ECB Warns of `Herd-Like' Mentality in Derivatives

Discussion in 'Financial Futures' started by Joma, Dec 13, 2006.

  1. Joma


    What do have the following articles in common ?

    By Hamish Risk

    Dec. 11 (Bloomberg) -- Credit derivatives are causing a ``herd-like'' mentality among investors that may increase financial risk when markets start to deteriorate as money managers rush to exit, the European Central Bank said today.

    Investors are pouring money into securities that group credit-default swaps, known as collateralized debt obligations, the Frankfurt-based European Central Bank said in a report. They are used to speculate on improving credit quality.

    ``By providing unlimited liquidity during quiet times these synthetic instruments can reinforce herd-like behavior,'' the ECB said today in its Financial Stability Review. ``Crowded trades in the credit derivatives market are less visible and potentially larger, and therefore can cause greater systemic problems.''

    Sales of CDOs jumped 73 percent to $446 billion this year from a year earlier, according to data compiled by JPMorgan Chase & Co. The market for credit derivatives is the fastest-growing part of the derivatives market, helping to spur record earnings for banks including New York-based Morgan Stanley and Goldman Sachs Group Inc.

    Banks create CDOs by packaging debt or derivatives into a pool and funneling the payments and collateral to investors. The notes are sliced into portions of varying risk that can offer higher yields than the assets being pooled. The rise in sales of CDOs means a wider group of investors is exposed to any deterioration in global credit quality.

    Investors receiving the highest yields have the lowest priority for interest and collateral and those that receive the least are the first priority.

    ``From a financial stability viewpoint the focus of concern should therefore be on investor behavior, rather than the instruments themselves,'' the report said.

    Highly Leveraged

    Complex credit products tend to be highly leveraged, the ECB said in the report.

    ``This means that the likelihood that positions taken in them would have to liquidated in the event of an adverse market environment is greater, as is the potential market impact,'' the ECB said.

    Banks this year created so-called constant proportion debt obligations, leveraged bets on investment grade securities that provide junk bond-like returns. CPDOs invest as much as 15 times the amount raised from investors in credit-default swaps.

    Credit-default swaps were conceived to protect bondholders against default and pay the buyer face value in exchange for the underlying securities should the company fail to adhere to its debt agreements.

    Derivatives are financial instruments derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates.

    To contact the reporter on this story: Hamish Risk in London at


    Goldman Hires Amaranth Traders as Hedge Fund Stumbles (Update5)

    By Christine Harper and Katherine Burton

    Dec. 11 (Bloomberg) -- Goldman Sachs Group Inc., the world's biggest hedge fund manager, hired 17 traders from Amaranth Advisers LLC to expand the firm's investments in fixed-income markets, said a person briefed on the matter.

    The team includes 14 credit specialists in New York and three in Singapore and will be led by Gregg Felton, who managed Amaranth's investments in debt markets, said the person, who declined to be identified because Goldman hasn't announced the additions. Some of the traders already started at Goldman.

    Amaranth collapsed in September after bad energy bets wiped out 70 percent of its $9.5 billion in assets. New York-based Goldman, the world's largest securities firm by market value, is dedicating more capital to risky strategies after its $10 billion Global Alpha Fund fell 11.6 percent through November and as returns worsen this year across the hedge fund industry.

    ``It speaks to the investment banks' having decided to make a long-term commitment to hedge funds,'' said Les Satlow, who helps oversee $380 million at Cabot Money Management in Salem, Massachusetts. ``They certainly have the capital. If they think they're able to get the talent at the right price, then why not do that?''

    Peter Rose, a Goldman spokesman, declined to comment on the recruits from Greenwich, Connecticut-based Amaranth or Global Alpha's performance.

    Popular Investments

    Hedge funds are private pools of capital that allow managers to participate in gains on the money invested. The average hedge fund rose 11.7 percent in the first 11 months of 2006, trailing the Standard & Poor's 500 Index's 14.2 percent gain including dividends, according to data compiled by Chicago-based Hedge Fund Research Inc.

    Investors pumped $44.5 billion into hedge funds during the third quarter, the most since at least 2003. Hedge funds now oversee a total of more than $1.3 trillion, more than double the amount they managed five years ago. Goldman runs $29.5 billion in hedge fund assets, the most of any firm in the industry.

    Goldman rivals, including Morgan Stanley, JPMorgan Chase & Co. and Citigroup Inc., have been expanding in hedge funds, either through acquisitions or by hiring traders. Hedge fund managers typically charge investors fees equivalent to 2 percent of assets under management and keep 20 percent of returns.

    The former Amaranth traders will invest only Goldman's capital, said the person briefed on the matter. The Wall Street Journal reported the hires from Amaranth on Dec. 9.

    Amaranth's Founder

    Goldman, led by Chief Executive Officer Lloyd Blankfein, probably will say tomorrow that fourth-quarter profit jumped about 80 percent to $5.99 a share from a year earlier, according to estimates from 15 analysts compiled by Bloomberg. That would boost full-year net income to more than $9 billion, more than the combined earnings of the industry's five biggest firms in 2001.

    Felton, 35, who holds graduate degrees in law and business administration from Georgetown University, joined Paloma Partners Management Co. in 2000, where he worked with Amaranth founder Nicholas Maounis. Previously, Felton was at Chase Manhattan Corp., now part of JPMorgan Chase, where he co-managed the bank's distressed-debt investment fund for almost three years. He then focused on convertible bonds for Amaranth's hedge funds.

    At Goldman, asset management and securities services produced $485 million, or 21 percent, of its $2.36 billion in pretax profit for the fiscal third quarter. The Amaranth traders will work for Goldman Sachs Asset Management, which includes the firm's hedge fund business.

    Fee Structure

    So-called alternative assets including hedge funds, private equity and real estate accounted for $139 billion of the $629 billion overseen by Goldman's asset-management division at the end of August.

    Goldman typically receives annual performance fees during the fiscal first quarter ending in February. In the first quarter of fiscal 2006, Goldman's asset-management revenue included $739 million of incentive fees from alternative-investment products, up from $131 million a year earlier.

    The Global Alpha fund, which started in 1995 with $10 million, uses computer-driven models to help make investment decisions. Other so-called macro strategy funds, which bet on global stocks, bonds, currencies and commodities, are up an average of about 7 percent this year through November, according to Hedge Fund Research. Last year Global Alpha rose almost 40 percent, said two investors who declined to be identified.

    Registered in Ireland

    Managed by Mark Carhart and Raymond Iwanowski, both 40, Global Alpha lost money partly on wrong-way bets that equities in Japan would rise, stocks in the rest of Asia and the U.S. would fall, and the dollar would strengthen, according to two investors in the funds. In August, the fund lost almost 10 percent from unprofitable investments in the global bond markets.

    The euro strengthened against the dollar in the past two months, reaching a high of $1.32 against the dollar at the end of November, up from a low of $1.25 on Oct. 13. Japan's Nikkei 225 Stock Index gained about 3 percent so far this year, 10 percentage points less than the S&P 500.

    Allied World Assurance Holdings Ltd. said in an October filing with the U.S. Securities and Exchange Commission that Goldman's Global Alpha Fund Plc, which is registered in Ireland, charges a management fee equal to 1.5 percent of assets and keeps 20 percent of investment gains. Allied World is a Bermuda-based insurer.

    To contact the reporter on this story: Christine Harper in New York at . Katherine Burton in New York at .
  2. Goldman's Global Alpha Fund Plc, which is registered in Ireland,

    why is it registered in Ireland of all places.....anybody know?
  3. Ireland has become a hub for hedge funds. It's no Cayman yet, but it's popular.
  4. zdreg


    be specific to the advantages of ireland.
  5. Well for a start, I'm in Ireland - if that's not enough the Guinness is great, the authorities are amenable, the girls are terrific and there's a Tax Free Zone.
  6. zdreg


    if you make a post which is supposed to be taken as fact you are the one who is supposed to gvie the citation. in this case it was a reference on the internet.

    this post is not only addressed to the poster above but all people who provide facts rather than myths or hyperboles. provide your sources with the post.
  7. Huh? As I said, I used google and found that web page. And yes, that web page is on the internet.
  8. zdreg


    why huh? when you write something as fact it is not for you to suggest that the reader verify your facts. it is you who should have orginally posted your source with the post.
  9. I'm sorry I answered the original question. From now on, instead of answering a question I know the answer to, I will let you do your own research. Why waste my own time doing research for you when I already know the answer and you are too lazy to do the research on your own?
    #10     Dec 14, 2006