1. Hedge Funds: 80% Are Underwater… And They Shrink When Wet
As of the start of this month four out of five hedge funds, like the market itself, were losing money since the start of the year according to Hedge Funds Review. While hedge funds added $8.7 billion in net new money during the third quarter, 61% of funds shrunk, suggesting that while hedge fund investment is still growing, investors are chasing few funds.
Why are so many hedge funds shrinking now? Here’s one possibility. Hedge fund managers get paid a fee and make a share of the upside they produce for the investor. However, that upside is measured from the point of their investment. Managers then often require that the funds remain with the fund for a set period (lock-up period), usually 18-24 months. Investors that jumped back into the market after 2008 are just now free to move their money. They may be tired of being underwater and are heading for higher ground.
Now the question will remain what will managers do? The way the incentive system is established, managers whose funds are deeply underwater are incented to close the existing fund and open new funds so that they don’t have to recoup all those losses before they start to share in their investor’s profits. Such closings cause considerable animosity from losing investors and can tarnish a manager’s reputation.
2. Forex Back in the News
BNY Mellon has been named in an administrative complaint by a Massachusetts public pension of defrauding the fund of tens of million by “undisclosed markups in foreign currency exchanges over a decade.” The claim stems from BNY Mellon’s role as trustee for the pension’s overseas assets. When securities are bought or sold internationally the currency involved must be exchanged and often the trust bank will execute that trade. Here the Massachusetts pension is claiming that BNY Mellon repeatedly overcharged. We have seen similar allegations levied by pension funds against trust banks in the last two years. As a result, I believe that the manner in which foreign exchange is executed will change substantially over the next few years.
3. SAC Capital: Suspicious or Just Really Good
Finra, the Financial Industry Regulatory Authority, has flagged trades worth $14 million made by Steven A. Cohen’s successful SAC Capital and reported those trades for further investigation to the SEC. The trades in question were made shortly before important market moving announcements, like drug test results in the case of pharmaceuticals and merger news. SAC has been the subject of previous allegations. Senator Grassley, a senior member of the Senate Finance Committee states that his office has received 20 reports of alleged insider trading at the firm. Hedge funds routinely jump in and out of stocks quickly; often anticipating breaking news likes mergers or earnings results. When successful these trades can look like insider trading. Smart can sometimes look suspicious. In the case of SAC, it is now up to the SEC to decide.
4. Seeing Double: Private Equity May Have to Report Twice
Until this coming year private equity funds avoided registration and did not have to report their numbers to regulatory agencies. Starting in January they may have to provide different sets of reports to the SEC and the CFTC (Commodity and Futures Trading Commission). Unless the agencies can come to agreement on the format of the reports, funds may have to prepare the two sets of documents with largely similar information for the separate regulatory bodies. [Insert bureaucracy joke here].
5. Insider Trading Reaches the Boardroom
Ex-Goldman Director Rajat Gupta was arrested this week on charges of criminal fraud. He surrendered to the FBI and was later released on $10 million bail. The former director’s phone had been tapped by authorities and he is accused of having leaked to convicted insider trader Rajaraturam such information as the pending purchase of $5 billion worth of Goldman shares by Warren Buffett’s Berkshire Hathaway. Gupta was a major investor in the Galleon funds.
The lesson to be learned here is that no one is immune the SEC . Wire-taps and new trading analytical software are making insider trading easier to spot and prove. Good news for the good guys. Not so good for the others.
While the number of nationally chartered banks (as opposed to state chartered) are shrinking quickly – their assets are ballooning. As the chart below shows the OCC (which manages the largest national institutions) now oversees two-thirds of the nation’s banking assets but less than one-fourth of its banks.