Getting Started in HEDGE FUNDS SECOND EDITION by Daniel A. Strachman

Getting Started in HEDGE FUNDS SECOND EDITION by Daniel A. Strachman

1 CHAPTER
Hedge Fund Basics
For the better part of the past twenty years, the only time the
press mentioned hedge funds was when one blew up or some
sort of crisis hit one of the world’s many markets. All that
changed in the late summer of 1998. The currency crisis in Asia
spread to Russia, then crept into Europe, and finally hit the shores of
the United States in mid-July and early August. Many who follow
the markets assumed that things were bad and were going to stay that
way for a very long time. And of course the first people who were
looked at when the volatility hit was the hedge fund community.
Although no one knew for sure what was going on and who and how
much was lost, one thing was clear: Many of the most famous hedge
funds were in trouble.
After weeks of speculation and rumors, the market finally heard
the truth: The world’s “greatest investor” and his colleagues had
made a mistake. At a little before 4 P.M. eastern standard time (EST)
on Wednesday, August 26, Stanley Druckenmiller made the an-

nouncement on CNBC in a matter-of-fact way: The Soros organiza-

tion, in particular its flagship hedge fund, the Quantum Fund, had
lost more than $2 billion in recent weeks in the wake of the currency
crisis in Russia. The fund had invested heavily in the Russian mar-

kets and the trades had gone against them. When the ruble col-

lapsed, the liquidity dried up and there was nothing left to do but
hold on to a bunch of worthless slips of paper. During the interview,
Druckenmiller did mention that although the fund had sustained
significant losses in its Russian investments, overall its total return
was still positive for the year, with gains upwards of 19 percent.
However, in the months that followed, the Soros organization an-

nounced significant changes to the operation including closing one
fund that lost over 30 percent.
When asked by the CNBC reporter where the losses came from,
Druckenmiller was not specific. It appeared that it was not one trade
but a series of trades that had gone against them. The next day, The
New York Times reported that the fund had also posted losses in dollar
bond trades.
When Druckenmiller made the announcement, the Russian eq-

uity markets had been down over 80 percent and the government had
frozen currency trading as well as stopped paying interest on its debts.
The Asian flu had spread, and Russia and many of the other former
Soviet republics looked to be in trouble. The difference was that in
Russia and the surrounding countries, things looked quite a bit worse
than in east Asia.
Although there had been rumors of hedge fund misfortunes and
mistakes in these regions, no one knew the true size and scope of the
losses. Druckenmiller’s announcement was the tip of a very big ice-

berg and the beginning of a trend in the hedge fund industry, one that
was a first: to be open and honest about losses. Hedge fund managers
en masse seemed to be stepping up to the plate and admitting pub-

licly that they had made mistakes and had sustained significant losses.
The day after the Soros organization spoke up, a number of
other hedge fund managers issued similar statements. Druckenmiller’s
interview turned out to be the first of several such admissions of losses
by famed fund managers. And the losses were staggering.

Getting Started in HEDGE FUNDS SECOND EDITION by Daniel A. Strachman