The Hedge Fund Mirage by Simon Lack

Author:Simon Lack [Lack, Simon]
Language: eng
Format: epub, mobi
Publisher: John Wiley & Sons, Ltd.
Published: 2011-11-17T05:00:00+00:00

Timing and Tragedy

The collapse of Lehman Brothers in September 2008 triggered all kinds of unexpected consequences. Many hedge funds had obtained prime broker financing from Lehman’s London subsidiary which allowed them to circumvent Federal Reserve constraints on leverage (known as “Regulation T”). When Lehman filed for bankruptcy protection under Chapter 13 of the U.S. bankruptcy code, its London subsidiary fell under U.K. bankruptcy law, which, as everyone soon learned to their dismay, operates differently and with apparently less urgency than in the United States. Many otherwise-solvent hedge funds with collateral now locked in Lehman International faced very real difficulties in meeting client redemptions. To name just a couple, New York’s Bay Harbor Management had $190 million seized (Adamson, 2008) and Harbinger Capital Partners was looking for $250 million. MKM closed down their $1.5 billion multi-strategy fund because of poor performance but also because of their Lehman exposure. In an ironic twist, many hedge funds were forced to restrict client redemptions because they themselves had been restricted in accessing their capital from Lehman. While many of the events were almost impossible to anticipate and may well qualify as the proverbial thousand-year flood, the complexity of the hedge fund structure rendered many of these risks unknowable to investors. I attended meetings that year during which we quizzed managers on their prime broker relationships and Lehman was a concern for some time prior to their failure in September. But few could have been aware of the additional exposure created by a trans-Atlantic bankruptcy straddling two quite different sets of statutes and credit treatment.

One tragic story I followed concerned Marc Cohodes of Copper River. Marc’s fund was a short seller, one of only a handful of hedge funds that sought to make most if not all of their money by shorting stocks. Copper River was originally known as Rocker Partners after its founder David Rocker. David was based in New York while Marc was in California. Following David’s retirement the name changed to Copper River and Marc assumed full control.

Hedge fund managers that concentrate on running short portfolios are among the most thick-skinned people in the industry. Many hedge funds short stocks, and that in itself is a fraught activity. Significant forces are lined up against you—for a start, the target company’s management may vilify you and engage in all kinds of attempts to discredit you and cause the stock price to rise, costing you money. For a case study of how this can happen, go no further than David Einhorn’s absorbing story, “Fooling Some of the People All of the Time” in which he recounts his multi-year battle against Allied Capital’s fraudulent accounting. David was ultimately proved right, but retaining the conviction of his research required unimaginable fortitude in the face of government indifference and Wall Street opposition. Shorting stocks requires borrowing them for extended periods of time, which requires ensuring their long-term availability. And there’s always the possibility of a short squeeze, when speculators may buy the target company’s shares in the hope of forcing the short seller to cover his position, driving the price up even higher.

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