28 November 2008

Investment Fads

When is looks to be too good to be true there is probably something wrong with it.
We never claimed to be the smartest investor on the block but we always kept a healthy portion of scepticism about any new investment fad that became fashionable in the past few decades. Sometimes experience helps - for who among today's market participants (not to mention regulators) still remembers Bernie Cornfeld's IOS and the infamous Fund of Funds that he peddled in the early 70s?
So we always felt like a helpless country cousin when reading about the untold riches that could be made by so-called Structured Investment Vehicles (SIV's) that invested in credit paper and financed the stakes by issuing short-term debt in the money market. The idea was that this would offer a positive spread (not only due to a generally positive-sloping yield curve but also thanks to 'intelligent' hedging of all associated risks.)
Basically it appeared to be nothing more than blatant market speculation (with leverage added to spice up returns). We were left scratching our heads about how this could work as we knew how volatile markets could be over different cycles. But the scheme worked for a while - thanks to a gradual decline in credit spreads and availability of cheap short-term finance. The staff at these funds reaped huge salaries and bonuses and were quickly set up for life.
But the old saying - 'Genius is being long in a Bull Market' - is still valid. And the bull market in Credit Bonds ended in the Summer of 2007. Since then one of these vehicles after another has hit the rocks. The latest to make (negative) headlines was Sigma Finance where most creditors are facing complete losses when the assets of the SIV are sold next week.