NO QUARTER FOR CORRUPTION (Focussing on The Fed./FRBS)

[bartermania]

Failed hedge funds make a big noise
Thursday, June 09, 2005

By Len Boselovic, Pittsburgh Post-Gazette

In the pantheon of hedge fund blowups, the $215 million that Downtown money manager MDL Capital Management lost for the Ohio Bureau of Workers' Compensation is small potatoes.

Nor is Mark D. Lay, who built MDL into an influential $2.8 billion money management firm that has stumbled in recent years, the first investor to lose millions making an errant bet on interest rates.

But the loss will put increased scrutiny on hedge funds, an $875 billion industry that's growing about 20 percent annually, according to figures from The Hedge Fund Association.

The investments, which rely on such techniques as interest rates swaps, options, futures contracts and other complex strategies that typically involve borrowing money or putting down only a fraction of funds, were once strictly targeted at affluent individuals.

Now, pension funds and other institutional accounts are using them to offset risk and enhance performance, particularly at a time the stock market, coming off its steep sell-off earlier this decade, is struggling to generate the sort of returns that seemed commonplace in the go-go '90s. While they are still off limits to most individuals, investors don't have to be as affluent as they once did to buy into the exotic funds.

In the right manager's hands, hedge funds can outperform plain vanilla stock and bond investments with less volatility and less risk. This year, their performance has been less than spectacular.

Because of the leverage involved -- it's not unusual for a hedge fund investor to control $100 million in securities with a $5 million down payment -- the consequences can be dramatic when hedge fund managers' bets go awry and they have to make whole on their bets.

In 1998, the Federal Reserve Bank of New York orchestrated the $3.6 billion bailout of Long-Term Capital Management, a hedge fund that faced enormous losses after Russia devalued its currency and defaulted on its bonds.

In April, the SEC announced proceedings against Advanced Investment Management, a defunct Fifth Avenue Place money manager that rang up more than $415 million in losses for its clients, including Allegheny County's pension plan.

According to the SEC, the firm purchased futures contracts for stock market indexes at 5 percent of what the actual basket of index stocks would have cost and invested the other 95 percent in short-term, high grade debt. As long as the market went up, AIM would see the value of the contracts rise in tandem, earning it profits at a fraction of what it would have cost to buy all the stocks itself.

But when the stock market went south instead, AIM increased its stake in the futures contracts in hopes of making up for the losses. The additional investments magnified the losses when the stock market continued to fall.



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