I almost missed this news item in Reuters a week ago regarding growing investor interest in new derivative instruments designed to reduce exposure to hedge funds which have refused redemptions by investors in order to prevent selling assets at depressed prices. According to Elinor Comlay, banks, like BNP Paribas SA and Nomura Holdings, have started to offer "swaps that are meant to offer investors the opposite of returns in hedge funds: if the funds fall 10 percent in value, these swaps should rise 10 percent." These new swaps are structured around mathematical models of expected hedge fund returns.
It sounds almost counter-intuitive for this derivative product to be making headway--again--this early, in light of the current credit crunch, precipitated in large measure by Wall Street-securitized subprime mortgages. Flawed quantitative models with faulty assumptions spooked the whole system. Is the market ready to take a chance again on the checkered past record of quants?
Richard Bookstaber's book, "A Demon Of Our Own Design," is highly instructive in this regard. Mr. Bookstaber, an option theory expert from MIT who had worked at Morgan Stanley and Salomon Brothers, had helped design complex derivatives and sophisticated computer models for making investing decisions. As an insider, he admitted that the recurring turmoil in the financial markets comes more from the complex derivatives designed to control risks than from changes in the economy.
Yet, why is the siren call of derivatives apparently so seductively irresistible despite its tarnished record? Fabrice Hugon of BNP Paribas in New York reported, for instance, that they have sold about $350 million of these derivatives since the middle of September, and that this could double by the end of the year. Hmmm, do markets have such short memories or worse, none at all?
Alas, there's a disturbing answer. According to Alice Yurke, a partner at law firm McKee Nelson, "Some [investors have] kind of a fatalistic view that they've already lost enough and so what's the harm?" That sounds very much like Admiral David C. Farragut's command at the Battle of Mobile Bay during the American Civil War: "Damn the torpedos, full speed ahead!" Indeed, if you are among the investors locked into hedge funds that are losing money, these swaps seem like your only salvation. No wonder.
Make Own Payments?
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2 comments:
Hi Sir, I just saw your link at PMT. I am also interested in the investment banking industry. In fact, I worked in an asset management firm before involved in distressed debts and assets.
Welcome, then, to my blog. Visited your blog. Nice looking.
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