analyst at CMC Markets, said: "It would be naive to think the worst is behind us."

Charles Stanley analyst Jeremy Batstone agreed, saying yesterday's rebound in London was unlikely to mark the end of the volatility.

"This entire period of economic expansion has been built on a vast amount of debt," he said. "Increase the cost of that debt, tighten loan conditions and one might be in for a bit more than just risk aversion."

Among key developments yesterday were:

• The European Central Bank injected a further 47.7 billion (£32.3bn) into the banking system to soothe rattled credit markets. And it took further intervention by the Bank of Japan before Tokyo rallied. Japan's central bank injected ¥600bn (£2.5bn) into money markets.

• Investment bank Goldman Sachs and investors including former AIG Group chairman Maurice "Hank" Greenberg are to pump $3bn (£1.5bn) into a hedge fund that has fallen more than 30 per cent this year. Goldman's Global Equity Opportunities fund, which had a net asset value of $3.6bn before the infusion, is the third Goldman-managed hedge fund to be hammered in the market turmoil.

• Private equity firm Kohlberg Kravis Roberts said yesterday it has been asked for information from US antitrust authorities. The request is in connection to the Justice Department's ongoing investigation of private equity firms. The government is trying to determine whether they have engaged in conduct prohibited by US antitrust laws.