The following fictitious letter, with two possible endings, is compiled largely using the exact words used by fund managers at Citadel Investment Group, Greenlight Capital, and TPG Axon, among others, in letters sent to investors in recent weeks. The alternative ending owes much to Andrew Lahde of Lahde Capital. All the words have, however, been rearranged and no longer necessarily reflect the views of these managers.
Dear Crunch Capital investors:
Our Big Absolute Return Fund (BARF) returned minus 23.4 percent net of fees in the third quarter of 2008. We are embarrassed [1] by our performance, and we remind you that we eat our own cooking as the largest investors in our funds.
Last year was a strong one for us, and the first half of 2008 was solid. In sharp contrast, the last quarter has been abysmal, and we are sorry to have let you down with the terrible performance of the portfolio.
Candidly, in hindsight we grew a bit overconfident in our ability to navigate treacherous waters. By June, we were already materially reducing risk. But midyear economic data threw markets for a loop [2]. Everything that had gone up in the past few years-equities, foreign currencies, and commodities-was dumped by investors as they fled in the other direction.
The July reversal in markets caused damage to many hedge funds, which had clearly been in "extreme agreement." As a result, investors have been unwinding trades that might otherwise make sense because 1) they are nervous about short-term losses, 2) they are reducing risks and leverage generally, and 3) they are possibly facing redemptions from their own investors.
In hindsight, our suggestion last quarter to cash out and go to the beach would have been the better option. We failed to foresee the financial disaster that was to unfold, and September was the single worst month [3], by far, in Crunch's history.
The extraordinary market conditions were combined with unpredictable financial sector rescues and with regulatory changes driven more by populism than policy. Among other things, the decision of regulators around the world to ban the short selling of equities created dislocations across many of our portfolios.
The collapse of several large financial institutions was caused by bad practices and poor risk management. The loud complaints about short selling are acts of desperation, to distract attention from the real problems, by business and government leaders who have been caught with their pants down [4].
Political risk is usually associated with developing markets, but for the moment, suddenly changing regulations-sometimes overnight-are having a large impact on U.S. markets. Still, we recognize that our job as investors is to play by the rules the policymakers set.
General release ending:
With that in mind, we have incurred a great deal of additional pain in recent weeks to reshape our portfolio, and we are optimistic about our current positions and our long-term prospects. We can't make the money back overnight, and we expect markets to continue to exhibit "manic depressive" behavior as they vacillate between fear and optimism, so we urge your patience.
Not only that, but we think the hedge-fund industry model is likely to be tested and reshaped in meaningful ways.
But we do believe the next 12 to 18 months may prove one of the best buying opportunities [5] we have ever seen. Markets are a train wreck, and there is substantial opportunity to profit handsomely.
We have never backed down when faced with a challenge, and this time will be no exception. We are immensely grateful for your support. Please don't withdraw your money!
Yours truly,
Crunch Capital
Director's cut ending:
Happily, we have been able to do that successfully in our biggest asset pool, the Global Short Fund, which gained 800 percent and provided you-and ourselves-with massive gains overall. Most of our forecasts have unfolded or are in the process of unfolding. Rather than gloating, however, we are writing to say goodbye [6].
We were in the game for the money. The low-hanging fruit-idiots whose parents paid for prep school, Yale, and then the Harvard MBA-were there for the taking as they rose to the top of companies such as American International Group, Bear Stearns, and Lehman Bros.
We will no longer manage money for other people. We have enough of our own wealth. We will let others try to amass nine-, 10-, or 11-figure net worth. We plan to throw our BlackBerrys away and enjoy life.
Please don't try to contact us. Others will handle the dissolution of the fund. Oh, and the United States should legalize marijuana.
All the best,
Crunch Capital
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