Hardly a day passes that we do not see that a hedge fund has closed. Many of the long time hedge funds in the past year have taken significant losses and the resulting exit of investors. The reasons are many but mostly they revolve around a market where placing hedge bets increasingly result in losses. Since these losses are hedged the loss factor can sometimes be many times the bet made. Hedging in it's simplest essence is stock insurance either on the bull or bear side. Any insurance market where losses become unacceptable or more importantly where the writer of the insurance can no longer see some reasonable assumption that the majority of the hedges will end up making money the writer stops making insurance shop.
This is exactly what has happened in the US stock markets as more funds are as I said exiting the market. Without the insurance protection, but more importantly without the insurance protection with reasonable premiums investors are left totally naked. Like it or not lack of hedging in the stock and bond markets mean a much more unstable investing market going forward. Imagine automobiles and homes where insurance companies will not write insurance or where the insurance cost is higher than most people can afford.
Our fund has in the last year taken some losses as well, but even into the last quarter we were positive cash flow. Much of this is due to the structure of our fund in that we hedge only certain kinds of stocks and then only a dozen of those that make the cut. We have been selective and our structure has always made cash flow a priority with a built in planning where even when we might be sitting on losses we could cover interest and trading fees until the market improved. The key was to make enough cash flow via premium gains to make money. However there has to be some solid base of reliable stock pricing to make this plan work. In the past year the constant unreliability of stock pricing has made placing hedges almost impossible. Much of this is due to a political environment where one has no idea where Obama or some other politician makes doing business for this or that business much harder by some policy move. In the past year be it oil, tobacco, telecom, real estate, business development, and finally utilities have been hit by some form of policy change that resulted in stock price hits that could not be hedged via the normal news cycle.
The last one utilities is by far the most extreme in that for years those businesses operated as boring regulated dividend producing widow and orphan stocks. No longer is that the case. Southern Company the first company we ever blogged about was as boring as they come. This past week they finally succumbed to the global warming/climate change policy and took a earnings hit. We honestly believed that was impossible up to now since the regulatory environment they operated in was most positive.
The past week following the re-election of Obama the full force of the unreliability of earnings and dividends has come forward in a large sell off in the stock market and the pending losses in our fund are now more than our accumulated cash flow over the past year. We are hoping their will be some relief in the brutal sell off of the past week the next five days prior to the options expiration cycle ending next Friday that will at least bring us back to even for the year. Even if it does not we are now considering ending our hedge activity after many years of doing so since the Obama environment makes it too difficult to do planning with so many unknowns involving policy decisions.
We have always played with house money and used other people's money to make insurance coverage decisions. Therefore if we do indeed decide to exit the trading market we leave with no more assets or no less assets than we brought in, just the loss of cash flow. Frankly in a political environment where common sense and logic are replaced with emotion and cronyism we just prefer not to play. Over the next couple of months our blogging will be much less as we continue to survey the current trading environment. We will take this time to unravel our positions and begin an orderly exit of the options market. We suggest others consider removing assets from danger as well.
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