Comments on: The Wile E Coyote Theory Disproven Preemptively http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm We dividend our ad money to you. Wed, 17 Mar 2010 17:04:13 -0700 http://wordpress.org/?v=2.9.1 hourly 1 By: Jeremy http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-82833 Jeremy Sat, 12 Apr 2008 22:06:21 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-82833 I help run a fund that buys high yield bank loans in Collateralized Loan Obligation (CLO) structures. We are 12.5 to 1 leveraged, just like most commercial banks. The bank loan market is enormous by the way. Even though the average bank loan traded down to roughly 90, we still exist because the mechanics of the fund do not call for immediately marking to market (just like a commercial bank), and all our liabilities are non-call so an investor can't say I want out. As long as there is a reasonable expectation that the vast majority of the loans will be paid back at par, then there is no problem. Again similar to a commercial bank. Now the reason most bank loans traded down isn't because of defaults but rather other investments started yielding much more and required rates of return have gone up. There have been some defaults and I am sure they will accelerate over the coming year and that could very well be the next shoe to drop. We don't get anywhere near 2 and 20. More like 40 basis points and 20% of returns above a hurdle rate of 12 to 15%. So if the IRR of the fund is 10%, we get no incentive fee. If the IRR is 17% and the hurdle is 12%, we would get 1% or 20% of the 5% outperformance. However, we wouldn't get that fee for at least 5 years. Hedge funds that run bank loans under different structures would probably get 1 and 15 or 20 although I am sure there is a wide range. Those funds have almost all been blown out of the water because they are marked to market daily. I help run a fund that buys high yield bank loans in Collateralized Loan Obligation (CLO) structures. We are 12.5 to 1 leveraged, just like most commercial banks. The bank loan market is enormous by the way.

Even though the average bank loan traded down to roughly 90, we still exist because the mechanics of the fund do not call for immediately marking to market (just like a commercial bank), and all our liabilities are non-call so an investor can’t say I want out. As long as there is a reasonable expectation that the vast majority of the loans will be paid back at par, then there is no problem. Again similar to a commercial bank.

Now the reason most bank loans traded down isn’t because of defaults but rather other investments started yielding much more and required rates of return have gone up. There have been some defaults and I am sure they will accelerate over the coming year and that could very well be the next shoe to drop.

We don’t get anywhere near 2 and 20. More like 40 basis points and 20% of returns above a hurdle rate of 12 to 15%. So if the IRR of the fund is 10%, we get no incentive fee. If the IRR is 17% and the hurdle is 12%, we would get 1% or 20% of the 5% outperformance. However, we wouldn’t get that fee for at least 5 years.

Hedge funds that run bank loans under different structures would probably get 1 and 15 or 20 although I am sure there is a wide range. Those funds have almost all been blown out of the water because they are marked to market daily.

]]> By: Lee D http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81372 Lee D Sun, 30 Mar 2008 18:10:32 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81372 Well done, both with the post and the discussion. You are all of course aware that Coyote finally abandoned his schemes and sought to make his fortune the American way, via a personal injury lawsuit. http://www.torinfo.com/justforlaughs/coyote_v_acme.html Well done, both with the post and the discussion.

You are all of course aware that Coyote finally abandoned his schemes and sought to make his fortune the American way, via a personal injury lawsuit.

http://www.torinfo.com/justforlaughs/coyote_v_acme.html

]]> By: Size http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81101 Size Fri, 28 Mar 2008 20:18:16 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81101 Ah! By Victor, I think you've got it! Shall we call it the Niederhoffer Theorem? Ah! By Victor, I think you’ve got it! Shall we call it the Niederhoffer Theorem?

]]> By: Mr Juggles http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81099 Mr Juggles Fri, 28 Mar 2008 19:33:03 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81099 Now you get it. If you have to lever something up 10x+, you're doing it wrong. Actually, to be more clear, you're doing it wrong for your investors, but you are doing right for yourself. Year 1: Collect 2 & 20 Year 2: Collect 2 & 20 Year 3: Collect 2 & 20 Year 4: Collect 2 & 20 Year 5: Collect 2 & 20 Year 6: Collect 2 & 20 Year 7: Anomalous Event Y happens, fund blows up, lose all my investors money, pray I don't have too much in the fund Year 8: Raise money for new fund that will be modeled after old fund, which would have worked well if not for those pesky kids Now you get it. If you have to lever something up 10x+, you’re doing it wrong. Actually, to be more clear, you’re doing it wrong for your investors, but you are doing right for yourself.

Year 1: Collect 2 & 20
Year 2: Collect 2 & 20
Year 3: Collect 2 & 20
Year 4: Collect 2 & 20
Year 5: Collect 2 & 20
Year 6: Collect 2 & 20
Year 7: Anomalous Event Y happens, fund blows up, lose all my investors money, pray I don’t have too much in the fund
Year 8: Raise money for new fund that will be modeled after old fund, which would have worked well if not for those pesky kids

]]> By: Size http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81097 Size Fri, 28 Mar 2008 19:07:28 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81097 Oh, wait....I'll answer my own last question: because they can. Oh, wait….I’ll answer my own last question: because they can.

]]> By: Size http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81096 Size Fri, 28 Mar 2008 19:05:56 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81096 I don't know how many of them were doing it. I have absolutely no idea how much bank loan paper was available relative to the number of hedge funds that wanted to buy it. The funds I know of that were buying bank loans were levering their positions 8x and that wasn't their only strategy. They're still around - barely. Levering CDOs 10x was more common - wasn't Global Beta...I mean Global Alpha doing that too? Isn't that what blew up the Bear funds, Sowood and a few others? It never struck me as a good idea to lever an asset for which there is no good hedge. But that was the only way they could earn an acceptable ROE. Everyone just ignored the fact that the leverage amounted to a massive short volatility position and that their risk adjusted return (of which they made a big deal) was based on a muted volatility calc due to the lack of trading in these loans and that it expired with the next volatility spike. Where's the alpha in that? Why are these guys getting paid 2 and 20 for just loading up on risk? I don’t know how many of them were doing it. I have absolutely no idea how much bank loan paper was available relative to the number of hedge funds that wanted to buy it. The funds I know of that were buying bank loans were levering their positions 8x and that wasn’t their only strategy. They’re still around – barely. Levering CDOs 10x was more common – wasn’t Global Beta…I mean Global Alpha doing that too? Isn’t that what blew up the Bear funds, Sowood and a few others? It never struck me as a good idea to lever an asset for which there is no good hedge. But that was the only way they could earn an acceptable ROE. Everyone just ignored the fact that the leverage amounted to a massive short volatility position and that their risk adjusted return (of which they made a big deal) was based on a muted volatility calc due to the lack of trading in these loans and that it expired with the next volatility spike. Where’s the alpha in that? Why are these guys getting paid 2 and 20 for just loading up on risk?

]]> By: Mr Juggles http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81093 Mr Juggles Fri, 28 Mar 2008 18:18:12 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81093 Not most of them (I just don't imagine there is enough bank loan paper but correct me if I'm wrong) and not at greater than 10x. Otherwise the 10% downward move in the bank loan market means they would no longer exist (maybe they don't?). Not most of them (I just don’t imagine there is enough bank loan paper but correct me if I’m wrong) and not at greater than 10x. Otherwise the 10% downward move in the bank loan market means they would no longer exist (maybe they don’t?).

]]> By: Size http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81092 Size Fri, 28 Mar 2008 18:03:10 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81092 Well, when credit spreads are almost zero, it's pretty hard to generate sufficient ROE without piling on more risk by piling on as much leverage as you can beg your prime broker to extend to you. How many hedge funds were levering bank loans and CDO's? Well, when credit spreads are almost zero, it’s pretty hard to generate sufficient ROE without piling on more risk by piling on as much leverage as you can beg your prime broker to extend to you. How many hedge funds were levering bank loans and CDO’s?

]]> By: nick gogerty http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81090 nick gogerty Fri, 28 Mar 2008 17:08:39 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81090 the relationship between wile E coyote and VaR. Ok it is a VaR article with a snazzy cartoon image. http://nickgogerty.typepad.com/designing_better_futures/2008/03/flaming-var-val.html the relationship between wile E coyote and VaR. Ok it is a VaR article with a snazzy cartoon image. http://nickgogerty.typepad.com/designing_better_futures/2008/03/flaming-var-val.html

]]> By: Mr Juggles http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81089 Mr Juggles Fri, 28 Mar 2008 16:28:31 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81089 What if he started it in...the Cayneman Islands. HAR HAR HAR. What if he started it in…the Cayneman Islands.

HAR HAR HAR.

]]> By: To The Hilt http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81087 To The Hilt Fri, 28 Mar 2008 16:11:26 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81087 If Jimmy Cayne starts another bank, you should probaby short that too. If Jimmy Cayne starts another bank, you should probaby short that too.

]]> By: Mr Juggles http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81086 Mr Juggles Fri, 28 Mar 2008 15:57:42 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81086 I just noodled on it. The answer is yes, sort of. Hedge funds typically do NOT have that kind of leverage. Some do obviously. I-banks and banks have a different type of model so are not an apples to apples comparison; this is why the recommendation specifies to short FUNDS. I just noodled on it. The answer is yes, sort of. Hedge funds typically do NOT have that kind of leverage. Some do obviously. I-banks and banks have a different type of model so are not an apples to apples comparison; this is why the recommendation specifies to short FUNDS.

]]> By: Mr Juggles http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81085 Mr Juggles Fri, 28 Mar 2008 15:51:20 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81085 You might be onto something. Let me noodle on it. You might be onto something. Let me noodle on it.

]]> By: ConsultantNinja http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm/comment-page-1#comment-81082 ConsultantNinja Fri, 28 Mar 2008 15:03:29 +0000 http://longorshortcapital.com/the-wile-e-coyote-theory-disproven.htm#comment-81082 I thought all the regular and investment banks have leverage ratios of liabilities to equity of 10, 20, or 30 to 1, as well as most hedge funds. I get that leverage kills, but none of these operating models generate sufficient ROE without leverage, right? I thought all the regular and investment banks have leverage ratios of liabilities to equity of 10, 20, or 30 to 1, as well as most hedge funds. I get that leverage kills, but none of these operating models generate sufficient ROE without leverage, right?

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