Good Read On Hedge Funds

Interesting article by Ultimi Barbarorum:

Trimming the Hedgies

November 12, 2008 ·

Going through my daily abnormal returns browse these days makes me want to misquote Admiral Beatty at the Battle of Jutland: there seems to be something wrong with our bloody hedge funds. They’re crapping out left and right. What gets me is not just that they are all doing it at the same time, which is astonishing enough, it is that it seems to be getting worse. Given half decent risk management, this should not be happening. I was aware of the existence of hedge fund beta where it comes to Quants, but I had always assumed there was sufficient diversity of opinion within the rest of the popular hedge fund strategies, particularly in equity long short, so that they would have some sort of diversity in their returns. I had also assumed that these guys were smart and flexible enough to be able to stop themselves out, to switch stuff around and refashion their portfolios to find something that works. At the very least, they could have just stopped doing anything, cover shorts, sell longs, and go flat.

This is clearly not the case, and I have not yet found a convincing explanation for it. The Citadels, Atticus(-ses, Attici?), Tontines, Fortresses of this world seem to be deer in headlights. Their performance is deteriorating over the course of this year, not stabilising. September was the worst month ever, we were told, so it would not be a very difficult decision to retrench, take some action, gross down and change orientation some way. Instead we find out that October was worse.

M y opinion is the hedgies got too big and too greedy to turn down the money offered them by late to the party "me too" bankers. Arb strategies are not always scalable to bigger size so less profitable but growable strategies are utilized and the returns jacked up with huge leverage. At 40 to 1 a 3% retracement is a 100% plus loss. Live by the sword die by the sword.