Hedge world

STOCK PICKING IN SHORT SELLING

The fact that a stock is overvalued is not enough on its own to trigger short selling: for example, the market might be rewarding a business reorganization. The company must be going through a down-performing period.

Let’s examine the necessary characteristics for a company to be an ideal short sale target:
• Deteriorating fundamentals and onset of a catalytic event, namely, an event that may have a negative impact on the company in the short term (for example, announcing lower profits than expected by analysts, accounting problems, adverse regulatory changes, funding problems). In particular, before setting up a short position on a stock, it is necessary to identify a catalytic event, because a stock can go on being overvalued for years. This brings to mind a maxim attributed to John Maynard Keynes, who, speaking about market irrationality, said: “Markets can remain irrational longer than you can remain solvent”.
• Companies belonging to distressed industries negatively affected by external changes.
• Changes in the equity structure.
• Companies with inflated share prices characterized by:
– low cash flow
– high price earning
– strong leverage.
• Companies whose management lies to its investors, for example by adopting aggressive accounting practices, through “accounting tricks” with stock options, “accounting tricks” with pension funds, one-off depreciations, reports with pro-forma data instead of actual data. Warren Buffett maintains that EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) is profit net of bad news, something you would want to take with great caution.
• Companies who are destroying value: i.e., companies with a low return on equity and a high price/earning ratio, who are putting their liquidity in investments whose return is lower than their return on equity, and are therefore bound to erode their profit structure.
• Companies with a high insider selling, i.e., with lots of shares being sold by the company’s managers. (Do not confuse insider selling, which is legal, with insider trading, which is illegal.) Insider selling data are published periodically by the SEC.

A useful exercise to spot short sale target companies is to read public documents, such as the Company Annual Report (10K filing), the Company Quarterly Report (10Q filing) and other reports published by the SEC (SEC filing). Another document is Form 144, which has to be filled out by company executives whenever they place a personal order to sell their company’s shares. Top managers must also fill in Form 4 within ten days of the month end to report on the purchases and sales of their company’s shares. When an investor owns a stake of 5% or more, he must file Form 13-D with the SEC. Every year, during their general

annual meeting, companies must file a proxy statement with the SEC aimed at informing the shareholders on which items they can vote. This document also reports how many shares are held by management, executive remuneration, shareholders with a greater than 5% stake in the company’s equity, pending legal disputes and a lot of other useful information.

It is useful to analyze the executive compensation packages, in particular incentives (stock options, loans extended by the company to top managers, fringe benefits, golden handshakes, insurance policies, private airplanes, apartments), to understand whether the company is managed for the benefit of shareholders or of top managers.

Additional information on a short sale target company can be obtained by interviewing the company management, competitors, suppliers, customers, trade associations, advisors, journalists, independent analysts, etc. This information can then be used to form a personal idea as to the assumptions made in the company’s business plan.

Before getting into a short sale, it is necessary to gain a macro-view: you must identify sector dynamics and deteriorating industries, economic cycles, the state of public finance, capital flows and emerging trends.

Many traders feel it is also necessary to read technical analysis indicators, such as trend indicators, oversold/overbought trends, momentum indicators, Fibonacci’s indicator, money flow indicators. And it is important to monitor the volume of options traded on the company. A further step is the collection of reports issued by brokers to measure analyst consensus of the company and the expectations of the financial community.

Hedge fund managers follow a strict discipline for short selling, fixing target prices that represent a threshold that, once reached, leads to the sale or closing out of the position. Generally, short selling managers do not resort to leverage, in that short selling is an inherently leveraged strategy. One of the greatest risks short selling managers run is that once they have spotted an overvalued company and they have sold it short, a buyer steps in, offering to take the company over and paying a premium to shareholders. Shorting a company with good fundamentals because it is experiencing temporary problems or based on an excessive valuation is risky, because a good management team can rapidly fix problems.

Short sellers try not to be deceived by the apparent story represented by financial statements; they try to scratch the surface and see what lies behind the numbers. To evaluate the health of a company, analysts study the financial reports of the last two years (10Q, 10K and possibly 8K). Great attention must be devoted to footnotes, and in particular it is important to figure out what has not been written in reports that should have been. Analysts look for accounting items whose actual value is lower than their balance-sheet value: securities that have not been marked to the market, real estate with inflated prices, inventory made up of obsolete products, receivables unlikely to be collected, etc.

Most of the recommendations expressed by brokers on shares go from buy to add to hold, and only a few analysts are willing to express a sell, reduce or underperform guidance on a stock. Analysts are constrained by corporate finance relationships or by the need to protect their business relationships with corporate management. This is why brokerage firms tend to be rather biased towards optimism.

To get complete information, you should buy this book!

This review is from: Investment Strategies of Hedge Funds
A great book of explanations on investment strategies. An easy read that explains each strategy a hedge fund might employ. If you want to invest in hedge funds or you are studying to someday run a hedge fund, you need to know what they do. There are so many blogs, articles, news reports out there telling how risky these vehicles are. Make your own mind up. Read this book.

The Risks of Short Selling

Short-only hedge funds are funds that adopt an investment strategy which is the exact contrary of the one followed by traditional mutual funds, that go for a long-only strategy. Although short selling may theoretically be considered symmetrical to the purchase of a security, in reality short selling entails very specific risks:

The downside of a short sale position is potentially unlimited. When all goes wrong, the worst that happens to a share is that it drops to zero, whereas on the upside it can rise forever. Faced by this statement, short sellers argue that according to their experience there are many more shares tumbling to zero than skyrocketing to heaven! In any case, a risk asymmetry exists between a long and a short position.
The risk of a short squeeze, when a broker demands the immediate delivery of lent securities. The short sale agreement gives the broker the right to call in lent securities at any time. Lent securities can be called in for various reasons: to take part in the company shareholders’ meeting or for extraordinary equity events, such as mergers.
The risk of a dividend payout. If the share pays out a dividend, the dividend amount is charged to the short seller and is paid out to the broker who lent the securities. Changes to existing tax laws can be dangerous for short sellers. For example, in the United States on 28th May 2003, President George W. Bush passed the “Job and Growth Tax Relief Reconciliation Act”, introducing a change in share dividend taxation: whereas before dividends earned by single individuals were taxed at a maximum marginal rate of 38.6 %, once the Act was passed the maximum rate was brought down to 15 %, like long-term capital gains, thus acting as an incentive for companies to increase the distribution of dividends to shareholders.
The impossibility of setting up a short sale as a result of the up-tick rule. Hedge funds, just as any other market participant, must comply with the regulations enacted in 1938 by regulatory authorities (in this case the SEC, but SEC’s regulations apply only to stock listed on NYSE or NASDAQ), allowing short sales only if the latest price change of the security being shorted was an upward movement (SEC rule 3b-3). In practice, short sales are authorized only if there was an “up-tick” (an upward movement between two immediately following prices) in the share price. As a result, it is forbidden to short a stock while its price is falling. In 1994, the SEC approved an experimental regulation, called “bid-test”, to stop short sales on stock listed on the NASDAQ at prices equal to or lower than the bid quote when the price is lower than the previous bid quote.
The liquidity shortage risk. Generally, managers set up short sales only on large cap companies, which have a greater liquidity and therefore their shares are more available to be borrowed from a broker, and where the short squeeze risk is smaller. Often it is not possible to short sell small and medium cap stock, because the market for borrowing the securities has become tight. Short selling should be allowed only on financial instruments that are considered liquid enough to close out the short position by repurchasing the financial instrument. In the case of very severe crises, the financial instruments concerned are generally suspended, which puts the parties involved in a short selling contract under a liquidity risk.

Short selling is more complicated than long-only. Borrowing a stock may be difficult, expensive, and the share can be called in at any time. A successful short position narrows more and more as the share price declines, while an unsuccessful position grows in size.

The emergence of large private equity funds is the most recent risk for the short selling activity. Private equity firms in 2004 raised $85 billion, a huge amount of money if we consider that they can use leverage in addition. Private equity funds can target underperforming small and mid cap companies and can offer a premium on the current market prices for the control of some companies. The activity of private equity funds can be an obstacle to short selling, making it trickier to short companies.

This review is from: Investment Strategies of Hedge Funds (The Wiley Finance Series)
If you want to have an overview of the top hedge fund strategies, this is a good book to read. It is an overview though. It does not go deep into each strategy, and at times, the explanations are superficial, or inaccurate, ex: when talking about merger arbitrage the author mentions the collapse of the tender offer for American Airlines in 1989.... but it was really the inability to finance a going private transaction for United Airlines at $180 plus per share that marked the end of the LBO driven bull market of the 80's.

Goodman & Co announces Dynamic Power Hedge Fund series consolidation

_*Goodman & Company, Investment Counsel Ltd, manager of Dynamic Funds
has announced a series consolidation for Dynamic Power Hedge Fund
whereby Series A units and Series F units of the fund will be
reclassified into Series C units and Series FC units, respectively.
The reclassification is expected to take place on March 25, 2011.*_

Each Terminating Series (A and F) has the same characteristics as its
replacement Continuing Series (C and FC). Effective, March 21, 2011,
both Continuing Series, which are currently capped, will be opened to
new purchases, while both Terminating Series will be capped to new
purchases and will no longer be offered. The reclassifications will be
automatic and will have no tax consequences to unitholders.

In 2009, in response to a decline in net asset values experienced as a
result of the global financial crisis, the manager added high water
marks to the performance fees of certain Dynamic investment funds,
including the fund, to protect investors from paying twice for the
same performance. At the same time, duplicate series of units of the
affected funds were created for administrative purposes to track the
different high water marks that would apply to purchases prior to and
after January 1, 2009.

The net asset values of the fund's units have since returned to and
surpassed the year end levels they achieved in December 2007 before
the markets began their decline. As a result, all four series of the
Fund have overcome their high water marks, eliminating the need for
the duplicate series.

Source: Hedgeweek.com

Hedge fund firm RAB slumps to "unsatisfactory" loss

By Laurence Fletcher

LONDON | Wed Mar 16, 2011 7:04am EDT

LONDON (Reuters) - RAB Capital saw losses almost treble last year
after assets fell further, highlighting the hedge fund firm's
struggle to recover from a client exodus during the credit crisis.

The group, which warned in September that full-year results would
miss expectations, posted a pretax loss for the year to end-December
of 20.2 million pounds, compared with a loss of 6.9 million pounds a
year ago.

"Our results for the year are not satisfactory," Chief Executive
Charles Kirwan-Taylor said in the results statement.

Assets under management fell to $1.06 billion in December from $1.35
billion a year before, after the firm closed five funds and one
European bank pulled out money from RAB's fund of funds.

However, RAB saw "modest" inflows into its remaining funds towards
the end of the year.

RAB had managed around $7 billion at the end of 2007.

The firm also faces the prospect of losing more clients as a
three-year lock-up on its troubled Special Situations fund comes to
an end later this year. This fund bought into Northern Rock before
the lender's collapse and also invested heavily in unlisted
securities, many of which proved difficult to sell during the crisis.

RAB's Prime Europe UCITS fund, the first in a range of European-based
portfolios it is launching to try and attract new clients, "had a
quiet launch" a month ago, according to Kirwan-Taylor, who declined
to say how much it had raised.

RAB's difficulties in attracting back clients since the crisis chime
with the experience of Man Group (EMG.L), which in January posted
further net outflows.. The wider industry saw $55 billion of net
inflows last year, according to Hedge Fund Research.

Last year, RAB's Energy fund rose 46.6 percent while its Global
Mining and Resources and Octane funds were also up, helped by surging
commodity prices, although Special Situations fell a further 7.6
percent.

The firm took a 3.5 million pound restructuring charge, which
included cutting staff numbers by more than 30 percent to around 70
after it became "apparent to us that a quick return to organic growth
in our business was unlikely", the firm said in the statement.

Kirwan-Taylor told Reuters the cuts would not affect performance from
its remaining funds.

"We are optimistic about the prospects for the group in its current
form," he added.

In December, RAB said it had taken on two fund managers and a
long-short equity fund from rival Park Place Capital.

Source: Reuters.Com

U.S. Stocks Have Room To Run As Bull Market Turns Two

Bernanke's Fed remains the largest inquiry mark as stocks aim for
further gains. Image by Getty Images via @daylife

From the depths of March 2009 the S&P 500 has just about doubled,
rising from 666 to 1,322 in two years. And though everything from
escalating oil prices to the anticipated end of the Centralized
Reserve's asset buys threatens the advance, Barclays Capital is
still advising clients to buy on the dips and stick with the surging
equity market.

Part of the firm's case for a continued rally goes back to the
historically accommodative monetary policy from the Fed. The central
bank has kept interest rates near zero and become the largest buyer of
U.S. Treasury debt, scooping up the supply of "risk-free"
securities and approaching investors to equities and other risk
assets.

Larry Kantor, Barclays Capital's head of research, acknowledges
there are factors that could derail that trend, but for the time being
he does not see whatever thing that will kill the two-year surge in
equities. "Nearly every box on the checklist [that makes stocks
attractive] is filled," says Kantor. An economic recovery is
underway, the Fed is holding the line on interest rates and corporate
weigh sheets are flush with cash, far less debt-burdened than they
were pre-crisis and lean enough that any incremental revenue gains are
flowing straight to the bottom line.

_For more on the leaders and laggards in the market's rally see Bull
Market Turns Two: Winners and Bull Market Turns Two: Losers_

The chief risks to further gains – which Barclays Capital expects
with a 1,450 year-end target for the S&P 500 – are the possibility
of further debt flare-ups in Europe, an even steeper spike in oil
prices that takes a bite out of U.S. GDP and, most importantly,
missteps from the Fed when it finally shifts gears on policy.

While the unrest in the Middle East is a concern, Kantor is skeptical
that oil at current levels – West Texas crude traded near $105 a
barrel Tuesday — is vacant to have a prolonged impact on the equity
market. He argues that a chunk of the current price is tied more to
better economic growth prospects, since crude traded through the $90
level before the violent uprisings in countries like Egypt and Libya.

The European debt picture seems to be stabilizing – the ECB is
widely expected to tighten interest rates in an inflation-fighting
measure at its next meeting – and for the time being it appears that
officials will be able to "draw the line at Spain," says Kantor.

A larger risk than oil or Europe, says Kantor, is how the Fed
extricates itself from what is the most accommodative monetary policy
in U.S. description. That can't last forever he says, but it remains
to be seen how timely Ben Bernanke and the central bank will be in
withdrawing its stimulus.

"If the Fed gets in front of it, I don't reckon it's a
killer," says Kantor, who expects a larger correction in
fixed-income than stocks."

The threat, he warns, is if they keep the accelerator pushed to the
floor and the same conversation is on the table a year from now, when
the S&P will presumably be considerably higher. "If [the Fed] get
ahead of it maybe you see a 10-15% correction, if not it could be a
lot larger."

_For more on the leaders and laggards in the market's rally see Bull
Market Turns Two: Winners and Bull Market Turns Two: Losers_

_Follow ?migr? On Wall Street, or Twitter @SchaeferStreet_. _And for
more Forbes coverage check our section pages for Markets, Stocks
andCommodities on the Investing channel._

Source: Forbes.com

HSBC sees macro hedge funds profiting from Libya crisis

By Laurence Fletcher

LONDON | Wed Mar 9, 2011 9:23am EST

LONDON (Reuters) - Hedge funds that bet on interest rates and
currencies are set to profit from the economic fallout from Libya's
unfolding crisis, says HSBC Alternative Investments, which has
already benefited from rising oil prices.

The uprising in Libya, the bloodiest in a tide of pro-democracy
protests in North Africa and the Middle East, has already helped push
up the price of Brent crude to its highest since 2008 last month.

Certain strategies such as global macro -- made well-known by
managers such as billionaire George Soros -- and computer-driven
trend-following funds have already profited with gains of 1.29
percent and 1.59 percent, respectively, in February, according to
Hedge Fund Research, helped by energy and commodity bets.

HSBC AI, which runs funds of hedge funds, is positive on macro funds
-- which bet on moves in currencies, interest rates, commodities and
stocks -- and thinks they may profit further if the North Africa
crisis hits global economic growth.

Such an consequence could cause central banks to cut or delay raising
interest rates, providing a range of new opportunities for these
funds.

"Macro and trend-followers are making a bunch of money," said Peter
Rigg, global head of the alternative investments group, at a press
interview on Tuesday.

"If the circumstances persists, then the effect on growth and the
response of central banks will be very fascinating. Macro managers
should be very well placed, and fascinating opportunities will come
out of it."

While hedge funds made a range of bets on Europe's sovereign debt
crisis last year, many have shied away from taking positions on the
North Africa turmoil for dread of being 'whipsawed', or betting on a
market go only to see it immediately reverse.

But, HSBC AI said it has already profited from funds that bet on
volatility or market trends.

"Our managers are generally making excellent money from the
circumstances," said Tim Gascoigne, global head of portfolio
management.

"One example is volatility; when you get volatility you can generate
excellent returns. Volatility and trend-followers are making money in
these conditions."

(Twitter: @reutersfletcher. To read the Reuters Funds Blog click on
blogs.reuters.com/fundshub; for the Global Investing Blog click here)
(Editing by Sinead Cruise and Will Waterman)

Source: Reuters.Com

Ayaltis Acantias Offshore fund is launched

Ayaltis has launched the Ayaltis Acantias Offshore fund, a fund of
hedge funds focused on undervalued assets in the stressed and
distressed credit space.

The fund aims to capture value in all credit markets investing across
all seniority levels following through the current period of strong
technical versus essential dislocations expected to last for the next
few years.

The fund is very concentrated, investing in between six and eight
seasoned distressed credit hedge funds with proven investment skills,
leadership, innovation and management talent.

The fund's target is an annualized return of 18 to 24 per cent per
annum with a volatility of eight per cent per annum over a three to
five years investment horizon. The fund is up 8.35 per cent
year-to-date and since its launch in March 2010.

Ayaltis, the investment adviser of the fund, has also hired Guillermo
Worlicek (pictured) and Massimo Martino to strengthen its team.

Worlicek has joined from Harcourt Investment Consulting where he
worked for five years, most recently as executive director. He will be
a partner and is responsible for implementing a risk and quant
management framework within Ayaltis.

Martino has joined from Banca del Ceresio where he spent more than six
years as fund operations manager of its six fund of hedge funds
managed by the bank. At Ayaltis, he will be responsible for the
complete life cycle of the fund operations service.

Ayaltis is a fund of hedge funds adviser with focus on fixed income
and credit strategies based in Zurich, Switzerland.