Knock Out

Two More Hedge Funds Bite the Dust

Knock Out

In a recent Wall Street Journal article1, we learned of the closing of Rinehart Capital Partners LLC which specialized in emerging markets stock picking. Interestingly, the manager (Andrew Cunagin) blamed high-frequency trading (HFT) for the shutdown:

“This is a circus market rigged by HFT and other algorithmic traders who prey on the rational behavior of warm-blooded investors.”

This sounds like something straight out of Michael Lewis’s book, Flash Boys, which we discussed here. While we tend to associate the HFT phenomenon with the technologically advanced US markets, Cunagin describes it as a worldwide problem, even affecting the Mexican stock market. He dismisses the search for a “level playing field” as an exercise in futility. Facing losses of 7% in 2012, 15% in 2013, and 4% through midyear 2014, Cunagin decided to throw in the towel.

Another hedge fund manager who also recently shut down his fund is Steve Eisman, one of the lead characters of another Michael Lewis book, The Big Short. You may recall that Mr. Eisman was one of the few managers that correctly called the subprime mortgage meltdown of 2007-8 and also had the good fortune of not being too early to The Greatest Trade Ever. Unfortunately, lightning did not strike twice, and his fund (Emrys Partners LP) delivered market-lagging returns of 3.6% in 2012 and 10.8% in 2013, according to this Wall Street Journal article2. In the regulatory filing for its shut down, the firm wrote that “making decisions by looking solely at the fundamentals of individual companies is no longer a viable investment philosophy.” Perhaps they did not get the memo from legendary investor Benjamin Graham who made this startling admission in an interview shortly before his death:

“I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity say, forty years ago when our textbook Graham and Dodd (Security Analysis) was first published. But the situation has changed a good deal since then. In the old days any well-trained analyst could do a good professional job of selecting undervalued issues through detailed studies. But in light of the enormous amount of research now being carried on, I doubt that in most cases such extensive efforts will generate sufficiently superior returns to justify their costs.”

So what did Professor Graham advocate in place of elaborate security analysis? He explained himself in the same interview:

“The thing that I have been emphasizing in my own work for the last few years has been the group approach, to try to buy groups of stocks that meet some simple criterion for being undervalued—regardless of the industry and with very little attention to the individual company.”

We don’t know about you, but to us, this sounds very much like a value-tilted index fund.

For many years, IFA has advised investors to steer clear of hedge funds. Their “two and twenty” fee structure makes it very difficult for investors to earn a return that is appropriate for the risk undertaken. Also, their opaque structure makes it very difficult (if not impossible) to assess their risk exposure. Sometimes, hedge fund investors don’t find out how much risk they had until it is too late, as happened with Amaranth Advisors. If you are currently invested in a hedge fund and having second thoughts, please give us a call at 888-643-3133.

1Copeland, Rob, ”Fast Traders Blamed as Firm Closes.” Wall Street Journal, 9/5/2014.

2Chung, Juliet, “Emrys Partners Hedge Fund Shuts Down.” Wall Street Journal, 7/3/2014.