Thursday, March 12, 2009

in bad times, you necessarily start to liquidate your (seemingly) good investments

From Felix Salmon:

Hedge Fund Datapoint of the Day

This is how badly the hedge-fund universe is being shaken out these days: John Paulson lost 16% of his assets under management in the second half of 2008, and still managed to rise to 3rd place in the list of biggest hedge-fund managers, from fourth place at mid-year. Or, to look at it another way, $29 billion in funds under management was enough to garner him eighth place in January 2008, but the same number got him the bronze medal this year.

Paulson's flagship fund returned 38% last year, largely thanks to short bets which paid off when the market tanked in October. Let's say that his investors saw a 20% return in the second half alone, and that he started the second half managing $34.5 billion. Then by the end of the second half, if he'd had no redemptions, he would have been up to $41.4 billion; in fact, however, he was down, to $29 billion. Which implies that even John Paulson -- the one person who seems to be doing unambigously well during this crisis -- got a whopping $10 billion of redemption requests in the second half of 2008.

Now some of that will have been due to simple common sense and portfolio rebalancing: if one of your funds does very well while most of the rest lose money, then in order to keep your asset-allocation decisions constant you need to redeem money from the successful fund and invest it in the less successful ones. If you don't, you end up with too many eggs in one basket.

But I suspect that quite a lot of the requests are a function of a simple need for liquidity: people needing money. It's the same phenomenon which did for Bernie Madoff: in bad times, you necessarily start to liquidate your (seemingly) good investments. Fortunately for his investors, John Paulson, unlike Madoff, is not a crook."


This also goes to the point about not letting Debt-Deflation run its natural course, as Justin Fox mentions today as well. There's no telling where it will end. It's a spiraling downward with no natural stopping point, because you can't predict who and how much and under what conditions investors will flee to safety, or when they'll stop.

So, it leads to this:

"in bad times, you necessarily start to liquidate your (seemingly) good investments."

When people are fleeing John Paulson, you know that you're in the path of some major panic.

If you don't see Debt-deflation as the problem, I can understand saying let it all shake out as it will. If you do, taking that chance seems crazy. You might well shake out enough wealth that only major social change will suffice. Good luck then.

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