The Hedge Fund Name Game: High-Grade And Enhanced Leverage

In a recent post I talked about the dangers of using leverage when investing and how it has helped this market to continue its run toward record highs.

Front page news at MarketWatch tells us some more details about the subprime debacle and its effect on two of Bear Stearns hedge funds, one of them which is down an amazing 91% for this year.

Minus 91%?

Hmm, I guess using sell stops to protect investor capital would be out of the question. Makes you feel kind of glad that you and the size of your portfolio aren’t qualified to participate in these kinds of ventures, doesn’t it?

To make their investors feel better, the company stated that “in light of these returns, we will seek an orderly wind-down of the funds over time.” Oh yeah, that sounds great. Be sure to hurry up, the investors could use the left over money to gas up their cars.

The High-Grade fund had $1 billion in assets while the Enhanced Leverage fund had about $600 million and via leverage they controlled more than $10 billion in mortgage related securities and other derivatives.

I can see why they would name one of their funds the “Enhanced Leverage” fund. What I don’t understand is how the other one can be called “High-Grade Structured Credit,” because of the involvement of subprime mortgages, which are anything but high-grade. The article further states that “the losses partly reflect unprecedented losses in the valuations of several securities with top AAA and AA credit ratings.”

I don’t get that. Either they did not really own AAA rated securities or the ratings were incorrect. On the other hand, maybe they simply misread the label “subprime” loans to mean “supreme” loans? We may never find out but the smart guy in this transaction has to be the hedge fund manager on the other side of these trades who made a killing for his clients.

I am sure the investors will get the obligatory “thank you and come again letter.” After some passage of time, Bear Stearns will come out with a “new and improved” hedge fund and solicit the same investors with promises of great fortunes. It’s business as usual.