Speculation Away From Subprime, Part 4

A smaller piece to end this series.  If you have read all four parts of the series, you won’t need to read the compilation post that I am putting together for Barry Ritholtz at The Big Picture, so that he can use it in his linkfest.

  1. Regarding 130/30 funds, particularly in an era of record shorting, I don’t see how they can add a lot of value.  For the few that have good alpha generation from your longs, levering them up 30% is a help, but only if your shorting discipline doesn’t eat away as much alpha as the long strategy generates.  Few managers are good at both going long and short.  Few are good at going short, period.  One more thing, is it any surprise that after a long run in the market, we see 130/30 funds marketed, rather than the market-neutral funds that show up near the end of bear markets?
  2. Investors like yield.  This is true of institutional investors as well as retail investors.  Yield by its nature is a promise, offering certainty, whereas capital gains and losses are ephemeral.  This is one reason why I prefer high quality investments most of the time in fixed income investing.  I will happily make money by avoiding capital losses, while accepting less income in speculative environments.  Most investors aren’t this way, so they take undue risk in search of yield.  There is an actionable investment idea here!  Create the White Swan bond fund, where one invests in T-bills, and write out of the money options on a variety of fixed income risks that are directly underpriced in the fixed income markets, but fairly priced in the options markets.  Better, run an arb fund that attempts to extract the difference.
  3. Most of the time, I like corporate floating rate loan funds.  They provide a decent yield that floats of short rates, with low-ish credit risk.  But in this environment, where LBO financing is shaky, I would avoid the closed end funds unless the discount to NAV got above 8%, and I would not put on a full position, unless the discount exceeded 12%.  From the article, the fund with the ticker JGT intrigues me.
  4. This article from Information Arbitrage is dead on.  No regulator is ever as decisive as a margin desk.  The moment that a margin desk has a hint that it might lose money, it moves to liquidate collateral.
  5. As I have said before, there are many vultures and little carrion.  I am waiting for the vultures to get glutted.  At that point I could then say that the liquidity effect is spent. Then I would really be worried.
  6. Retail money trails.  No surprise here.  People who don’t follow the markets constantly get surprised by losses, and move to cut the posses, usually too late.
  7. One more for Information Arbitrage.  Hedge funds with real risk controls can survive environments like this, and make money on the other side of the cycle.  Where I differ with his opinion is how credit instruments should be priced.  Liquidation value is too severe in most environments, and does not give adequate value to those who exit, and gives too much value to those who enter.  Proper valuation considers both the likelihood of being a going concern, and being in liquidation.

That’s all for now.