“Carnoustie Effect” Trumps Black Swan
Have you tired of the Black Swan references?
That makes two of us. And from where we sit it appears the Carnoustie Effect is at work in the financial markets.
defined as "that degree of mental and psychic shock experienced on collision with reality by those whose expectations are founded on false assumptions."
False assumptions seem to underpin the pricing of CDO's, at least until reality so rudely intruded on the party. And some investors did not really know what they were getting themselves into, according to Veryan Allen:
It is important when picking investment styles to differentiate between skill-based and risk premium based strategies. I don't think funds simply exploiting a risk premium can be considered hedge funds. Many forms of credit and fixed-income arbitrage just exploit such phenomena. The yen carry trade or positive yield curve trades are examples. In equity-land only a fraction of micro-cap or emerging market "hedge funds" actually are hedge funds; most are just playing the risk premium that often occurs during strong global bull markets. Hedge Fund Blog
There is a big difference in mark to market, and mark to model. What is your margin of safety?
It is not in the nature of proper hedge funds to blow up, it is the nature of hedge fund wannabes and those who don’t understand complex strategies or risk management to blow up. It all comes down to experience in the strategies and due diligence in identifying whether the targeted returns are sufficient for the risks being taken. For illiquid, mark to model credit funds, 1% a month was woefully below the required return for any margin of safety in an obviously hazardous strategy.
Ratings agencies, Ralph Cioffi and others market participants have been taught a very expensive lesson. And apparently, the countless days Jimmy Cayne spent on golf courses have not taught him anything, either.
But some things never change. Golf and financial markets will likely continue to make fools of many of us in the years ahead.
Happy Blogoversary, Veryan.
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