Even Goldman is trapped

From today’s FT

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What’s going on with Goldman’s Global Alpha fund

It may have been a horrible, final week
in July for the hedge funds. But Goldman Sachs is in particularly
zealous damage control over reports of trouble at its Global Alpha
hedge fund.

On Tuesday Goldman denied market talk that it was liquidating the
fund, following reports it had fallen a total of 12 per cent in two
weeks, reports Reuters – and lost what Bloomberg reports
was 8 per cent alone in the last full week of July. The losses were
magnified because the fund borrows money to make its trades, and
finished the month down 9 per cent, net of fees, suffering another 3
per cent drop in the first three days of August as the S&Ps 500
Index fell 1.5 per cent and credit spreads widened, says Bloomberg,
quoting investors.

Earlier, says Reuters, several traders noted persistent market talk
that the Global Alpha fund was being wound down, and that it was
selling large amounts of stock in German car parts supplier
Continental, aerospace company EADS and Italian carmaker Fiat. Goldman
wasn’t commenting.

Bloomberg on Wednesday reported
that the Alpha fund had fallen 12 per cent in the two week period ended
August 3, and was down 16 per cent for the year, with recent losses
caused by wrong-way bets on US stocks and investment-grade debt.

The Alpha fund aims to generate returns that are not correlated to
the S&P 500 index, although the risk the fund takes on, as measured
by the volatility of its returns, is supposed to be similar to the
S&P 500, notes Reuters, quoting a fund of funds investor. The
investor added that the Global Alpha fund invests mainly in liquid
assets, “and should be able to sell assets to meet investor redemption
demands.”

A Goldman spokesperson in London declined to comment on the fund’s
position in those individual stocks while a Goldman spokesman in New
York declined to answer questions about the fund, citing US regulations
surrounding hedge funds, Reuters added.

Underperformance by Global Alpha’s managers put a dent in Goldman’s
first-quarter results, Reuters added. Fund management incentive fees
for the asset management group fell 78 per cent to $23m from $105m a
year earlier, and much of that was driven by Alpha, analysts said.

Perhaps, then, that is why Goldman is trying a whole new approach, as FT Alphaville noted last
week, citing a New York Times report that Ranaan Agus, head of
Goldman’s equity prop trading desk, will move over to asset management
to start a new fund.

Part of his principal strategies team – the formal name for the prop
desk – will join Mr Argus to start the fund, which insiders told the
NYT could reach $10bn. The fund will raise money both from within
Goldman and from outside investors.

The fund, through which Goldman can continue to put its own money in
the hands of Mr Agus, as well as generating fees and offering a vehicle
for its clients to invest in, will be the bank’s first large long-short
hege fund.

Sounds as though it might just be a safer bet than Global Alpha, at this point.

This entry was posted by Gwen Robinson
on Wednesday, August 8th, 2007 at 7:00 and is filed under Capital markets, Hedge funds. Tagged with continental, eads, Fiat, goldman sachs. You can follow any responses to this entry through the RSS 2.0 feed.

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From tomorrow’s WSJ

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Blind to Trend, ‘Quant’ Funds Pay Heavy Price

By HENNY SENDER and KATE KELLY

August 9, 2007

Computers don’t always work.

That was the lesson so far this month for many so-called quant hedge funds,

whose trading is dictated by complex computer programs.

The markets’ volatility of the past few weeks has taken a toll on many

widely known funds for sophisticated investors, notably a once-highflying

hedge fund at Wall Street’s Goldman Sachs Group Inc.

Global Alpha, Goldman’s widely known internal hedge fund, is now down about

16% for the year after a choppy July, when its performance fell about 8%,

according to people briefed on the matter. The fund, based in New York,

manages about $9 billion.

The fund’s traders in recent days have been selling certain risky positions,

according to these people. Early this week, those moves sparked widespread

rumors on Wall Street that the entire fund might be shut down. A Goldman

spokesman has said the rumors are "categorically untrue."

Campbell & Co., an $11 billion hedge fund that trades in the futures market

as well as in stocks and bonds and is completely driven by such computer

programs, was down 10% to 12% by the end of July.

Quant funds — "quant" stands for quantitative — generally operate by

building computer models of market behavior and then allowing the computer

programs to dictate trading. A recurring characteristic of the recent

trouble in financial markets is that many lenders, funds and brokerages were

following statistical models that grossly underestimated how risky the

market environment had become.

"Our risk models failed to pick up the fact that we were due for a

correction," says Keith Campbell, founder of Campbell & Co. "We were highly

diversified. It was the perfect negative storm."

Campbell’s losses occurred because of wrong bets on interest rates,

currencies and stocks. While Mr. Campbell declined to disclose just how much

leverage was behind his trades, he says Campbell isn’t "a highly levered

house."

He told investors that the losses stemmed from "a unique combination" of

factors. These included the unwinding of the world-wide carry trade — where

investors borrow money in low-interest-rate currencies to invest in higher-

yielding assets — an investor flight toward less-risky investments and the

stock market’s reversal.

Mr. Campbell called the recent market turmoil "very unusual." Critics say

that is one of the drawbacks of the investing style. Much of the time, the

market can be accurately modeled by computer programs. The times when they

don’t work are treacherous.

"All [computer-driven] managers say the models make sense and look like they

are working," says Bill Johnston, founder of Bayon Capital, an investment

fund based in San Francisco that isn’t computer-driven. "But then something

happens which statistical probability suggests would never happen."

Rumors of forced selling in the wake of losses contributed to the volatile

ride in the stock market yesterday.

Not all quantitative funds are struggling. Renaissance Technologies Corp.,

the most successful quantitative-hedge-fund manager, is holding up despite

the market’s downturn. Renaissance’s flagship Medallion hedge fund is up

about 25% so far this year, while the firm’s Renaissance Institutional

Equities Fund is down slightly, according to a person close to the firm.

Medallion made money in July, though it hasn’t fared as well so far in

August, the person said. The Institutional fund lost about 3% in July, in

line with the overall market.

Other hedge funds declined to disclose to brokers or portfolio managers in

charge of so-called funds of hedge funds just how badly wounded they have

been by the recent extreme swings.

In most cases, their losses had nothing to do with the meltdown in the

subprime-mortgage market and occurred across all strategies. Moreover, in

many cases, those losses were magnified by the use of borrowed money.

Yesterday, many fund managers were watching for additional knock-on effects

of recent losses, which have forced funds like Global Alpha to liquidate

certain risky positions. Some think the pain will next be felt overseas, in

places such as the United Kingdom and Japan, where asset managers are also

likely to begin offloading riskier bets.

The reliance on models can be especially problematic because many quant

hedge funds have very similar models. That means they are often doing the

same trades and buying the same shares. Moreover, because the strategies are

supposed to be market-neutral, with no net positive or negative bent, the

funds often borrow large sums so they can bet more and achieve better

returns when things go their way.

That massive borrowing adds to the pressure when markets reverse course

several times in the course of a single day, as the stock market has done

repeatedly in recent weeks, or when tried-and-true relationships between

different markets suddenly break down.

–Gregory Zuckerman contributed to this article.