Hedge fund secondary markets Thursday, May 08, 2008

Allaboutalpha reports here on a study about secondary market trading of hedge funds based on Hedgebay data.

Having been closely involved in a venture that sought to launch a regulated secondary market for the trading of hedge fund interests via underlying and synthetic instruments, with related clearing and settlement, I found the findings fascinating. Most notable were the size of premiums/discounts operating, which re-enforced my beliefs that investors always prefer to have competitive liquidity venues and the price they pay/accept depends upon their circumstances regardless of underlying reported value, with immediacy of execution being a key determinant.

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posted by John Wilson @ 4:33 PM Permanent Link ,

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Twitter - yet to hit the banking/finance world Friday, March 14, 2008

Despite earnest demands that Twitter has broken out of geekdom into the wider world, given the storms surrounding the activities in credit markets this is the amount of attention it grabbed in Twitter since the service launched, reported by Twittervolume i.e. hardly any traffic.



Funny that.

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"Honey, get a doctor. I've got the confidence virus"

Confidence underpins business. Whenever you transact with someone, you demonstrate confidence that they can satisfy their end of the deal e.g. Amazon will deliver the book you ordered online and for which you gave your card details; the butcher is selling you fresh meat.

When confidence is lost, you stop doing business with that person/company and usually share that news with others.

In financial markets, loss of confidence about firms solvency is a primary contributor to the current paralysis - will this firm be able to pay me back or settle any trade I do with them? This is exacerbated by the viral nature of confidence. The demise of Carlyle Capital is now causing worries about the solvency of Bear Stearns, understood to be one of its prime brokers. Amplified by rumours and fears, this knock-on effect [systemic loss of confidence] is unconstrained.

In Bear Stearns case, solvency concerns exist because it is believed they will have seized collateral in the form of mortgage backed securities. Since this have become highly illiquid, so they cannot be easily converted to cash and will sit as idle assets. This is precisely why the Fed moved to offer the asset exchange facility, albeit I doubt they will publish which firms used it and in what size given the potential impact on confidence this may have - the use of such a facility may imply desperation and was the reason the run on Northern Rock began.

Elsewhere the move by the Chicago Mercantile Exchange ["CME"] to raise the margin limits for transacting five- and 10-year Treasury futures and currencies will have risk teams and dealers speculating on who will be hit by this drain on cash. Hence, CME will ask its' members for more margin, who in turn will demand higher margin from their customers. If clients can't meet these calls, they will either have to forcibly close positions and/or sell collateral, hoping that this will cover potential losses. Consequently, brokers like MF Global will be closely scrutinised/monitored in case any of their clients appears to be struggling that may have potential knock-on effects.

At the same time, the "generous" credit lines some hedge funds will have enjoyed will have been slashed by their brokers, reducing their trading capacity and requiring them to adjust portfolios i.e. trade, in smaller increments within the lower headroom they have. Combined with counterparty concerns, this has an effect on the depth of the market and the ability to trade in size [reference to the quantity of shares/units]. Trading in size matters, because if you can't trade in large quantities, then it becomes even harder to sell blocks assets at all or at least without triggering sizeable price falls.

Loss of confidence happens far faster than gains occur, so expect recovery to take a long time.

UPDATE: Just hours after writing this post, Bear Stearns shares collapsed by over 50% and it was forced to arranged emergency funding via JP Morgan with the New York Fed. Alan Schwartz, Bear Stearns CEO said in a statement that the bank’s liquidity had ”significantly deteriorated” in the last 24 hours as counterparties and clients rushed to close positions with the bank and withdraw funds. JP Morgan is provide back-to-back finance as an intermediary between the Fed and Bear Stearns, because technically Bear does not have access to the discount window. JP Morgan, notably, stressed it was just facilitating the deal and providing lending on identical terms to those of the Fed - it wouldn't wish to catch the confidence virus by association! It is hard to see a stand-alone future for Bear Stearns given the market-wide fear of trading with the Bank given its' evident insolvency.

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How the FA Cup creates unnecessary pain for IT managers Thursday, March 13, 2008

Making your IT department endure unnecessary pain would seem like a reasonable idea to many users seeking retribution for their computer experiences.

One recipe for this but which may to rebound on you [and your customers] is to follow these steps:
Such a situation occurs any time that tickets go on sale for an event. You automatically create a surge in activity as everyone tries to simultaneously log on/phone in and grab the best seats before they're gone. Inevitably the facilities can't cope as resources are maxed out and customers end up angry/frustrated etc. The situation is exacerbated by setting the start time for tickets going on sale at a peak time eg 9/10am.

This morning, for instance, the sale of West Brom's FA Cup semi final tickets go on sale online to season ticket holders, who will have an exclusive window of 4 days to get their tickets before the eligibility criteria is widened. They are guaranteed to get a ticket and allowance was made for people to buy groups of tickets together. Hence, there should have been less panic other than where you got to sit and at what price. Made no difference - the site was inevitably under strain from the high volume of log-ins being attempted.

Result - the customers will be unhappy and criticise the "lack of preparedness" of the site when it was inevitable it would be hit with high volumes. The club will challenge the supplier about it readiness, and the supplier's management will question its' IT team. They in turn will complain about "lack of resources" and no one ends up happy with the situation.

Whilst the service provider, Tickets.com, will be familiar with this scenario [they also handle Chelsea FC's ticketing], it is immensely costly to carry capacity for such occasional spikes and no one really wants to pay to have this idle capacity.

Is there a better solution I can suggest to mitigate the problem? No solution is perfect but a few options include
Just a thought.

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Speaking the language of hedge funds Thursday, August 16, 2007

This article on MSNBC was a cutting piece on the explanations being offered by Hedge Funds on their current "discomfort".

Some great highlights included

Hedge-Fund Phrase: Challenging
Translation: Run for the hills!

Hedge-Fund Phrase: Unprecedented, unique circumstances
Translation: Stuff happens. But we had no clue.

Hedge-Fund Phrase: Market volatility has produced unfair, unrealistic prices.
Translation: The market is efficient only when it works in our favour.

Hedge-Fund Phrase: Our results were affected by the selling behavior of other firms.
Translation: We made the same dumb trades as everyone else.

Goldman Sachs CFO David Viniar noted that the firm's decision to inject $2 billion into its ailing Global Equity Opportunities fund "reflects our collective belief that the value of this fund is suffering from a market dislocation that does not reflect the fundamental value of the fund's positions." In other words, the losses shown by these funds isn't the fault of the managers, it's the fault of a market that just won't value assets properly. Ironically, you never hear fund managers say that their gains have been unwarrantedly large due to the market's failure to reflect stocks' fundamental value.


Today is also the last day for investors to give their usual 45 days notice to withdraw funds ahead of Q407. So a number of hedge funds are going to find out what investors think about the current situation and their confidence in their managers. Of course, this could well prompt another bout of selling to create cash to fund redemption, which will be amplified by leverage i.e. if you used investors funds as a deposit on leveraged trades say 10x. Then for every hundred dollars they need to be paid, you need to liquidate a thousand dollars of positions.

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Be still my bleeding heart & mind the gate Tuesday, August 14, 2007

The Street has another story of how Sentinel Group is dealing with its' investors requests to redeem their investments including this letter sent to the investors.

SENTINEL MANAGEMENT GROUP, INC
August 13, 2007
Dear Client

As you undoubtedly know, the credit markets, along with most other markets, have experienced a liquidity crisis in the past several weeks. Investor fear has overtaken reason and has induced a period in which most securities have simply ceased to trade. We’ve all read the stories about one hedge fund or another suffering losses related to subprime exposure and closing down or being rescued. This fear, while warranted in some cases, has spilled over into the rest of the credit market and liquidity has dried up all over the street. In addition, investment banks and securities firms are stuck with LBO deals they’ve already entered into but cannot find buyers for the bonds so must inventory them themselves. This liquidity crisis has caused bids to disappear from the market and makes it virtually impossible to properly price securities or to trade them. High grade securities are trading like junk bonds as panicked investors dump names like General Electric at Tyco‐like prices.

We have carefully monitored this situation for the past several weeks and have met regularly to discuss the potential impact it may have on our clients. We had previously thought that the market would return to some semblance of order and that our clients would not join in the panic. Unfortunately, this has not been the case. We are concerned that we cannot meet any significant redemption requests without selling securities at deep discounts to their fair value and therefore causing unnecessary losses to our clients. We contacted the CFTC today and asked for their permission to halt redemptions until we can honor them in an orderly fashion.

Sentinel has always sought to protect your interests and since our inception in 1980, we have
never experienced a situation quite like this one. We will continue to monitor the markets and we will raise cash as opportunities present themselves.

We understand that this will obviously cause inconveniences on your part however, at present, we do not see an alternative and we don’t believe it is in anyone’s best interest if a run on Sentinel took place and we were in a forced liquidation mode.

We value your trust in us these past 28 years and this has been a very difficult decision for us
and we understand the implications of this decision both on you and on Sentinel. We feel, however, that this is the best way to assure you the best possible value on your investment.

We will remain in contact with you and update you as things progress.

Sincerely,

Sentinel Management Group, Inc.


Mind the Gate! It snaps fasts

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Hedge Funds & Beta - no longer an oxymoron?

Hedge Funds are not a homogenoueous group - individually they pursue many different strategies. However, one thing you will consistently hear from people in the hedge fund industry is that such funds are not closely (or in some cases, not at all) correlated with major market indices i.e. just because the markets go down doesn't mean funds will be affected i.e. the measure of correlation or "beta" is weak.

It is for this reason, investors are told, that hedge funds charge 2 & 20 (2% annual management charge on funds under management and 20% of gains made), rather than the paltry 10bps or less for index trackers.

So, it must have come as a shock to many investors to read headlines such as
Hedge funds forced into equities fire sale
Tue, 14 Aug 2007, 00:11 The Times

Goldman Sachs has made the announcement that everyone has been waiting for. The investment bank admitted yesterday that three of its high-profile hedge funds had off-loaded massive equity holdings following days of stock market turbulence. In recent days, whispers at rival fund managers had blamed a fire sale at Goldman Sachs for the devastating downward spiral afflicting global financial markets. The truth is that the bank was not alone. Almost every big quantitative fund using a strategy similar to Goldman's - known as an equity market neutral (EMN) strategy - was suffering in its own way. The result has been a rout of one of the most popular types of quant fund. Hedge Fund Research's EMN index had lost 7.6 per cent by last Thursday and undoubtedly saw further points shaved off during Friday's plunge in equities.

Unsurprisingly it is anticipated that a large number of investors will curtail future investments. More importantly the industry is bracing itself for withdrawals of investment at the next pricing point (assuming funds can even be valued in the current climate - many fund administrators are clashing with managers over the value to place on illiquid instruments in the current environment). This potential exodus is significant for a number of reasons. Most importantly, how many funds will simply close the "gate" and deny the investors the ability to withdraw funds, as I posted on recently? Equally important though, is that if funds are forced to liquidate positions to satisfy redemptions then this will have a market impact as Merrill Lynch found when they sold Bear Stearns collateral.

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When buyers go crazy Thursday, July 19, 2007

A key element of some of the economics theory I studied at university was rational behaviour on the part of individuals and markets. This was propped up with an assumption that everyone had the same information - perfect markets. In the real world, markets can often be driven to some temporary irrational behaviour, either through imperfect information or exuberance.

It was interesting to read a report about a study on ebay by Ulrike Malmendier, an economist at the University of California at Berkeley, which found that consumers didn’t always buy goods at the best deal.

In one example, 166 auctions were tracked offering "CashFlow 101," a board game. During the seven-month trial, the game's designer sold the box set on his website for $195. Meanwhile, eBay sellers usually offered an opening price of about $45 and set a one-click, "buy it now" price of about $125.

However, some bidders grew so enthusiastic about winning the auction that they lost sight of the "buy it now" price, sometimes offering more than $185. In 43 percent of the auctions they found that bidders ended up paying more than the 'buy it now' price.

In a different study, Tanjim Hossain, an assistant professor at the Hong Kong University of Science and Technology posted his own controlled auctions. He offered identical items eg CDs, but played with the specifics of the sale. One copy would start at $4 with free shipping. The other would open at 1 cent but charge $3.99 for shipping. Either way, the initial cost was $4.

But bidders didn't see it that way. On average, the low-cost, high-shipping auction attracted more bids, more bidders, and 25 percent more money.

The least startling revelation was that buyers seem to favour auctions with more bidders. People will always take comfort from an item appearing to be popular, as it suggests this item may represent a great deal. Likewise being the first bidder is uncomfortable since it means you have to "tip your hand" and you may find yourself bidding alone.

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Get a new car cheaply and then park at my house Thursday, March 08, 2007

If you read this blog more than once (apparently someone has), you'll have realised I am fascinated and passionate about markets and market mechanisms, amongst other things. So whenever someone at OpenCoffee starts to outline a venture that is markets related I confess to taking a keen interest in understanding how they intend to operate the market.

Last week I met with the founder of autoedbid, which is an excellent business that operates a reverse auction for the sale of new cars. Quite simply, you publish the car specification and the maximum price you commit to pay, then let car dealers fight it out for your business by competitively bidding down the price they are willing to sell you the car for. Autobid operates a "no win, no fee" revenue and has 700 UK dealers signed up.

Dealers submit their bids anonymously thereby protecting their reputation - only the buyer gets to find out who the successful dealer was and the identity of other bidders remains secret. Dealers are motivated to use this service as it enables them to quietly shift stock to meet quotas and earn improve terms. Buyers are motivated to use the service simply getting a better deal and without the pressure sell they might get in a dealership - of course, the buyer has to make a commitment when opening the auction; it's not a play thing, so take care.

This market simply could not exist in any workable fashion without the internet.

Today I came across Parkatmyhouse, which is an online market for parking spaces, the founder of which is an OpenCoffee member. People willing to rent out their driveways/parking space post a listing including a price and details of when the space is available.

People looking for a space can then search locations to identify listings or can post a "want" listing if no suitable ones are presently showing. Spaces are shown in context on google maps.

Presently there is no price negotiation facility I could locate on the site, nor is there any price history data (the site is fairly recent) of advertised spaces or transactions done on the site, to help participants gauge what to pay/charge. I think both of these would help.

Whilst this market could exist in the classified ads section, the fact that it didn't shows two things

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BitWine - the marketplace for advice Monday, February 12, 2007

I chatted with Alon Cohen today, who is the co-founder of BitWine, which is a marketplace for finding advice on a whole range of subjects from "experts".

In essence you can offer your services in any field - ("long tail" notion) and provided that a) you correctly describe yourself b) people are searching for such expertise AND using the same terminology; then you will be gainfully employed to some extent.



BitWine itself acts as
Piggybacking on skype (it is a skype extra), "experts" can quote a per minute fee to provide advice via a video call, albeit this is negotiable with the expert

At the outset of the call, the customer and expert will normally have a few free minutes conducting a brief interview to understand needs and capabilities. The BitWine application operates a "time meter" which is activated when both parties on the call agree it should start. A customer can stipulate a maximum amount they wish to spend on a call to protect against incurring a large bill without realising.

At the conclusion of a call, experts are rated online by customers and hence other users can get see how good or otherwise the experts are - similar to an ebay rating scheme; to be treasured by the expert both for the rating they receive and the volume of customers they have assisted.

To address the problem of unsatisfied customers, BitWine does have a feature whereby the customer can ask for a refund from the expert, who needs to consent.

BitWine has over 10,000 registered users and over 3,000 "experts" already, after launching only 8 weeks ago. Presently, BitWine doesn't take a fee whilst it builds up its' user base but will eventually introduce a fee on sellers.

BitWine has an affiliate scheme but which operates on an on-going revenue share basis rather than a CPA one-off payment.

This is an example of a "crowd-dependent" venture, with a few twists on it.
I discussed with Alon the fact they are likely to miss out on some billable hours that might otherwise bring them revenues, since not all advice/service will involve interview face time. For instance, someone may go away to write up their findings or provide me with research offline. This is a scenario that ODesk has dealt with on their marketplace. BitWine experts and customers can still agree to settle via BitWine for this.

Alon presented recently at the NY Tech Meetup and the video is below. Also their illustration of what BitWine is about is here

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Trendio - A marketplace for words Thursday, January 11, 2007

I confess to have a fascination with markets; how they operate; what makes them successful; the types that exist and where they are applied. It was probably inevitable I would work in the City which has the the clearest manifestation of markets in action (and there are many versions that operate to suit different products/instruments).

Indeed, most of my new venture ideas (origination) tends to have a "marketplace" element to it. This will become readily apparent in the coming months as some of the ventures coming out of our sandbox hit the street.

Hence, I was taken with Trendio for no other reason than their creation of markets in "words" linked to their appearance in the media.

Trendio claims it is the first current events stock exchange, where words from the news are the stocks. The value of the words is calculated according to their presence in the media.

On the Trendio current events stock exchange, you can buy and sell words. Buying a word is making a bet that this word will be increasingly present in the media: if this is the case then the price will increase and will make the value of your portfolio increase.

Quite simply, Trendio are tracking many newswires and identifying the frequency that a word is used. Users then "trade" their forecasts of how often the word will appear in the media versus the current market expectation or price. If you think a word/person/place will appear more in the near term than the current market forecast you will buy the "stock". Conversely if you think the word will be edged out from the news and appear less frequently than the current forecast you will sell.

However, in this market, you are not trading against others but against the "bank" and the value is calculated according to the presence of the word in the media - not easily influenced.

You are using a play currency, but it's still competitive - increase your currency in absolute terms; compete against others (fantasy football style) you know or in competitions run by the site. The only limit to the number of words you can have in your portfolio is the currency balance you've got to spend to buy/sell things.

If you are familiar with spread betting, this will be very familiar. If not, its a great way to learn in a safe environment.

Its actually very similar to inklingmarkets, the main difference being that with inkling you can make markets in anything with a future outcome such as stock prices, goals, project success likelihood!. This is gaining increasing traction with companies as a means of getting insight into employee sentiment - if staff are "selling" the likelihood of a project succeeding from its current likelihood price of 80%, it's a good indication there seem to be some serious doubts out there that you should look at. Why do staff dare to contradict the party line that everything is fine; because they are rewarded for trading in the market and correctly predicting outcomes.

It doesn't matter if staff can materially influence the outcome individually (near impossible in Trendio, unless you are Paris Hilton deciding to streak) since they will be signalling their intentions eg Project Sponsor bets on the likelihood of the project being cancelled and sells!

Obviously, the rewards from trading shouldn't be large in real world money/goods so as not to make it worthwhile to derail things deliberately (converse is true that some people might be motivated to work harder because they "bought" because they think the current expectation of success is too low). But you do want to motivate people to participate. If the developers start betting something is going to be later than the current "market" forecast, that's a pretty good sign they probably know something is wrong.

Go on, give it a try. My tip is Beckham is a buy given the uncertainty over his contract with real madrid and the likely speculation on where he will turn up.

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