The typical large hedge fund would be insolvent if they lost 28%. That's the risk of levering up 2.5 times.
This article describes data recently collected from large (over $500M in net assets) hedge funds by the SEC. In aggregate the funds have $1.47 Trillion in net assets and $1.06T in debt, which leaves $0.41 Trillion of equity. Of course hedge funds are looking at the other side, which is if they achieve 10% growth of net asset the return on equity would be 36%.
http://www.bloomberg.com/news/2013-07-31/sec-says-largest-u-s-hedge-funds-debt-tops-1-trillion.html
Investors in hedge funds are usually very sophisticated, professional money managers, such as pension fund managers. Why would they pay a hedge fund 20% of gains to take on leverage and the inherent risks with their equity. Do they believe that hedge fund managers have an edge so that gains are more assured? Is this their way to buy in to high frequency trading, market manipulation, and insider trading?
I remember back in junior high we learned that the 1929 stock market collapse was exacerbated by the practice of buying stocks on margin. This inflated the stock price, and then led to a more precipitous drop when investors couldn't make their margin calls. I'm certainly glad we learned our lesson.
ReplyDeleteHere's one you can explain to me: why is the rising rate on the 10 year bond unavoidable?
http://www.zerohedge.com/news/2013-08-01/most-important-number-entire-us-economy?page=3
Can't the Fed just buy a bunch of these? Andrew Gause says that the Fed will continue with QE when the interest rates get too high.
What lessons were learned? I read some facetiousness in your comment. But, lessons were learned by some:
Delete- invest other people's money - and charge 2% and 20% for the service.
- obtain the power to change allowable margin levels at exchanges without warning in order to influence short term trading volume and prices.
- make sure that your counter party will be bailed out if they happen to go bust, such as Goldman Sachs did with AIG.
- secure visibility to all market participants' levels of margin debt and stop loss orders and then front run your clients.
I will check out the zerohedge post and comment on it later.