Friday, September 15, 2006

The Hedge-Fund King Is Getting Nervous

The Weekend Journal has a rambling piece about Steven Cohen, the SAC Capital Hedge Fund founder and trading guru. It's mostly a fluff piece, but still a fascinating story all the same.

The author received rare access to Mr. Cohen's business (Cohen sits in the center of a giant room full of traders), and home ("name dropping" every major painter that ever lived- and how much he paid for each).

More importantly, Mr. Cohen opens up about the crowded hedge fund trading, and what that probably means in the not too distant future.

[Cohen's] success has inspired a generation of scrappy Wall Streeters -- some of them with no experience whatsoever handling other people's money -- to open their own hedge funds.

That quick-trading game is now over, says Mr. Cohen. With about 7,000 hedge funds competing for investment ideas, good stock investments are getting more scarce. "It's hard to find ideas that aren't picked over, and harder to get real returns and differentiate yourself," he says. "We're entering a new environment. The days of big returns are gone."

To make matters worse, the stock market, he says, is no longer as forgiving for investors. The tailwind of low interest rates, low inflation and strong corporate profits, he says, has been lost. There are no more easy pickings, he says...

The throng of rival hedge funds could create a dangerous logjam, he says. Mr. Cohen worries that some of his largest holdings are also favored by other hedge funds. A rush for the exit could spell trouble. He says he expects that eventually there will be a sudden and sharp reversal in the stock market -- but he's not worried about that happening this year. "There will be a real decline that may devastate hedge funds that have crowded into the same stocks," he predicts.

"Hedge funds are bigger than they used to be. Their positions are bigger," he says. "I worry that if everyone were to sell, could we get out?"...

As is typically the case with a "Rags to $3 Billion in Riches" story, the whole thing is a good inspirational read. But I also thought it was interesting the way the author came full circle in the final paragraphs.

Mr. Cohen concedes that holding investments longer and betting bigger could lead to lower returns. A year ago, SAC told investors the fund was aiming to return between 10% and 15% a year, people familiar with the matter say.

That isn't the only risk. These days, many of Mr. Cohen's big bets are popular with other hedge-funds. SAC's top holding in August, Time Warner Inc., is held by 79 other hedge funds, according to Goldman Sachs Group Inc. Atlanta-based energy company Mirant Corp., another big holding, is held by 97 hedge funds. If the funds tried to bail out of these stocks en masse, share prices would likely tumble.

Mr. Cohen says he worries about whether SAC's investments are beginning to look like those of any other hedge fund. What's worked for SAC in recent years, he says, may not work going forward.

On June 9, around midday, Mr. Cohen walked off SAC's trading floor and slumped into a chair. The markets had been choppy all week. He was growing more certain that stocks were in for a significant decline, but ventured that it was more than a year away.

"The hedge-fund run is not over," he said. "I think the game is changing, and if it is, I have to react. We won't go off the ledge with everyone else."

I've got good news and bad news.

The bad news is the market is going to hell when all these hedge funds realize they're the ones that have run the whole thing up in the first place. The good news is you've got about a year. (Seriously, regardless whether it takes a week, month, or year, I've got a feeling Cohen comes in to work everyday and keeps one hand on the panic button.)


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