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Long short hedge funds?

By Veryan Allen on 07/04/2010 – 10:42 pm PDTLeave a Comment

Long or short? France are out of the soccer world cup and it’s Warren Buffett’s fault? Berkshire Hathaway short sold Les Bleus to profit from their demise. Negative bets “cause” failure according to those who blame short sellers for the credit crisis. Did the team fail from fundamental problems or shorts? Have sovereign debt spreads widened due to some belatedly realizing there are no risk free bonds or use of credit derivatives? The fact is that markets where short selling and derivatives are not allowed have worse volatility and drawdowns. Anyone not shorting is not hedging. A flight to “quality” so BUY bonds and the yen? Long/short is the way to go.

A portfolio without shorts or derivatives is like a soccer team with no defenders or goalkeeper. Winning funds and teams also require strong management, teamwork and tactical adjustments to nimbly react to changing opportunities. The unhedged, unskilled crowd has underperformed CASH since France won back in 1998; so far my best ever year but commonly regarded as “bad” for hedge funds due to the blow up of one. Hedge funds have demolished long only managers since England won back in 1966; the year long/short was first widely publicized and shown conclusively to be a vastly superior alternative for portfolios. After 44 years how much longer must most investors wait to be allowed to properly diversify and allocate to genuine skill?

Some say short selling is a drag on returns, derivatives must be banned while security analysis and active manager selection are a waste of time. Diversification is “Don’t put all your eggs in one basket” so surely it makes sense to bet that some or most of the eggs will indeed get broken. Shorting and hedging are the way to REDUCE risk. If there is no such thing as investment skill, there is no such thing as sporting skill? Anyone competent knows FUTURE talent is detectable in any field. It just takes hard work, due diligence and experience to find the top performers in advance. Skill must be unconstrained which is why mandating good managers to be long only gets similar results to blindfolding good soccer players. For those who prefer human decisions to computer driven strategies, check out the results of world cup referees not using modern technology.

For long term investors, long/short is safer and better aligned with economic reality than long only. People exposed to rice and wheat price volatility have hedged with shorts and derivatives for centuries but even today there is not enough hedging of equity and credit beta risk. Those seeking consistent performance invest in skilled managers not asset managers. For funds that hold the largest stocks to reduce tracking “error”, BP is yet another reminder that there are no blue chip, buy and hold “securities”. BP stock crashed due to poor management or short sellers? If one hedge fund drops a few billion some urge avoiding all hedge funds but when a stock loses $100 billion they don’t say avoid all stocks. Why?

Avoid all bonds because of Greece? I recently met with a famous fund that blamed the “unprecedented” Greece situation for why they lost money! Proud of their terabytes of “historical” data, amazingly they were unaware Greece had many defaults in the past starting with Solon financial regulatory reform in 600BC and for over 100 of the past 200 years. Investors can learn a lot from the greeks. On trial for daring to challenge conventional wisdom, Socrates’ prophetic last words were “Please don’t forget to pay the debt”. Archimedes invented leverage and was prescient in saying “Give me enough leverage and I will move the world” considering how borrowers have moved world markets recently. It always puzzled me how experts worried about leveraged hedge funds but treated government bonds as risk free

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