WorldCom has had a damaging effect on the stock markets, US investor confidence and hedge funds, wr...
WorldCom has had a damaging effect on the stock markets, US investor confidence and hedge funds, writes John Butcher.
Certain hedge fund strategies could be hit and long-term investor attitudes changed while bankruptcy fears have gripped many US investors and proved another knock to confidence.
The collapse of WorldCom and similar stories, are making credit risk hedge fund strategies more dangerous, according to David Smith, chief investment officer, multi-manager group, Global Asset Management.
The number of funds relying on an in-depth analysis of credit risk has been increasing and those that have bought into distressed companies like WorldCom, only to find they are more distressed than expected, stand to lose out, he said.
'The point with WorldCom is that it exposes what I have always suspected ' that these strategies are in fact far less hedged and do have notable risks. Some have viewed them as free lunches, especially some less experienced investors.'
There may be investors who did not realise where they were investing who will also lose out because of a tendency for some hedge funds to mis-represent themselves, he added.
'A lot of people have been buying into distressed debt ' into the Enrons and similar stories ' putting them into their portfolio and describing them as arbitrage positions, because investors do not like them buying distressed positions,' he said.
Smith suspects WorldCom-type stories will have a, 'big effect on certain strategies.'
Some of the major convertible bond, distressed and fixed income arbitrage have been hit by 1%-3% and some of the lesser players are down even more, according to Smith.
'We have been warning investors for sometime about these strategies and I have been wrong as they have been making money, however, I think if the markets continue, the less experienced managers will lose even more,' he said.
'The true greats in this sector, and there are some really talented teams here, will have the market experience to hedge their portfolios well and keep to their risk disciplines. However, maybe some of the less able managers who have enjoyed the rising tide in this sector are about to be exposed.'
With even some big names being affected, smaller players could be hit hard, he added.
The longer-term outcome will be that investors become disillusioned and distrustful and look for far greater risk/reward rates than ever before, said Smith.
'There will be creeping disillusionment from investors,' he added. 'Death by 1,000 cuts ' continual disappointment due to a misconception of what they were buying.'
The immediate market reaction to WorldCom was for the Dow Jones industrial average and Nasdaq composite to open down 2% and 3% respectively on Wednesday 26 June.
Nearly all telecom stocks initially followed the market reaction to WorldCom, but this position diverged to become one of haves and have-nots.
Bankruptcy concerns gripped investors and Qwest was placed as the next candidate, falling 57% by the end of trading. Similarities between WorldCom and Qwest included the departure of a high-profile chief executive officer, large debt and an SEC investigation.
Shares in Sprint FON Group and AT&T also fell.
The reaction of the Dow Jones Sector Titans 30 Index was to remove WorldCom.
The WorldCom scandal has validated fears in the US about the reliability of corporate accounts, according to Haydn Davies, chief economist of Barclays Global Investors.
While investors were already betting WorldCom would go bust it is yet another knock to their confidence, which has already been sapped by tension in the Middle East, the threat of a terrorist attack and concerns the global economy is not in as good shape as had been hoped, he said.
Data quality is key
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