Hedge funds have had some terrible results lately. And while the hedge fund industry has long been steeped in secrecy, copies of the letters they're writing to investors are surfacing -- and make for interesting, if sobering, reading.
I was inspired to dig up a hedge fund letter to investors, to see what I could find. My little quest was rather eye-opening.
A soap opera
The opera Tosca is a tragedy about love, torture, betrayal, sacrifice, murder, and suicide. To its investors, the recent performance of the Tosca hedge fund was a tragedy, too, featuring a loss of about 57% year to date, as of the end of September. (The month of September alone featured a 35% loss.)
So what did the managers of the London-based fund have to say? Well, they acknowledged the bloodletting, but from their language you might think it was more of a paper cut than a triple amputation: "We understand that the circumstances have put both us and all our investors under strain." They apologized for the results, and said they were confident they could explain how the performance "will be recovered."
Let's think about this. For one thing, I don't see how anyone can be so sure that certain losses will be recovered. It might be an aim, but it can't be a certainty. The fact is that we never know exactly what various stocks or the market will do over the short run. Even in the long run, the best we can do is calculate probabilities.
For instance, based on my estimates of its future earnings, my calculations may tell me that Lowe's (NYSE:LOW) is worth $40 per share when it's trading around $20, but I can't be sure when or if it will hit $40. I can be reasonably sure it will at some point. I bought into Starbucks (NASDAQ:SBUX) awhile ago, feeling sure it was undervalued. Well, it's down more than 50% now. Was I wrong? Not necessarily. I think I'll eventually be well in the black. But it may take a while. The same goes with my investment in General Electric (NYSE:GE), also considerably underwater.
The blame game
The folks at Tosca seemed to be pointing a lot of fingers. They explained that their fund was "damaged by the failed global monetary system." Also cited were regulators clamping down and manic media coverage of the collapse. Oh, and the fact that they owned restricted shares of Washington Mutual that they couldn't easily sell. (Much of Washington Mutual was sold to JPMorgan Chase (NYSE:JPM).) They even blamed their own shareholders, citing redemptions as a cause for some losses.
Well, that's kinda, sorta true. When a fund underperforms, shareholders do often withdraw their money. And if a lot of them do that, the funds have to sell various holdings (often at a loss) in order to be able to cash out those shareholders. But I would think that managers would know and expect this. It's all fair and part of the rules.
The Tosca managers speak of positioning their portfolio to take advantage of undervalued securities. They ask investors to be patient. Fair enough -- that's actually a good way to invest, focusing on company fundamentals and not looking to just take advantage of momentum.
Contrast
I can't help but think of Warren Buffett's famous letters to shareholders, and how he speaks clearly to the people he thinks of as his "partners." What Buffett has done over time, and what some hedge funds might also do, is spend time educating and informing their shareholders as to their investing philosophies and styles. Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) shareholders know to be patient. They know that long-run results are what really matter. They trust their money manager.
If hedge fund investors are bailing out (and many have, from many different hedge funds), perhaps it's because they don't trust their money managers. Perhaps they don't understand how the fund has set up its portfolio and what to expect in various time frames. An investment in better communication might pay off well.
