Are Hedgefunds A Bubble? Or Just In Toil & Trouble?
Today we’re back to our posts on James Montier. I’m featuring a strategy paper he wrote in 2004 on the potential hedge fund bubble. How prophetic this strategy paper has proven to be. Click Here To Skip The Introduction & Read Jim Montier’s Prophetic Words On The Hedge Fund Bubble
Article Introduction & Excerpts (Via DRKW)
Fads come and go in investment, just as they do in fashion. The current darlings of the investment world are the hedge funds. However, to us it appears hedge funds are a bubble, and one probably very close to its peak. Investors are chasing returns and underestimating the risks involved. The euphoria won’t last forever.
“The Kindleberger/Minsky model provides a useful framework for analysing bubbles. According to this view bubbles pass through five stages. We apply this approach to hedge funds.”
“We suspect that hedge funds are currently in the euphoria stage (the third stage). Euphoria is accompanied by returns chasing behaviour, the overestimation of prospective returns and excessive gearing. We find evidence of all of these. Investors are clearly throwing money at funds that have had the best performance. In fact, there is a negative relationship between inflows and returns. This is consistent with overcrowded markets and alpha cannibalisation.”
“Investment banks have followed the hedge fund lead, and stepped up their leverage massively. The average VaR is 32% higher than it was a year ago. Plus they are all counting on a large diversification reduction (on average reducing their VaR by almost 50%!). Given overcrowded, one way round markets, counting on diversification may not be the best strategy. If we are right about the demise of the global reflation trade, it may not be long before we slip into the fourth stage: – financial distress.”
Click Here To Read Jim Montier’s Prophetic Words On The Hedge Fund Bubble
