During my last vacations, I ended up reading the book “Money Mavericks: Confessions of a Hedge Fund Manager” by Lars Kroijer which I found to be very interesting. The world of hedge funds is something that I’ve written about in the past and that’s always interested me.
This particular book was very interesting to me for 2 main reasons:
-the author is very good at explaining how things evolved in his fund and why he took specific decisions about trades, strategies, leverage, etc. He is very honest about mistakes that were made or about what he and his team had in terms of strengths, etc.
-The fact that he has a somewhat similar strategy to my long & short tech stocks. In his case, he was mostly doing “arbitrage” that could be called capital structure long & short arb.
His fund had a very tough start in terms of raising assets which is not surprising given how young he was but ended up managing over $100M.
It’s interesting how managers often talk about strategies only working for a given size but then when more investors show up, it becomes very difficult to refuse them which ends up becoming a problem. Luckily (or not), I’m not likely to face that anytime soon.
Another issue though is that long & short funds typically use leverage to some extent. That means a bad pick can end up having a significant impact on the fund. I have not increased the amount of leverage that I use but it’s always a tempting way to increase returns. That can be an issue when overall returns are negative but even more so when one pick goes bad.
It’s happened to me a few times over the years and while those hurt, they never killed me. And yes, somewtimes they go the other way. I was short RAX which got killed last week:
But then imagine being short a stock like Green Mountain when Coca-Cola (KO) announces it’s buying a 10% stake. A fund that is highly leveraged could end up suffering a significant loss on one event which then starts the whole redemption/getting out of trades at bad prices/worse returns/more redemptions, etc
The way this guy put it, his clients were asking for more leverage which makes a lot of sense. But then he probably knew that a blow (in his case, it was very bad earnings from one holding) could/would eventually happen resulting in a big loss. So should he have resisted? Perhaps.
I’ll try to always remember these lessons and give myself more margin for error… but who knows how that will work out
In any case, I highly recommend you reading it.