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June 13, 2006
Uncorrelated Correlated Hedge Funds
Gosh, hedge funds are considerably more correlated than their promoters have pitched:They're all backing the same trades, behaving like index- tracking mutual funds. Instead of convincing investors that the only way to make 50 percent in a year is to be willing to lose 20 percent in a quarter, they eke out profits by retiring winning trades almost as soon as they are in the black. Instead of scouring the globe for unidentified gems, they spend their time bandwagon-hopping."The correlation of hedge-fund returns is very worrying,'' said Donald Sussman, chairman and founder of Greenwich, Connecticut-based Paloma Partners Management Co., who spoke at a panel discussion in a tent at the festival. "Everyone does well in a bull market, and badly in a bear market."
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The hedge fund biz is like many others in that the flash of easy money attracts plenty of dolts and con men. A lot of the so-called hedge funds out there are little more than elaborate scams designed to take advantage of the unprecedented sea-of-liquidity environment we had been in for the past few years.
One of the more popular rackets, for example, was selling volatility--you write naked S&P puts and collect fat premiums of 1-2% every month, for months on end, and your investors think you're a hero for delivering a baby-smooth equity curve. This strategy worked like a charm until recently, when it fell apart completely. Eventually the black swan hits and your fund blows up over night... but who cares, you made a killing in fees and incentives between here and there. The aftermath is a huge ugly mess, and we're working through it here and now.