Monday, October 16, 2006

Hedge Funds are Sharing Information....Gasp!!

This lead story in today's New York Times probably has more than a few people nervous in Greenwich and on Wall St.

"The Movie Gallery case provides a window onto the growing power of hedge funds in financial markets, and raises questions about their role in how information flows on Wall Street. Hedge funds have become a dominant force in the New York and London stock exchanges, and now account for roughly half of all trading in those markets. But they also have recently become major players in the more opaque debt market, which includes bonds as well as loans, and is more than one and a half times as big as the stock market.

“If hedge funds are privy to inside information and they invest in different securities all over the capital structure, this raises lots of concerns” said Alistaire Bambach, assistant director for the Northeast regional office of the S.E.C. She declined to comment on any open investigation.

The power shift in the loan market has prompted the trade association for lenders to develop new guidelines, to be announced today, governing how confidential and material — meaning potentially market-moving — nonpublic information is used.

Lending was once a clubby world dominated by banks, which are highly regulated and go to great lengths to separate their various lines of businesses. To keep bankers from possibly sharing inside information with traders, some banks even separate their divisions on different floors and use coded identification tags to restrict access.

“Hedge funds have become a dynamic force in Chapter 11 cases,” said Harvey R. Miller, vice chairman at Greenhill & Company and the former head of the bankruptcy and reorganization group at Weil, Gotshal & Manges. “Where you used to have a syndicate of banks, today you have a syndicate that is mostly hedge funds, and it would appear they have different objectives than a syndicate of banks used to have. Their horizons are much shorter.”

Two quick observations:

1) In 2005 EVERYONE was hot for commodities - gold, oil, copper, etc - and frequent readers will know that I believe the hedge funds pushed prices up 20-30% above their natural levels. Well in 2006 it has been all about debt. Every time I speak to an industry contact they are begging me to help them understand debt instruments. These guys are in way over their head.

2) If you take away information edge, every hedge fund goes out of business. Their entire game is this - the big boys (the Yankees/Red Sox of the Hedge Fund world) get the call first "Movie Gallery is sucking wind", they put on a position and call the second tier of funds (White Sox, Dodgers, Mets) who put on a position and call the third tier (Phillies, Blue Jays), who put on a position and call ......... well you get the idea.

With hedge funds accounting for 1/2 of all trading there is no way Wall Street will let this business model change. Right or wrong (and it's most definitely wrong) this is the nature of the beast.

Update - CNN actually ran the "Why have oil prices dropped?" story. About 2 weeks ago, I said it was no hurricanes, no Iran chatter, changing the Goldman Unleaded futures weighting and Hedge Funds bailing like they were going down on the Titanic. CNN concurs.....

"By late summer, hedge funds and other investors had poured billions into long positions in oil, gasoline, natural gas and the rest of what traders call the "energy complex," all betting on a replay of the severe 2005 hurricane season that sent prices soaring in the wake of Katrina and Rita. But one day after oil reached a monthly high of $76.98 a barrel on Aug. 7, government meteorologists downgraded their hurricane forecast and cautioned that a repeat of 2005 was "unlikely."

That announcement, combined with the end of the summer driving season and a recalibration of the Goldman Sachs commodity index that reduced the weighting of gasoline, prompted speculators to head for the exits even faster than they'd piled in.

According to Joel Fingerman of Chicago-based, between the peak of $77 a barrel in August and the October low of just under $58, traders dumped nearly 40 million barrels (a 20 percent drop) from their long positions. The volatile gasoline market showed an even sharper decline - with traders cutting long positions from 32 million barrels in midsummer to just 1.7 million in October.

"Whatever you want to call it - speculators, fast money, hot money - a big part of the drop in crude that we've seen this year is because of selling by hedge funds," says Merrill Lynch technical analyst Mary Ann Bartels."

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