“Mind Boggling” Losses Might Mark a Turn

Summer in New England is normally a time to relax. Red Sox baseball, clambakes and sailing are perennial activities from Newport to Maine. For the children of New England, July is the best of times. But for Sowood Capital Management, July was the worst.

Sowood Capital Management LP lost 50 percent in July, or about $1.5 billion, the biggest hedge-fund manager to collapse after declines in the corporate bond and loan markets.

Sowood sold most of its assets to Citadel Investment Group LLC and will unwind its two funds, Jeff Larson, founder of the Boston-based firm, told investors in a letter yesterday. Sowood sought a buyer when it couldn't meet lenders' demands for more collateral. Terms of the sale to Chicago-based Citadel weren't disclosed.

``The transaction enabled us to avoid anticipated forced sales at extreme prices,'' Larson, a former Harvard University endowment manager, said in the letter. ``The weakness in corporate credit, particularly focused on loans and loan credit- default swaps, accelerated sharply during the week of July 23.'' Bloomberg

In the Chicago pits, savvy operators typically "run the stops", looking for weak hands that can be taken out of positions at the point of maximum pain. For Sowood, and Amaranth before it, Citadel and the rest of the poker players knew where the pain would end as the capitulation begins.

This particular episode will be a black eye for the well-regarded alumni of Harvard’s vaunted endowment team, who raised hackles for making big bucks while steering the largest university endowment in the land. Apparently subprime was not the prime culprit here as had been widely assumed. Sowood’s general counsel claimed they were devoid of mortgage backed securities as well, but did hold $6.4 billion in stocks at the end of March. And reading between the lines, some derivatives were part of the toxic stew they concocted. Leverage kills once again.

Sowood’s misnamed Alpha Fund Ltd. and Alpha Fund LP shed 56% and 51%, respectively, in the month of July.  And the reviews are in:

``It’s mind-boggling,’’ said Bradley Alford, a former investment manager at the Duke University endowment who runs Atlanta-based money-management firm Alpha Capital Management LLC. ``This last week, the velocity of losses has picked up dramatically. The models work when they look at history, but not when history is all new.’’

Ken Griffin & Company sat on their hands until they felt compelled to act, knowing their arrival would calm the waters:

After widening out by another 60 basis points in early trading Monday to kiss a recent risk premium high of 602 basis points, the high-yield bond market, as measured by its related CDX derivatives index, snapped back on news that hedge fund Citadel Investment Group is buying the soured credit holdings of hedge fund Sowood Capital, which manages about $3 billion. The CDX index closed Monday at a risk premium of around 500 basis points. The Street.com

Sowood is sorry....

``A loss of this magnitude in such a short period is as devastating to us as it is to you.’’

And so it goes.

Sowood Funds Lose More than 50% as Debt Markets Fall
Bloomberg

Debt Worm Turns for a Day
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