This year has shown that the majority of big name investors/traders have appalling risk-management skills. Basically their technique is to be long - either outright, or in a roundabout way - and hope. A serious bear market has screwed them badly. This implies that their returns were made by taking gigantic risks. Their true Sharpe ratios are probably not that good. Why do so many of these guys have such noob risk management skills? They are supposed to be professionals. Drawdowns of 40%+ show that they weren't managing risk in any meaningful sense.
The sharpe ratio itself is flawed. Thats a start. If people were actually trading appropriately, daytraders, option sellers, insurance writers... and so many hedge funds wouldn't exist in any kind of quantity like they have over the past 10 years. In Canada, like many financially sophisticated places over the past 10 years I read that only 2.4% of managers beat the 10 year return of Canadian saving bonds. Its all about Marketing, not about risk. You might get some return to systematic managed futures again when people realize the manufacturing of sharpe ratios between various parties no longer works.
Its interesting. everybody makes fun of LTCM but most of these investors traders put their money to work like them. they look at historical data then say 'this is the cheapeast since 19XX' 'this is not supposed to be priced like this since bond yields are at X'. I bet Ospraie LLC wasn't expecting a more than 20% decline in commodities(heck I wasn't either), now its at 50%. Just goes to show historical data is so frigging dangerous, the paranoids always live
My guess would be a combination of forced deleveraging with liquidity issues i.e can't get out of positions without a huge concession plus their supposed stella returns were Walt & Irmas buy and hold return juiced to 30-40% by 4:1 + leverage. Just look at their holdings. Their results can only really come from leverage.
Yeah but the irony is that historically, much worse has happened than this. 1932 for stocks, for example. 1980-82 in commodities where silver went from $55+ to $10 and gold halved. So anyone who looked at a mere 70 years of data could have seen this was possible, without even needing to anticipate so-called "black swan" events (e.g. 1987) - it has all happened before in many, many markets, and much worse than this in some cases. Also you don't have to have expected the recent declines. I was bearish on stocks in the summer, and turned from bullish to moderately bearish commodities in August. Despite that I definitely didn't expect such large declines. But I certainly had in place positions and risk control (stops & options) so that huge declines would not cause me a gigantic 30%+ drawdown if they did in fact happen. My plan if the S&P hit 800 and oil hit the low 50s was not to go "Oh shit, I just lost 50% in 3 months". It was to either stay out, or if I bottomed fished (which I did eventually), to get the fuck out if it kept going. Risk management is not about keeping losses low when what you *expect* to happen does in fact play out - that is easy, in fact you will make profits not losses in that case. Risk management is about saving your ass when you are *completely and utterly wrong* in your positions. Clearly most of these guys had no plan whatsoever for if they were totally wrong. Also I don't buy the liquidity arguments. When you are trading size, liquidity is one of the *first* risk factors you consider. Just as with short-selling, you check the float first (some forget that with VW too), potential corporate activity second, and only then consider placing a trade. I can understand an inexperienced home trader forgetting this stuff, but a professional multi-billion dollar hedge fund with dozens of staff on six and seven figure salaries? Come on. There are two explanations. The charitable one is that it's total f*cking amateurism and noobishness. The sinister one is that they knew exactly the risk they were taking, but were gambling with investors money in order to earn performance and management fees, effectively writing deep OTM puts on risk, using the trader's option to earn money for earning no long-run return (or an infinite negative long-run return).
It seems very common that market professionals take huge losses on shorts when a market becomes the pension overweight or retail frenzy. Think of Soros/Druckenmiller getting killed on tech shorts because their frame of reference was the P/E at which the mutal funds that had previously dominated the market reached their 'nosebleed valuation' perception. The public buys on incremental good news. Likelwise Ospraie got killed by shorting copper ahead of the pension fund overweight if I remember correctly.
If you look at some of the stocks they were holding as recorded by the GS hedge fund index it is obvious that they were all in a crowd trade. I disagree that liquidity was not a factor. They were all holding the same thing which in a sell off would mean stuff ordinarily liquid enough was not liquid enough, and some of this stuff was not huge e.g. POT. With institutional size you get out when the market lets you out if there is no one to cross with - which there probably wasn't. It can take ays or weks to unwind a multibillin dollar AuM funds size in noemal conditions, if you were forced deleeveraging into that you would be doins so against competition from others and comptition from all the counterparties working YOUR order. Look at the big name buy side holders of bankrupt and internet stocks. it's not just becuse they do nothing(and they they don't) , it is because it very quickly reaches the stage where they can't do anything. They had to keep the game and thius the monthly performance going - the industry structural imperative that Klarmann talks of. If you did the sensible thing and went to cash you would immediately face masive withdrawals so you had to keep dancing even though you knew this was a game of musical chairs with 2 chirs fro every 10 or dancers.