HedgeSpeak: Fear of Melt Down or Melt-Up?

May 2009

"Rather than fight the riptide we decided to go with it until it ebbed. We reduced a number of our short positions and covered our index shorts that had served us so well in the market meltdown, reducing our notional short exposure in the process. We also bought high yield indices to hedge out our remaining short exposure and to cover our portfolio for a further melt-up."

General consensus is that hedge funds make money in all market environments. It remains a naive statement with limited appreciation for the actual market realities and the difficulty to continuously manage short positions. Very few appreciate the maddening aspect for a hedge fund manager to maintain hedges throughout a rally. Managers will often second guess themselves, and in some cases be influenced by (frustrated) investors demanding performance on during rallies. Often, the manager will have doubt and reduce those hedges just as the market reverses and then lose the benefit of those same hedges.

The manager has to weigh the pros and cons: Do I hold steady? Do I shift? Is a Melt Up worse than a Melt Down?

Anyone? Anyone?