Monday, October 02, 2006

Hedge Funds: Game Over

Hedge-Fund Managers Make Midair Pitches

Small-Fry Firms' Hopes Take Off On Eos Flight of Captive Investors Amid Delicate Time for Industry

Wall Street Journal

There was an interview in, I believe, Barron’s several years ago, consisting of a roundtable discussion among some of the smartest minds in technology investing.

When the subject came to microprocessors—the chips that drive the computers we all use—and whether to invest in market-leader Intel or perennial Number Two AMD, one of the smartest of the smartest minds at the table said this:
“It’s game over—Intel won.”

Unfortunately for the magazine's readers, AMD stock proceeded to triple while Intel languished. In hindsight, his words had been spoken at or near the absolute bottom in AMD’s stock price, precisely because all the bad news about AMD that made it such an easily dismissed company in the pages of a financial magazine had already been reflected in the stock price.

Things could only get better for AMD, and they did, thanks to a new CEO and a new generation of microprocessors that caught Intel flat-footed, making AMD—not Intel—the microprocessor stock to own at the very moment it was declared “game over.”

Which is why I hesitate to declare anything so bold as “game over” for anything but, say, the Red Sox without Manny Ramirez.

Still, once in a while, things get so out of hand—such as last summer’s Time Magazine cover article about “Why We Love Our Homes,” which marked the absolute top in the U.S. Housing Bubble—that the phrase comes to mind and refuses to leave.

And Friday’s Wall Street Journal article about hedge fund managers pitching their funds on New York-to-London flights is about as obvious a sign of a top as I have seen since, well, “Why We Love Our Homes.”

I have tried to figure out how to excerpt the article, with appropriate comments, as I did the housing story last summer, but I find the hedge fund article is so full of fin-de-siecle whoppers that commentary merely detracts from the entire experience.

It begins thusly:

As Eos Airlines Flight 2 lurched amid heavy turbulence on Saturday night, hedge-fund manager Kurt Hovan tried to stay on course, making his pitch to a prospective investor.

The 25-minute sales job by Mr. Hovan, manager of a $21 million health-care fund, fell flat. The investor didn't bite -- he said the fund was too tiny and its investment team too green.

Mr. Hovan was one of a handful of small-fry hedge-fund managers whose hopes took off with the Eos flight. Each paid $3,900 for a round-trip seat on the New York-London trip. The draw: to mingle with captive big-time investors and make sales pitches over champagne and canapes. Investors rode free of charge.

"It's speed dating for hedge funds," says Bartt Kellermann of Global Capital Acquisition, which raises money for hedge funds. If investors express interest, Mr. Kellermann arranges follow-up in-flight dinner dates.

For the rest of it, including the hedge fund manager who believes he deserves a 2-and-20 fee structure because of his returns since inception all of 18 months ago, I will only suggest you dig up Friday’s newspaper or, more realistically, check it out online and read it from beginning to end.

As Time Magazine’s everybody-in-the-housing-pool cover story last summer proved, the smart money does not invest in a trend when it is front-page news—especially not when cracks in the foundation, such as the Miami condo market back then, and the Amaranth fiasco today, are visible.

Which is why I’m calling “game over” in hedge fund land. Buyers on the New York-to-London flights, beware...or at least insist on a longer track record than Britney Spears' latest marriage, which, for the record, will be two years in November.

Jeff Matthews
I Am Not Making This Up

© 2006 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.


Lee_D said...

It's true: by the time either a pop culture or business trend makes the front page, it's already over.

Over the past year, China has had three cover features in Canadian Business magazine. Naturally, every social event I attend has at least one person holding forth on how I "have got to get into China." Sometimes for a change of pace I get told how India is hot, hot, hot.

True story: last month I was told that Uranium was where it was at, and I had to get into it now. In this case, I know the person in question is a smart cookie, has been into uranium stocks from the bottom, and is dropping a "hot tip" so that the "me-too" types will buy in and keep him in upside for a while longer. I suppose I can't fault him for that.

whydibuy said...

Well this is cute. Jeff bad mouths the fund mgrs for saying famous last words and then proceeds to utter some himself with the statement" It could only get better for AMD". I wonder. Did jeff back up the truck and buy AMD stock by the bushel. I very much doubt it. Seems I heard that phrase applied to numerous co's, most that no longer exist. Reminds me of peter lynch's book " one up on wall street" where he counters that logic with the saying " its always darkest before pitch black". The future is never clear and it sure wasn't clear AMD would ever be anything other than a 2nd rate chip mfgr at that time.

Jeff Matthews said...

"whydibuy" needs to switch to decaf.

My remarks about the poor guy who declared "game-over" for AMD before the stock tripled were prefaced by the qualifier "In hindsight..." and implied no such 'bad-mouthing' of anybody.

Except, perhaps, the anybodys who invest their client's money based on a silly airplane pitch...

whydibuy said...

I'm not refuting that the bold fund mgr call signaled a bottom in AMD. Thats a historical fact now ( my phrase for hindsight ). Unfortunately, your comment beginning in the fourth paragraph clearly states without any such disclaimers that " Things could only get better for AMD". That is a future prediction about that co from that point onward. How could you possibly know that? I find that I cannot honestly say that about any co WITH the benefit of hindsight that things could've only gotten better from any point in time. But, nice try at spinning it as a misinterpetation. Have a cup of java or better yet some red bull. It'll wake ya up.

engynear said...


I concur.
I am a broker of 25 years working for a wirehouse. And whenever someone "downtown" actually proactively picks up the phone to specifically solicit me to sell something to my client, the red flag flies high.
Today was one of those rare days. The product?...a fund of hedge funds. The bait to the client?..."take your money out of your company's 401K plan as an in-service distribution, place it in an IRA and go to town with hedge funds which are not offered through your company's 401K platform"... the platform which, I might add, must adhere to prudent investor rules whereas the IRA may not. The client's company toes the legal line in its protection of the client from his own irrational investing self. But my firm seems to see this as an opportunity to offer hedge funds. I guess the ranks of all other other prospective investors as well as all other marketing schemes have been exhausted with this product.

Game-set-match coming up on this product.

Aaron Koral said...

Jeff: I read the WSJ article alluded to in your post. I got some good laughs today! The sad thing, however, is that most of the 7000 hedge funds jockeying for assets will cease to exist in 3-5 years not because of ther inability to market themselves, but rather, because of their inability to generate alpha that justifies the 2 + 20 fees (but I could be wrong). Happy Yom Kippur everybody!!!

Johnny said...

Props for knowing Britney's wedding day. You go Jeff.

BaronofBanks said...

I disagree somewhat with Jeff's comments. Perhaps hedge funds are in the "late adolescence" phase of their lifecycle.

The "two guys and a Bloomberg" model will become more and more difficult to execute, that is, grow above $25 million or so. Airplane pitches smack of desperation.

That said, in the next bear market, those hedge funds that provide decent return with an established infrastrcture, will likely see assets soar.

One last thing, almost every article that I read says hedge funds are, or should be, finished, including the article Jeff cites. I honestly can't remember the last time I read an article that said, "Hedge funds are great. Go all in!"

With this little rant finished, I do agree that maybe 6,000 of the 8,000 hedge funds extant probably should close (and probably the same number of mutual funds should close for that matter). And I think Jeff has a great blog. Kudos.

Sam S. Park said...

To add to Aaron's point about alpha, it seems like the diminishing opportunities - because of too many chasing the same thing - has influenced hedge fund managers to look at areas of less expertise and other times take huge bets to realize the high alpha. I don't know, but his seems very shaky to me.

ptkelly said...


what route do you suggest the recent MBA take in the investment management world these days?

join a start-up hedge fund with a 50/50 shot of survival?

join a mutual destined to track the s&p50 and live in a outperform, market perform, underperform world?

join a sell-side research dept that doesn't have the budget for paper clips let alone compensation? and then be tainted by the sell-side stain?

dkman said...

In my opinion, the biggest problem with hedge funds today is that no one seems to remember what the word "hedge" stands for.

To most, who left the mutual fund world or brokerage order taking drudgery to try their luck as hedgehogs, it seems to mean "gravy train".

Of course, it is to be expected that any concept will evolve over time. But, when you start talking about sector hedge funds (e.g. healthcare fund that the poor chap was pitching on that expensive plane ride) or hedge funds who have to aggressively margin up to take huge directional trades, I think we are definitely ready for a shakeout.

However, I also don't subscribe to the doom-and-gloom predictions that the whole hedge fund world is about to implode and disappear. Hedge funds are cyclical beasts. Thousands of them closed in 2000 and 2001 and thousands more opened in 2003 and 2004. Thousands are again closing this year and the most capable will survive and probably thrive.