Wall Street Journal: Hedge Funds Article
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Hedge Funds Hit Rocky Stretch As Field Becomes More Crowded
Gregory Zuckerman and Henny Sender. Wall Street Journal.
Hedge funds, the large private investment pools that have exploded in popularity this decade, have hit their most challenging performance stretch in at least a year, raising questions about whether their growth may be slowing and what that could mean for global stock and bond markets.
Investment returns in the average hedge fund dropped about 1.8% in April, according to Hennessee Group LLC, a New York advisory firm for hedge-fund investors. In all, returns are down 1.6% for the year.
While that doesn't sound like much, it could put pressure on some players in the crowded, lightly regulated arena. Customers including big institutions, pension funds and wealthy investors have flooded hedge funds in recent years seeking outsized returns that aren't necessarily tied to moves in stock and bond markets, unlike the returns of mutual funds and many other investment vehicles.
Hedge-fund managers make most of their profit from their investment gains, typically claiming a hefty 20%. Without any gains, some funds could quickly lose key employees or assets, if investors start demanding their money back.
Some investors and hedge-fund veterans wonder whether the industry is poised for a slowdown after years of runaway growth.
"The hedge-fund industry has become so large that it has eliminated the very opportunities it was seeking to exploit," says Joe Aaron, of San Francisco-based Wood, Hat & Silver, which invests in hedge funds on behalf of investors but has been pulling out of them lately. "For hedge funds, regression to the mean has been faster than a speeding bullet. The good old days are gone and may be gone forever."
Others are less downbeat. "This is less bad than some other downturns, in part because May is not off to nearly the same rough start that April ended with," says Brett H. Barth, of BBR Partners LLC in New York, which invests in hedge funds on behalf of wealthy individuals.
To be sure, the data cover only a short period, and could represent a mere pause rather than a peak. An estimated 8,000 hedge funds are in operation -- up from 4,800 four years ago -- embracing investments and strategies ranging from aggressive to quite conservative, and many have bucked the downward trend.
So far this year, hedge funds have continued to outperform the overall stock market. Compared with the 1.6% drop in return on investment that hedge funds experienced in the first four months of 2005, the Standard & Poor's 500 index of 500 large, publicly traded stocks was down 4.5%. Over the past four years, the average hedge fund gained 6.4% annually, compared with an average annual gain of less than 2% for the S&P 500 and an average annual gain of less than 1% for the Dow Jones Industrial Average.
Over the same period, hedge funds have seen their assets soar to about $1 trillion from about $400 billion, thanks to the influx of new investment and the high returns.
Still, hedge funds are lagging behind bonds, which generally are viewed as safer investments. The Lehman Brothers U.S. Aggregate Bond Index, a broad index tracking bonds, is up 0.7% this year, through April. Some managers say that because hedge funds generally aim for much less volatility, it's unfair to compare them to broad stock and bond indexes.
Among those affected are some of the biggest and best-known funds, including Caxton Associates LLC of New York and Citadel Investment Group in Chicago, each of which has an estimated $12 billion in assets. Each lost more than than 2% in April, according to investors. Representatives of Caxton and Citadel declined to comment.
As they have grown, hedge funds, which have the leeway to invest more aggressively than mutual funds and can use borrowed money, or leverage, to amplify their returns, have become much bigger players in trading in stock and bond markets, often through derivatives strategies. Problems at some funds could rebound through global markets if they unwind their positions in stocks and bonds.
Similarly, some funds could seek to increase their leverage to make up for limp returns. Federal Reserve Chairman Alan Greenspan recently warned about keeping an eye on hedge-fund leverage.
A range of causes explain the challenges for hedge funds. The recent drop in oil prices has caused losses at commodity funds, while currency-oriented hedge funds have been hurt by recent resilience in the dollar, which caught some by surprise. As the hedge-fund field becomes more crowded, some managers find their strategies are mimicked by other funds, making it harder to find opportunities.
Some hedge funds have been betting against shares of General Motors Corp., which has been suffering slumping sales and high costs. They took a hit last week when investor Kirk Kerkorian disclosed that he wants to raise his stake in GM to about 9%, helping the stock surge. At the same time, some funds betting against the auto maker's shares also bought GM's bonds, figuring those bonds were safer. But while Standard & Poor's decision to cut its credit rating on GM to "junk" status last week caused the bonds to fall, it didn't affect the stock as much, thanks to Mr. Kerkorian's interest. That hurt funds making this bet.
Another problem area has been convertible bonds, which pay an interest rate, like any other bond, but allow holders to convert them to stock from the issuer at a preset price. By some analyst estimates, hedge funds own more than 75% of all convertible bonds on the market.
Like other bonds, convertibles have been dropping in price amid worries about the health of the economy. That has sparked some investors to pull money out of convertible-bond hedge funds, forcing the funds to sell convertibles to raise cash to pay back their investors and putting even more pressure on the overall market. April was the worst month in more than 15 years for convertible bonds, with convertible hedge funds losing 3.5%, according to Goldman Sachs.
Because of the hedge funds' complicated trading strategies, problems in convertible hedge funds are spreading to other hedge funds that trade corporate debt, as well as to the stock-oriented hedge funds that have been at the core of the hedge-fund boom. Hedge funds known as "equity long/short funds," which buy some shares while betting on others to fall in price, lost about 2.2% on returns in April, according to the Hennessee Group, worse than the S&P drop. They are one of the largest categories of hedge funds.
Many hedge funds increasingly focus on credit-default swaps, or derivative securities that serve as insurance protecting a holder against the default of a company. If hedge funds see big losses they could be tempted to sell these derivative positions, which in turn would weigh on the shares and bonds of the underlying companies.
One of the hallmarks of hedge funds is that investors can't just pull out their money any time they wish to do so. Many funds require investors to exit only at the end of the quarter -- at best. Some worry that at the end of the second quarter in June, there will be significant withdrawals.
"My question is how many hedge funds will pack it in," says Marc Freed, a managing director at Lyster Watson & Co., which invests in dozens of hedge funds on behalf of both individual and institutional clients. Mr. Freed notes that those funds that lost in April may have trouble making up those losses in a challenging market.
That will be a key test. Similar scares appeared in the spring of 2003 and 2004, but were overcome. Some industry experts say the difference now is that interest rates are higher and many hedge funds themselves are relatively newer, with limited experience.
Gregory Zuckerman and Henny Sender. Wall Street Journal.
Hedge funds, the large private investment pools that have exploded in popularity this decade, have hit their most challenging performance stretch in at least a year, raising questions about whether their growth may be slowing and what that could mean for global stock and bond markets.
Investment returns in the average hedge fund dropped about 1.8% in April, according to Hennessee Group LLC, a New York advisory firm for hedge-fund investors. In all, returns are down 1.6% for the year.
While that doesn't sound like much, it could put pressure on some players in the crowded, lightly regulated arena. Customers including big institutions, pension funds and wealthy investors have flooded hedge funds in recent years seeking outsized returns that aren't necessarily tied to moves in stock and bond markets, unlike the returns of mutual funds and many other investment vehicles.
Hedge-fund managers make most of their profit from their investment gains, typically claiming a hefty 20%. Without any gains, some funds could quickly lose key employees or assets, if investors start demanding their money back.
Some investors and hedge-fund veterans wonder whether the industry is poised for a slowdown after years of runaway growth.
"The hedge-fund industry has become so large that it has eliminated the very opportunities it was seeking to exploit," says Joe Aaron, of San Francisco-based Wood, Hat & Silver, which invests in hedge funds on behalf of investors but has been pulling out of them lately. "For hedge funds, regression to the mean has been faster than a speeding bullet. The good old days are gone and may be gone forever."
Others are less downbeat. "This is less bad than some other downturns, in part because May is not off to nearly the same rough start that April ended with," says Brett H. Barth, of BBR Partners LLC in New York, which invests in hedge funds on behalf of wealthy individuals.
To be sure, the data cover only a short period, and could represent a mere pause rather than a peak. An estimated 8,000 hedge funds are in operation -- up from 4,800 four years ago -- embracing investments and strategies ranging from aggressive to quite conservative, and many have bucked the downward trend.
So far this year, hedge funds have continued to outperform the overall stock market. Compared with the 1.6% drop in return on investment that hedge funds experienced in the first four months of 2005, the Standard & Poor's 500 index of 500 large, publicly traded stocks was down 4.5%. Over the past four years, the average hedge fund gained 6.4% annually, compared with an average annual gain of less than 2% for the S&P 500 and an average annual gain of less than 1% for the Dow Jones Industrial Average.
Over the same period, hedge funds have seen their assets soar to about $1 trillion from about $400 billion, thanks to the influx of new investment and the high returns.
Still, hedge funds are lagging behind bonds, which generally are viewed as safer investments. The Lehman Brothers U.S. Aggregate Bond Index, a broad index tracking bonds, is up 0.7% this year, through April. Some managers say that because hedge funds generally aim for much less volatility, it's unfair to compare them to broad stock and bond indexes.
Among those affected are some of the biggest and best-known funds, including Caxton Associates LLC of New York and Citadel Investment Group in Chicago, each of which has an estimated $12 billion in assets. Each lost more than than 2% in April, according to investors. Representatives of Caxton and Citadel declined to comment.
As they have grown, hedge funds, which have the leeway to invest more aggressively than mutual funds and can use borrowed money, or leverage, to amplify their returns, have become much bigger players in trading in stock and bond markets, often through derivatives strategies. Problems at some funds could rebound through global markets if they unwind their positions in stocks and bonds.
Similarly, some funds could seek to increase their leverage to make up for limp returns. Federal Reserve Chairman Alan Greenspan recently warned about keeping an eye on hedge-fund leverage.
A range of causes explain the challenges for hedge funds. The recent drop in oil prices has caused losses at commodity funds, while currency-oriented hedge funds have been hurt by recent resilience in the dollar, which caught some by surprise. As the hedge-fund field becomes more crowded, some managers find their strategies are mimicked by other funds, making it harder to find opportunities.
Some hedge funds have been betting against shares of General Motors Corp., which has been suffering slumping sales and high costs. They took a hit last week when investor Kirk Kerkorian disclosed that he wants to raise his stake in GM to about 9%, helping the stock surge. At the same time, some funds betting against the auto maker's shares also bought GM's bonds, figuring those bonds were safer. But while Standard & Poor's decision to cut its credit rating on GM to "junk" status last week caused the bonds to fall, it didn't affect the stock as much, thanks to Mr. Kerkorian's interest. That hurt funds making this bet.
Another problem area has been convertible bonds, which pay an interest rate, like any other bond, but allow holders to convert them to stock from the issuer at a preset price. By some analyst estimates, hedge funds own more than 75% of all convertible bonds on the market.
Like other bonds, convertibles have been dropping in price amid worries about the health of the economy. That has sparked some investors to pull money out of convertible-bond hedge funds, forcing the funds to sell convertibles to raise cash to pay back their investors and putting even more pressure on the overall market. April was the worst month in more than 15 years for convertible bonds, with convertible hedge funds losing 3.5%, according to Goldman Sachs.
Because of the hedge funds' complicated trading strategies, problems in convertible hedge funds are spreading to other hedge funds that trade corporate debt, as well as to the stock-oriented hedge funds that have been at the core of the hedge-fund boom. Hedge funds known as "equity long/short funds," which buy some shares while betting on others to fall in price, lost about 2.2% on returns in April, according to the Hennessee Group, worse than the S&P drop. They are one of the largest categories of hedge funds.
Many hedge funds increasingly focus on credit-default swaps, or derivative securities that serve as insurance protecting a holder against the default of a company. If hedge funds see big losses they could be tempted to sell these derivative positions, which in turn would weigh on the shares and bonds of the underlying companies.
One of the hallmarks of hedge funds is that investors can't just pull out their money any time they wish to do so. Many funds require investors to exit only at the end of the quarter -- at best. Some worry that at the end of the second quarter in June, there will be significant withdrawals.
"My question is how many hedge funds will pack it in," says Marc Freed, a managing director at Lyster Watson & Co., which invests in dozens of hedge funds on behalf of both individual and institutional clients. Mr. Freed notes that those funds that lost in April may have trouble making up those losses in a challenging market.
That will be a key test. Similar scares appeared in the spring of 2003 and 2004, but were overcome. Some industry experts say the difference now is that interest rates are higher and many hedge funds themselves are relatively newer, with limited experience.
Greg Zuckerman of The Wall Street Journal and Charles Gradante of the Hennessee Group discuss hedge funds
LARRY KUDLOW, host:
It was Mark Twain who once said, `The reports of my death have been greatly exaggerated.' Could hedge funds be saying exactly the same thing? Is it true? Joining me now with more on the potential demise of hedgies: Gregory Zuckerman, reporter for The Wall Street Journal and co-author of today's front-page article which set the rumor mill in motion--did it ever; and Charles Gradante, managing principal at the Hennessee Group, which advises hedge-fund investors. Mr. Gradante has testified in front of the House, the Senate and the SEC on the topic of hedge funds.
Greg Zuckerman, welcome back. Listen, old buddy, to me this hedge-fund story in the market was big news and it was bad news. All right, a day after you wrote this thing--or, let's say, a market day after you wrote this thing, what have you learned, what do you know now that you might not have known this morning or last night when you filed it?
Mr. GREGORY ZUCKERMAN (The Wall Street Journal): Well, we don't want to scoop ourselves. We have a paper coming out tomorrow that we want people to pick up. You know, problems are continuing in the hedge-fund world, as we suggested. Today I guess it's twofold: You got underperformance--hedge funds across the board, big names, famous names, guys who haven't had down months, are all down this year, not terribly so. They're still outperforming the overall market.
KUDLOW: Which big names, Greg? You got a name or two for us?
Mr. ZUCKERMAN: Caxton's a big one. Bruce Kovner's a major name in the hedge-fund world, multibillion-dollar hedge funds. These guys outperform month in, month out. They're down over 2 percent just in April.
KUDLOW: Kovner's a brilliant guy. I mean, he's had a great long-term record, hasn't he?
Mr. ZUCKERMAN: Yeah, yeah. Citadel is another one in Chicago, again, unbelievable long-term records, and all of a sudden these guys are having challenges. Now, again, they're still outperforming the overall stock market, and you don't want to go overboard here. But if those guys are having some issues, you wonder about who may be having even more problems. That's the concern.
KUDLOW: Charles Gradante, let me just ask you, see if you've heard some names today. QVT was on sort of the hot seat. They deny any problems. In fact, I want to be fair. This fund--I believe it's a Boston hedge fund--they say they're up 2.6 percent year to date through April, and they're already up slightly in May. The other name that jumped out like a sore thumb is Deutsche Bank. It is alleged--now this is just market rumors--that they are the prime broker of a hedge fund that's in a heap of trouble. The Deutsche Bank stock fell 2.9 percent. They made no comment. Sir, do you know any information? Have you heard the same rumors that I've heard?
Mr. CHARLES GRADANTE (Hennessee Group Managing Principal): I've heard those same rumors, and I'm glad you brought up Deutsche Bank. A lot of credit risk is on the banking side, whether it's Deutsche Bank or JP Morgan, Citibank. So the banking community is participating in hedging their balance sheet and creating a lot of trades that look like hedge-fund-related trades.
KUDLOW: What kind of risks, Charles?
Mr. GRADANTE: Well, for example...
KUDLOW: This is a very interesting--they're making loans to hedge funds, who are then levering into highly risk assets?
Mr. GRADANTE: No, they...
KUDLOW: Is that what you're saying?
Mr. GRADANTE: That's one thing, but what about credit-default swaps? In many cases, the banks have sold or let credit-default swaps, the hedge funds, who are hedging their bond exposure--their credit exposure, and the bank is not holding the bond. So they're short the credit-default swap, as the GM event risk caused many commercial banks and investment banks to start hedging their counterpart risk and their market risk in the credit by shorting the bond or the underlying equity.
KUDLOW: Greg Zuckerman, come back to you. You're listening to Charles talk about these credit risks. It's very important. Now I am told by sources today that some hedge funds levered heavily into something called second liens, which are really crummy pieces of paper; not even banks would buy them. But now with credit somewhat suspect, with a little whiff of deflation in the high-yield junk bond market and so forth, this second lien stuff on top of convertibles, which have virtually no credit standing--this is a problem. What do you hear on that?
Mr. ZUCKERMAN: Well, the bigger problem is that which they own, but also how they're hedging it. As we remember with LTCM, it wasn't just what they were owning but they were hedging, back at LTCM, Long-Term Capital. They were hedging by selling Treasuries, and then it went the other way on them. Similarly here, sometimes they're buying stuff that, in the debt world, it's a little risky. And sometimes they're protecting themselves, hedging themselves by shorting underlying shares. And sometimes that's not working--for example, GM, where the shares actually went up and the debt went down. And that's happening different places: converts and credit-default swaps. So that's where you want to be careful of.
And you talked about leverage earlier. I think leverage is a big issue. Leverage has come way down since '98 when LTCM had all that leverage. But you want to be careful about how some of the Wall Street banks have been loaning to investors in hedge funds.
LARRY KUDLOW, host:
It was Mark Twain who once said, `The reports of my death have been greatly exaggerated.' Could hedge funds be saying exactly the same thing? Is it true? Joining me now with more on the potential demise of hedgies: Gregory Zuckerman, reporter for The Wall Street Journal and co-author of today's front-page article which set the rumor mill in motion--did it ever; and Charles Gradante, managing principal at the Hennessee Group, which advises hedge-fund investors. Mr. Gradante has testified in front of the House, the Senate and the SEC on the topic of hedge funds.
Greg Zuckerman, welcome back. Listen, old buddy, to me this hedge-fund story in the market was big news and it was bad news. All right, a day after you wrote this thing--or, let's say, a market day after you wrote this thing, what have you learned, what do you know now that you might not have known this morning or last night when you filed it?
Mr. GREGORY ZUCKERMAN (The Wall Street Journal): Well, we don't want to scoop ourselves. We have a paper coming out tomorrow that we want people to pick up. You know, problems are continuing in the hedge-fund world, as we suggested. Today I guess it's twofold: You got underperformance--hedge funds across the board, big names, famous names, guys who haven't had down months, are all down this year, not terribly so. They're still outperforming the overall market.
KUDLOW: Which big names, Greg? You got a name or two for us?
Mr. ZUCKERMAN: Caxton's a big one. Bruce Kovner's a major name in the hedge-fund world, multibillion-dollar hedge funds. These guys outperform month in, month out. They're down over 2 percent just in April.
KUDLOW: Kovner's a brilliant guy. I mean, he's had a great long-term record, hasn't he?
Mr. ZUCKERMAN: Yeah, yeah. Citadel is another one in Chicago, again, unbelievable long-term records, and all of a sudden these guys are having challenges. Now, again, they're still outperforming the overall stock market, and you don't want to go overboard here. But if those guys are having some issues, you wonder about who may be having even more problems. That's the concern.
KUDLOW: Charles Gradante, let me just ask you, see if you've heard some names today. QVT was on sort of the hot seat. They deny any problems. In fact, I want to be fair. This fund--I believe it's a Boston hedge fund--they say they're up 2.6 percent year to date through April, and they're already up slightly in May. The other name that jumped out like a sore thumb is Deutsche Bank. It is alleged--now this is just market rumors--that they are the prime broker of a hedge fund that's in a heap of trouble. The Deutsche Bank stock fell 2.9 percent. They made no comment. Sir, do you know any information? Have you heard the same rumors that I've heard?
Mr. CHARLES GRADANTE (Hennessee Group Managing Principal): I've heard those same rumors, and I'm glad you brought up Deutsche Bank. A lot of credit risk is on the banking side, whether it's Deutsche Bank or JP Morgan, Citibank. So the banking community is participating in hedging their balance sheet and creating a lot of trades that look like hedge-fund-related trades.
KUDLOW: What kind of risks, Charles?
Mr. GRADANTE: Well, for example...
KUDLOW: This is a very interesting--they're making loans to hedge funds, who are then levering into highly risk assets?
Mr. GRADANTE: No, they...
KUDLOW: Is that what you're saying?
Mr. GRADANTE: That's one thing, but what about credit-default swaps? In many cases, the banks have sold or let credit-default swaps, the hedge funds, who are hedging their bond exposure--their credit exposure, and the bank is not holding the bond. So they're short the credit-default swap, as the GM event risk caused many commercial banks and investment banks to start hedging their counterpart risk and their market risk in the credit by shorting the bond or the underlying equity.
KUDLOW: Greg Zuckerman, come back to you. You're listening to Charles talk about these credit risks. It's very important. Now I am told by sources today that some hedge funds levered heavily into something called second liens, which are really crummy pieces of paper; not even banks would buy them. But now with credit somewhat suspect, with a little whiff of deflation in the high-yield junk bond market and so forth, this second lien stuff on top of convertibles, which have virtually no credit standing--this is a problem. What do you hear on that?
Mr. ZUCKERMAN: Well, the bigger problem is that which they own, but also how they're hedging it. As we remember with LTCM, it wasn't just what they were owning but they were hedging, back at LTCM, Long-Term Capital. They were hedging by selling Treasuries, and then it went the other way on them. Similarly here, sometimes they're buying stuff that, in the debt world, it's a little risky. And sometimes they're protecting themselves, hedging themselves by shorting underlying shares. And sometimes that's not working--for example, GM, where the shares actually went up and the debt went down. And that's happening different places: converts and credit-default swaps. So that's where you want to be careful of.
And you talked about leverage earlier. I think leverage is a big issue. Leverage has come way down since '98 when LTCM had all that leverage. But you want to be careful about how some of the Wall Street banks have been loaning to investors in hedge funds.
KUDLOW: So this is a hedge-fund problem potentially, but it is also a banking problem potentially. That's what I'm hearing from you guys.
Mr. GRADANTE: That's right. And another point to bring out is Greenspan has always pointed to hedge funds as...
KUDLOW: Yeah. Some people think, Charles, that he is using that as a policy target for his tightenings.
Mr. GRADANTE: Well, but also the point that hedge funds provide liquidity where the commercial banks have pulled back as they consolidate. So that junk bond that you were talking about that hedge funds are purchasing--or the mezzanine financing...
KUDLOW: Yeah, it's the mezzanine stuff that really concerns me.
Mr. GRADANTE: Yeah, there are a lot of hedge funds that are long mezzanine financing, and they're short the collateralized debt or the secured debt of the corporation as a hedge. And they were actually playing a Goldilocks economy. Now that things are being shaken up a bit, it's coming home to roost. But without hedge funds, who would buy the mezzanine financing?
KUDLOW: Well, OK. But, Charles, let me ask you this. I mean, to defend hedge funds for a minute, I mean, they're out there; they're not going away. They're a legitimate investment vehicle, for heaven's sakes. Most of them, in my experience, are highly disciplined. And, in fact, the long and short concept is itself a risk-averse concept, is it not?
Mr. GRADANTE: Definitely.
KUDLOW: And it says to its investors, `We're not necessarily going for home runs, but we want to take a more balanced risk-averse position to give you somewhat lower but more palatable, more predictable returns.'
Mr. GRADANTE: As a matter of fact, that's the way the smart money on Wall Street has always been managed. You came from Wall Street; I came from Wall Street. Proprietary trading is really where long-short was invented back in the turn of the century. Lehman Brothers and Goldman Sachs were doing it back in 1920.
KUDLOW: I...
Mr. GRADANTE: It's where--that's how to manage smart money.
KUDLOW: I agree.
And, Greg Zuckerman, I mean, there's no question, as your article noted today, it's become a very competitive field. You got a lot of hedgies in there. There's a lot of money, trillion dollars. The thing's really--so it's gotten tougher. Competition means your margins are going to shrink. But in your reportorial inquiries, you're not finding any evidence that hedge funds are going away.
Mr. ZUCKERMAN: Are they going away? No, not necessarily. Not at all. I mean, they still outperform mutual funds. I mean, the whole concept of hedge funds is to create absolute return rather than relative return. The whole idea that mutual funds are doing well for their customers because they're down 10 percent and the S&P 500's down 12 percent has not borne out in the last bear market. People--investors are very disappointed, and they continue to shift to hedge funds, who say, `We're going to try to give you outperformance in any kind of market.' The question is as hedge funds keep getting larger and if they run into some outperformance, what kind of impacts they'll have on the market as they try to dig out of these problems.
Mr. GRADANTE: I...
KUDLOW: Well, and, Charles, your data from the Hennessee indexes does show--I'm looking at this, for example: Short Biased Index.
Mr. GRADANTE: Right.
KUDLOW: They're up big this year...
Mr. GRADANTE: Right.
KUDLOW: ...17 1/2 percent.
Mr. GRADANTE: Right.
KUDLOW: You made money in the Latin-American Index. You made some money in the Event Driven Index, in the Europe Index. I mean, some people are making money out here.
Mr. GRADANTE: Some people are making money. But the notion that hedge fund--or the money flowing into the hedge fund industry is causing poor performance is misleading. The lackluster performance is a function of the tight trading range that we're experiencing in the equity markets, the flattening of the yield curve. I mean, hedge-fund bond traders, just like the proprietary traders on Wall Street, are having the same problems--you know, a flat yield curve.
KUDLOW: Yeah.
Mr. GRADANTE: The carry trade is gone.
KUDLOW: I agree.
Mr. GRADANTE: Volatility traders--the volatility...
KUDLOW: I agree.
Mr. GRADANTE: The VIX is down to 13 percent.
KUDLOW: All right, we gotta close it down. Charles Gradante, thank you very much. Greg Zuckerman, I appreciate it. I think everything you guys--I don't want the Fed to keep tightening. I think that's one...
Mr. GRADANTE: I agree.
KUDLOW: ...(unintelligible). But thank you, gentlemen.
Mr. GRADANTE: Yes!
KUDLOW: Appreciate it.
All right, kids, next up, we've got an important interview with Senator Jon Kyl; his view on president Bush's message diplomacy--sharp message diplomacy. Freedom, democracy--those are watch words on KUDLOW & COMPANY. Please--we're coming back after the break.
Secretary-General KOFI ANNAN (United Nations): As you know...
Announcer: Still to come, is change at the top necessary for confidence in the UN to be restored? Senator Norm Coleman weighs in. Keep it with KUDLOW & COMPANY. We'll be right back.
Mr. GRADANTE: That's right. And another point to bring out is Greenspan has always pointed to hedge funds as...
KUDLOW: Yeah. Some people think, Charles, that he is using that as a policy target for his tightenings.
Mr. GRADANTE: Well, but also the point that hedge funds provide liquidity where the commercial banks have pulled back as they consolidate. So that junk bond that you were talking about that hedge funds are purchasing--or the mezzanine financing...
KUDLOW: Yeah, it's the mezzanine stuff that really concerns me.
Mr. GRADANTE: Yeah, there are a lot of hedge funds that are long mezzanine financing, and they're short the collateralized debt or the secured debt of the corporation as a hedge. And they were actually playing a Goldilocks economy. Now that things are being shaken up a bit, it's coming home to roost. But without hedge funds, who would buy the mezzanine financing?
KUDLOW: Well, OK. But, Charles, let me ask you this. I mean, to defend hedge funds for a minute, I mean, they're out there; they're not going away. They're a legitimate investment vehicle, for heaven's sakes. Most of them, in my experience, are highly disciplined. And, in fact, the long and short concept is itself a risk-averse concept, is it not?
Mr. GRADANTE: Definitely.
KUDLOW: And it says to its investors, `We're not necessarily going for home runs, but we want to take a more balanced risk-averse position to give you somewhat lower but more palatable, more predictable returns.'
Mr. GRADANTE: As a matter of fact, that's the way the smart money on Wall Street has always been managed. You came from Wall Street; I came from Wall Street. Proprietary trading is really where long-short was invented back in the turn of the century. Lehman Brothers and Goldman Sachs were doing it back in 1920.
KUDLOW: I...
Mr. GRADANTE: It's where--that's how to manage smart money.
KUDLOW: I agree.
And, Greg Zuckerman, I mean, there's no question, as your article noted today, it's become a very competitive field. You got a lot of hedgies in there. There's a lot of money, trillion dollars. The thing's really--so it's gotten tougher. Competition means your margins are going to shrink. But in your reportorial inquiries, you're not finding any evidence that hedge funds are going away.
Mr. ZUCKERMAN: Are they going away? No, not necessarily. Not at all. I mean, they still outperform mutual funds. I mean, the whole concept of hedge funds is to create absolute return rather than relative return. The whole idea that mutual funds are doing well for their customers because they're down 10 percent and the S&P 500's down 12 percent has not borne out in the last bear market. People--investors are very disappointed, and they continue to shift to hedge funds, who say, `We're going to try to give you outperformance in any kind of market.' The question is as hedge funds keep getting larger and if they run into some outperformance, what kind of impacts they'll have on the market as they try to dig out of these problems.
Mr. GRADANTE: I...
KUDLOW: Well, and, Charles, your data from the Hennessee indexes does show--I'm looking at this, for example: Short Biased Index.
Mr. GRADANTE: Right.
KUDLOW: They're up big this year...
Mr. GRADANTE: Right.
KUDLOW: ...17 1/2 percent.
Mr. GRADANTE: Right.
KUDLOW: You made money in the Latin-American Index. You made some money in the Event Driven Index, in the Europe Index. I mean, some people are making money out here.
Mr. GRADANTE: Some people are making money. But the notion that hedge fund--or the money flowing into the hedge fund industry is causing poor performance is misleading. The lackluster performance is a function of the tight trading range that we're experiencing in the equity markets, the flattening of the yield curve. I mean, hedge-fund bond traders, just like the proprietary traders on Wall Street, are having the same problems--you know, a flat yield curve.
KUDLOW: Yeah.
Mr. GRADANTE: The carry trade is gone.
KUDLOW: I agree.
Mr. GRADANTE: Volatility traders--the volatility...
KUDLOW: I agree.
Mr. GRADANTE: The VIX is down to 13 percent.
KUDLOW: All right, we gotta close it down. Charles Gradante, thank you very much. Greg Zuckerman, I appreciate it. I think everything you guys--I don't want the Fed to keep tightening. I think that's one...
Mr. GRADANTE: I agree.
KUDLOW: ...(unintelligible). But thank you, gentlemen.
Mr. GRADANTE: Yes!
KUDLOW: Appreciate it.
All right, kids, next up, we've got an important interview with Senator Jon Kyl; his view on president Bush's message diplomacy--sharp message diplomacy. Freedom, democracy--those are watch words on KUDLOW & COMPANY. Please--we're coming back after the break.
Secretary-General KOFI ANNAN (United Nations): As you know...
Announcer: Still to come, is change at the top necessary for confidence in the UN to be restored? Senator Norm Coleman weighs in. Keep it with KUDLOW & COMPANY. We'll be right back.
NEW YORK, May 11 (Reuters) - Deutsche Bank AG (DBKGn.DE: Quote, Profile, Research) on Wednesday said its trading unit has no exposure to hedge fund investments, distancing itself from rumors about possible losses that drove its share price down on Tuesday.
"We don't give cash lending to hedge funds," the bank's Chief Financial Officer, Clemens Boersig, told a UBS global financial services conference in New York.
"There is no cash lending exposure whatsoever and global markets does not invest in hedge funds," Boersig said, referring to the bank's trading unit. The unit "does not have principal investment in hedge funds. This is very important to know, particularly these days."
Boersig said Deutsche's exposure was fully collateralized.
He added that the bank's proprietary trading desk, where brokerages make bets with their own money, was a "conservative" investor.
"Our proprietary trading activities, percentage-wise, are smaller than the average in the market," he said.
Shares in Deutsche Bank (DBKGn.DE: Quote, Profile, Research) had fallen 3 percent on Tuesday on market talk of possible losses in investment banking relating to its proprietary trading book, making it one of the largest decliners on the German DAX Index that day.
On Wednesday, after rising more than 1 percent on the initial reporting of Boersig's comments, shares of Deutsche ended the day up 0.44 percent, at 62.12 euros, in trading on the German stock market.
Dealers had cited several rumors circulating in the market that Germany's biggest bank suffered losses on trading in collateralized debt obligations (CDOs), which combine credit exposure to a number of companies and then slice that exposure into various pieces according to the level of risk.
In particular, fund managers and investors talked of one proprietary book run by Deutsche Bank traders that deals in correlations across credit markets and may have lost money in CDOs.
Traders said several investors, including the Deutsche Bank proprietary book, were thought to be running into trouble on trades in which they took exposure to the so-called "equity," or riskiest, tranches of CDOs, and hedged that by taking a short position on more senior tranches of the obligations.
Other rumors cited in the market included possible losses related to large proprietary positions in the bonds of U.S. automakers General Motors (GM.N: Quote, Profile, Research) and Ford (F.N.: Quote, Profile, Research) -- which were cut to "junk" status last week -- and possible exposure to a struggling U.S. hedge fund.
Deutsche did not discuss Ford or GM in the Web cast of Boersig's presentation to the New York conference.
© Reuters 2005. All Rights Reserved.
"We don't give cash lending to hedge funds," the bank's Chief Financial Officer, Clemens Boersig, told a UBS global financial services conference in New York.
"There is no cash lending exposure whatsoever and global markets does not invest in hedge funds," Boersig said, referring to the bank's trading unit. The unit "does not have principal investment in hedge funds. This is very important to know, particularly these days."
Boersig said Deutsche's exposure was fully collateralized.
He added that the bank's proprietary trading desk, where brokerages make bets with their own money, was a "conservative" investor.
"Our proprietary trading activities, percentage-wise, are smaller than the average in the market," he said.
Shares in Deutsche Bank (DBKGn.DE: Quote, Profile, Research) had fallen 3 percent on Tuesday on market talk of possible losses in investment banking relating to its proprietary trading book, making it one of the largest decliners on the German DAX Index that day.
On Wednesday, after rising more than 1 percent on the initial reporting of Boersig's comments, shares of Deutsche ended the day up 0.44 percent, at 62.12 euros, in trading on the German stock market.
Dealers had cited several rumors circulating in the market that Germany's biggest bank suffered losses on trading in collateralized debt obligations (CDOs), which combine credit exposure to a number of companies and then slice that exposure into various pieces according to the level of risk.
In particular, fund managers and investors talked of one proprietary book run by Deutsche Bank traders that deals in correlations across credit markets and may have lost money in CDOs.
Traders said several investors, including the Deutsche Bank proprietary book, were thought to be running into trouble on trades in which they took exposure to the so-called "equity," or riskiest, tranches of CDOs, and hedged that by taking a short position on more senior tranches of the obligations.
Other rumors cited in the market included possible losses related to large proprietary positions in the bonds of U.S. automakers General Motors (GM.N: Quote, Profile, Research) and Ford (F.N.: Quote, Profile, Research) -- which were cut to "junk" status last week -- and possible exposure to a struggling U.S. hedge fund.
Deutsche did not discuss Ford or GM in the Web cast of Boersig's presentation to the New York conference.
© Reuters 2005. All Rights Reserved.
Sooooo does that mean I shouldn't continue to start MY hedge fund....???