Among the hedge funds hardest hit were credit funds and those using a type of statistical arbitrage, known as long-short equity neutral. Stocks in these portfolios are picked assuming certain shares will rise and others will fall. In this case, the complex models that drive them were upended by the extreme market volatility. Four building-blocks of such models are stock valuations, quality, price momentum and earnings momentum. These usually offset each other, but when they all started suffering, the models went awry. Some of the world's biggest hedge funds all began selling the same things at the same time. “You had the proverbial camel trying to get through the eye of the needle,” an analyst says. Although the pain was not confined to hedge funds—some long-only mutual funds were also hurt—the use of ample leverage (a staple in the hedge-fund world) meant they were hardest hit. One big investment bank is said to have offered leverage of 20-to-one to hedge funds investing in subprime mortgages just months ago.The drawing is by Vaszary Janos, and is called Menekultek (Refugees). It pictures Jews in a train station fleeing to Hungary and the West during the First World War.
Thursday, August 16, 2007
Forced selling and bankrupcy
The problem of a panic is that everybody wants his money ... NOW. If too many players are pressed to sell, the price will collapse and the whole system, based on peace, order, clear laws, mutual confidence, dies. That seems to be happening before our eyes. I am not sure that the collapse started with the hedge funds, since they had a rational, low risk investment strategy. According to Goldman Sachs, the problems started when too many hedge fund managers concentrated on the same stock, which started to behave in a strange, unexpected way.