NY Metro Hedgefund Law & News

A Promise Fulfilled - Why They're Called Hedge Funds

I promised on day one of this blog/blawg to write on why they're called hedge funds.

Well no good reason really, a lot of them don't hedge.

What's a hedge - well essentially taking offseting bets in a market to try to reduce investment risk. For example, using fairly current numbers, buy 100 MSFT at $27.20  and also buy 1 November '06 Put on MSFT with a $25 strike price at about $0.15 premium. MSFT is Microsoft.

1 put represents the right to sell 100 shares at the strike price at any time up to expiry. Essentially, you get benefit if MSFT rises enough but also limit losses(until expiry of the put in November, 2006)  to the point of  MSFT falling to $25. There is no further damage if the price falls below $25.00

The break even (leaving out commissions) for the position is $27.35 which is $27.20 plus $0.15 the price of the put. So this bet (ex-commissions) wins if MSFT rises to $27.35. The real world breakeven will be higher on account of  commissions.

The downside protection (leaving out commissions) is that losses are maximized (for the period until expiration of the November put) at $235 which is the maximum  position loss of $220 ($2.20x100) and the premium cost of $15 ($0.15x100). Add in the commissions and you get the real world maximum loss.

After expiry in November 2006 the puts no longer provide downside protection. So at that point the MSFT still owned is no longer "hedged" by those puts.

Disclaimer: don't take this as an endorsement of hedging or options. It is merely my own home spun attempt to illustrate one hedging technique.

Further disclaimer: I am not an investment adviser and this is not meant as investment advice. I am certainly not endorsing any stock named in this blog. I do own shares in MSFT albeit the chances of this blog having any effect on the market for MSFT have to be about nil.

Frustrations of a Blogger

Well the link in the past article doesn't work and we have the usual blogger typos. As Popeye said "how embarassking".

Try this.

Put this in your PIPE and Smoke It

OK, so get into a PIPE as a hedge fund investor, sell the issue short at a higher price and then cover with your lower price discount stock when the PIPE deal finalizes. (For mechanics and PIPES 101 see this blog.)

Works great except it's illegal trading on inside info.

Today's winner:  feds brought criminal charges against Hilary Shane, a ex-hedge fund manager with First New York Securities, a Manhattan based hedge fund with using this tactic in the shares of Compudyne, a small security contractor, in 2001 to garner a tidy $300K+ in gains.

Gotta love the NY Post which described as Ms. Shane as an "ex-hedge honchette".

Ahoy Mates! Aarggh!!

So now its Pirates (Pirate Capital LLC) getting some unwanted attention.

This is a so-called activist fund operating out of Norwalk, CT. As you  know activist funds are the pros from Dover who invest in and then come in to set small companies straight.

Pirates committed the unpardonable sin of losing at least some money (albeit not big losses on a % basis) this year for investors. Never a good idea if you are running money.

Moreover, there is an SEC investigation into whether Pirates breached rules that require investors owning positions equal to 5% or more of a company to promptly disclose when they materially raise or lower their ownership positions.

No comment from Pirates. We'll see how this one develops.

P.S. Don't you just love the names in this business?

Hedge Funds - Something Old Something New Something Borrowed Something Blue

Some think of the hedge fund industry as a fairly new innovation, but its history began in the late 1940s and perhaps even the early 1930’s.

One Alfred Winslow Jones was the first fund manager to combine a leveraged long stock position with a portfolio of short stock positions in an investment fund. Using a private limited partnership structure for his fund, Jones was paid on an incentive fee basis. Investors in Jones' little known fund enjoyed very handsome returns as his fund outperformed all mutual funds of the time.

However, Karl Karsten came up with the technique (in concept) in 1931 which he published that year in a book entitled “Scientific Forecasting”. Karsten’s theory, intended for small funds that could not diversify across entire markets, was “Buy the stocks in the group predicted to rise most in comparison with the others, and sell short the leading stocks in the group predicted to fall most”.

Nowadaze we have fancy cocktail buzzwords for Karsten's simple concept. The long positions purportedly accent "alpha" (i.e. benchmark outperformance). The short postions purportedly minimize "beta" (i.e. volatility).

There may be something new under the sun, but don't count on it.

Amaranth Legal Woes

No surprise that some investors in Amaranth are looking at making claims and the SEC has begun an investigation into whether or not investors were misled.

Usually the focus in these things is on the disclosure (or lack thereof) made to investors. So private lawyers (and the SEC) will be looking at, for example, representations regarding valuations, strategies, and position concentrations.

Another issue may be whether Amaranth, a so-called multi-strategy fund, blew its mandate by so much concentration in the natural gas market.

Whether people will get tossed from the industry or put in jail, of course, remains to be seen as well. Kinda early on that one.

A very pragmatic issue, assuming any cases can be won, is what if anything will be collectible. It's one thing to win and something else to actually get paid.

PPA and ERISA Plan Assets

This one is primarily of interest to hedge fund promoters and managers.

The prohibited trasactions rules of ERISA can create all sorts of headaches for hedge funds who take on too many retirment plan and IRA investors. Too many is essentially generally 25% or more of AUM (assets under management).

There was some talk of raising this to 50% but it didn't happen. Two things did happen - tho  - under the recently enacted so-called Pension Protection Act of 2006. (PPA)

The first and simplest is that post PPA AUM from church, government, and foreign plans are no longer counted in determining whether the 25% ceiling has been breached.

The second is more complex and chiefly of interest to FOFs (funds of funds). Pre-PPA: once a FOF hit the 25% level of plan investors then a second tier fund in which the FOF invested had to count all of the FOF's AUM as plan investor AUM for the second tier funds own 25% calculation. Post PPA: the second tier fund only needs to count as plan investor AUM the actual plan investor AUM in the FOF and not the entire AUM of the FOF.

The pension plan market is, of course, huge so this could open up some opportunities for the hedge fund industry.

Unclear? Got questions? Then let me know.

BTW don't mess with this at home - get professional advice. Applying the rules in any given situation can be very tricky.

Bob K

Amaranth Redux

Congress is reported to  be into the fracas as to whether trades by hedge funds in energy markets add to volatility.

Aparently a year ago the Commodity Futures Trading Commmission  said no - that in fact the hedge funds provide trading partners for energy companies.

However, it has been reported in the financial press that a recent report by a Senate committe claimed energy markets were underregulated - especially new electronic trading exchanges and OTC markets allegedly not regulated by the CFTC.

What do you think?

BTW keep an eye on the weather in Calgary this winter. Nuff said.

So What's With Amaranth??

OK so as any reader (if there be one at this point) of this likely knows apparently Amaranth Advisors, based in Greenwich, Conn., lost more than $3 billion in the recent downturn in natural gas.

Yes, if it did indeed happen, these things can happen. However, the article I read on this was, in my humble opinion, kinda short on details and kinda long on criticism.

So what's going on in the press anyhow? Is this part of a push to get Congress to regulate the industry following the recent fiasco of failed SEC attempts to require '40 Investment Adviser Act registration of hedge fund advisers?

What nasty secrets and hidden agendae, if any, are being kept from us - the vaunted public? And by whom?

Fortress Investment

A recent NY Times article talked about the "heresy" of this Manhattan based hedge fund going public.

Actually, as I read it it's not that the investment vehicles themselves that are going public but the fund promotor itself. So I don't know how much increased scrutiny that brings other than to make sure the public is informed about the business of the fund promotor itself (i.e. largely what will be the public shareholder participation in the presumably rich carried interest fees and other manager goodies). Don't see why the funds themselves can't do their "investment as usual" (or unusual) business as private funds.

Put differently I don't see that the deal requires registration of the fund as an investment company under the '40 Investment Company Act. What does seem to come into play is the registration provisions of the '33 Securities Act and perhaps the reporting provisions of the '34 Exchange Act (???) - quite a different set of considerations.

There looks to be a possible German interest involved in Fortress. Does anybody know anything about that?

Stay tuned and let me have your comments and views. Just keep it clean and don't rough me up too much!