Hedge Funds: The Wild West

Welcome to the wild, wild west. Have you heard about the Canarsie Hedge fund? More money was lost in three weeks than most of us will see in our entire lifetimes. How did this happen and why? The P4Capital team examines this in this week’s Round Table Discussion.

Amanda: Good morning listeners, and welcome to the wild, wild west! Do you know what a hedge fund is? More importantly – do you know what happens when one goes wrong? This week the P4Capital executive team discusses the Canarsie hedge fund, and how it lost nearly 60 million dollars in three weeks. Stay tuned.

Jim: Today’s topic is about a hedge fund that went south in a hurry, and the implications that is has on our industry.

Jeremy: Yeah we’re talking about the Canarsie hedge fund that was operating in New York. They went from 60 million dollars assets under management, down to 200,000 dollars in a matter of only three weeks through a series of bad bets. So that’s a loss of 59, 800, 000 dollars in three weeks.

Shaheerah: The goal of most hedge funds is to maximize the return on investments, and hedge funds are designed to make money whether the market is going down or is going up, and that’s because managers hedge themselves by going either long or short. So now for this hedge fund, it was initially worth 100 million back in March 2014, and now its just 200K, so that’s a total loss of 99.8% in nine months.  And now my question here is, how easy is it to lose that much money in a hedge fund?

Jeremy: Just to quickly elaborate, the additional 38 million dollars was money was money that was also borrowed and lost. So 60 million dollars owned by people invested in the funds, with an additional 38 million invested most likely through their prime broker, which was Morgan Stanley.

Archana: Hedge funds get created and then they get dissolved, and a lot of them actually float under the radar. This one definitely caught the interest of Wall Street primarily because of the founder of the company, Owen Li, who was a former Galleon fund management trader. Galleon is one of the companies that was owned and operated by Raj, Raj Rajaratnam who is serving sentence inside prison for insider trading. Also, of interest is a person who joined Owen  was the head of risk management at Morgan Stanley, Ken Durrett. He was the head of Risk Management before joining, he was at Morgan Stanley.

Jeremy: That’s just incredible, that someone would go invest in a fund thinking “all right, well – I’ve got the former head of risk management from Morgan Stanley looking after me, and they’re investing through Morgan Stanley, so what could possibly go wrong?” Well, apparently everything!

Jim: And Jeremy, what was that? What did go wrong there because, they went from hero to zero in three weeks so there’s not a regulator in the world who can catch them that quick. What were they doing that made those bets so bad?

Jeremy: Well Jim, since it’s a hedge fund they’re not subject to any regulatory filings the way a normal fund would be. To invest in a hedge fund in the first place, you have to be an accredited investor, which means you have to be making an income of over 200, 000 dollars a year, and have net liquid assets of over a million dollars as well.  The theory is that the people investing in these funds shouldn’t be investing more than they can lose, which opens up some more aggressive practices by the fund managers, which can go wrong.  Looks like they invested in some options that theoretically have no limit to how much they can lose, and that’s exactly what happened.

Archana: So the company’s prime broker just recently changed hands, so Goldman Sachs was recently appointed as the company’s prime broker and this happened in March of last year, apparently Morgan Stanley raised some red flags in terms of the risk practices that this company was adhering too, and Morgan Stanley at this time wasn’t very comfortable with the risk practices that this company was adhering too. So, not sure whether we should have seen this coming or not, but this was a definite red flag.

Shaheerah: Owen Li says he’s very remorseful. He wrote an open letter to investors in which he writes “I take responsibility for this terrible outcome. My only hope is that you understand that I acted in an attempt, however misguided, to generate higher returns for the fund and its investors. But even so, I acted over zealously causing you devastating losses for which there is no excuse.” They said that December was supposed to be a good month for stocks because of the Christmas season and performance chasing funds. When this didn’t happen, they decided to make these bad bets to overcome that and to overcome the bad returns that they had in December.

Archana: The recent collapse of this hedge fund definitely draws more attention to the bigger question at hand: hedge fund as an industry; is this just a one-off incident or is there a future for Hedge Funds in general? Of late, financial heavyweights like George Soros and Warren Buffett have actually been, in fact Soros just recently went public saying that public pension money should not be put in hedge funds, because the market is very volatile and it’s a very risky bet. And what came after this announcement was made, California’s biggest public pension fund actually withdrew a major chunk of money from hedge funds.

Jeremy: Yeah, it’s an interesting point Archana. It raises the question how much exposure does the individual have to hedge funds, even though they can’t invest in them directly? There are pensions that are a big contributor to hedge funds. Universities like Harvard has billions of dollars in hedge funds. Any university with a substantial endowment fund has a lot of money and exposure into hedge funds as well.

Archana: And so while investors who lost their money are really upset and angry, the general public is also lashing out on social media. And here are some of the comments that were posted on zerohedge.com: “Is Owen Li’s last name LI short for Lie?” “Overzealous is too big a word for someone stupid enough to lose this kind of money. Something else happened.” “Don’t they have risk controls and checks and balances? Why did no one say anything? Why does this guy have final say?” “Seeking higher returns equals I took your money to the casino.”

Jim: So Shaheerah, it sounds like with some of the facts on the table, the answer to your question and having seen witness of this in other walks of life, they made a series of bad bets and got caught in the old syndrome that the gamblers employ is don’t chance bad money with more. And it seems that’s what they did. They had 60 million at their disposal, went to the market to get another 40 million and basically just compounded loss into loss, and because of speed and the unregulated nature of the business, I’m not sure we could say anything else but buyer beware.

Amanda: That was the P4Capital team discussing the Canarsie hedge fund, and the obscene amounts of money that were lost.  Want to know more? Check out our all new website at http://www.planet4it.com or follow us on twitter @pfourdigital or @p4capital. Thanks and see you next time.


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