Comment: Hedge funds are scapegoats as long-only managers panic
It is hard to believe that hedge funds are the only contributors to the problem except on an occasional basis
It has become fashionable to blame hedge funds for the implosion of the global financial sector, on the argument they regularly go short on stocks in crisis. Last week, the Financial Services Authority showed where it thought the blame should lie, banning short selling on financial stocks until January.
But it is hard to believe that hedge funds, whatever their strategy, are the only contributors to the problem except on an occasional basis, although politicians seem to have convinced themselves this must be the case.
Putting aside the appalling management of banks during the credit boom, Percival Stanion, strategist with Baring Asset Management, is in no doubt that sales of stock by traditional asset managers have caused more havoc.
He points out that clients and consultants are putting value managers under great pressure every time their performance is seriously damaged by a rogue bank stock. When clients pull mandates away from managers damaged by this factor, they end up selling yet more bank stocks. Sales of bank stocks this month to avoid the risk of a nasty third-quarter report to clients were inevitable.
In certain ways, you have to admire the conviction of AllianceBernstein, which owned 9% of Lehman Brothers prior to its collapse, and Legg Mason’s Bill Miller, who owned 12% of Freddie Mac prior to its near-collapse.
Pzena Investment Management funds had a staggering 40% weighting in financials earlier this year. But the average hedge fund manager would be first to argue that he would never have been so stupid.
Value managers suffering as a result of their stock picks still strive to be true to their style, but they are only human. Despite Friday’s rally, they could be even less inclined to retain big bets on financials, for fear of losing the support of clients.
Sales of bank stocks by value managers over the past few months preceded the decision of hedge funds to go short, after deciding share price momentum is heading down. This can make a difficult situation a great deal worse, but you cannot blame hedge funds for putting the process in motion.
Their shorts tend to be tactical and, as prices fall lower, the majority of hedge fund trades become more tentative, not least when a Government-engineered rescue is on the cards.
Hedge funds are much more constrained on borrowing money to gear up their positions than in the recent past.
Often, proprietary traders employed by rival investment banks are more assertive, perhaps explaining the faint cheers heard when Goldman Sachs shares came under pressure last week.
Hedge funds, if anything, have tended to be more circumspect in their activities in recent days, now the market has fallen so far.
The fact that equities briefly yielded more than bonds, following last week’s dash for safety, further undermined their bearish stance.
It is an open question as to whether the UK regulators needed to act against shorting financial stocks. But they are not renowned for being subtle when the political heat is on.
As traditional investors and hedge funds cease to be on the same side of key trades, the clouds should clear somewhat. It is only when their actions coincide that problems erupt.
Baring’s Stanion hoisted a storm warning in June and he is yet to turn positive. He is particularly wary of prospects for technology suppliers now that banks are set to rein back on buying computers.
But he is beginning to be attracted to industrial and energy services stocks. Fidelity’s Anthony Bolton reckons the last phase of the bear market is in sight, predicting a further setback in commodity prices, with interest rate cuts to follow.
Funnily enough, the commodity price setback follows last year’s surge in futures, which fuelled crude oil suppliers’ pricing strategy. That surge was also blamed on hedge funds – even though traditional investors triggered the problem by a sudden dash into the sector. Strangely enough, there is talk of tougher regulation against traders in that area as well.
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