Hedge Lines

Media pendulum swinging toward short sellers?

2010-03-24T11:32:00.009-04:00

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

At BusinessWeek.com, 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.

Walking the talk on transparency

2010-03-10T11:47:00.006-05:00

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.

It's not the hedge funds, stupid!

2010-03-04T10:19:00.010-05:00

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."

Goldman adds bad press to list of business risks

2010-03-02T13:39:00.013-05:00

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."

John Bogle to institutional investors: Stop being part of the problem

2010-02-11T11:19:00.013-05:00

In a recent op-ed in The Wall Street Journal, investing legend John C. Bogle argues that institutional investors need to change the way they do business and begin to assert their fiduciary responsibilities as dominant shareholders. The ability for institutional investors to exert activist pressure on corporations to ensure the creation and preservation of value for investors is among the remedies Bogle seeks.

Bogle indicts institutional investors, who control 70% of shares of U.S. corporations, on several levels and writes, the "failure of money managers to observe the principles of fiduciary duty played a major role in allowing our corporate managers to place their own interests ahead of the interests of their shareholders."

He says that the apathy of instituional investors is partly to blame for a range of ills including the rise of speculation over long-term value investing, the ready acceptance of financial engineering and "innovation," and excessive corporate compensation systems.

At the same time, Bogle sees institutional investors as having the potential to be agents for positive change and as having the potential to act as important corrective forces in better functioning financial markets. This blog calls that kind of dynamic the new financial world order. The role of institutional investors, including, ostensibly, hedge funds is important, Bogle says, because government is ill-equiped to effectively police the markets. "There are few regulations that smart, motivated, targets cannot evade," he writes.

A recent example of an institutional investor trying to use its weight to enforce fair play is AllianceBernstein's opposition to the terms of Novartis' takeover of Alcon. The deal would pay Nestle, the majority shareholder in Alcon $180 per share, while minority shareholders in Alcon will receive $147.

The New York Times piece linked above notes that it is rare for AllianceBernstein to take such a public stand that challenges corporate interests. That's because the bar is too low for mutual- and pension- fund managers. They don't have enough incentive to put the time and effort into correcting corporate abuses and they simply shift their assets elsewhere. Bogle believes that has to change.

Clearly, though, hedge funds are incentivized to take on corporate boards and constructively use activist strategies to enhance the value of their investment. In the Alcon situation, getting $180 per share for the minority holders represents at 22% increase in value. What hedge fund wouldn't pursue that?

Hedge funds need to take the lead in ensuring corporations deliver value and need to, when appropriate, get other money managers to support activist campaigns. There is no lack of targets. Morgan Stanley reported that compensation at the firm last year represented 62% of net revenue. TIAA-Cref, Oppenheimer, and Calvert Asset Management are among the institutions publicly decrying the situation.

With massive failures of leadership at America's largest (and at one time most respected) companies, like GM, Citigroup, AIG, TimeWarner, etc, it has become easier to effectively criticise boards and the media is more receptive than ever to views that challenge management. Hedge funds and other asset managers can capitalize on that to exert pressure on boards and corporations.

The failures of corporate boards are detailed in Money for Nothing: How the Failure of Corporate Boards is Ruining American Business and Costing Us Trillions. An interview with the author can be heard at Slate.com.

UPDATE: Calpers' portfolio of funds that challenge underperforming companies exceeded the return of the S&P 500 by 8.2% since 1999. "The long-run returns for experienced activists should again beat the broader market. Slumbering boards beware," writes a column by BreakingViews on the market prospects for activist hedge funds.

A video discussion with William D. Cohan and John Guillespie about corporate boards is at Bloggingheads.tv.

New Citi Web site takes positive message straight to Main Street

2010-02-04T21:40:00.003-05:00

At the beginning of February, Citigroup launched a new Web site to speak directly to clients, employees, shareholders and other stakeholders. Called The New Citi Blog, the site is part blog, part social media and all extension of Citi's PR and internal communications departments.

Featuring video testamonials from a range of Citi employees and already two posts by CEO Vikram Pandit, the site tries to send multiple messages to multiple audiences. Citi is a good place to work, Citi values its clients, Citi is serious about risk management, the Citi organization is getting better at working together.

Citi might or might not be a viable institution in its current form, but this new Web site is a good tool to communicate management's vision and put a human face on the much maligned bank. Citi is taking advantage of the Web to go around media to get its message direct to stakeholders. Sure, media is still important and the third party validation is more valuable than the obvious corporate spinning going on at New.Citi.com, but this could be an important tool to reach the people Citi needs to reach. Besides, it is unlikely that the media are buying whatever Citi is selling, so the bank needed a new channel.

Companies need to realize that the Web and social media provide conduits to go direct to the stakeholders that matter the most. Before these technologies it simply was not possible to effectively present a company's view of complex situations or defend itself from criticism, much less engage people -- in large numbers -- in a dialog. Companies now can inject their own voice into the debate and have new tools to actively take charge of their reputation.

For this reason, I routinely disagree with PR people who say that the Internet has killed the news release. If anything, news releases are more valuable now than they ever have been, because of the reasons above and the fact that a news release on the Internet now has a more diverse audience than just the media.

The media still matter. It's just that now the media don't necessarily have to have the last word.

A bulge of media opportunities for non-bulge-bracket banks

2010-01-25T12:40:00.011-05:00

It is "morning in America" if you happen to be a non-bulge bracket bank. Think about it: your larger, previously-unassailable competitors have either dissolved or are consumed with their own issues (TARP, compensation, regulation, risk management, etc) and now, finally, second- and third-tier institutions have a historic chance at grabbing market share.

From a media relations perspective the opportunity is simply amazing. Again, think about the landscape: Bear Stearns - gone; Lehman - gone; Merrill Lynch - gone(ish); Citigroup - utterly consumed with their own operating issues; Morgan Stanley - retrenching, then expanding, probably only to retrench again; Bank of America - too big to succeed. These firms were the go-to providers of analysis in media coverage of capital markets, equity research, corporate earnings, M&A, industry trends, currency markets, economic trends, etc. They simply dominated the Wall Street Journal, Reuters, Bloomberg, BusinessWeek, The New York Times, and other major financial media. Not any more.

Not only have firms disappeared or retrenched, but the reputations of the survivors are seriously compromised. First came the questions of culpability of major banks in the mortgage/financial crisis. Then came the restrictions accompanying TARP bailouts. Now, the big banks are up against the wall over the issue of compensation. This will be the hardest bullet to dodge and look for compensation issues to persist througout 2010.

Moroever, the media understand now that they have almost a fiduciary duty to broaden their sources away from the large banks and trading firms. This, combined with heightened skepticism by reporters and deeply seeded resentment (in my opinion) about compensation practices, opens the door like never before for smaller firms in virtually every financial sector to enhance their brands and market themselves through the media.

Since September, my firm has been representing a small fixed-income broker-dealer that had no previous experience in working with media. Our hypothesis at the start of the engagement was that the media would welcome a new voice for analysis of credit market trends. We were right and even underestimated media demand for the client's perspective. More than 80 stories in major financial media cited the firm's credit market expertise.

I mention this to underscore the size of the opportunity for firms that previously may have been at competitive disadvantage when it came to media relations. Even compensation comes into positive focus in a story about a mid-tier broker-dealer like Jefferies.

Already, non-bulge-bracket firms are scrambling to fill the vaccuum created in markets ranging from credit trading to M&A advisory. Firms like Cantor Fitzgerald are hiring like crazy. Citadel's foray into investment banking has been well chronicled. Now, Blackstone is said to be interested in entering the banking market in the U.K.

[Update: The February 8 issue of Barron's profiles Jefferies, Broadpoint and other firms hoping to capitalize on the troubles at big banks.]

It's not all downhill sledding, though. Last summer the head of marketing of a leading broker-dealer told me that despite all the carnage at the top of the market, his firm's research showed lingering client preference for doing business with the old guard firms.

Asserting themselves more through the media can help mid-size firms overcome client inertia to expanding their list of preferred banking and trading partners.

To illustrate how much the compensation issue can derail the large banks, here is a sampling of recent stories:

Goldman caps London bankers' comp (Bloomberg)

Morgan Stanley chief to receive up to $13 million bonus (New York Times)

Investment bankers on bonuses: "less show, no tell" (New York Times)

Reputation risks associated with bank bonuses (Hedge Lines, January 2009)

The two faces of hedge funds

2009-12-02T20:53:00.005-05:00

An interesting dichotomy arose at the Walkers Fundamentals of Hedge Funds Seminar in New York today. Seeing the beauty in the hedge funds industry, not surprisingly, was Joel Press, managing director in the prime brokerage division at Morgan Stanley. Seeing the beast, also not surprisingly, was Gregory Zuckerman, hedge funds reporter at the Wall Street Journal and author of the recently-released The Greatest Trade Ever, an account of Paulson & Co.'s bet against the mortgage and financial services market in 2007-2008.

Here's a quick summary of both points of view:

Joel Press -- The beauty is back in hedge funds

Press predicted that AUM by hedge funds will be "well north of $3 trillion" in four years.
"There is no need for [hedge fund] fees to go down," because the the performance of the asset class is better than anything else an investor can find. He also says FOF fees should not go down.
He says that in the run-up to the credit crisis hedge fund investors "didn't know what they were signing," referring to the LP documents, but the "documents were clear." "Managers never thought they would need to gate" investors claims Press.
When it comes to liquidity, Press said "you can't fight what investors want, but we are not a mutual fund industry...We need to reestablish what we are about." Investors, according to Press, mismanaged their asset liability and were forced to redeem underwater hedge fund investments.
Press predicts that hedge funds of funds will continue to control 40-45% of the industry, due in large part, he says because FOFs will "maintain the standards of due diligence"
Press sees institutions and endowments returning en masse to hedge funds -- particularly for the equity strategies in their portfolios. Furthermore, Press predicts that funds dedicated solely to pension fund assets (because of regulatory requirements) will be a growth area for the industry.

Greg Zuckerman -- The beast is still loose in the hedge fund industry

Gates continue to"bother" investors, says Zuckerman. He says that it is "remarkable" that certain funds have maintained their gates, despite the return of liquidity to most markets and called it an act of "hubris" for a manager to launch a new fund while the gate was down on other funds he manages.
Returns touted by the hedge fund industry are inflated by the "survivorship bias" (if a fund closed in 2008, for example, its losses are not tallied in the final calculations for the industry for the year).
Hedge fund industry players knew Madoff was a fraud, but "played along," says Zuckerman.
"We are in an age of bubbles," said Zuckerman. He says there in an incentive for the industry to "pile on trades" and follow the herd."
Zuckerman sees gold as the "hot trade" of the day. He pointed out that the downside is much greater with gold than it was with mortgages, when Paulson placed his prescient trade, or earlier this year with financials, when Citi was at $0.97. He characterizes the run up in gold as a "crowded" trade that "follows conventional wisdom," hinting that it is a bubble. Yet, Zuckerman notes that Paulson & Co. has $30 billion invested in gold and will launch a gold-focused fund in January.
Zuckerman appears to doubt the wisdom of the industry itself. He notes that "funds are fully invested" and thinking about "adding leverage," but managers don't have conviction about the rally we are seeing in the market. "Will they all get out in time?" wonders Zuckerman.

Who is right? Maybe they both are, but Zuckerman raises interesting questions about correlation, contagion, and diversification that hedge fund investors need to carefully think about. Press of Morgan Stanley himself admits that reputation is a leading factor for investors allocating to hedge funds. Zuckerman as a journalist is, perhaps, more skeptical than most, but his opinion, in part, shapes the reputation of the industry.

It was a shame that the program went long and Zuckerman, as the last speaker, had to rush his presentation. Outside perspective in healthy doses is what the hedge fund industry needs.

Getting some respect for hedge funds

2009-11-30T20:09:00.001-05:00

Israel A. Englander, the founder of Millennium Partners shared his views on the state of the hedge fund industry in a keynote address at the Absolute Return Symposium in New York. Millennium, like all hedge funds, said Englander, is feeling the pressure to increase “investor friendliness.” He outlines four areas of investor concern that need new focus by the hedge fund industry: transparency, risk management, liquidity and duration of capital, and focus on core competencies.

A few highlights from his remarks follow and the the entire document is linked below:

On valuation and transparency: Englander says it's hard for hedge funds to get respect these days. “When Goldman Sachs puts a value on a position, everybody accepts it. When Citigroup puts a value on a position, everybody just accepts it... When a hedge fund puts a value on a position, first we have to get some highly regarded independent verification that we really do hold that position somewhere, then we have to get independent verification of the value of that position. Why do I feel like Rodney Dangerfield?”

On risk managment: Englander says, "Our risk management practice aren't changing. But the way we communicate these practices to our investors and the level of transparency we provide with regard to our risk management is increasing."

On liquidity: Englander says the industry needs to focus on "better matching the duration of the investors' capital with the fund's investment horizon." At the same time, he says, hedge funds should do "due dilligence" on investors because "it helps in making sure the interests of the manager of a fund are well aligned with the interests investors..."

On investment "style drift": Englander says a lesson for his fund was "to work on keeping the grass green on our side of the fence, and to forget about looking over the fence at somebody else's grass. The grass may look pretty green on the other side of the fence, but the fertilizer can be very expensive."

On hedge fund regulation: Mr. Englander says that oversigh “isn’t something to be too afraid of” because, whether it is a smart response or not, it may result in investors feeling more comfortable about the industry in general.

These investor-friendly trends in the hedge fund industry will combine to deliver superior risk-adjusted returns for investors in the asset class, says fund-of-funds manager Nexar Capital in a new report to investors. Nexar cites new transparency initiatives, lower fees, less leverage and better liquidity terms as factors that should attract investors back to hedge funds.

The kinder, friendlier hedge fund might not be the way forward for some managers, though. According to The Wall Street Journal, Ken Griffin, head of Citadel Investment Group "expressed exasperation at investors' desire to keep dissecting last year's disaster, comparing their fascination with people's inability to look away from a car crash. "I've told the story of 2008 many times," he said."

Israel Englander Keynote Address at the Absolute Return Symposium

Shamrock whips Texas Industries board

2009-11-02T15:43:00.007-05:00

In a column in Sunday's New York Times entitled "When Shareholders Crack the Whip," Gretchen Morgenson writes about three directors failing to win reelection at Texas Industries. Shamrock Holdings, the firm that helped oust Michael Eisner from Disney, nominated the alternate slate of directors. The election results, according to the column, "are an example of what happens when shareholders act appropriately -- like the company owners they are."

The story appears to be good news for activists and governance advocates, but the novelty of such shareholder success is in itself a cautionary tale and those seeking to shake up corporate boards still have an uphill battle. Before launching its proxy contest, Shamrock received no response to its suggestions on how to improve governance and perforance issues at Texas Industries. "We had a read tough time getting management to sit down and talk to us...They just stonewalled us," said Shamrock. Shamrock estimates that its campaign cost $1 million and attributes its success to growing interest among mutual funds to support the activist route.

Morgenson notes that "no single election proves that investor attitutes are a-changing everywhere," but that is a major understatement. Pershing Square spent $10 million and failed to get a single board seat at Target. The Children's Investment Fund threw in the towel in its effort to get CSX to switch tracks.

Research by The Corporate Library shows that the more troubled the company, the more tone deaf the directors. A study of financial firms that required government assistance showed that boards ignored withhold votes by shareholders. Another study showed that nearly two-thirds of directors who received majority withhold votes retain their seats.

Fact is that it takes much more than a whip to take on an entrenched board of directors. Activist hedge funds and governance advocates need to get media and the SEC to shine a brighter light into the lack of responsiveness of boards. When it comes to proxy fights, sadly, there is a bigger lesson to be learned from the efforts that fail than the ones that succeed.

Update: SEC Chairman Mary Shapiro has called for changes in proxy access to make it easier and cheaper for shareholders to nominate corporate directors.

The risk of talking about risk

2009-10-21T17:00:00.014-04:00

In a recent article in The New Yorker entitled "Rational Irrationality" John Cassidy seeks to explain how bubbles occur. In deconstructing the tech bubble and the housing bubble, the article basically argues that there is no such thing as the "irrational exuberance," so famously described by Alan Greenspan. According to Cassidy, it is precisely rational behavior that leads to bubbles and that fact pretty much guarantees the occurence of bubbles in the future. "In a market environment the individual pursuit of self-interest, however rational, can give way to collective disaster. The invisible hand becomes a fist," writes Cassidy.

Wall Street is particularly succeptible because of the pressure to generate earnings forces banks into riskier and riskier businesses. As Cassidy writes, "In the midst of a credit bubble, though, somebody running a big financial institution seldom has the option of sitting it out. What boosts a firm’s stock price, and the boss’s standing, is a rapid expansion in revenues and market share. Privately, he may harbor reservations about a particular business line, such as subprime securitization. But, once his peers have entered the field, and are making money, his firm has little choice except to join them."

As early as July 2007, Charles Prince, CEO of Citigroup acknowledged that a collapse in the credit markets could result in huge losses for Citi. He also understood the Catch-22 he was in. “When the music stops, in terms of liquidity, things will be complicated,” Prince said. “But as long as the music is playing, you’ve got to get up and dance," he said.

The game of musical chairs appears to have started up again and is playing in real time. Morgan Stanley had a serious brush with insolvency last fall. The bank retrenched and posted losses while gutsier firms like Goldman Sachs scored huge profits from trading.

Now Morgan Stanley is playing catch up. Value-at-risk reached $123 million, the highest level since 2007 and its strong earnings of $2.1 billion are still more than $1 billion lower than Goldman's. VaR at Goldman hit $208 million last quarter. Morgan Stanley plans to hire 400 people to bolster its trading businesses and its VaR is bound to rise, whether they like it or not.

What is a bank CEO to do? Clearly there are massively complex business decisions to be made. But CEOs also need to begin speaking clearly and publicly about risk and it's not the big risk-takers that need to start that dialog. Rather, the imperative falls on those firms (banks, insurance companies, hedge funds, etc.) that do not want to get trapped in a game of financial musical chairs.

The conversation centers on articulating how an enterprise is prepared to balance reasonable growth with reasonable risk and the limits the firm is willing to accept to protect its strategy and growth plan. It takes vision and it takes courage and it will take perseverence because firms will see their earnings lag other, potentially riskier, firms.

Why can't a bank, for example, make a case for controlled growth? Don't firms like investment banks that tend to have volatility in their earnings have lower PE ratios than slower growing, but more predictable institutions?

CEOs with something to lose should be ready to begin the risky discussion about risk. If someone doesn't stop the game of musical chairs, we will know that the cynics are right and that on Wall Street the game really is heads I win, tails you lose.

Update: Warren Buffet in a new interview touches on Wall Street compensation. He says, "in addition to carrots, there need to be sticks...We need to create a downside to people who mess up large institutions...too many people have walked away from the troubles they've created for scoiety...and they've walked away rich." Creating this downside will bring risk management and communicating about risk to the forefront of the financial industry.

Update: Here is commentary advocating that investment banks need to return to being private partnerships in order to effectively manage risk.

The sinking feeling about Galleon

2009-10-20T10:06:00.009-04:00

The Wall Street Journal's editorial page jumped to the defense of Galleon yesterday. "When Wall Street and business are as politically unpopular as they are now, the media temptation is to chalk up every indictment to "greed" and assume prosecutors are always right. In this case they may be right, but when political calls for scalps are in the air is precisely when the rest of us should reserve judgment until they prove it in court."

It is a curious move for the Journal's editorial board, which has been pretty muted about hedge funds, despite ample opportunities to address issues like short selling, risk management, compensation, etc. Yes, the accused are innocent until proven guilty, but there seems to be a lot of smoke in this case. The market seems to sense this too and Galleon is facing $1.3 bn in redemptions -- more than one-third of its assets under management -- and counterparties like Merrill Lynch and Barclays are cutting Galleon off from trading.

The New York Times explains that insider trading is difficult to prove, but author Dan Strachman suggests on CNBC (see clip below) that trading on insider information could be an issue for the entire money management industry, not just hedge funds. Indeed, Reuters reports that the SEC is poised to announce more cases involving insider trading and people in the financial industry.

How big a black eye the Galleon episode is for the hedge fund industry is unclear. Certainly it is not a good thing. However, for the first time in a year, the industry is net positive for asset inflows and many funds are posting solid performance amid the broad recovery in the markets since March.

We can expect that cases like Galleon, so close on the heels to the Madoff fraud, will rightly make investors even more cautious. Hedge funds need to embrace a higher bar for transparency and they must be prepared to communicate better with investors about their strategy and the specific drivers of performance. Funds which cannot explain their performance to proactive investors are going to be told to walk the plank.

Update: Galleon is winding down the fund. In a letter dated October 21, founder Raj Rajaratnam wrote to clients, "I have decided that it is now in the best interest of our investors and employees to conduct an orderly wind down of Galleon’s funds while we explore various alternatives for our business."

Update: See the Reuters column about potential defense strategy for Rajaratnam.

Hedge fund conspiracy theory about to go mainstream?

2009-10-01T15:38:00.005-04:00

Everyone has heard about the 9-11 conspiracy theory. Millions have seen the slickly produced video which argues that a plane did not hit the Pentagon. It's easy to dismiss as the work of a small group of whatever you want to call them. However, one cannot deny the pervasiveness of that particular conspiracy nor the effectiveness of the Web in propagating the allegations.

Here's a conspiracy theory that the financial industry needs to watch: that short selling and the outsize power of firms like Goldman Sachs were at the root of the financial crisis. At the center of that theory is a blog site called Deep Capture which rails against short selling and in particular the destructive nature of naked short selling. A video on the site that attributes the fall of Bear Stearns and Lehman Bros. to massive spikes in naked short selling is eerily similar in tone and style to the 9-11 video. The name of that video: "Hedge funds and the global economic meltdown."

Deep Capture is founded and probably funded by Patrick Byrne, CEO of Overstock.com. Mr. Byrne is infamous for consistently alleging that the shares in Overstock.com are unfairly and illegally targeted by short-sellers. In the About section of the site, it writes:

"...short-sellers and affiliated investors use a variety of other tactics to drive down stock prices and destroy public companies. They hire thugs to stalk and threaten corporate executives and their families. They pay small armies of “bashers” to flood the Internet with scurrilous rumors and lies. They engage in extortion and blackmail. And they collude with crooked law firms to saddle corporations with bogus class-action lawsuits. They also conspire to cut off companies’ access to credit. They finance dubious market indexes and credit rating agencies that spread false information about the prospects of companies and the economy. They pay shady financial research shops to publish false, negative information, disguised as “independent” analysis. And they manipulate credit default swaps and derivatives, the prices of which are considered indicators of corporate health."

You get the picture.

Matt Taibbi, a writer for Rolling Stone, who gained notoriety for a conspiracy-esque article about Goldman Sachs, now writes on his blog about Golman's lobbying efforts to head off curbs on short selling. The blog entry alleges, but by no means proves, that Goldman is also trying to defend the practice naked short selling. According to the New York Times, in public filings Goldman has argued that new short-selling rules adopted last year have worked to curb abuses and “fails to deliver” — the term for problems associated with naked shorting — and that further restrictions are not needed.

Here's my own conspiracy theory about the conspiracy theory: the people behind Deep Capture are working to influence journalists like Taibbi to do their bidding and get their ideas into the "mainstream" media.

I myself have no idea about whether new curbs on short selling are sufficient nor about the true market impact of naked short selling. I do know that questions about short selling, transparency and efficient market function are immensely complex, that that the causes behind the collapse of Bear and Lehman are widely misunderstood, and that neither the government nor the banking industry has been clear about what went wrong and how to prevent future shocks to the financial system.

The confluence of these unknows is the condition that gives rise to conspiracy theories and hedge funds, which already have the stigma of being opaque, private and secretive, now more than ever need to avoid being the subject of conspiracy theories.

Mr. hedge fund goes to Washington

2009-09-24T08:50:00.004-04:00

BusinessWeek observes that hedge funds are increasingly turning to think tanks, political analysts and lobbying firms to gauge how political forces and legislation might affect the private sector. Particularly for sectors like insurance, health care, and energy, what transpires in Washington will affect those companies' financial fortunes.

While this is not "big news," it does demonstrate the extent to which politics have become entwined with the economy. Bringing expert political analysis into the investment decision-making process seems only sensible. It is part of developing a mature outside-in perspective that any enterprise needs to thrive.

With new perspective on political risk, hedge funds might be able to develop keen insight into the winners and losers in regulated sectors. Taking that assumption a step further, hedge funds might become more vocal on policy issues.

For hedge funds that see business value in shaping the debate in Washington, media will become an important tool and they will find that the media will listen. Independent voices in the private sector are too few and far between these days and the media will welcome institutional investors' view on policy matters.

If it quacks...

2009-09-15T17:48:00.004-04:00

In virtually every meeting I have had with communications and marketing people in the financial industry this year, they each say that their institutions are different from their peers. It makes sense, because from hedge funds, to banks, to insurance, companies are trying to distance themselves from their troubled industry segments. I am not sure that it is working, though.

Here are some examples:

"Our investment process is different from that of other quantitative hedge fund." - Hedge fund marketing executive.

"Media don't understand that mutual insurance companies are more financially sound than traded firms." -- Insurance industry communications officer.

"We don't consider ourselves to be in the same tier as those other firms." - Communications director at a leading independent advisory firm.

"Our business model is different from other private equity firms." - Communications VP at a major PE firm.

Here's the catch, the natural tendency media, client prospects and the general public is to group businesses into tiers and categories. Each of those groupings has its own identity -- for better or for worse. It is extremely difficult to differentiate a firm within its group, much less shed the group identity.

So, a quant fund is a quant fund. A private equity firm is a PE firm and even the most storied independent M&A firm is just that -- not Goldman Sachs, not a specialized boutique, but one of the handful of firms in between. If it quacks like a duck, for most of the world, it is a duck. The only question is is it a big, medium or small duck.

So, how does a firm change it spots (sorry for mixing metaphors)? Not easy. In practice, it's less about standing out in the traditional category than creating a new category all together. It requires aggressively walking the walk and talking the talk. From business model to corporate culture, to marketing, everything needs to be rebranded and reinvented.

It doesn't stop there. CEOs committed to changing the paradigm of how they are perceived need to speak out about controversial industry practices and take the lead in embracing sensible regulation among other initiatives designed to set the company apart from firms that would otherwise be considered peers.

The process can take years and it involves risk. However, if there ever was a time to "think different" as Apple (one of the few companies that defy categorization) used to say, it is now. For hedge funds, banks, and private equity firms facing regulation and government officials hopped up on populist backlash, the stakes could not be higher.

No time to waste. Get quacking!

Goldman's evil reputation

2009-08-04T09:30:00.010-04:00

A new study shows that Goldman Sachs' reputation is something less than golden. The survey shows that while the reputations of most banks have deteriorated in the last year, Goldman's has fallen the farthest.

During the best of times Goldman was criticized for working "both sides of the deal." People grumbled, but still did business with the bank, sometimes out of necessity. These days, things are more sinister. Goldman is accused of owning the allegiance of top government officials, manipulating bank bailouts to favor itself, paying executives lavish bonuses at the expense of taxpayers, profiting from high-frequency trading, and reverting to its high-risk, high-leverage ways to generating revenue (aka multi-million dollar bonuses).

Much of this is sour grapes. Fact is Goldman weathered the financial crisis better than other banks, was forced by the government to accept TARP funding (recently refunded with interest) and just reported record quarterly earnings. People, especially during hard times, like to hate supremely-successful organizations. In that regard, Goldman Sachs is like the New England Patriots or New York Yankees of commerce. Goldman is not tone-deaf to what is going on and CEO Lloyd Blankfein is reported to have cautioned employees to keep a low profile and avoid conspicuous consumption.

Does that mean that Goldman has nothing to worry about? Not really. Pulling strings with Paulson, Geithner, Summers, et al is one thing, fending off congressmen hopped up on populist rage is another. Not many in Congress are willing to have an thoughtful discussion about the role of risk-taking and risk management in modern capital markets, but the nature of public concensus on those complex issues is the primary risk facing Goldman and why reputation matters to the firm.

Fueling negative sentiment about Goldman is an column from an unlikely source: Rolling Stone. Matt Taibbi's now famous column argues that Goldman manipulated the governement into doing its bidding during the height of the financial crisis. Even New York magazine has attempted to shed light on Goldman's dealings and its article suggests that Goldman itself was close to failure back in September.

The influence of Taibbi's article, in particular, demonstrates an important fact about media today. Because it is so easy to share news and opinion via email and the Web, where an article is published is less relevant today than in prior years. What influences people is who circulates the article to whom. In other words, while I might not think Rolling Stone is an authority on capital markets, if I am referred to Taibbi's article by someone I know and trust, I am likely to ascribe greater credibility to the piece (and, in turn, circulate the piece, furthering its influence).

This is both an opportunity and a threat to institutions large and small. On one hand, companies don't necessarily need the Wall Street Journal to get ideas into the marketplace. On the other hand, it is much more difficult to contain negative publicity because of the degree to which reputation-damaging opinion can be syndicated by individuals.

Regulation, driven by excesses on Wall Street, is coming, but I don't expect Goldman to be particularly affected. Goldman will jettison its bank charter and get back to the real work of printing money.

What do you think? Submit a comment via the link below and I'll update the blog with your views. If you'd like to remain anonymous, just indicate so.

Getting serious about hedge fund marketing

2009-06-28T18:44:00.011-04:00

Hedge funds are marketing harder than ever and fewer investors are listening. Investors report fielding more phone calls and receiving more marketing literature from fund managers and are taking steps to limit the deluge. At the recently concluded GAIM conference, for example, in order to avoid being badgered by funds on the hunt for new cash, one family trust manager had cards printed without phone or email information.

What do hedge funds have to do to be effective at fundraising in this environment? Hedge Lines recently spoke about the challenge with two asset management professionals. Not surprisingly, many of the keys fundraising hinge on effective communication with investors and other influential parties. Here is some insight:

It's the strategy, stupid. Hedge funds need to understand that smart investors buy into strategy, not simply performance. "The key is for the manager to show conviction in his or her ability to manage money," said author Daniel Strachman. "They need to be able to communicate how they actual put a trade on and why. Performance is important but conviction in one's strategy is more important and ability to communicate why the strategy works is most important. If it was me, this is what I would be talking about all day and all night."

Don't hide losses, explain losses. "Funds need to communicate in the big picture what happened, not just the number," advises investment professional Andrew Tilzer. He says that funds need to be clear about the time horizon they use and their peer group to put performance in context for investors. "If I was down 10%, 20% or more or less, the story would not be the returns it would be the strategy and why it failed," said Strachman. Document strategy with proof of your real-time thinking, like investor letters, to show consistency and conviction, adds Tilzer.

Invest in relationships. "Too many hedge funds don't truly know why their existing clients came to them and how they appeal to different classes of investors," said Tilzer. "To raise new assets, it is important for funds to have the patience to learn what existing LPs like about them and what prospective clients need." This outside-in perspective helps define what makes a fund unique and gives the fund insight about the niche they fill in the market that they can use to further differentiate themselves.

Leave marketing to marketing people. The Reuters story cited above noted that more managers attended this year's conference in person, as opposed to sending marketing staff. This is a worrisome trend and PMs need to resist the urge to be personally responsible for marketing. "There is a difference between being a portfolio manager and a business manager," explains Tilzer. "To be efficient, the manager has to respect the back office."

Don't hang up on the media. "The idea that hedge funds don't want to talk to the press is lunacy. It is also lunacy to think that talking to the press will help raise money - directly. Indirectly, however, talking to the press is a good thing because it provides third party credibility," notes Strachman. Too many funds are disengaging from the media process and the industry needs to resist that instinct. Quantitative and activist strategies are among those currently out of favor. Managers in those sectors, for example, need to use the media to promote the investment case for their specialties.

Ackman to media: Screw you guys, I am going home!

2009-06-10T11:47:00.005-04:00

Seven months after announcing that he was going to become more visible via the media, William Ackman is going home. In November, Ackman told investors that he decided to engage with the media, in part, because "it is important for the hedge fund industry to come out of the shadows and defend the importance of our work." Now, in his most recent letter to investors, he writes, "you should expect that we will do our best to fade into the sunset as far as the media is concerned until such time as an investment opportunity requires us to work more closely with the press. We hope such time is many moons from now."

In Cartman's words, screw you guys, I'm going home.

What happened? Ackman waged a very public and expensive proxy fight against Target and lost. A media program designed to build support for electing new directors to the Target's board included appearances on CNBC and an open town hall meeting. It didn't work. At the Target shareholder meeting last month, neither Ackman nor any of his other nominees were elected.

What's worse is that Ackman took some lumps in the media. Most notably, a column in the New York Times, questioned Pershing Square's motivation and tactics.

Here's some friendly advice for Mr. Ackman and other shareholder activists:

You need a thick skin. Publicity invites criticism and the motivation of hedge funds are always going to be questioned. That said, if the straw that broke the camel's back was indeed the critical column in the New York Times, it would be a shame. The column appeared after the shareholder vote and the writer had the benefit of hindsight to dissect Pershing Square's argument. As such, it is not as much of an indictment of the fund's approach as it might have been had the column appeared before the vote. Mr. Ackman did not see it that way and felt compelled to issue a long rebuttal. This was a mistake. Activists need a thick skin and be prepared for criticism. When the record needs correcting, it has to be done in a more selective and efficient way.

Understand the risks. Pershing Square needed to understand that most shareholders did not feel that Target was a company in trouble and in need of a shakeup (Target was trading at about $40 per share in early November and is still at that level). Moreover, the core of Pershing Square's campaign hinged on non-operating fixes for Target (selling off its real estate and its credit card operation). It was too easy for the company to paint these strategies as "financial engineering" that had nothing to do with the retail business. Pershing appears to have underestimated the difficulty in changing the prevailing sentiment among Target shareholders:"if it ain't broke, don't fix it."

Nice guys finish last. In Ackman's own words, when it comes to activism "thoughtful and constructive engagement based on careful and detailed analysis focused on shareholder value creation will always, in our opinion, be an effective means to maximize value in the public markets." Maybe not. Throughout its campaign, Pershing Square took pains to be non-adversarial. It praised management and even Target's board. It encouraged "exploration" of options like selling the real estate assets. Curiously, more tangible strategies, like getting Target into the grocery business, as Wal Mart has done, were never at the forefront of the campaign. Overall, this fight needed a much sharper edge to compell shareholders to vote with Pershing Square.

I encourage Mr. Ackman to rethink his decision to withdraw from the public debate about hedge funds, activism and even the business prospects for Target. His next activist situation will require engaging with the media and the steps he takes between now and then can affect the how his argument will be perceived by the market.

He had it right in November when he wrote "if we and others (that includes hedge fund investors in addition to the managers) don’t do so [engage in the public debate via the media], the industry, in my view, is at even greater risk of further regulatory, tax, and other legal changes that will materially harm our business models and industry."

Reputation risk sinks Pequot

2009-06-02T18:26:00.003-04:00

The resurfacing of an investigation that began in 2006 has led to the shuttering of Pequot Capital Management. The fund, which managed $15 billion at its height in 2001, still managed more than $6 billion in March 2008 and now has $3 billion that will be unwound.

The inquiry focuses on Pequot's trading in Microsoft stock in 2001. While both the SEC and the Justice have reopened the investigation, there is no indication that the regulators will pursue enforcement actions.

Pequot lost money last year, but was up so far this year. Nonetheless, fund manager Arthur Samburg wrote to investors, "With the situation increasingly untenable for the firm and for me, I have concluded that Pequot can no longer stay in business.”

Historically hedge funds and other asset managers have been able to weather inquiries and settle with regulators without jeapoardizing their business. These are not normal times, though, and this case shows how management of reputation risk is at least as imporant as the management of market risk to the survival of hedge funds.

Go to the New York Times account of the Pequot closing.
Go to Reuters' story.
See Arthur Samberg's letter to investors.

Ackman goes to town on Target

2009-05-13T20:43:00.007-04:00

On Monday, William Ackman, president of hedge fund Pershing Square, held a "town meeting" in Manhattan and broadcast on the Internet to present his case to shareholders of Target and encourage them to elect new directors that he called more experienced and more independent than current members of Target's board who are up for reelection.

In his hour-long presentation, Ackman says that Target does not have the proper structure for its credit card operation and that the company should offload the credit risk to a bank or other financial institution. He also notes that among retailers, Target owns the most real estate and claims that the company has several options to monetize its real estate assets. Third, he points out that Target missed the boat on grocery sales and, as a result, cannot challenge Wal Mart in that category. The directors endorsed by Ackman has extensive operating experience in those three key disciplines.

What's innovative here is Ackman's use of the town hall format. The meeting was open to anyone interested and during Q&A questions were fielded from the audience and from those viewing the webcast. This degree of transparency is fairly unique in the realm of proxy fights and marks a continuation of Ackman's earlier pledge to be more public about issues facing his business and the hedge fund industry.

From a communications perspective, Ackman dedicated part of his presentation to systematically countering recent claims Target has made against him. He also took pains to praise Target's management and positioning his beef with the board as one focused on independence and receptivity to new ideas intended to enhance shareholder value. Most noteworthy, he was clear that shareholders have a choice among directors and that voting for one or more of those endorsed by Pershing Square does not require them to vote for Ackman himself, who is also on the alternative slate.

In all, it was an effective presentation of a business argument and the event went a long way to refuting Target's claim that this proxy fight is all about Ackman and his fund's short term interests.

Update: In a move that The New York Times calls "unusual tactic in proxy fights, but one the company feels it must make in order to win over shareholders," Target is fighting back by issueing its own presentation that tries to discredit the nominees supported by Pershing Square.

Hedge funds need a community organizer

2009-05-08T10:51:00.003-04:00

"Hedge funds really need a community organizer," quips Clifford Asness, managing partner at AQR Capital Managment, in a strongly-worded letter rebuking the administration's comments about secured investors opposing the reorganization plan for Chrysler. When asked about the 16 or so bondholders who were not willing to accept the government's terms President Obama said, “I don’t stand with those who held out when everyone else is making sacrifices.” Mr. Asness, rightly, tries to set the record straight.

Certainly there are plenty of targets for bondholder ire in the Chrysler case -- even for funds, like AQR, that are not invested. The sanctity of contracts, the government intrusion in the economy, the package offered to the UAW, the merits of bankruptcy court are all at issue here. However, the size of the auto companies and their historical importance to the econmy make it easy to tar as un-American those who would see Chrysler in bankruptcy.

In the economic crisis, there is a broad perception that, as the President suggests, we are all in this together and we need solutions that require cooperation from all parts of society and business. This puts Chrysler's dissident bondholders in the same uneviable position as those investors who oppose restructuring mortgages because of ripple effects into the bond market. The complexity involved in both of these situations and Main Street's lack of understanding of the rules of bankruptcy and the financial system in general contribute to the reputational risks associated with taking a principled but massively unpopular stand on hot-button issues like automakers and mortgages.

Of the Chrysler holdouts, The New York Times writes, "this bit of brinkmanship — which many characterized as a game of chicken with Washington — has become yet another public relations disaster for Wall Street...What is striking to many in financial circles is how much Chrysler’s reluctant creditors gambled for what is, in the scheme of this bankruptcy, a relatively small amount of money."

Yes hedge funds need a community organizer. Job one would be to unify the industry and develop a sense of, well, community based on shared business interests. Job two would be to become more effective at advocating common sense on critical issues facing hedge funds' ability to operate freely in the marketplace. Job three would be to know which fights, like Chrysler, cannot be won.

TCI switches tracks on CSX campaign

2009-04-29T20:23:00.007-04:00

London-based hedge fund The Children's Investment Fund has sold its position in railroad operator CSX and will resign the board seat it gained after a long court battle last year. This "defeat" for TCI demonstrates the difficulty investors of all stripes, even the most sophisticated and deep-pocketed, have in advocating change at traded companies.

BreakingViews writes, "the top brass at CSX demonstrated an unwillingness to take criticism or suggestions from a substantial shareholder — the kind of parochial response that other investors should find worrying." Agreed.

However, BreakingViews goes on to say "if hedge fund activism is indeed on the wane, then shareholders looking for a more enduring advocate for their interests may need to do the job themselves. Come to think of it, that wouldn’t be such a bad outcome after all." Disagreed.

If hedge funds cannot be effective activists, how in the world can anyone on Main Street be an effective voice for change? What are individuals supposed to do? Show up at annual meetings and grab the microphone? Yeah, right.

View the story from BreakingViews.
View the story from The Journal of Commerce.
View the story from DealBook at the New York Times.

Springing forth: Op-eds by hedge fund managers

2009-04-20T17:28:00.006-04:00

April showers have brought a bloom of recent op-ed articles by prominent hedge fund managers. Mark-to-market accounting, regulation of financial services, executive compensation and corporate governance are the subject of articles written by the likes of James Chanos, Carl Icahn and Paul Singer in the Wall Street Journal and New York Times.

These are high-profile and important pieces because they demonstrate how the interests and opinions of the hedge fund industry are aligned (in these cases) with the best interests of the country. Icahn argues that shareholders should have more influence and that it should be easier to replace corporate boards. Who would disagree? Chanos writes that while mark-to-market accounting isn't perfect, it is an important contributor to integrity of financial statements. Seems logical. Paul Singer, head of Elliott Management, writes that "private responsibility and practical government regulation will help ensure that the capitalist system continues to be a source of opportunity and prosperity throughout the world." Sounds reasonable.

Articles like these, appearances on CNBC, and meeting with lawmakers are important steps in publicly aligning the interests of the hedge fund industry with the economic recovery and the creation of a well-functioning marketplace that this blog calls the New Financial World Order.

See also Andy Kessler's op-ed on bear raids that provides good perspective on the shorting of financial companies.

Media misses demand side of hedge fund equation

2009-03-31T09:32:00.008-04:00

Think about what you read about hedge funds. What makes "news?" It's the AUM for the industry -- way up and now way down. It's the activists, the larger-than-life manager, the lavish hedge fund affairs. It's the flame outs, the frauds, the gates and the side pockets. It's the compensation. It's shorting and "black boxes."

All of this is the supply side of the industry. Nobody is writing about the demand side of the industry -- the source of those trillions in AUM and those willing to pay the notorious two and twenty for performance. This lack of focus on the demand side is central to the the poor state of the reputation of the industry.

The result is a situation in which the media criticize hedge funds without asking the simple question, "why do hedge funds exist?"

They exist to serve the needs of their investors. Plain and simple. If they fail in what Dan Strachman in his new book calls the "hedge fund promise" (the ability to use all the arrows in Wall Street's quiver without taking on significantly more risk than the market as a whole to deliver alpha), hedge funds cease to exist. Everything about hedge funds is completely elastic. No performance, no assets. No assets, no hefty fees.

The people stretching (or not) that elastic are the investors, mostly large institutions. But hedge funds reporters are not talking to those people and, as a result, don't understand the demand for hedge funds and the ways good investors work with hedge funds on the key management issues like risk management, governance and reporting.

If I were advising a major fund or the MFA, I would work to have the fund's investors do much of the talking (to the media) for the fund. A company's customers are always the best evangelists and it is no different in the hedge fund industry. In fact, it's even more important in the hedge funds business because the demand side has received so little attention. Think about it. What's more credible to a reporter's ears? Having a hedge fund say that they allow investors free access to their books or having an investor tell the reporter that his auditors spend several days a year poring over the books with the hedge fund CFO and COO.

A recent profile of megafund Bridgewater Associates in Fortune takes steps in that direction. Here's an excerpt: "I view them [Bridgewater] more as a partner than a vendor," says John Lane, the director of Eastman Kodak's $7.5 billion pension portfolio, which has had money with the firm since the late 1980s. "We don't make a major change here in strategy without calling Bridgewater to get their view...Of all the investment firms we work with," he says, "they're the most trusted."

That is powerful. Any manager worth his or her salt, though, should be able to get similar endorsements from their clients.

The media and the public need to better understand why hedge funds exist. The answer comes from the demand side and the industry needs to figure out how to get those voices out there.

The rocky shoals of regulation and reputation

2009-03-23T10:31:00.004-04:00

It's time to set the record straight about short selling. The media doesn't get it. Congress, certainly, doesn't get it. And the hedge fund industry is at risk of getting it right where it hurts, if short-sighted regulation is the result of misplaced concern about short selling. A recent column on Bloomberg blames naked short selling for the collapse of Lehman Brothers. The column begins with this shrill statement, "the biggest bankruptcy in history might have been avoided if Wall Street had been prevented from practicing one of its darkest arts." Fraud, dark arts, and collusion are among the charges levied against hedge funds in the piece.

An effective counter-argument can be found on Portfolio.com, but just because a debate on short selling exists, doesn't mean that people are hearing both sides. The critics are much more vocal and their claims play on the concerns people have about everything Wall Street. Experts say that people need to hear something between three and five times before they believe it. Believe me, people have heard that short selling is bad, dangerous, even un-American lots of times. They are writing their congressmen. Congressmen (and there are not many bankers and securities lawyers in the House), in turn, are turning up the populist rhetoric against the industry.

What's at stake here is license to operate. When I worked for Texaco, license to operate was the primary PR concern of the company. The energy industry understands that reputation is central to winning contracts with foreign governments, executing acquisitions and preventing over-regulation.

Ensuring that short selling does not come under unreasonable regulation should be taken as seriously as the energy sector takes regulation on offshore drilling ,CO2 emissions, double-hulled tankers and other aspects central to its operation and profit.

Right now, the hedge fund industry is running a proverbial oil tanker onto a reef and they don't even know it.

What can be done? Here are some tactics:

Get independent third party experts, like academics or former regulators, to set the record straight.

Sponsor and promote independent research that documents the effects of short selling on the market.

Get involved in the debate online. The blogs listed (see right hand column) on this site all feature intelligent comment and debate among readers.

Become more vocal in the media.

Educate key lawmakers.

The blog on Portfolio.com listed above suggest creating an official panel (like the 9-11 Commission) to investigate (and hopefully vindicate) short selling.

Jon Stewart swings and misses in showdown with Cramer

2009-03-12T23:59:00.013-04:00

Jon Stewart flopped Thursday night in the final battle of his much-hyped "war" with CNBC and Jim Cramer. Stewart was neither funny nor insightful in his attempted grilling of Cramer. The only comedy was watching two non-journalists talking about the presumed guilt shared by real financial journalists in not foreseeing the financial crisis (see March 4 post). In his attempt to be serious, Stewart lost the art of what makes him so effective -- the ability use humor to point out the serious, even insidious hypocrisy in politics, business and society.

Stewart has interviewed people with whom he has more philosophical differences than Cramer. John Sununu, Mike Huckabee, Dana Perino, Bill O'Reilly, Bill Kristol, Ari Fleisher, to name a few. But he reserves the long knives for Cramer and despite his domination of the conversation (Cramer doesn't get too many words in edgewise), completely whiffs. The result is an interview that is just as superficial and farcical as the CNBC body of work Stewart was lampooning in the first place.

I don't blame Cramer for agreeing to the interview, but he was unprepared and let Stewart set and dominate the agenda. Poor media training. Maybe he was blindsided, expecting Stewart to be more like his playful real self. Maybe he didn't know what he wanted to achieve in agreeing to the interview. Bottom line is that Cramer hasn't learned his lesson from his longer-running, much more serious feud with Barron's. The bad blood there began to be spilled in 2007. Barron's won't let go of this "story" and recently revisited its critique of Cramer's stock picks.

Cramer's problem is that he doesn't know what his show is really about and has not found an effective way to put his stock "picks" into perspective. He needs to admit to himself that his picks and pans are NOT what the show is about. His show is about speaking to (mostly) young investors about how the market works and how to do research on investments. It's not a stock picking show, stupid! On The Daily Show, Cramer should have said, "Jon, I don't think you understand my show" and taken control over the interview from there.

Cramer needs to understand that what he does is not very serious and very serious at the same time. Not serious because he cannot have an informed micro-level opinion about all of the equities covered in the Lightening Round and very serious because he is communicating with an audience ignored by the financial community in a way they understand and connect with (could Suze Orman fill the basketball arena at any university like Cramer routinely does?)

In response to the most recent salvo from Barron's, I wrote as much to the editors of Barron's. Scroll half way down the page.

Oh, in my ranting, I almost forgot: Bank of America (one of the institutions supposedly coddled by CNBC and Cramer) advertises on The Daily Show.com. How's that for irony?

Hedge funds silent on "golden coffins" and other governance issues

2009-03-11T09:01:00.003-04:00

Apparently its not enough for some CEOs to get massive compensation packages, lavish corporate perks and a golden parachute when they get fired for mismanaging their enterprise. Now there are "golden coffins" too. According to the Wall Street Journal, golden coffins are generous posthumous payouts to senior management and dozens of corporations offer generous death-benefit packages that might include allowing heirs to collect unvested equity, posthumous severance payouts, supercharged pensions and/or years of postmortem salaries.

With executive pay coming under intense scrutiny in the wake of the banking crisis, corporate governance issues are moving to the forefront. Hedge funds -- except Carl Ichan -- are surprisingly silent on the matter. This is a mistake. Corporate governance is a non-controversial issue, but one of great importance. Fighting the good fight right now are a couple of pension funds, academics and proxy advisors. These are mostly passive players, however, and corporations are not under meaningful pressure.

That could change if hedge funds enter the fray. Aligning with other governance activists would demonstrate that hedge funds are a responsible part of the modern capital equation. It would also show that hedge funds can be watchdogs and enforcers of fair play in the markets in what this blog calls the "new financial world order." Lastly, it would advance their business interests as shareholders in corporations that are less wasteful, have better boards, and are less protected by poison pills and other anti-shareholder defense mechanisms.

Organizations that hedge funds should cooperate with on the issue of corporate governance include:

The Corporate Library

RiskMetrics Group (ISS)

The Weinberg Center for Corporate Governance (U Delaware)

GovernanceMetrics International

CalPERS

Hear no evil, see no evil, speak no evil.

2009-03-04T17:52:00.010-05:00

"How could 9,000 business reporters blow it?" asks Dean Starkman, a former Wall Street Journal reporter and current writer for the Columbia Journalism Review, in a recent essay that examines how the media missed the warning signs in the run up to the credit crisis. According to Starkman there are several factors to consider:

- Shrinking newsrooms and increasing financial pressure on media as factors that have reduced investigative reporting.

- The rise of M&A reporting, in effect, made media Wall Street "insiders" dependent on Wall Street for information and potentially coopting independence

- An editorial focus on outsized CEOs was a distraction from the real business stories underfoot

Starkman makes good points but sensibly does not entirely indict media for missing the boat. Indeed, many in the media were asking the right questions and reporting about smoke in the real estate market. As early as 2005, Ruth Simon and Bob Hagerty of the Wall Street Journal were asking my clients hard questions about subprime lending practices and default rates. It is clear to me that they knew something dangerous was happening, but they never could get their suspicions confirmed by the right people. The complexity of mortgage securitizations and CDS and CDO markets made it almost impossible for journalists to identify what was going on, much less "expose" anything with confidence. (See a more complete defense of financial media at The Deal.)

The big question is how can the media (or regulator or other whistle blower) focus on bad news when the market is going up and up? Not easy. Ask Harry Markopolos. Indeed, there were examples of stories that identified exactly what the risks were. In September 2005, the Wall Street Journal wrote an in depth piece on the limitations of the Gaussian coupola, the formula at the heart of the models evaluating mortgage securities and derivatives. The piece explains how the formula was being applied to gauge risk of CDOs and synthetic CDOs. Read today, the article is truly scary. Back then no few paid attention. The Gaussian coupola is the subject of the cover story in Wired this month.

Of course, there were many who figured out at least some of what was happening. Steve Eisman of Front Point Partners (see the December cover story of Portfolio) and John Paulson made fortunes shorting financial firms. It's just that their voices were not heard over the din inflating the bubble. Why be a sourpuss when everyone is getting rich?

Someone, though, always seems to know the truth. Even in the Bernie Madoff scandal, certain private banks refused to allow their clients to invest in the Madoff funds.

It appears that, especially during bubbles, it takes more than one voice to show that the emperor has no clothes. It can't be media alone, or short selllers alone, or a noble minded whistle blower, like Markopolos, alone.

In the wake of the banking crisis, hedge funds should choose to be more vocal, utlizing the media and other means to expose unsound unsound business practices, accounting sleight of hand and fraud. Speaking up and getting people to listen, even when they don't want to hear the truth, is good for hedge fund business, the economy and our society.

Short sellers: "The real financial detectives"

2009-02-27T18:09:00.007-05:00

James Chanos, president of Kynikos Associates, recently did an eleven-minute interview with PBS' Nightly Business Report. Similar to William Ackman's recent appearance on Charlie Rose (see previous post), this was a thoughtful exchange about key issues facing capital markets. Veteran reporter Darren Gersh did not pull any punches in the interview, querying Chanos on short-selling, vetting of qualified investors, and transparency issues. So, this was no puff piece.

The important fact though, as Chanos demonstrates, is that there are credible, logical answers to just about any question a responsible hedge fund might face from the media. Moreover, reasonable people watching at home are likely to agree with those answers. If hedge fund managers did more of these interviews there would be far less confusion about the roles hedge funds play in the market, the institutional investment needs they seek to fill and how they make money.

Some notable quotes by James Chanos during the interview:

Short selling "should be encouraged, not discouraged."

Short sellers are "the real financial detectives. Regulators are the financial archaeologists."

Regarding accusations by bank CEOs that short sellers imperiled their banks: "It's easier to point fingers at others, when you've screwed up."

On Bernie Madoff and whether there is such a thing as a "sophisticated" investor: "people will always do stupid things with their money, when greed takes over."

On the effectiveness of regulation, the largest "financial disasters happened among regulated firms."

Click on the image below to view the interview in a new window.

I trust you. NOT!

2009-02-25T22:08:00.006-05:00

Edelman's annual trust barometer study suggests that the financial industry has a long road to travel before it can rebuild the trust it requires to operate. It also suggests that intelligent media relations might provide much of the solution that will once again win the industry the support of the public and regulators.

First a few grim statistics from the study:

- While trust in all industries in the U.S. declined last year, banking suffered the most, with a 35% decline in the trust metric. Banks and insurance companies are among the three least trusted industries in the U.S.

- Only 49% of Americans think the free market function is sufficient to prevent future financial crises

- 61% of Americans think that government should impose stricter regulations on business and people were evenly split on whether the government or business should be most responsible for ending the credit crisis

- CEOs were the least trusted of all expert spokespeople and people cited excessive compensation as the number one reason they had less trust in corporations (When President Obama spoke about demanding new accountability from CEOs, the MSNBC audience reaction meter went into the stratosphere of approval ratings... even higher than it did than when he outlined a new commitment to cure cancer!)

What's a bank or hedge fund or private equity firm to do? Ramp up the public relations. The study shows that using media to win back third party validation of a company's mission and merit is the best way to rebuild trust. Importantly, old media remains a key component of influencing opinion and creating trust. According to the study, traditional media (analyst reports, articles in business magazines, newspaper articles, and radio and TV news) are the most credible information sources, even for young people (age 25 - 34). In fact 55% of those age 25 - 34 and 43% of those age 35 - 64 find business magazines the most credible of all media. After media, people find conversations with company employees highly credible, meaning that employee communications need to also be a priority.

Ok, no problem, right? Not so fast. Part of the challenge is that people need to get information from multiple sources, multiple times to believe it. The study says that 60% of people need to hear or see something (positive or negative) about a company between three and five times before they believe it to be true.

This means that there are no shortcuts on the long road back to trust. The journey is worth it, though, as trusted corporations have greater license to operate and receive the benefit of the doubt when things inevitably do go wrong in the future. Heidi Moore, DealJournal columnist at the Wall Street Journal says, "You can call on trust when you need it."

Where are the good apples?

2009-02-17T12:35:00.003-05:00

Portfolio.com argues that the private equity industry doesn't produce real returns for investors. According to the article, "private equity firms generally don’t make their money by choosing good investments. They make it on an amazing Technicolor array of fees: management fees, deal completion fees, consulting fees, performance fees, special events fees, fees of every kind and stripe. Chalk it up to yet another racket of the bubble years."

The entire spectrum of alternative asset management is under attack. Much of it is deserved and we are in the early phase of a shakeout. In the meantime, the good apples are tainted by the bad and they are not doing much about it.

Are there hedge funds that are delivering for investors even now as so many funds are making excuses instead of money? Yes. Are there private equity firms that are truly creating value instead of paying themselves out by further saddling their portfolio companies with unnecessary debt? Yes.

The problem is that no one is talking about the good apples in the alternatives arena. No one is making the case that hedge funds and private equity are valuable, even important, vehicles for institutions, like pension funds, that should reasonably expect to make money even when the market is down. This should be an easy argument to make, but no one is actively taking it on.

No one ever got fired for buying IBM, for making the safe choice. The question at hand is will the alternative arena become perceived as the patently unsafe choice for institutional managers? And if so, will it go down without a whimper?

Hedge funds aim at bird in the hand

2009-02-11T09:17:00.004-05:00

With raising assets becoming more difficult, hedge funds need to focus on retention. Funds need to realize that institutions of all sizes have suffered losses and are scrutinizing all of their managers. The spectrum of communications, including investor letters, meeting with investors, and media relations need to be stepped up as part of a broader effort to compete for allocations.

Investors need more detail of how funds are managing in the current environment, which opportunities they are targeting and why. Some funds are choosing to share more information about specific investments. See previous post.

A few funds with significant losses are thinking creatively about management and incentive fees. This is a good strategy because it recognizes the fact that investors have been hurt across the board, not just in one fund. For example a single stock fund run by William Ackman's Pershing Square Capital Management is down 90%. Pershing Square is helping investors recoup losses by suspending incentive fees on their investments in other Pershing funds until they are whole. It might not satisfy all investors, but demonstrates the degree to which Pershing will go to retain investors. See shareholder letter from Pershing below.

Hedge funds have always competed aggressively for assets. The battle now is to keep assets from walking out the door.

Pershing Square IV Letter to Investors

Publish at Scribd or explore others: Finance & Investing Business & Legal target william ackman

Reactionary forces continue to oppose hedge funds

2009-02-06T14:31:00.003-05:00

Martin Lipton, founder of the venerable law firm Wachtell, Lipton, Rosen & Katz slammed hedge funds at a recent New York Bar Association conference. In his keynote address, Lipton accused activist hedge funds as being motivated by short-term gains instead of long-term value. Ironic, since Lipton is credited with the creation of the poison pill -- a strategy used by corporations to prevent takeovers, even takeovers that offer premiums to shareholders.

Hedge funds need to plow through this reactionary bluster and step up their activist strategies, not curtail them. In the new financial world order (see previous post), activists and short sellers are an important part of the marketplace of ideas that enforces good corporate governance and compels CEOs to explore all alternatives to create value for shareholders -- even at the expense of their own jobs.

Poison pills and break-up fees are nothing more than anti-shareholder defense mechanisms designed to preserve the status quo and the lucrative relationships law firms maintain with corporations.

Clearly Wachtell, Lipton, Rosen & Katz is part of the problem, not the solution, and hedge funds need to identify the forward looking law firms, PR firms and other service providers to help them with constructive activism.

Hedge funds must be part of the new financial world order

2009-01-30T09:23:00.005-05:00

Could hedge funds be part of the solution? Could short-selling hedge funds be doing the market and regulators a valuable service? Surely you jest. However, that's exactly what ex-Wall Street Journal columnist Jesse Eisinger hints at in his story about restructuring the financial system in the current issue of Conde Nast Portfolio.

"We need more dissidents. We need to make the world a safer place for short-sellers to criticize companies. Regulators should publicly praise short-sellers, rather than periodically ban their activities. Critics and whistle-blowers, no matter how self-motivated, should be regularly consulted about suspicious companies, not dismissed as cranks once they expose wrongdoing." Really. Page 47.

For hedge funds to be a respected part of a new financial world order, two things need to happen. Regulators, analysts and shareholders need to aggressively seek the opinion of independent parties and be much more skeptical of corporate claims and the CEO bully pulpit. That shouldn't be too hard.

Second, short-sellers and hedge funds of all stripes need to admit they are part of the system and behave like they have an interest in stability in the market, preventing fraud and encouraging financial fair play. Once they take their positions, they must go public in cases where systemic risk, fraud, or deceptive accounting is afoot. Profits will still be made, but full-blown crises might be averted.

What hedge funds cannot do is sit on the sidelines grinning like the Cheshire cat. In a new financial world order, it is not sufficient to be the smartest guy in the room. You also need to be responsible.

In the same issue of Portfolio, John Paulson, whose funds made $15 billion in 2007 by betting against homeowners, banks and mortgage companies in 2007, is scrutinized along these lines. "Left unexamined is the uncomfortable moral dimension of Paulson's achievement. If he saw all of this coming, was it right for him to keep his own counsel, quietly trading while the financial system melted down? Do traders who figure out a way to profit from our misery deserve our contempt or our admiration, however grudging?"

Financial firms risking more than reputation by continuing lavish spending and bonuses

2009-01-28T10:41:00.007-05:00

Wall Street bonuses have always drawn the attention of journalists. In the best of times, the topic of bonues at investment banks has been covered much like auctions at Christie's -- phenomena to behold, but not quite believe. These are not those times and the issue of bonuses at Merrill Lynch was toxic enough to send John Thain into retirement. How can Citigroup buy a new corporate jet on the heels of more financial support from the government? How can AIG pay $450 million to workers at the unit that brought down the firm? It is hard to fathom that the culture of compensation and the perception that it requires bags and bags of money to retain talent in the financial sector is so pervasive that the same hand that is begging for taxpayer-funded relief is signing whopping bonus checks.

Bankers need to look at the case of Detroit for a reality check. Automakers were denied a government bailout partly because public sentiment was against them. Financial firms will lose political support in hurry if they continue to enrich their own at public expense.

By comparison, the 2/20 compensation system for hedge fund managers, long criticized by media, seems aligned with the interests of investors. Not that you are going to read that anywhere soon!

Maureen Dowd turns her wit on John Thain and Wall Street bonuses in today's New York Times.

Bloomberg outlines $450 million in payments at AIG's financial products unit.

A former Merrill banker writes about the bonus culture on Wall Street in an op-ed in the New York Times.

Wall Street paid $18.4 billion in bonuses last year, the sixth biggest bonus year on record, according to the New York Times.

John Thain's$1.22 million office renovation is detailed on the DailyBeast.com.

Of course the antique commode purchased by Thain for his office at Merrill is too tempting for the Daily Show to pass up. The first three minutes of last nights intro segment lampoon John Thain.

The Daily Show With Jon StewartM - Th 11p / 10c

Stim City

Daily Show Full Episodes
Daily Show Tickets

Classic IR tactic not working for banks

2009-01-23T09:23:00.003-05:00

Insider buying by CEOs and other top executives is a classic tactic to signal that the market has the wrong perception about a company. The problem is that it is simply not working for banking CEOs these days. Confidence is just too low in the financial sector and would-be investors simply don't trust banking CEOs. Trust in CEOs overall might be at an all time low and companies need to understand that and adapt to a new communications environment where new efforts are required to earn trust.

Earlier this week Ken Lewis and other chiefs at Bank of America purchased more than 513,000 shares. It won't make a difference. The Wall Street Journal writes "credibility is a series of small, successful gestures [and] bank executives must see that their gestures are being read by the market as empty ones." In fact, research by InsiderScore.com and other analysts suggest that buying by insiders should be a strong sell signal for everyone else. Turns out that execs, of late, have been wrong more often than they have been right.

BreakingViews.com writes, "given how erroneous the public statements on Wall Street's top banking executives have proven to be, it would be hard to take their prognostications seriously."

Unfortunately for bank CEOs, the market is not doing as they say nor, when it comes to insider buying, is it doing as they do. The herd is going the other way.

Communicating with current investors is job one

2009-01-23T08:12:00.002-05:00

The New York Times' DealBook blog profiles JHL Capital Group, a Chicago-based hedge fund run by James Litinsky. While JHL returned up to 18 percent to investors last year certainly bucks the current trend, it is not the only thing notable about the fund. From his quarterly letter to investors, Mr. Litinsky clearly realizes that resting on the laurels of exemplary performance is not sufficient in today's environment. Good returns alone might not prevent newly risk-conscious investors or investors who have suffered losses elsewhere from cashing in their chips. Managers must give investors compelling reasons to stay in the fund or risk redemptions.

In the case of JHL, Mr. Litinsky uses his quarterly letter to reinforce his investment philosophy and detail the business case for two primary investments, the bonds of The New York Times Company and Lamar Advertising. For each, the fund explains its view of why the debt was undervalued, but secured. It also explains why neither company is likely to default in the near term and goes on to give worst-case scenarios for both investments.

Mr. Litinsky writes: "In both the NYT and LAMR situations, we modeled out the path to paydown. We not only had asset coverage well in excess of our basis but also had a priority interest on family heirlooms. If conditions deteriorated further, the management teams would likely be most focused on maintaining long-term control of the assets rather than extracting an extra dividend or attempting something more overtly hostile. Those are the kinds of borrowers we like."

This level of transparency is one way to give investors the confidence to maintain or even increase their commitment to a hedge fund. Right now, getting the right information to current investors is job one, superseding any new marketing and fundraising.

Hedge fund "convergence" is good for embattled industry

2009-01-22T08:41:00.008-05:00

All About Alpha.com writes about "convergence" in the asset management industry. Citing recent examples of Putnam launching an "absolute return" mutual fund and quant fund manager AQR starting its Diversified Arbitrage mutual fund, the story discusses how hedge funds are morphing into diversified financial institutions that are providing traditional asset management and investment banking services among other offerings not typically associated with the hedge fund business.

While this trend is good for hedge fund business, it is also good for the reputation of the industry. The media don't appreciate the extent of the role hedge funds play in the global capital equation, particularly now, as commercial banks are severely constrained and the investment banking options reduced. Why can't hedge funds and private equity firms be a driving force behind recapitalization of the banking industry and the broader economic recovery? By stepping into the breach created by troubled banks, new institutions can be part of the solution -- and maybe, just maybe get credit for it.

See a previous post about hedge funds and their importance to the broader market.

As early as 2005, the New York Times was writing about hedge funds getting into corporate lending.

Read the Wall Street Journal's account of the new AQR fund.

Read the FT's story on hedge funds morphing into investment banks.

Transparency at issue in bank system fix

2009-01-21T21:41:00.005-05:00

The New York Times writes about the Obama administration's options in dealing with the ongoing banking crisis. The story notes that one of the main differences among options being discussed is the level of transparency about the ultimate cost to taxpayers and the degree to which banks would be required to disclose the true magnitude of likely losses.

According new analysis by the Congressional Budget Office, costs to taxpayers are highest when bailouts involve opaque transactions that are difficult to understand. TARP is the poster child for a program with limited transparency. The CBO estimates that taxpayers will end up absorbing 26% of $247 billion in disbursements to financial institutions through December. The AIG bailout, another complex program, is estimated to cost taxpayers more than $20 billion. November's decision to guarantee $306 billion of toxic assets on Citgroup's books is estimated to cost the public $5 billion.

The new administration must do a better job in disclosing the real costs and real value behind its plans for the banking system. More transparency and better communication with voters and the media are needed to both ensure the best solution is reached and help stabilize reeling bank stocks. In addition, more transparency will increase the likelihood that hedge funds and other private investors buy some of the assets in question and invest in the banks themselves.

The Times notes, however, that "banks may not want that kind of openness, because accurately valuing the toxic assets could force many to book big losses, admit their insolvency and shut down."

MFA's Baker Interviewed

2009-01-15T22:09:00.004-05:00

Fortune interviews Richard Baker, head of the Managed Funds Association. The short Q&A covers the Madoff affair, the ban on short-selling, and prospects for increased regulation of hedge funds. This blog has commented that the MFA and similar bodies in the U.S. have struggled to defend the reputation and interests of the hedge fund industry, but the article notes that the lobbying restrictions on Baker, a former Congressman, lift next month.

PR advice for Goldman Sachs

2008-12-23T10:41:00.005-05:00

The "Jack Flack" column at the New York Times Dealbook blog dispenses reputation management advice for Lloyd Blankfein, CEO of Goldman Sachs. The column notes that, while Goldman has avoided the massive writedowns taken by its i-banking bretheren, it is still guilty by association from the perspective of reputation. The very act of registering as a bank holding company raises the question of what is going on at Goldman and is the jig up.

All the counsel offered by Jack Flack to Goldman is directly applicable to hedge fund managers: tell 'em what you've learned, be careful about compensation, tell people what the future of your institution is, have honest discussions about risk and risk management.

Speaking of risk, the issue of risk for hedge funds and risk for investment banks (or whatever we're calling them now) is not the same thing. Everyone knows hedge funds are risky and their core business is taking and managing risk. What the media and the public don't fully appreciate or admit is that the level of risk, how risk is managed and investing strategy of hedge funds is shared (in non Madoff funds, at least) with investors and investors can meet with managers to have detailed discussions on risk.

Not so for the banks. In fact, the banks, like Goldman, upon becoming publicly owned, offloaded the risk to investors (who don't have the ability to discuss risk management with the instition). Goldman execs retain the lions share of the upside when the bank does well (see the bonuses for the last few years) and bear virtually none of the downside during bad years. Bonsuses, temporarily, go by the wayside, but salaries are paid. Goldman partners may frown in public, but at home they gotta be smiling for the years they spent laughing all the way to the bank. Jack Flack doesn't speak about this fact and risk to reputation. Probably because there is no way around it.

I wonder if the CDO/CDS crisis would be this large if Bear Stearns, Lehman, and the other investment banks were privately held and the risk been owned directly by the partners, instead of shareholders.

Justin Fox, writing in the January 19 issue of Time, examines the link between outsized risk taking and public ownership of investment banks.

Massive Madoff fraud nails hedge fund reputation

2008-12-17T13:51:00.004-05:00

Thank you sir, may I have another. That's what hedge fund managers must have thought when the news of the massive fraud perpetrated by Bernard Madoff was uncovered. The Wall Street Journal writes that the scandal is the nail in the coffin for the fund of funds business. One of the key advantages promoted by FOFs is that they do the due-diligence on hedge funds. Oops. The Journal notes that "in an industry that depends on trust and confidence, the fact that so many respected names fell short is likely to lead to yet more redemptions across the sector.

Of course the Madoff affair has set off new calls for regulation of the hedge fund industry and a former SEC official was on the Newshour last night. The official called hedge funds "unregulated" and predicted that regulation is on the way, due in part because the SEC's "international reputation is now taking a major hit." View the segment on PBS.org.

The New York Times writes that certain banks spotted "obvious" red flags when doing due diligence on Madoffs funds, but other banks weren't so lucky.

Billions in losses, mammoth fraud, Palm Beach society and non-profits left high and dry. Thank you sir, may I have another.

Activist model seen as having staying power

2008-12-15T12:56:00.003-05:00

Several recent articles note that activist hedge funds are well positioned to weather the credit and market crisis. Opportunities in the distressed sector and the fact that activist funds tend to have longer lock ups are cited among the factors favoring activist funds. Check out the following:

Hedge fund industry outlook from Investment Dealers' Digest.

Carl Icahn is interviewed by Financial Week.

Reuters writes about changing activist strategies.

Media is a part of Kynikos' short strategy

2008-12-08T14:42:00.005-05:00

A long profile in New York of Jim Chanos, president Kynikos Associates, a short-selling specialist illustrates the role media plays in his investment strategy. The article notes how Kynikos shares information and investment hypotheses with journalists and other asset managers. The fund will even walk reporters through the financial statements of companies it sees as overvalued.

According to the article, "In this information culture, Chanos has built valuable relationships with journalists who take his ideas seriously, promote his point of view, and ultimately help make him rich. Like Washington, Wall Street is a game that is fueled by the selective leak. The right tip can mean the difference between winning or losing millions."

Critics of short-selling call this manipulation, but they are wrong on this count, too.

The stock market is a marketplace of ideas and information. These ideas compete, and in a perfect world, the best/right ideas win out and drive stock prices up or down. The more ideas that compete the better. Shorts have just as much a right to advocate their positions as longs. Moreover, the ultimate longs are the companies themselves and they have big advantages when it comes to influencing media.

Still skeptical? Consider this: Chanos is credited with pointing Fortune to the misdeads at Enron and we all know how that turned out.

How to say we're sorry

2008-12-08T12:25:00.005-05:00

Financial Times columnist Lucy Kellway deconstructs investor letters from hedge funds. In her sights are the recent investor letters issued by Greenlight Capital and TPG-Axon. The story brings into harsh relief a very important question: what do you say to investors when you are down 20, 30 or 40%? Using these two funds as templates, Kellway notes 8 "rules" of the investor letter, ranging from being too long to sounding upbeat about the future.

What she doesn't appreciate or mention in the article is that, in these circumstances, the letter is a formality. The more important communications with investors are happening in person and over the phone.

Click here for the Greenlight letter.

Click here for the TPG-Axon letter.

Greenwich Financial Services sues Countrywide and opens Pandora's Box of media scrutiny

2008-12-05T19:44:00.006-05:00

Greenwich Financial Services has raised the hackles of Lou Dobbs and Congresswoman Maxine Waters, among others, over its decision to sue Countrywide after the bank decided to modify the terms of 400,000 troubled mortgages. Greenwich says that modifying the loans damages the financial interests of the bondholders.

William Frey who heads GFS and his attorney both appeared on a CNN interview. They deserve a lot of credit for taking a very unpopular position in a very public manner. Hopefully, their investors will appreciate the effort.

The explosiveness of the situation and risk undertaken by GFS is clear in the CNN interview when Rep. Maxine Waters refers to GFS as "greedy hedge fund operatives...looking for fast money."

The New York Times writes about the lawsuit and includes more details about the complaint.

Check out the Deal Professor's analysis of Countrywide's pooling and servicing agreements and the merits of Greenwich's claim.

Survey: 98% of hedge fund managers expect new regulation of industry

2008-12-05T16:25:00.003-05:00

A survey by accounting firm Rothstein Kass finds that virtually all hedge fund managers expect increased regulation. Areas where new regulation is expected include: asset valuation, counterparty risk management, capital raising and transparency. 77 percent of the respondents said that the overall impact of the new administration on the hedge fund industry "will not be positive."

Hedge fund cowboys "fell off their horses"

2008-12-05T15:04:00.004-05:00

The infighting has begun. In a story on Reuters, Veritas Asset Management manager Ezra Sun blames his fellow fund managers for the "tremendous" reputational damage he sees the industry having sustained. Sun accuses hedge fund "cowboys" of not properly hedging, boosting returns through unwise borrowing, charging high fees, and locking up investors once the losses started piling up.

While accurate, Sun's critique further damages the industry. Rather than finger pointing at the very visible bad apples, we should reading about seasoned managers who are weathering the storm and earning their keep for preserving, if not enhancing, their clients' assets. Investors need to hear that the good managers are surviving and that the industry will emerge from the current crisis stronger and smarter.

Paulson to hedge funds: "Make it work."

2008-11-19T16:02:00.007-05:00

A major feature in the Washington Post on the recent decisions and legacy of Treasury Secretary Henry Paulson notes that he believes that it is time to begin regulating hedge funds, reversing his long-held opposition. "You should not be thinking about how to fight it [regulation] but how to make it work," Paulson is quoted telling hedge fund managers.

Paulson is reported to have said that the policy statement he crafted on hedge funds in January 2007, which stated they should not be regulated, was wrong.

The article says that Paulson is working on a proposal that would grant the federal government broad new powers to take over a wide range of financial firms (beyond banks) whose collapse could endanger the financial system. Paulson said Congress would have to define which companies meet the criteria and determine how much they would contribute to a fund that would help cover the cost of closing them in an orderly fashion if they cannot be saved.

Regulation is coming. Hedge funds need to act proactively to make sure the regulation is sensible. Part of the process is demonstrating to Congress, the media and the public the important roles they play in enforcing good governance, providing liquidity in markets, and the degree to which they are an important source of capital to an economy constrained by banks' inability to lend.

Governance priorities for the new administration

2008-11-18T16:26:00.007-05:00

The banking crisis and the state of the U.S. auto industry have investors looking more closely than ever at corporate management teams and the accountability of boards of directors. Hedge funds should act opportunistically now to advocate in the media, the board room, Capitol Hill and on Main Street for improvements to corporate governance.

For starters, Nell Minow, co-founder of The Corporate Library has posted her governance to-do list at Carl Icahn's blog. Her priorities range from executive pay to board elections to regulatory reforms.

Also relatively new at The Icahn Report is Mr. Icahn's United Shareholders of America intiative which promises to "push back against board entrenchment and make it easier for shareholders to promote change in companies they own." People can "join" the campaign and receive email updates about its work.

Carl Icahn discussed corporate governance in an extended interview with the Wall Street Journal last Saturday.

Reputational risk prominent in Pershing Square investor letter

2008-11-17T15:47:00.004-05:00

In his third quarter letter to investors in Pershing Square Capital Management, William Ackman inlcudes seven paragpahs on "reputational and regulatory risks." Citing reputation risk as a "key risk factor" in the industry, he writes about the steps the fund is taking to preserve its reputation in this volatile environment. "Our approach to assessing reputational risk is to apply the New York Times test. We ask ourselves whether we would be comfortable having our family and friends read a front page New York Times story about actions taken by Pershing Square written by a knowledgeable and intelligent reporter who has access to all of the facts. If we are comfortable with such an article being read by our close friends, our families, and the public at large, our action passes the test. If not, we reconsider our potential action."

He also writes that he has recently decided to take public positions about issues affecting the hedge fund industry (see previous posting on this blog). He writes that it is "important for the hedge fund industry to come out of the shadows and defend the importance of our work." He continues, " If we and others (that includes hedge fund investors in addition to the managers) don’t do so, the industry, in my view, is at even greater risk of further regulatory, tax, and other legal changes that will materially harm our business models and industry."

Ackman cites the short-selling ban as one example of misplaced regulation that the industry was powerless to stop.

Mr. Ackman, if more hedge fund managers follow your lead on reputation management, this blog will be out of business. Until then, we salute you.

William Ackman interviewed by Charlie Rose

2008-11-13T16:54:00.004-05:00

On Tuesday, William Ackman, CEO of Pershing Square Capital was interviewed on PBS' Charlie Rose program. You can view the video here. In the half-hour segment Mr. Ackman gives thoughtful analysis of the financial crisis, prescribes solutions for Freddie, Fannie and GM, and talks about the need for regulation of credit derivative swaps. When asked about the hedge fund hearings that ocurred on Capitol Hill today, he says that Congress is "looking for a scapegoat." He also says that the through the bans on short-selling the SEC has "destroyed opportunistic capital" and contributed to the crisis of confidence in the markets.

Mssrs. Ackman, Einhorn, Paulson, Griffin and other leaders in the industry need to be in front of the issues and the camera more frequently. Only then will they have the chance to head off unwarranted regulation of the hedge fund industry and influence government priorities and action in this and future financial crises.

Hedge fund leaders endure Waxman hearing

2008-11-13T14:54:00.012-05:00

Hedge fund directors George Soros, chairman of Soros Fund Management LLC, James Simons, director of Renaissance Technologies LLC, John Alfred Paulson, president of Paulson & Co Inc, Philip Falcone, senior managing director of Harbinger Capital Partners, and Kenneth Griffin, CEO and managing director of the Citadel Investment Group testified before the US House Oversight and Government Reform Committee today.

The fund managers supported the creation of a clearning house for credit derivative swaps and cautiously open toincreasing disclosure requirements for hedge funds. Most criticised the federal response to the financial crisis. Short-selling was defended, as was treating gains from investments in hedge funds as capital gains, not ordinary income.

Read the summary of the hearing at the Wall Street Journal and its great "live blogging" from the hearing room.

The first hearing of the day, which featured testimony by academics and former financial regulators, can be viewed via C-Span here.

Activist campaigns gaining support

2008-11-12T12:48:00.007-05:00

A panel at The Deal's M&A Outlook 2009 conference discussed the effectiveness of hedge funds' activist campaigns. The panel noted that "activism" applies to any shareholder that tries to improve the performance of a company. Hedge funds were noted for their ability to get companies to better communicate with investors about their strategy and performance. It was pointed out that activists are getting more "aggressive and creative" and that institutional investors who are not themselves activists do align with activists to instigate change.

When advocating change at an underperforming company, the investor has the high ground. A sensible business case or complaint about poor corporate governance instantly arms the investor with tools needed to a) pressure the company through direct discussions, the media and other means; and b) gain the support of other investors who would also benefit from the desired change.

Hedge funds are virtually the only institutions in our market with the sophistication and wherewithal to effectively advocate for change at corporations. The role of sheriff is important and hedge funds should embrace activism as a regular business strategy, not only to identify and create value, but also to enforce market discipline and fair play.

Traxis downplays risks of redemptions

2008-11-11T15:39:00.003-05:00

Barton Biggs, director at Traxis Partners says at Fortune.com that fears about the market and possible effects of redemptions from hedge funds are overblown. He estimates that about $250 billion worldwide will be withdrawn from hedge funds by mid-2009. He notes that this is a relatively small amount and that funds have been preparing for it (the industry's net long position is said to be about 20% of equity, an all-time low).

He points out that despite well-publicized losses by the hedge fund industry this year, traditional long-only managers have done worse. This should mitigate redemptions. "So where are the redeemers going to put their money?" asks Biggs.

The industry needs more voices like Biggs advocating the, ahem, long view.

Hedge titans to testify on Capitol Hill

2008-11-10T12:21:00.005-05:00

Leaders of the hedge fund industry, including Philip Falcone, Kenneth Griffin, John Paulson, James Simons and George Soros are scheduled to appear before the House Committee on Oversight and Government Reform on Thursday. A preview story in the Wall Street Journal notes that the Managed Funds Association and other organizations representing hedge funds are spending record amounts lobbying, according to industry insiders. The story says that having five of the best-known and wealthiest investment managers together publicly before Congress is "unprecedented." It's not going to be pretty and one can almost hear the pontification of Waxman and others now.

This blog has long argued that the hedge fund industry has done a poor job of safeguarding its reputation and defending its practices, like shorting, to the Hill, the media and others. All this lobbying by MFA sounds like too little way too late.

Waxman, it should be noted, is a grand inquisitor of all kinds of perceived high-crimes and misdemeanors. After all, he called Roger Clemens to testify about his use of steroids in Major League Baseball.

Read the Financial Times' preview here.

Jack Welsh on how to "survive a media mauling"

2008-11-04T15:02:00.002-05:00

Jack Welsh's latest column in BusinessWeek focuses on how to manage through media crises. His advice isn't rocket science: tell the truth, tell one version of the truth, etc. He does, however, point out the need to take "media coverage into your own hands" via the Web. Welsh accurately notes that the Web is a critical defensive and offensive tool in combatting negative publicity.

The media are not the bad guys, and in Welsh's own words, "the only question is whether you have the guts to engage the media as they engage you."

Citadel holds conference call to calm bondholders

2008-10-27T14:13:00.005-04:00

Last Friday, hedge fund giant Citadel held a conference call with bondholders to quench rumors about its losses, standing with counterparties and need to liquidate holdings. More than 1000 people tried to dial into the call. Breaking Views outlines the substance of the call while noting that it is very difficult for a financial institution to deal with rumors. At a time when former Lehman executives are under investigation for misleading investors, the market simply does not know how to interpret what banks and others are saying. As a result, it is a Catch-22 to say anything at all. The New York Times offers a play-by-play of the call.

Self-inflicted wounds hurt hedge fund industry

2008-10-21T14:30:00.004-04:00

Dealbook by the New York Times reports that Andrew Lahde is closing his funds and returning money to investors. The article reprints Lahde's "farewell" letter to investors. Unfortunately, the letter is more of a "screw you" than a farewell and wanders into head-scratching territory including a defense of growing hemp and recommendations on what George Soros should do with his free time.

Lahde writes, "I was in this game for the money. The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy ofthe education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America."

That's all the industry needs: proof that egotistical managers are pulling fast ones on naive investors.

Hopefully, people (and the media) will recognize that Lahde operated his own LA-based fund for less than two years and his opinion should be taken with a grain of salt.

A story on Bloomberg gives a little more information about Andrew Lahde.

Paulson comment foreshadows storm for hedge fund industry

2008-10-14T14:33:00.005-04:00

According to an email sent to a colleague, former Lehman Brothers CEO Richard Fuld said Treasury Secretary Henry Paulson wants to "kill the bad HFnds + heavily regulate the rest." Fuld was in a very public battle with short sellers, but this sentiment held by Paulson (if accurate) should send shivers down the spine of the hedge fund industry.

With the ban on short selling, it is clear that Treasury and other regulators have view collateral limits on trading options of hedge funds simply as collateral damage the battle against the financial crisis.

More regulation seems inevitable and, the industry is not well-positioned to do much about it. For too long hedge funds have tried to fly under the radar, but it was naive to think that a $2 trillion industry would not attract outside scrutiny or regulatory interference. The industry resisted even the slightest infringement on independence, like registration. It turned a blind eye to high-profile cases of fraud and deception. It did not view challenges involving risk management, valuation, market practices and governance as risks to the entire industry.

Most important, the largest, most institutionalized funds did not band together (as was done in Europe) to create a unified front against unnecessary regulation and to serve as the voice of the industry in an increasingly shrill political and media environment.

It is ironic that Henry Paulson would want to kill the bad hedge funds and heavily regulate the rest. Isn't Goldman Sachs, after all, a giant hedge fund? However, the statement shows just how vulnerable the hedge fund industry is.

Reputation, regulation and hedge funds' consternation

2008-10-10T13:47:00.004-04:00

The UK-based Hedge Funds Standards Board recently announced that its increased membership now represents half of the hedge funds assets in Europe. HFSB chairman Antonio Borges said in an interview with Reuters that he fears regulators could be swayed into enacting harful legislation in the wake of the credit crisis. "The reputation of the industry will drive public opinion and therefore politicians in directions which might be harmful for all of us, not just hedge funds," he said.

Hedge funds in the U.S. can almost certainly count on new regulations. Even Republican nominees McCain and Palin are calling for more oversight of financial markets. If the industry could not effectively head off the ban on short selling (Borges calls such a ban "bad for the whole market"), how can it hope to avoid more and even more onerous restrictions, now that the crisis has deepened?

Who is spooking whom?

2008-10-08T14:58:00.004-04:00

Tina Brown's new news Web site The Daily Beast asks the question: is the media spooking the market? The article offers examples ranging from Jim Cramer to the outdated story on United Airlines that each are correlated "panic" among investors. Is the media to blame? I don't think so.

Rather, the media and investors are themselves spooked by bank CEOs, the President, Bernake and Paulson, none of whom effectively have explained the roots, extent and, most important, remedy for the financial crisis. In this vacuum bad news sounds worse than it is and pessimism is unchecked. But don't blame the media.

It is this same lack of leadership and demonstrable solutions that leads to ineffective half-measures like the ban on short selling. It is questionable whether the ban fulfilled its intention, given the freefall we've seen in the markets this week. However, the real solutions were not forthcoming and regulators had plenty of political cover for sticking it to the hedge fund industry. (The industry's anemic efforts to head off the short selling ban is best discussed in a separate entry.)

For the record, as early as 2005, reporters at The Wall Street Journal were asking my clients about the state of the mortgage market, risks of subprime lending, and risk management practices in mortgage lending. The media was right, it was everyone else who had their heads in the sand.

CEOs, lies and tickertape

2008-10-01T13:42:00.007-04:00

A colunn by Andrew Ross Sorkin in the New York Times examines whether financial CEOs can tell the truth about the state of their companies. He notes that Wachovia CEO Robert Steel told CNBC just two weeks ago that the bank had "a great future as an independent company." Wachovia's banking business was sold to Citigroup on Monday. Was Steel lying? Was Lehman CEO Richard Fuld lying about the prospects of that, now defunct, bank? Maybe yes, maybe no.

Clearly, financial CEOs are trying to reassure investors, who these days don't need much to head for the door. Being negative, realistic or telling the "truth" could result in the proverbial run on the bank. Truthfully.

At the same time, maybe, just maybe conditions facing banks are moving so quickly that CEOs truly don't know what the future of their institutions holds. The Wall Street Journal reports that Wachovia executives and directors bought $30 million of Wachovia stock this year. They, surely, didn't foresee selling the bank for $1 per share. Steel himself bought $16 million of stock when he was appointed CEO. Similarly, insiders at AIG and WaMu also bought shares in their companies and, presumably, lost big.

See a related Hedge Lines entry on this topic.

Atticus gags self

2008-09-09T17:51:00.005-04:00

Atticus Capital, which has been denying rumors about its solvency, recently announced that it would suspend issuing mid-month reports because investors had been "leaking" them to the press. The fund will continue to issue end-of-month reports.

The decision comes at a time when hedge funds are closing, even big ones like Ospraie and speculation about future closings are generating the wrong kinds of headlines for the industry.

It raises interesting questions about how to report and communicate with investors and what can reasonably be expected to kept private in an increasingly transparent world.

Hedge funds should assume that whatever they publish could make its way into the public domain. But if a fund is down 25%, like Atticus is, the least of its problems is what may or may not appear in The Wall Street Journal.

Are hedge funds good for the economy?

2008-08-28T11:35:00.002-04:00

The Wall Street Journal reported yesterday on the degree to which hedge funds are providing commercial real estate loans. In a time when banks are pulling back from all forms of lending, hedge funds are stepping into the breach to keep business moving. The article notes that the interest rates on some of the deals can be high (12% is cited), but deal makers a) have no alternatives and b) can afford higher financing costs because the price of the assets have fallen.

Lending is not a new business for many hedge funds, but as banks' inability to lend perpetuates the credit crisis, the presence of hedge funds who are willing to lend becomes an important prop up for an economy that appears to be teetering.

Another Journal article yesterday says that financial institutions will have to pay off at least $787 billion in floating rate notes and other medium-term obligations before the end of 2009 and the cost of new borrowing to pay off the old borrowing is only going up. This reality means that it will be difficicult to borrow from traditional financial institutions well into 2009.

Could hedge funds really be important for the health of the US economy? Let's see who writes that story...

Gordon Gekko of Sweden stirs staid companies

2008-08-19T11:45:00.002-04:00

Bloomberg profiles Christer Gardell, co-founder of Cevian Capital AB. Cevian, a $5 bn fund based in Stockholm, is a frequent target of media criticism for its activist strategies. Swedish media have called Gardell "the butcher," "the corporate pirate'' and "the bad boy of Stureplan,'' after Stockholm's financial district.

It sounds like Swedish corporate culture could use a bit of American-style activism. The article notes that in Sweden, "criticism of an individual is rare and heated debates at meetings are unusual, says Martin Lindell, a professor at the Swedish School of Economics and Business Administration in Helsinki."

Cevian, which sits on the board of Volvo AB, among other companies, recently bought a three percent stake in Munich Re and is working to end cross-shareholding, the practice of companies owning shares in one another.

"Cross-shareholdings eliminate the shareholder pressure and result in passive boards and CEOs who are running everything,'' Gardell says. "After you eliminate this, shareholders start to show up and put pressure on the boards, which become more active and take more responsibility.''

Insana folds FOF

2008-08-19T11:21:00.004-04:00

Former CNBC anchor Ron Insana closed his fund of funds, the New York Times reports. Even access to mega funds like SAC Capital and Renaissance Technologies wasn't sufficient to sustain Insana's smallish fund. His experience is illustrative of the struggle of FOFs to demonstrate their value in this environment and managers will have a hard time convincing new investors to pay two levels of fees.

Fee structure is at the heart of much of the criticism of hedge funds and fees come into high relief when funds lose money. Unfortunately, for the industry, high water marks, which are intended to keep investors whole, don't factor in much to the discussion about hedge funds' management fees.

Ironically, Insana, who was not lured from his day job by the dotcom craze, wrote a book in 2002 entitled, "Trendwatching: Don’t be Fooled by the Next Investment Fad, Mania, or Bubble." It appears that the next big thing was just too good to resist...

Harbinger stake triggers charm offensive by Cablevision

2008-08-15T13:36:00.007-04:00

Something is stirring at Cablevision, the cable giant and owner of the notoriously mismanaged New York Knicks. According to an article in the Wall Street Journal, CEO James Dolan "surprised" investors by announcing that Cablevision will explore options to boost its stock price. Also, top executives met with large investors for the first time in years to discuss the company's future. Most significantly, Cablevision today announced that it is paying its first quarterly dividend.

Why the change of course by a company that was unfazed by the "Dolan discount," or the difference in valuation between Cablevision and its peers, wich stems from the unpredictability of the company's controlling family?

Simple: Harbinger Capital Managment, an activist fund, acquired a 5% stake. Harbinger, which recently won seats on the New York Times' board, hasn't made public any demands, but its mere presence has been a boon to shareholders. Cablevision shares have been up as much as 28% this month. This demonstrates how, when it comes to improving corporate governance, hedge funds can be a force like no other.

Now if only Phil Falcone, who heads Harbiner, were a Knick fan.....

New York Hedge Fund Roundtable aims to improve industry conduct, avert regulation

2008-08-12T12:01:00.004-04:00

A recently formed group, the New York Hedge Fund Roundtable, aims to improve practices in the industry and, in doing so, avert further regulation. Founded by Stanley Goldstein, the Roundtable aspires to "initiate best practices and knowledge transfer to the broader hedge fund world, allowing members to leverage peer information exchange and positively affecting both the profession and others."

Voluntary efforts by the industry to promote best practices can work, but the time is now to take real action to preempt newly-empowered regulators. The Roundtable might be a part of the solution, but a more codified approach to self regulation, like that promoted by the Hedge Fund Standards Board in the UK, would be a more effective mechanism.

See the Reuters story about the New York Hedge Fund Roundtable.

Earnings reporting puts public hedge funds in the spotlight

2008-08-07T10:01:00.005-04:00

Publicly-traded hedge funds and private equity firms are in the spotlight this week due to a string of losses reported for the second quarter. Listing seems to be a double-edged sword for hedge funds. On one hand, they raised new infusions of capital not subject to redemptions and gained extra flexibility to manage through market events. However, it is unlikely that any fund anticipated both the depth of the credit crisis and the potential of the US economy to fall into a prolonged period of stagnation. The long-term effect of public reporting by traded funds is unclear, but it will be interesting to monitor, particularly if they continue to struggle to produce returns in this market.

The Wall Street Journal notes that "in the case of poorly performing hedge funds, many won't be able to book performance fees again until their funds return to certain levels -- a high-water mark that for some is looking increasingly distant. And private-equity executives managing souring funds could be liable for returning performance fees they already booked, an investor-protection feature known as a claw back."

Not a pretty picture for their funds, their investors, or now their shareholders.

Here are some of the earnings coverage:

MarketWatch.com's critical commentary on hedge fund earnings

GLG's Q2 profit falls 64%

Ochs-Ziff loses $1.05 per share in Q2

Analyst puts "sell" rating on Fortress Investment Group

Blackstone and GLG post Q2 losses

Analysts rising

2008-08-05T18:35:00.004-04:00

Luminaries come and luminaries go. Right now, analysts, particularly bearish banking analysts are the darlings of media seeing no end to the financial crisis. Fortune profiles Meredith Whitney in its current issue and the New York Times just did a profile of Richard Bove. Both are lauded for their steadfast conviction that the banking crisis is going to get worse, much worse, before it gets better. Whitney and Bove, as skeptics, represent the flip side of the last luminary analyst cycle that brought us the likes of Internet stock pickers Abby Joseph Cohen and Henry Blodgett.

I am sure that most reporters don't pause to consider that outspoken hedge fund managers who have similar dark opinions about the health of banks are notorious rather than famous.

Nevertheless, the prominence of Whitney and Bove shows that if you follow your convictions and you are right you will earn respect, even from skeptical media. Einhorn, Ackman and other activists just might be the next luminaries. We'll see.

Internet takedown

2008-08-05T10:49:00.007-04:00

The New York Times, chronicles the Internet smear campaign against the former head of Credit Suisse's private equity arm. The drama centers on a revenge campaign organized by a man whose ex-wife had an affair years ago with the CS exec. While the CS exec did not violate company policies (the woman was not affiliated with the firm in any way), the saga resulted in his leaving the firm.

This situation illustrates two realities. First, banks are completely on edge. With all the reputation risks associated with massive financial writedowns, they simply cannot withstand any other scandals or appearance of scandal. Even, John Thain, the "fixer," is under attack for misleading investors and poorly navigating Merrill Lynch's course through the credit crisis.

Second, it demonstrates that what is said on the Internet influences perception in the interconnected and information-hungry financial universe. Web sites and blogs move money and stock prices. In this case, a Web site got a guy fired.

Any hedge fund trying to affect change at a company needs to be campaigning online. This blog previously noted TCI's "Stronger CSX" site as an model of thoughtful and constructive advocacy on the Internet. William Ackman's recent restructuring plan for Fannie and Freddie is another example of using the Internet to influence opinion.

Hits to hedge fund reputation do not deter HNW investors: survey

2008-07-30T10:31:00.004-04:00

A new survey by Bank of America finds that high-net worth individuals with alternative investments expressed greater satisfaction over the last 12 months with every category of alternatives, including hedge funds, venture capital, real estate and private equity, than with their more traditional investments. 57% of those surveyed expressed satisfaction with their alternative investments, compared with only 5% who are dissatisfied.

Interestingly, 44% of survey participants invested in hedge funds said that negative publicity about hedge funds has not affected their investment decisions. 20% said that hits to hedge funds' reputation did make them rethink their strategies.

While BofA surveyed individuals with more than $3 million in investable assets, the industry has to beware of creeping into the upper echelons of the retail arena. Blowups and scandals involving hedge funds, even sizeable funds, are inevitable and the media will dramatize the situation by seeking out the victims. Accounts of little old ladies, even really rich ones, who get burned will draw unwanted scrutinty to the industry.

The Wall Street Journal offers one example today - an investor in the failed Vesta Strategies.

Read the Bank of America news release on the survey here.

Cramer: no boo-yah for shorts

2008-07-22T15:55:00.002-04:00

In New York Magazine, Jim Cramer gives his view on how short sellers can "assassinate" a company. He argues that the SEC needs to reinstate the uptick rule and use its power to investigage collusion and market manipulation by hedge funds shorting stocks.

Cramer, to his credit, does point out that short-sellers "simply can’t bring down an honest, well-capitalized firm; it will buy every share from you and take it right back up again in your face." Short selling, Cramer says, "doesn’t work against every firm; it just works against every financial firm that has lost credibility by insisting that it is doing well and then failing to disclose that it hasn’t been. That was Bear Stearns’ real flaw, and it is Lehman’s too."

Exactly. Opportunities for short-selling are created by the very companies that have mismanaged themselves and have misled the market for too long. Too often that is the simple fact that is missed or glossed over in most news coverage about short positions.

Bank shoots messenger (again)

2008-07-22T12:16:00.004-04:00

BankAtlantic filed an anti-defamation suit against analyst Richard Bove of Ladenburg Thalmann. Bove had ranked BankAtlantic #10 on a list of 107 publicly-traded banks carrying a high percentage of troubled or nonperforming loans. BankAtlantic took exception to the ranking because the calculations were based on the capital base of the bank's parent company. Bove issued a clarification in a separate note, but that was not enough to mollify BankAtlantic.

At face value, this looks like another case of a bank trying to shoot the messenger. However, given the volatility of the banking sector, it certainly doesn't take much to unhinge already unsettled investors and institutions need to respond vigorously to quell rumors and misinformation. While this lawsuit might not go anywhere, it probably is the strongest signal (or bluff) that BankAtlantic can send to the market, at this time.

You want the truth? You can't handle the truth!

2008-07-18T09:49:00.005-04:00

The Wall Street Journal blogs about a recent CNBC segment in which anchors debated the "truthiness" of what CEOs say on their very programs. Whether CEOs lie, spin or flat out don't know what they are talking about is beside the point. The fact is that CEOs take the long view and make the argument that, in the long run, they are running value-creating enterprises.

Investors have the right to hear the flip side of the argument. That's where the opinions of equity and debt analysts, bond raters, and, now, short-sellers come into the picture. Each of these parties serve an important function (in varying degrees of competence). The question for the investor is, whom do I believe most?

Mike Maiello in Forbes asks do we really want to know the truth from CEOs? It's a nuanced and important question. Hedge funds say that they need gates and other mechanisms to limit withdrawals by investors. Don't CEOs need the ability to stall for time to manage through a crisis, when the "truth" might cause the proverbial run on the bank?

Yes, they do. In a competitive market of ideas the truth is out there, and everyone, longs and shorts might be varying degrees of right at the same time.

Hedge funds down under take swings at U.S. shorting rules

2008-07-17T12:04:00.003-04:00

The Australian reports that funds down under are crying foul about new regulations that would curb short selling of US financial stocks.

In the article, Paul Fiani of Integrity Asset Management complains, "It seems that some financial institutions are becoming protected species, which can take on any amount of risk, reward their executives obscenely and then rely on the Government to bail them out and provide protection from short sellers."

Unfortunately, the hedge fund industry has done little to educate the media, Capitol Hill or Main Street about the true effects of shorting. Much of the media coverage gives a nod to the shorts' view, but skepticism abounds about the practice and impact of shorting. For example, the Wall Street Journal's story on Tuesday's SEC decision contained this one line of counterpoint to the general notion that shorting stocks created significant downward price pressure: "In practice, this [profiting from short positions] is extremely difficult to do with big companies whose stocks are heavily traded..." That's not much to balance the scales.

Where is any concerted response from the Managed Funds Association?

2008-07-09T17:57:00.005-04:00

Reuters reports that European hedge funds are slow to sign on to the voluntary operating principles developed by the newly-formed Hedge Funds Standards Board. While it is complex to adopt the operating principles outlined by the HFSB, the industry needs to follow the lead of the original 14 signatories. European funds risk further regulation by not signing on.

The hope is that the aegis of the HFSB will promote best practices in the industry, head off unsound regulation, and help defend the industry's reputation, which in Europe is even more beleaguered than in the U.S.

Reuters notes that hedge funds are "widely mistrusted in continental Europe, where senior German politicians have branded them as "locusts", new rules may seriously constrain hedge funds' activities, perhaps limiting the stakes they can build up in firms or curbing their ability to short-sell investments."

Antonio Borges, chairman of the HFSB warns that "we should not underestimate the fact that there is in some segments, especially in the political world, a movement in favour of very tough regulation, which I think would be quite detrimental to everybody."

In such an environment, the industry needs to take visible and meaningful steps to demonstrate that it is taking the lead in promoting prudent operating standards. Building consensus on the value of the HFSB is an important part of that process.

The Wall Street Journal also chimed in on this topic.

Finding the real Brian Hunter

2008-07-09T12:17:00.003-04:00

Fortune goes to Calgary for the first in depth interview with Brian Hunter, the infamous manager at Amaranth whose bets on natural gas resulted in $6 billion in losses. The story benefits from the talents of one of the most sophisticated financial writers in the business, Bethany McLean, who is credited with breaking the Enron story.

She humanizes Hunter, a man who has been demonized in the media for years (to the point where he refuses to be photographed). In a passage that should be read by all hedge fund reporters, McLean notes:

"Hunter is not especially arrogant or intense or brash. (He is Canadian, after all.) He's a family guy who talks more about his wife, Carrie, and his two young sons than about nights out on the town, and he's more of a math geek than a trader type. ("I'm a numbers guy," he says.) He's most enthusiastic when he's talking about the technical aspects (and are they ever technical) of trading natural gas. But he is self-aware enough to understand the perception of him. "I must be a bad guy," he says, ticking off the counts against him. Trader. Young. Rich. Hedge fund. "You couldn't ask for a more toxic mix. It's really frustrating, right?""

She also notes errors in media coverage of Hunter and disputes the common characterization that he was a "rogue trader." In addition, she casts a critical eye on the "Keystone Kops-like quality" of the market manipulation charges pending against Hunter.

Not many reporters have the talent nor the inclination to be as fair and balanced as McLean is in this important story.

Declawing the vultures

2008-07-08T10:29:00.004-04:00

Last week, I noted the feature story in Conde Nast Portfolio on "vulture" funds. The story, while not directly critical of funds like Elliott Management, is far from objective. From the artwork showing a vulture preying on Africa to several obvious omissions about how funds that buy defaulted foreign debt operate, the story stereotypes hedge funds and does little to ask the nuanced questions that would be required by a serious examination of "vulture" strategies.

Fortunately, Felix Salmon, who blogs for Portfolio, rebuts the story at Portfolio.com. Too bad, though, that the important clarifications Salmon makes are much harder to find on the Web site than the original, inflammatory article.

The rebuttal includes the following facts, none of which were part of the print story:

- The difference between the moneys awarded by the courts and what is actually collected is vast

- Going to court is often the last step in a process that includes direct negotiation with governments for payment

- Collecting any payments involves a lot of time and resources, meaning that profits can be slim, without even accounting for the tremendous uncertainty involved

One would have hoped that two writers for the same publication could have collaborated on this topic. The reult would have been a more balanced and insightful piece. Fact is, though, that rarely happens, particularly when the topic involves hedge funds.

Another defense of "vulture" funds by Salmon can be found here.

Media exterminators are in the dark about hedge funds

2008-07-02T14:49:00.003-04:00

A shrill frontpage article in today's Wall Street Journal compares hedge funds to roach motels. The story, an expose about Ritchie Capital and its use of gates to preserve itself, employs the roach motel metaphor to irresponsibly illustrate how investors cannot easily withdraw their money from hedge funds. In the 1980s, Black Flag famously marketed the Roach Motel with the slogan, "Roaches check in. They don't check out."

This misguided representation is further indication of media bias agains the hedge fund industry and illustrates the work the industry needs to do to enhance and defend its repuation.

The Journal would better serve its readers by more thoughtful analysis of the important issues that hedge fund investors face, like practices core to valuation, transparency and governance. By doing so it would help the process of getting funds on the fringe raise the way they do business to the level achieved by those who set the bar in the industry.

Hunting season on "vulture" funds

2008-06-30T10:53:00.005-04:00

The new issue of Conde Nast Portfolio writes about Elliott Management and other "vulture" funds. The story illustrates how Elliott buys foreign debt at deep discounts and then uses the courts to win payments from governments like Congo and Zambia. The practice has drawn the ire of activists who want to advance debt forgiveness as part of economic development in the Third World.

Note: A posting onPortfolio.com makes important clarifications to the print story and sets the record straight about "vulture" funds.

TCI's activist Web site

2008-06-25T14:30:00.007-04:00

CSX shareholders vote today on a slate of directors nominated by The Children's Investment Fund and 3G Capital Partners. The CSX-TCI battle is a marathon, not a sprint, though, and CSX says that it could take weeks to certify the election. Despite everything that CSX has thrown at it, the TCI freight train cannot be slowed. First, CSX sued TCI over disclosure requirements and the use of swaps to amass its position. That case resulted in a draw. Next, CSX played the jingoist card and enlisted Lou Dobbs to say that an asset crtitical to national security was in danger of falling into foreign hands. TCI is based in London. The red coats are coming!

That's the old media stuff. The new media stuff and what catches this blog's attention is TCI's activist Web site, "Moving Toward a Stronger CSX." The site explains TCI's view of the value of CSX and offers several documents related to its engagement with CSX. A white paper on the site details governance and perfomance issues at CSX that TCI wants to see improved. It also gives investors instructions on how to vote their shares and gives them the ability to vote by phone, mail, and Internet.

The site is a great resource for investors, institutional managers, other hedge funds and the media. Activist Web sites will become another arrow in activists' quiver as the industry catches on.

People are buying into TCI's argument. Hedge funds hold at least a third of CSX shares and the stock is up 42% this year, outperforming the Dow Jones Wilshire Rail Index, which is up 24%. Imagine, if TCI did a YouTube video? Just kidding...kind of.

Defending the shorts

2008-06-24T15:19:00.006-04:00

Even when they are right short-sellers get no respect. Lehman Brothers just reported a $2.8 billion loss, announced a plan to raise $6 billion in new capital, and replaced its CFO amid a long-standing and very public "dialog" with famous (or is it infamous) short-seller David Einhorn of Greenlight Capital.

Trouble is that people and many in the media still don't know quite what to make of him and his breed. Even other hedge fund managers won't endorse his practices.

It's never been popular to say that the emperor has no clothes. Fortunately some, like Einhorn, say it anyway.

That even Einhorn, who is renowned for forensic dissection of balance sheets and earnings reports to uncover hidden truths or at least very tough questions for management, faces criticism of his strategy illustrates how much work he and the hedge fund industry needs to do to educate the media and everyday investors about the facts of short selling.

A starting point is stressing that shorts have more skin in the game than long investors. First, they must keep collateral and pay fees to borrow stock. Then they must return shares bought on the open market to the lender. Profit arises when they are able to repay the lender with shares worth less than the ones borrowed. Thus, shorts are as on the hook and economically vested as long investors. This fact gives them equal moral authority to advocate their position and engage in public debate about the merits of a company.

Second, as noted by UConn law professor Steven Davidoff in the New York Times' DealBook blog, it is not illegal to "talk your book."

The opinions of equity analysts are considered part of the way the game is played on Wall Street. But doesn't a downgrade send the same message to the market as a short position? Just today, analysts at Goldman Sachs urged investors to "underweight" U.S. financials. It should be realized that short-sellers signal the market in similar ways, except they put their money where their mouth is.

As we witness the depth of the credit crisis and await action from the Fed and the SEC on the future of financial services regulation, what we need is more debate in the market, particulalry when it comes to accounting, reporting and governance issues, not less.

The industry is catching on. Today, the Financial Times reported that Bill Hwang, founder of Tiger Asia Asset Management noted that companies with major corporate governance issues are "a big red flag for short-selling for us."

New York magazine recently profiled Einhorn and his stance on Lehman.

Fortune reviewed Einhorn's new book, Fooling Some of the People All of the Time, which recounts his battle with Allied Capital.

Carl Icahn launches blog

2008-06-19T13:57:00.002-04:00

Carl Icahn today launched his blog, The Icahn Report. His first posts highlight "absurdities" in corporate governance and include "The Absurdity of Corporate Board Elections," "The Absurdity of the Staggered Board," and "The Absurdity of the Poison Pill."

Former CFO speaks on IR

2008-06-18T14:44:00.005-04:00

Here's rare communications insight from a company that has a serious communications problem -- Lehman Bros. Floyd Norris of the New York Times interviewed Erin Callan (coincidentally, right before she was replaced as CFO at Lehman) and she was unusually candid about the challenge a CFO faces in communicating with investors and media. “Trying to strike the right tone, to tell what really happened, what are the facts, and trying to give some confidence to your stakeholders, is a difficult process,” she said. “You don’t always get it right.”...“People are telling us they want to know more. They are not comfortable with what they know,” Ms. Callan said. “It’s a hard thing to figure out what that line is. How can we give a requisite amount of information that is satisfactory?”

That last question is hard to answer for any bank, right now. However, Lehman is in an extraordinarily difficult position, reputationally, as a result of its refusal to take the writedowns its peers have, become more transparent about the quality of its balance sheet, and become more proactive in its investor relations. Maybe the CFO and COO won't be the only members of the c-suite to pay the price.

Reputation management = risk management

2008-06-18T11:55:00.007-04:00

The Financial Times today reports that in the rarified air of private banking reputation management has become as important as risk management. It's a valid point, particularly at a time when the world and well-heeled clients are focused on risk. The story goes on to point out that the biggest problems come when clients incur losses on products that they do not understand. "The problem is more losses or products that have been sold to private clients that, actually, the clients have not understood." While I don't think we are going to see product suitability issues on a grand scale (like subprime mortgages) at the high end of the market, banks need to carefully review their sales and risk disclosure practices.

Crises of confidence are difficult to contain in the banking industry. Even typically "sticky" money, like retail deposits and assets at private banks can quickly become unglued. Banks need to re-audit their products and practices to safeguard against operational issues that escalate into reputation damaging events. A lot can be learned from the experience of E*Trade, which lost $2bn in assets in just one day. Fortune chronicles the de facto run on the bank and it is interesting to look back and see the interrelation between risk management, operations and reputation management.

She said, he said

2008-06-11T21:15:00.009-04:00

It shows you how rough things are in the banking sector when even good news hurts your stock price. Meredith Whitney, analyst at Oppenheimer, wrote this morning that Bank of America would not cut its dividend in the near future. The bank then denied making that claim and, in effect, reserved the right cut its dividend (BAC has a dividend yield over 8%). BofA might now be joining the list of banks grumbling about Ms. Whitney's calls. Well, she got it right on Citi and being bold and being right earns you credibility.

But this is not about an analyst's opinion. This is about Bank of America's failure to communicate effectively to the market on a number of important business issues. It's about not giving sufficient guidance on how its retail bank is going to perform as the health of the consumer fails (the retail bank delivers about 50% of BofA's profits). It's about Bank of America making deep cuts in its investment banking business and selling its prime brokerage. It's about Bank of America's inability to convince anyone that buying Countrywide was a good idea, much less that Countrywide has long-term strategic value, despite its short-term liability. It's about BofA's credibility and that's why BAC was down 1.4% today.

Post script: A Reuters story from a long interview with BofA CEO Ken Lewis is here.

Playing the don't pass line

2008-06-10T09:16:00.004-04:00

The New York Times' Deal Professor blog features an examination of the legal issues related to vocalism (I won't call it activism) by short sellers. Of course, the case study is Einhorn v. Lehman Bros. The writer, a law professor at UConn, draws the important distinction between "talking your book" and manipulating the market and doesn't suggest that Einhorn is engaged in the latter. Comparing the strategy of Einhorn to playing the don't pass line is a pretty good analogy. He may not be popular, but he is playing with the best odds.

This blog will compare the "moral authority" of activism by long- and short investors in the next week.

Buffet bets against hedge fund industry

2008-06-09T13:15:00.011-04:00

Fortune reports that Warren Buffet has bet Protege Partners, a New York-based fund of funds that five funds selected by Protege will not outperform the S&P 500 over the next 10 years. The $1 million bet is looking at performance net of all fees, costs, and expenses. Buffet, to quote the article, feels that it is the high cost structure of most hedge funds that makes them "onerous and to be avoided."

In making this bet, Buffet appears to agree with the findings of a Merrill Lynch research report dated February 22, 2008, that makes the case that hedge funds' returns are becoming more correlated with the broader market. Quoting the report: "Our analysis continues to show that 2000’s non-correlated asset classes are now often highly correlated to the S&P 500, and their diversification benefits now seem to be greatly reduced, if not completely eliminated."

High fees and the perception that risk and return for fund managers is uncoupled, because managers don't share losses equally with investors when the fund loses money, drove media scrutiny and animosity when the industry expanded so rapidly from 2004-2006. Going forward, the fee structure could continue to raise media, not to mention investors' eyebrows, particularly, if funds find it difficult to match historical returns in the current market.

The bet itself is overseen by the Long Now Foundation of San Francisco, which exists to encourage long-term thinking. The organization operates a betting mechanism for long-term bets and wagers include whether commercial air travel will be pilotless by 2030.

It's pretty hard to bet against Buffet, but Protege has shown keen foresight in the past. For example, they invested in Paulson & Co.'s funds, which were among the few to reap rewards from the subprime and real estate crises.

When the going gets tough, the tough might have to get more active

2008-06-09T10:55:00.006-04:00

Jeffrey Sachs, in the current issue of Fortune, writes that he sees many disturbing parallels between today's U.S. and global economic picture and the economic downturn of the 1970s. Indeed, striking similarities exist: rapid increase in the price of oil and other commodities, the U.S. fighting a costly and unpopular war, a weak dollar, among others. The result, back then, was 15 years of slower global growth. Should the scenario recur, it certainly will hurt retail investors looking (nervously) at retirement, but it also will make things harder for hedge funds and mutual funds seeking growth in a stagnant, albeit probably volatile, market.

In low-growth or stagflation the business-as-usual mindset of corporations, clearly, won't cut it. Hedge funds might have to increasingly turn to activist tactics to convince companies to unlock value and pursue unconventional growth strategies.

Lehman Bumps Up Earnings Call

2008-06-08T16:01:00.004-04:00

Lehman Brothers might release earnings this week -- earlier than its regular schedule -- in an attempt to stem the tide of speculation about the quality of its balance sheet. Lehman officials spent much of last week publicly quantifying its cash and liquid reserves in hopes of calming investors and trading partners. Even if investors aren't going to like the news about earnings and the need to raise capital, it's about time Lehman gave the market more insight into the scope of writedowns and its plan to catch up to other banks in writing down assets. The decision to release early leads me to believe that Lehman realizes that Bear Stearns was prepared to announce strong earnings two days after it was bailed out by JP Morgan.

Rumors, Fact and Fiction in Bear Stearns Collapse Show Limits of Traditional Media

2008-06-08T15:36:00.006-04:00

A recent three-part series of articles in the Wall Street Journal chronicled the collapse of Bear Stearns. As part of the company's effort, CEO Alan Schwartz, appeared on CNBC to dispel rumors about Bear's eroding solvency. In the old days, this might have worked, or at least have helped the bank buy time. Unfortunately, there was no real way for Bear Stearns to contain what was happening. No matter what the company said to CNBC and other major media was enough to convince traders around the world who were refusing to do business with Bear Stearns. The degree to which informal information networks among traders showed how banks, hedge funds and other financial institutions are all at risk of public crises of confidence, especially in this jittery market.

Time Warner Cable CEO Unabashed about $10 bn Debt Load

2008-06-08T15:07:00.006-04:00

The Wall Street Journal recently interviewed Time Warner Cable CEO Glenn Britt about the long-awaited spinoff from Time Warner. Surprising to analysts and deal watchers was the proviso that TWC would assume $10 billion in debt to pay a one time dividend, mostly to its parent company. In the interview, Mr. Britt claims that TWC's debt load is lower than the industry average and levering up was part of the effort to bring its capital structure in line with competitors. Sure TWC generates a lot of cash, but developing and delivering the next-generation services that customers want is not cheap. Why take a company that is at a competitive advantage (more free cash flow) and constrain it by borrowing to feed not its own growth, but the needs of the parent company?