A Hedge Fund Lesson for the Rest of Us

There are some things in this world that baffle us. One of them is how people who can flush billions of dollars down the toilet get a second chance. Case in point: Kenneth Griffin, who runs Citadel Investment Group. As reported by the Wall Street Journal, Griffin lost investors over $8 billion last year, with a 55% loss in their main fund offered to clients. Now he is on a globe trotting expedition to raise a ton of more money, open up more funds, and even start an investment bank. In any normal circumstances a 55% loss would mean the end of a career. Yet, somehow people believe he deserves a second chance because of his "track record."

It's similar to a woman who has been battered by her husband giving him a second chance. Well, men won't change, and neither will this manager. Someone who can lose 55% of clients' money cannot be trusted. That goes for a hedge fund manager such as Griffin, or a mutual fund or financial advisor that us mere mortals rely on. Was 25%, 35%, 45% not good enough? What's the point of having a "hedge fund" if you aren't going to do any hedging?

There is a huge lesson in all of this for retail investors. We continually hear about the "explosion" in the market this year, and Griffin certainly capitalized on that. His fund is up 58% year to date. Some may think that his 55% loss last year was made up for by his 58% gain this year. He must be up 3% overall.

But with some simple math we all know this is not the case. His fund is still down nearly 29%. In fact, to make up for the 55% loss of a year ago, his fund will need to return a staggering 122%. This is the importance of looking at drawdowns, even when examining a mutual fund, ETF, or an independent advisor's track record. Drawdowns are the peak to trough loss in an investment over a certain period of time. It is the most overlooked and miss-understood of all the investing metrics. For example, the S&P 500 (SPY), has a 55% maximum drawdown over the last 5 years. Gold (GLD) has a 30% maximum drawdown over that time period.The CGM Focus Fund (CGMFX), a popular mutual fund, has a 67% maximum drawdown over the last 5 years. Comparatively, The PIMCO Total Return Fund (PTTAX), run by Bill Gross, has a 7% maximum drawdown, with similar returns.

When you are managing your own portfolio, it is just as important to admit defeat and take a small loss, as it is to make the right trade and lock in a gain. Losses seen by Griffin will sink any portfolio, and there is no smooth talking that can get around that fact. Drawdowns are like quicksand, the more you struggle, the deeper you sink. Don't let anybody fool you, it is never acceptable or necessary to lose that much money.

Disclosure: No Positions

Comments

[macro -N- ietzsches]

You're forgetting about the rule of comfort. The women go back because they know exactly what is in store for them as opposed to the unknown of having self-esteem. The investors go back because they know if they lose money they can blame someone else, as opposed to the unknown of opening a book and learning something. She believes his mother, investors believe the propaganda that you can't do it yourself.

2009 Nov 19 02:24 PM

[notsosmart]

whats wrong with the rich losing their money over & over.if they werent so greedy(more,more,more,) they would not be with this guy or any of the losers.i dont feel sorry for the so called made-off"victims".just give me my 12%,no fee & no work on my part.they too got what they deserved.now the taxpayers have to help them out.tax deductions for their losses.what a joke.

2009 Nov 19 03:52 PM

[Mike Kane]

That is very true...never thought of it that way. Very good analysis


On Nov 19 02:24 PM macro -N- ietzsches wrote:

> You're forgetting about the rule of comfort. The women go back because
> they know exactly what is in store for them as opposed to the unknown
> of having self-esteem. The investors go back because they know if
> they lose money they can blame someone else, as opposed to the unknown
> of opening a book and learning something. She believes his mother,
> investors believe the propaganda that you can't do it yourself.

2009 Nov 19 04:05 PM

[Mike Kane]

The majority of investors in hedge funds these days are public pension plans and endowments...so its the little guy that gets hurt, not the rich


On Nov 19 03:52 PM notsosmart wrote:

> whats wrong with the rich losing their money over & over.if they
> werent so greedy(more,more,more,) they would not be with this guy
> or any of the losers.i dont feel sorry for the so called made-off"victims".just
> give me my 12%,no fee & no work on my part.they too got what
> they deserved.now the taxpayers have to help them out.tax deductions
> for their losses.what a joke.

2009 Nov 19 04:07 PM

[Old Trader]

I'm continually amazed at how little people seem to know about hedge funds....even on a site like this, where it should be safe to assume that the majority of readers, posters, etc., are much more financially literate than average.

2009 Nov 21 01:56 AM

[oldman]

what can you tell me about Paulsons hedge funds?

2009 Nov 21 10:15 AM

[Mike Kane]

Yea, they are one of those things that most people can't wrap their hands around...It's partly the media's fault, but much of the blame is in the financial industry. If people knew that they probably invest in hedge funds indirectly, they would have different opinions.


On Nov 21 01:56 AM Old Trader wrote:

> I'm continually amazed at how little people seem to know about hedge
> funds....even on a site like this, where it should be safe to assume
> that the majority of readers, posters, etc., are much more financially
> literate than average.

2009 Nov 22 06:51 PM

[Mike Kane]

there is a new book out that I recommend- "The Greatest Trade Ever," by Greg Zuckerman of the WSJ detailing Paulson...he is an interesting guy


On Nov 21 10:15 AM oldman wrote:

> what can you tell me about Paulsons hedge funds?

2009 Nov 22 06:53 PM