Why I’m not Jumping at the Investment Banks at Present
Three reasons:
- There are still significant areas of concern that have not unwound yet — residential housing exposure will increase as housing prices fall further, including lawsuits which will eventually prove not meritorious, and CDO exposure.
- It is my firm belief that their hedges hold in minor moves, but not major moves. VAR modeling is fine for when the winds are calm, but not when they are gale force. At gale force the Extreme Value Theory models kick in, and they are untested at present. Berkshire Hathaway’s experience in unwinding GenRe’s swap book was telling; few things were marked conservatively. That is probably true industrywide, partly because auditors are incapable of audit the swap books in all of their complexity, or they’d be working for the investment banks themselves.
- New accounting regulations make earnings quality more opaque, and less comparable across time periods and companies. This should result in lower multiples, akin to big commercial insurers.
That’s all. Personally I think the investment banks will be a buy sometime in 2008, but I am waiting to see how the current leverage unwind affects them.
September 28th, 200711:04 am at
Hi, how do you think i-bank incentive fees will effect EPS over the next year?
I worked for a technical trend following CTA in the 90’s that had a severe drawdown of -55% over the course of a year. It started with one bad day and the company was never even remotly profitable again and the owners closed it down 3 years later.
I think that people don’t understand that in order to make incentive fees the hedge funds have to make new highs, just being flat doesn’t cut it. Unless they are constantly making new highs, the hedge fund business is the same model as the mutual fund biz but with much higher overhead.
Alternatively they shut their existing funds down and open new ones to reset the mark but its hard to replace the truely large capital pools.
Interested in your thoughts.