January 2001 Newsletter
Issue One, Volume Two

HEDGE FUND TIME AGAIN!

By Mike Gasior

It is only the end of the year's first month, but already 2001 seems to be shaping up as an exciting one for the world's financial markets. Volatile stock markets. Volatile interest rates. Volatile currencies. A few volatile political situations. All of this can't help but make for good entertainment to those of us who make our livings in, and around, these markets. It proves even better for those of us who write our wit and wisdom into newsletters. So here goes.

A FEW ITEMS

A year ago I offered readers of this newsletter a copy of a wonderfully helpful document for those of you who either work with derivatives or who manage the professionals who trade them for your organization. I am now making available for download via the website. It was produced in 1996 by the Risk Standards Working Group and is called "Risk Standards for Institutional Investment Managers and Institutional Investors". It is my opinion that in the coming months we are in for a very interesting and volatile period in financial history. Perhaps equal to 1994, when interest rates went pretty crazy. We endured a series of tightenings by the Federal Reserve and the 30 Year Treasury Bond going from a 5.85% yield to an 8.15% yield in about 10 months. I won't bother to recap the series of Derivative disasters which resulted during that period, but organizations were left to scramble to assess whether adequate controls were in place to safeguard them against unrecoverable losses.

Many of them would have been VERY well served if they had had the chance to review this document sometime in 1993. I can honestly say that many of 1994's headlines could and would have been avoided. (Read Orange County and many others into my reference)

Also, the website has been revamped and all the 2001 schedules have been posted and are up-to-date. In addition to a week-long series of seminars in Bermuda in November, we have also added a week of programs in Grand Cayman in July. If you would like more info on Bermuda and Grand Cayman programs, as well as downloading the "Risk Standards" document in Adobe Acrobat format just visit our homepage at http://www.afs-seminars.com

You may also view all of last years newsletters on the website as well.

Now to the topics of the month.

CALIFORNIA AND ELECTRICITY

I apologize for being unable to not make a comment about the current situation in California, but I was raised in a household where my Dad spent over 30 years working for a utility company. I also spent a summer vacation working in a power plant myself, and the two items contribute to my current view about this crisis. Without trying to be callous to the people suffering innocently because of the hugely increased rates and rolling blackouts, I sum up my entire opinion in a simple five words:

You reap what you sow.

--California hasn't built a new power plant in over a decade.
--California has closed their nuclear power plants.
--California has closed their coal burning plants.
--California has FEWER power plants now than 10 years ago.
--According to U.S. Census Bureau data, California grew by 4.1 million people in the past decade.
--California already cannot produce all the power it needs everyday within it's own borders.
--There was a massive shortage of natural gas recently which caused prices to explode by six fold over a year ago. Sadly much of California's power is generated with gas.
--The State Government's mantra was that we don't need more megawatts - we'll make it happen with "negawatts". For those of you not versed in "cute" this means they thought they could solve everything with conservation. I guess they were wrong. I'll bet the smart asses in the advertising agency that dreamed that one up would take a few megawatts now.
--California tried the "deregulation" experiment which would allow literally anyone to sell electricity to consumers. The unfortunate part was that they capped what these parties could charge consumers for the power. Well that's great if the "cap rate" is $200 per megawatt hour and I can buy it wholesale for $150 and pocket a nifty $50 profit. A problem rises when the wholesale price rises above $200. You can bet your backside I'm not going to sell you electricity now and suffer losses, and you can't MAKE me sell it to you either. Oops.

Now to put this horse to bed; Governor Gray Davis made things even worse by threatening to take over the State's utilities by Eminent Domain if they (the utilities) don't fix this soon. Well if you scroll upward and remind yourself that the State's utilities don't make enough power in the first place. That seems to me like the world's stupidest idea ever. An idea that potentially could bankrupt these companies since who the hell is going to lend these utilities money or buy their stocks if the state is threatening to take them over. Stupid, stupid, stupid. Unless of course he it thinking of mobilizing the National Guard and invade some neighboring states to take over THEIR utilities. Good grief.

The answer seems pretty simple, but it will take a long time to work out. California needs more power plants. Should they decide to depend on the good graces of others they will find themselves in this situation again, and probably often. The other answers aren't very environmentally friendly either; kerosene lanterns or perhaps whale oil?? Just fix the politics. And don't try blaming this one on "W" like I've already heard some stooges on TV doing. My Mom would tell me as a kid; "you made your bed and now you can lie in it." Of course I never actually made a bed for in my entire life, but I do live with it unmade and that's how life goes. Nightie night California.

TIME FOR HEDGE FUNDS AGAIN?

Usually, when the tide begins to go out, it results in the lowering of many, if not ALL boats. Well the stock market tide is heading out and over the years hedge funds have proven a pretty good port in the storm of Bear Markets. I always hate pulling the old farty stuff on you guys, but it never ceases to amaze me how bull markets like we've enjoyed the past 18 years seem to make for millions of geniuses. Well suddenly all of these smarties aren't looking that bright anymore.

I needn't remind anyone that 2000 was a dismal year for U.S. stock markets. The S&P 500 was down 2.7%. The NASDAQ was down 17.2%. The average mutual fund barely made it into positive territory chalking up 0.5% returns. Since it is difficult to get precise numbers because of the secrecy under which most hedge funds operate, I have seen reports showing from 10% to 12% returns as the "average" for last year.

For any of you who don't really know much about hedge funds, or how they operate, let me run down some basic ideas.

--Most seldom actually "hedge" anything. The term was coined early on when many would go long one stock in a particular industry while shorting another stock in the same industry. The truth is, with regard to derivative usage, most "hedge" funds actually tend to use them for speculation.

--The term "Hedge Fund" goes back to 1949 and was first used for A.W. Jones Group.

--Hedge funds are not available to the "public" and are available via "private placement" only. This allows them to do things that mutual funds are not allowed to do (like sell short, speculate in derivatives, use leverage and so on). This also makes it difficult for the public to find information about hedge fund performance.

The other factor that might make hedge funds superior to mutual funds and other vehicles is that they have tremendous flexibility in what they can invest in, as opposed to the mutual funds which often must be managed via strict guidelines. For example, if I'm allowed to short sell it enables me to make money even during declining markets. This might prove a huge advantage for quite a while going forward. Some month soon I'll spend a little time discussing particular hedge fund styles of management.

There are lots of factors that can contribute to this, and why I think that hedge funds might prove a superior harbor for money in the coming few years. One is the talent drain that has occurred from the pension, insurance and mutual fund industries to the hedge fund industry. Most hedge funds charge in the neighborhood of 1% management fee to investors, not at all dissimilar to the way mutual funds charge. The big difference, however, is how hedge funds share in the profits when there are any. The most typical arrangement is 80% of the profits going to investors and 20% going to the hedge fund managers. This can obviously create a pool of funds that can compensate portfolio managers that other sectors cannot compete with. For example: Mr. Stanley Drunkenmiller who served as George Soros' Chief Strategist until late last year was paid $450 million in 1998 for his services.

Not to fret for poor Mr. Soros though; his personal take for 1998 was a Guiness Book of World Records record $1.6 BILLION in cash compensation for a single year. If you would like that in a more digestible portion, that means he made $4,383,561.65 a day for the year. EVERY DAY!! For all 365 days. Forget baseball or show business. It seems like hedge fund management is where kids ought to be planning on spending their futures.

Don't think for one second that Soros' clients feel like they're getting the short end of the stick. According to the annual report for his largest fund, The Quantum Fund, here is what YOUR performance would have been if you had invested the minimum $100,000 when he started the fund in 1969 and just left the money alone for the 30 years ending 1998:

--The NAV of your ownership in the fund would be $49,963,635
--AND you have gotten cash distributions of $92,960,400
--For a total of $142,924,035 not counting any interest you would have made on the cash distributions. And no, that's not a typo.

Not too much to be angry about there.

Two major players in the hedge fund business decided to cash in their chips in 2000, and they were Jeff Vinik who ran Fidelity Magellan after Peter Lynch left and Julian Robertson who had run The Tiger Fund, the second largest fund for many years. It might have seemed difficult for them to compete during the Internet feeding frenzy. Or maybe they were just damn tired, and I can't blame them for that. Both had been highly successful during their tenures and their clients will certainly miss them.

TOO FUNNY

I hate to admit that I am watching television while writing this newsletter (multi-tasking??), and that I have on 60 Minutes II. They just did a story on how Wall Street analysts often write glowing reviews of their firms clients and seldom ever write negative reports or suggest selling a stock. For somebody who has been in and around the markets for over 20 years it could just make me puke that this is even a "news" story. Perhaps next week they'll have a breaking story about how it sometimes gets really hot in Phoenix in the summer. I guess it's just another example of the mainstream media covering a story about a year too late, and something that plenty of people already knew about. Maybe they should go to my website and read my newsletters from a year ago when I was telling this same EXACT story.

These morons who were pouring money into these ridiculous Internet stocks learned an important lesson; "A fool and his money are soon parted." I remind everyone AGAIN of my prediction of March 2000......that the NASDAQ would collapse and not reach 5,000 again for 10 years. Well I'm now 10 months into looking amazingly brilliant with 110 months left to go. Now it's time to go off to the bond market for a few years.

Now 60 Minutes II can give up defending all these idiots. Their money is gone and the economy is feeling it. And just because I can't help saying it: Charles Groden is a moron too. His CNBC show couldn't have sucked more, so how did he even get this 60 Minutes gig? Yikes.

FINAL THOUGHTS

I look forward to seeing some of you in New York City on February 26th and 27th for the Mortgage & Asset Backed Securities Seminar. There is still room if you would like to register, and you can do that by calling the office at (860) 347-6568 or going to the website at http://www.afs-seminars.com

Final information about the Bermuda and Grand Cayman programs should be on the site by late February.

http://www.afs-seminars.com

Copyright 2001, Michael Gasior. All Rights Reserved

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