Lessons

Another hedge fund blew up yesterday. Ospraie Management LLC, a fund run by a guy with lineage to Julian Robertson’s Tiger Management shop and a few years with the world famous Paul Tudor Jones firm, had a “large” drawdown last month. An extremely bright gentleman named Dwight Anderson is the founder of Ospraie, and his background includes an undergraduate degree from Princeton and an MBA from North Carolina at Chapel Hill.

Click here for the Bloomberg story and re-cap of what happened.

Here’s a quote from Anderson: “I am extremely disappointed with this result and the fund’s sudden reversal in performance,’ Anderson, 41, said in the letter. “After nine years of striving to be a good steward of your capital, I am very sorry for this outcome.’

How many times do you hear the word “sorry” in our industry?

What are the lessons here?

“Commodities have been the story du jour, what with China’s 1.2 billion population industrializing,’ said Peter Rup, chief investment officer at New York-based Orion Capital Management LLC, which invests in hedge funds. “It’s easy to find a trend and ride the train. The problem is, managers don’t know when to get off it.’

Capital markets move more swiftly than ever. Volatility is heightened. Take yesterday, for instance, with a Dow up over +200 points in the morning, to give it all back and then some hours later, to close –26 points. You must plan and expect sudden and substantial moves in either direction. Tighter stops might be appropriate. Selling into strength and lightening up on winners could be another way to lock in gains.

Cash on hand is a good thing. Even better when you keep less than $100k at any bank. Remember John Maynard Keynes — “The market can stay irrational longer then you can remain solvent.” Take these words to heart.

Even the brightest of the bright can get burned in the market. How many times have we heard of hedge fund “dislocations” in the past year or two? Or even going all the way back to 1998 and Long Term Capital Management, a shop run by Nobel Laureates. If you think you are having a hard time with this market, think of the so-called hedge fund rock stars, with the latest gadgets, quantitative tools, computing horsepower, and cutting edge strategies, and they can still go upside down, and fast!

If your hedge fund manager sends you a letter saying he is shutting down your hedge fund for personal reasons, wanting to spend more time w/ family, etc etc… but then this, a small re-cap of events from Sam Israel’s firm, Bayou Capital (Mr. Israel was recently sent to prison, by the way)!

Despite some of the oddities, returns were solid and there was no cause for concern until Bayou investors received a letter from Israel dated July 27, 2005 stating he was closing the fund for personal reasons and would return all investor money. Initially Bayou indicated that it would take a couple of months to complete the audits but after some investors complained, Israel indicated that 90% of investor money would be returned by Aug. 15. It was kind of a tearjerker. I have talked to other investors who were going to write him and say ‘we understand, you’re making the right decision, your family comes first.’ Of course, it all was a big lie,” Bill, an investor in the hedge fund, says.

“And then the check never came. I called and the phone rang off of the hook and the mailboxes were full and the next thing I know I am looking at Gretchen Morgenson’s article in the New York Times. I completely freaked out,” Bill says.
Last but not least: If it sounds too good to be true, it probably is.

I could go on and on, but the Sam Israel story @ Bayou and all the other shenanigans in the hedge fund universe depress me. Bottom line, the markets are very different today..they move fast, change direction on a dime, and spike up or plummet down at any moment. It’s important to stay nimble.

Good Luck.