Ospraie's Poor Portfolio Weighting: XTO Contributes Major Loss to Fund

Ospraie Management has apparently told investors that its investment in XTO Energy (XTO) contributed to its losses over the last few months (see Bloomberg article).

While this is not surprising given that energy stocks have been down and have contributed to losses in numerous hedge funds, the XTO position of $128 million in shares was the largest position for the Ospraie fund, and does once again highlight the problems with having a fund be too concentrated in just a few positions. Such a concentration can cause the types of losses Ospraie incurred, including a 26.7 percent loss in just one month (see previous article and previous post).

Fund manager Dwight Anderson was quoted as once saying that: "The fact that I had a horrible quarter is a statistical probability, and we had always told people there is that possibility.'' Yes, and when you are overweight a volatile stock in a volatile industry, you can expect that statistics will line up less and less on your side. In fact, this is a common problem in a portfolio when a certain position does well. Before long a hot stock can become a major portfolio position, and one that may now be larger than your portfolio guidelines allow.

Nonetheless, even though you are now overweight the position beyond allowable levels, and even though VaR measures are screaming at you, it is hard to scale back the a security that is outperforming and in a sector that is on a roll. That is until of course everything changes, and the industry or sector corrects dramatically, as we have seen with energy stocks.

Sure, these are unusual moves, but they are also precisely the types of moves you should be trying to protect yourself against. Anderson went on to say in an interview last year that: "We do everything that we can to manage the risk, and I think we're better at it today than we were a year ago.''

Apparently, everything was not enough, and everything did not include consistently updating VaR measures, or simple looking at portfolio weights. Scaling back risk is a difficult, but necessary part of any fund management, even if it involves giving up a little return in order to play another day.

Disclosure: None

Comments

[helplessobs...:]

All these risk sharing schemes all look good on paper and get you an A on your school papers. They all, however, rest on a faulty foundation in that they assume stable markets. Portfolio insurance assumed airline pilots and doctors would remove the risk from large investment portfolios by their unlimited buying in the SP futures markets. Many a professor smiled and wrote "good work" as he fixed his A grade on the soon to be minted MBA's paper. As we later found out this risk control technique did not work as it was supposed to and millions were lost in the chaotic futures markets it created.

2008 Sep 07 02:15 PM

[2-cents:]

It's easy to point out others faults to make yourself looking good. I find it insulting

2008 Sep 08 06:15 AM

[Daniel Moser:]

An important factor to remember when evaluating fund blow-ups is style. Ospraie was by definition a global macro fund which brings with it a vastly different risk to reward ratio. Ospraie was not a portfolio engineering hedge fund like Jacobs and Levy, thus probably not concerned with the modern portfolio theory definition of risk (a.k.a. volatility of returns). Moreover, I speculate, based on the few pages I have read from Mr. Anderson, that Ospraie believed in definition of risk that is more oriented around the probability of losing money on an investment. However, one must recall the famous Keynes quote, "the market can stay irrational longer than you can stay solvent". This is where Ospraie got into trouble. They ran a global macro hedge fund that specialized in basic material industries (why because that was Mr. Anderson's background in school as well as at Tiger). They had to be concentrated because their style of investment management was such that you don't take risks unless you have a competitive advantage....they probably had a tremendous competitive advantage but in the end the market volatility, in the short term, took Ospraie down at the worse possible time.

While I must be sincere for a moment and acknowledge that everybody involved in Ospraie is not happy about the outcome currently, it is stories like these that make hedge fund investing so exciting. George Soros, Julian Robertson, Dwight Anderson, etc. are as heroic as dragon slayers or bull fighters. But every now and then the hero has to lose.

2008 Sep 09 10:41 AM

[buyforeclos...:]

Idiots should have sold when they were way up on xto..what they wait for it to drop 50% then sell?

2008 Sep 10 05:30 PM