Can hedge funds live to fight another day?

David Craig

17 January 2009

Losses are mounting and clients are clamouring for their cash in the aftermath of the Madoff scandal. But veteran professional investor David Craig has not given up hope

Hedge Fund Land seems to be in disarray. Investment losses keep mounting up. It would not come as a surprise to hear that fully 70 per cent of these often complex and sophisticated offshore investment vehicles have percentage losses running into double figures over the last year, with a large number down by over 25 per cent. This all seems to point conclusively to the fact that the majority of practitioners are unable to cope with market conditions and have failed to remember Investment Rule 1.01 for confronting losses: ‘Get out, stop losing and live to fight another day.’

The fact that most funds are losing should not be a cause for complete surprise, however. This brutal market has been nigh on impossible to stand up to. It set out to administer death by a thousand cuts, and has certainly taken a toll. Yet is that really much different to the sorts of frightening results suffered in past crashes and declines? There are those, myself included, who have been through a few of those episodes and believe that this time it is different — very different indeed. There are new risks to face, as well as new lessons to be learned.

Let us look back at previous episodes, starting with the Crash of ’87. When the stock market tumbled in October 1987 the decline experienced over the course of a few days by the Standard & Poor’s index of leading US stocks amounted to a massive 25 per cent. The sense abroad on Black Monday and the preceding Friday was that this was a deadly situation. The hedge fund for which I was responsible was cast adrift and severely tossed around. We had only one thought at the time — to get out at almost any cost. But that was not easy as we encountered massive swings in the value of the complex (by the standards of the time) arbitrage portfolio we had taken years carefully assembling.