Wednesday, March 24, 2010

Media pendulum swinging toward short sellers?

I was shocked, shocked, when I found two stories today outlining the constructive roles short sellers play in the market.

At, Susan Antilla, a Wall Street columnist for Bloomberg excoriates regulators and calls short sellers "important contributor(s) to keeping markets honest." Here are a couple of the many zingers in the article:
  • "With regulators taking a refreshing two-decade snooze, it’s now up to judges, plaintiffs’ attorneys, short sellers, bloggers and detectives to fill in for the somnolent stock cops."

  • "...regulators and whiny corporate executives often think the wise way to deal with shorts is to investigate them -- not the public companies they target for incompetence or cheating."
The New York Observer has a Q&A with Jim Chanos of Kynikos Associates. He touches on Lehman, health care, politics, Goldman Sachs, among other topics. Some highlights:

  • "People thought [Lehman Bros.] were tough, no-nonsense guys. But we were saying, actually, they’re incredibly aggressive risk takers with a wide berth for what they consider the truth."

  • "Putting more and more money into housing and keeping us healthy in our golden years doesn’t necessarily make us a more productive society. We should be devoting more of that money to technology and education."
Is the media pendulum really swinging toward understanding how short sellers work? Not yet, but people are beginning to realize that there is an important function for contrarians in the market.

Wednesday, March 10, 2010

Walking the talk on transparency

Why is a guy like Steven A. Cohen, who didn't used to even play golf with investors, sitting for a cover story in Bloomberg Markets magazine? Why is he inviting reporters into his firm right after SAC Capital 's name was linked to insider trading and the collapse of Galleon? Because he's smart. That's why. He understands that the rules have changed and that transparency, not performance, is now the name of the game. (And he's getting good counsel from his PR firm.)

SEI's The Era of the Investor: New Rules of Institutional Hedge Fund Investing study found that institutional investors said "transparency" was the most important challenge they faced in hedge fund investing. "Performance" was third. Similarly, according to Prequin's Global Hedge Fund Investor Review, "understandable/transparent strategy" was the most important consideration for institutions when choosing a hedge fund manager.

These days, according to an exec at a family office quoted in the Bloomberg Magazine story, "nobody will invest in an operation that is very clandestine...Even the most crass and abrasive managers are more investor-friendly now."

Engaging with media is an important part of walking the talk on transparency and savvy managers understand this. Furthermore, after the average hedge fund lost nearly 30% in 2008 and the Madoff fraud, most hedge funds need to do more than just ramp up the investor relations and provide more detail in their marketing materials.

Working properly with media can provide third party validation of how a fund thinks, works and generates returns. When this information reinforces what the fund is telling investors and prospects, it makes a difference when they decide to whom and how much to allocate.

In the Bloomberg Markets Magazine story, for example, we get insight into the following important aspects of SAC:
  • SAC's investment process (and how the fund has ended all non-equities trading)
  • The fund's risk-mitigating strategies at work during the credit crash
  • SAC's compliance department
  • How the firm is structured and how the firm runs itself as a collection of 100 small funds
  • How individual managers are held accountable for performance
The story also airs some dirty laundry, like Mr. Cohen's ongoing legal battle with his former wife, but that is anecdotal, in context of what we learn about the inner workings of SAC.

My criticism of the story -- and this extends to the decisions made by the reporters as well as to how SAC managed the boundaries of the story -- is that it details Mr. Cohen's art collection and has a photo of his mansion in Connecticut. It would better serve the interests of the firm had the focus of the story been all business (lose the list of Cohen's charitable contributions while you're at it) and included more commentary from other SAC investors (the story only quotes one).

To get an idea of what hedge funds should aspire to, when it comes to media, read the excellent profile of Bridgewater Associates in Fortune last year. It is noteworthy for two reasons. First, it avoids wasting ink on the fluff that too often permeates reporting about the hedge fund industry. More important, it articulates why investors choose to do business with Bridgewater.

This explanation of the "demand side of the hedge fund equation" is precisely what is lacking in media coverage of the industry and the opportunity for hedge funds to use media to demonstrate the value they provide clients, in their own words, is priceless.

Thursday, March 4, 2010

It's not the hedge funds, stupid!

Ready, fire, aim. That's what the Justice Department appears to be doing in opening an investigation on whether hedge funds colluded to bet against the Euro. SAC Capital, Greenlight Capital, Soros Fund Management and Paulson & Co. are among the funds who have received inquiries from Justice.

The inquiry partly stems from the fact that several hedge fund managers were in attendance at an "idea dinner" hosted by advisory firm Monness, Crespi , Hardt & Co. where investing ideas were discussed.

This "investigation" shows us, as if we needed convincing, two things. First, hedge funds continue to draw unwarranted scrutiny from regulators and media. Second, and more important, it is more proof that the deeply-rooted long-bias in our system of financial oversight is not changing.

This systemic bias that extends from Main Street to Pennsylvania Avenue is becoming the single largest threat to hedge fund reputation and operations.

Was it a mystery that Greece was overleveraged? No. It seems that months ago we saw reporting that currency and sovereign debt traders coined the word PIGS as a pejorative for the European economies bound for trouble (Portugal, Italy, Greece, Spain). Why wouldn't hedge funds or any other investment manager realize the same thing and try to profit from that assumption?

Where is the accountability? It's like Greece, Bear Stearns, Fannie Mae, Enron (the list goes on) were not to blame. We are led to believe that it was the "speculators," "short sellers," or "profiteers" who caused the problem.

Every trade has a buyer and a seller. Someone wins and someone "loses." Shorting is the same buying and, technically, has more risk (because the security can appreciate to infinity, while it can only depreciate to zero).

There are too few voices trying to set the record straight. Here are a couple:

Jim Chanos, quoted in the Wall Street Journal, today explains that going long the dollar is "exactly the same trade as going short the euro...It gets to a certain point of demonizing traders and hedge funds for mistakes elsewhere."

Peter Eavis, financial columnist for The Wall Street Journal acknowledges media and government overreaction to trading activity related to Greece's crisis and the fall in the Euro. He writes, "it appears that hedge funds are seen as more suspicious than other market participants....any evenhanded probe woul have to involve [banks] too. And how about the companies that sell Euros as a hedge for their business operations? Perhaps the more prosaic truth is that there are good reasons for the Euro to fall."

Tuesday, March 2, 2010

Goldman adds bad press to list of business risks

Goldman Sachs, in its most recent 10-K filed with the SEC, acknowledges risks to its business associated with bad publicity and hits to its repuation.

Goldman writes, "The financial crisis and the current political and public sentiment regarding financial institutions has resulted in a significant amount of adverse press coverage, as well as adverse statements or charges by regulators or elected officials. Press coverage and other public statements that assert some form of wrongdoing, regardless of the factual basis for the assertions being made, often results in some type of investigation by regulators, legislators and law enforcement officials or in lawsuits. Responding to these investigations and lawsuits, regardless of the ultimate outcome of the proceeding, is time consuming and expensive and can divert the time and effort of our senior management from our business."

See the section entitled, "We may be adversely affected by increased governmental and regulatory scrutiny or negative publicity" in the 10-K at the bottom of page 34. The section on reputation risk is number 17 of 24 material risks identified by Goldman.

Goldman is correct to draw a clear link between what is reported in the media and what happens on Capitol Hill. The risk that incomplete or erroneous media coverage results in unnecessary or harmful legislation is real. Just think about all the fuss about short selling.

Goldman Sachs' PR problems have been getting a lot of attention recently. Goldman Sachs recently hired a lobbying and PR firm founded by Dan Bartlett and Mark McKinnon, former message masters from the George W. Bush White House. Even Goldman's PR chief has become the object of media coverage.

I suspect that much of the criticism of Goldman will fade into the background with time, especially if the banking industry recovers relatively quickly (and that's a big if). Fundamentally, financial institutions need to pick their battles and fight to win when they choose to engage with media. For example, executive compensation is not a good battle to fight in the press. I don't think that banks can win.

However, ongoing misinformation in the media about market mechanics and trading activity, like negative press about hedge funds shorting Greek sovereign debt, is another matter. That the media don't acknowledge that there are two sides to every trade continues to boggle my mind.

Goldman is not the first financial firm to acknowledge reputation risk in the fine print. In late 2008, Pershing Square Capital Management cited reputation risk as a concern for the fund and the industry in its letter to LPs.

If anyone knows of any other public companies or banks citing reputation risk in SEC filings, please let me know.
UPDATE: On March 8, Goldman was sued by a pension fund for its its pay practices, which, according to the suit, "vastly overcompensate management and constitute corporate waste."