Thursday, August 9, 2007

Goldman Hedge Fund Takes A Hit

From the WSJ:

The markets' volatility of the past few weeks has taken a toll on many widely known funds for sophisticated investors, notably a once-highflying hedge fund at Wall Street's Goldman Sachs Group Inc.

Global Alpha, Goldman's widely known internal hedge fund, is now down about 16% for the year after a choppy July, when its performance fell about 8%, according to people briefed on the matter. The fund, based in New York, manages about $9 billion.

The fund's traders in recent days have been selling certain risky positions, according to these people. Early this week, those moves sparked widespread rumors on Wall Street that the entire fund might be shut down. A Goldman spokesman has said the rumors are "categorically untrue."

Campbell & Co., an $11 billion hedge fund that trades in the futures market as well as in stocks and bonds and is completely driven by such computer programs, was down 10% to 12% by the end of July.

Quant funds -- "quant" stands for quantitative -- generally operate by building computer models of market behavior and then allowing the computer programs to dictate trading. A recurring characteristic of the recent trouble in financial markets is that many lenders, funds and brokerages were following statistical models that grossly underestimated how risky the market environment had become.

Program trading has been popular and widely used for the last 20-25 years (and maybe longer). It greatly exaggerated the 1987 drop which led to trading curbs in volatile markets.

But notice what has happened. The programs in this hedge fund did not count on an increase in volatility. There was an underlying assumption of an orderly market. That's a huge assumption. But it also explains part of the overall market psychology. Traders have been lulled into a particular market perspective. That partially explains the increasing volatility over the last month or so. Traders are having an "oh shit" moment, when their overall psychology is completely crushed and they have to come to a new understanding of the market. And that event -- in and of itself -- implies an increase in volatility.