It’s been a yonk or two since credit strategy hedge fund performance reports were so eagerly awaited: by managers (who want to know how their peers and competitors did, or say they did), investors (who want to know how much money they have left) and the peanut gallery (which, strenuous denials notwithstanding, take a NASCAR crowd’s delight in watching wrecks involving multiple—more is better—speeding—faster is even better—vehicles).
They’ll likely leave largely disappointed.
Hedge funds, including the Bear Stearns (BSC) High-Grade Structured Credit Strategies Enhanced Leveraged Fund and its less aggressively juiced sibling, are expected to begin disclosing their ‘final’ June 2007 NAVs Monday. The reports will end four weeks of mostly behind-the-scenes intense activity involving managers (including any near-at-hand quants who might have some ’splainin’ of their own to do), counterparties, administrators, auditors and doubtless more than a few attorneys; put some hardish facts under the intense speculation about who’s got a problem and who doesn’t; and set markets up for the next phase of what is undeniably a season, not a single race.
After the jump, NakedShorts proffers some irresponsible media speculation about the days ahead:
Key considerations and qualifications
What’s been happening?
What you’ll see
What you won’t see...yet
Key considerations and qualifications:
- Managers will be announcing NAVs effective Jun. 30. Whatever—likely limited— repercussions flow from the RMBS downgrades announced last week by Standard and Poor’s and Moody’s will not be in the numbers. Yet.
- Most of the important players are at least somewhat protected by at least three factors: redemption dates, which are these days rarely more frequent than quarterly; redemption notice periods, generally 45 days but sometimes longer; and gates, which allow the manager to limit the proportion of assets under management that can be redeemed over any specific period.
- Those who don’t have such protections in place will probably wish they did. We have seen this movie, where a hero is carried out for no other reason than he can be, before.
- The good news on this front is that the Bear Stearns’ funds did not become widely known until early June, missing the May 15 cut-off for Jun. 30 redemption requests.
- RMBS—whether directly, or in CDOs and other complex derivatives—credit strategies investments are a strictly minority sport in HedgeFundia. Leverage—probably averaging somewhere in the 5-7-times range—does however significantly increase the actual ‘face’ amount controlled by hedge funds, which are also likely to have been the most aggressive purchasers of the most tawdry credits.
- Oh, and let’s stop calling this a ‘subprime’ problem. Right now. It’s a leveraged mostly-mortgage backed complex derivatives problem. Pretty much in that order.
What’s been happening?
- A lot. Since the Bear Stearns’ funds issues hit the radar in early June, and more intensely since those issues became daily headline fodder around Jun. 15, managers have been dealing with lots of calls from concerned investors.
- That scrutiny, along with the announcement that the U.S. Securities and Exchange Commission had opened an informal investigation into the Bear Stearns funds, has concentrated minds wonderfully: everybody’s on notice that everybody’s watching, and “because that’s what the model says” won’t be simply accepted as adequate explanation for the umpteenth consecutive month of ±1 percent returns.
- Because markets were essentially ‘locked up’ by a lack of bids for the chunks of Bear Stearns’ collateral that was offered, managers will have significantly intensified their price, as opposed to quote, discovery, as opposed to approximation, efforts.
- Further complicating the picture will have been, in essence, the games people play: widely-quoted derivatives consultant Janet Tavakoli said in early July that managers “are worried about mark-to-market issues. Different investment banks are offering differing marks. The managers want to head off future investor disputes about how portfolios are being marked.”
- With that in mind, managers and their service providers will likely have closely reviewed fund documents, with a focus on provisions for “emergency” valuation procedures and processes. Potential defendants in future investor litigation—prime brokers, administrators and auditors among them—will want things done by the book, and properly documented. The phrase ‘good faith’ will be tossed around with rather more abandon than usual.
What you’ll see:
- Results will, to paraphrase J.P. Morgan, fluctuate. Since Bear Stearns’ problems became known, three managers—United Capital, of Florida; Denver-based Braddock Financial; and Basis Capital, of Sydney, Australia—have suspended redemptions, or warned that gate provisions will be implemented. Against that, Paulson Partners’ Credit Opportunities Fund turned in a 40 percent gain in June, leaving it up almost 130 percent for the year.
- NakedShorts has been told that, in recent days, at least one Texas-based manager issued a revised—downward, natch—NAV for Apr. 2007. Restatements of earlier month’s NAVs are, however, much more likely to be the exception than the rule.
- More funds, but likely a minority, will either announce the suspension of redemptions, citing potential damage to remaining investors in fire sale scenarios. Others may take less drastic steps, to the extent they are available, such as increasing the hold-back on any Jun. 30 redemptions.
- Managers—or at least the smart ones—will likely be more forthcoming than usual about how they addressed pricing uncertainties, even if, as some will doubtless claim quite correctly, they were largely unaffected. Some will issue self-serving jeremiads—blaming, as Basis Capital did, the “indiscriminate” repricing of “otherwise fundamentally sound collateral”—while others will take advantage of the circumstances to remind their investors that all returns face risks that occasionally return unannounced.
- The smart ones will also be at least somewhat forthcoming as to how they see the current trials playing out and, no matter how Panglossian their story, slather on some mustard about how they are protected against the downside.
- Losses will, however, in most cases, be underwhelming—less than 10 percent in most cases, and less than 5 percent in many—as relatively few will have been sufficiently concentrated in the worst-affected instruments to suffer serious damage. Some long winning streaks will be stopped, and the losses may be much larger than investors in the affected strategies are used to, or anticipated.
- Another Bear Stearns-style implosion? Always possible, and as always in these times, no shortage of nominees. But probably not this week, or next.
What you won’t see...yet:
- The end game. Vast quantities of U.S. residential mortgages, particularly in the Alt-A and higher categories, are due to reset during the second half of 2007, and it seems likely that those products will float off into Subprime Swamp (of 499 RMBSs downgraded by S&P last week, 15 percent were originally rated A- or better, while another 56 percent held various B ratings).
- Past performance may be no guarantee of future results but it’s a good hint. Somewhere out there, someone will not be able to resist the temptation to understate their losses. Perhaps they’ll get away with it, with the market sweeping to their rescue before anybody notices...but a few months from now, perhaps a year from now, a caretaker will find a skeletal corpse in a far corner of the long-silent oval.
Clutched in his hand, a forged ticket from the June 30 2007 NAV.
Have we really learnt our leverage lesson from LTCM? [$$]
by Gillian Tett
The Financial Times Jul. 13 2007
Australian hedge fund warns about withdrawals [$$]
By James Mackintosh
The Financial Times Jul. 11 2007
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