Sam Jones in the FT reports that John Meriwether is getting back into the hedge fund business. Reportedly and not surprisingly the new JM Advisors Management plans to utilize a relative value arbitrage strategy that was the downfall of Meriwether’s two previous hedge fund operations. From the FT:
The strategy, described by the Nobel Prize-winning economist Myron Scholes as being akin to a giant vacuum cleaner “sucking up nickels from all over the world”, can be highly successful in periods following market dislocations.
Relative value trades profit by betting on unusual pricing relationships between securities, anticipating a return to an historically modelled “normal” state between them.
Michael Corkery at Deal Journal notes that Meriwether’s previous funds relied heavily on leverage to generate returns. And in the case of Long Term Capital Management, potentially endanger the entire financial system. Corkery writes:
It’s not clear how much leverage Meriwether and his merry band of investors will be willing to stomach in the latest fund…But in some ways that’s beside the point. The fact that Meriwether – whose name is synonymous with the high-flying hedge fund boom earlier this decade — is back in action says a lot more about investors’ overall appetite for risk. Namely, it’s back.
We have previously noted the many signs of the return of the risk culture. However we are no sure that this is one of them. The strategy Meriwether employs requires the capital markets act in a more normal (whatever that means) way. This may say less about risk and more about a belief that the worst of the crisis has past and that the historical relationships between various assets will mean-revert.
It has been shown that even the most simple arbitrage schemes can generate losses and higher than anticipated levels of return volatility. As Felix Salmon writes:
This is why only the biggest and most liquid companies tend to try their hands at arbitrage: it’s very much a don’t-try-this-at-home strategy. Even if you’re convinced that the trade is risk-free, it really isn’t.
Maybe the twin notions of a “return to risk” and a “return to normal” are not, as we previously thought, antithetical. Maybe they are simply two sides of the same coin. One thing the past year has taught is that arbitrage, or in this case relative value arbitrage, is in fact a risky endeavor. In short, a bet on the convergence of prices is in fact a risky trade. One need only look at Meriwether’s track record.
Then again maybe this news says less about the state of the global financial markets and more about hedge fund investors. As Joe Weisenthal at Clusterstock writes:
There really is no way to destroy your reputation in this industry, so long as your failures are spectacular…The craziest part is not that he’s starting a new fund (why not?) but that investors will throw their money at him.
Third time is a charm. Right?
Update: We just noticed two more (incredulous) posts worth a read on the Meriwether news. Felix Salmon notes that the hedge fund business is in large part an exercise in marketing. Kid Dynamite wonders how it is that Meriwether is getting another shot at managing money.