Gunning for each other

[nodoodahs]

Hypothetically, fund A is leveraged and in drawdown. The theory I've read/heard is that when funds B - Z become cognizant of this, they will frontrun fund A's unwinding of positions, for two reasons. First is to make an easy profit as fund A will close out positions to meet margin calls, second is to drive fund A into closing shop so that they can buy the remaining positions at a bargain-basement price.



How much of the above is true? How often does this happen?

[Jaxx]

obviously this is very case specific (ie fund A size relative to the market and more specifically what assets / strategies are traded).



firstly - you are taking a huge risk in trying to front run an unwind. its very hard to know if this is just rumour. but lets say you knew for sure a fund was unwinding - its very hard to know exactly what is in their portfolio and how levered they were and how much they need to unwind to meet margin calls. then you also have the huge uncertaintey as to how many other market participants know this and how much this is "in the price". the other major issue is that its likely that these trades have a positive ev over a longer time frame - so you really don't want to get stuck being short this strat.



i've found that generally unless you think that "fund A" is so big that they are going to push prices so much you are going to have to unwind / or others were and there isn't a fundamental problem then the way to make money is to be the person providing this liquidity - but again then you really care about your own capital stability, mtm sensativity and risk capacity as well as that of the others in your market who will be involved in supplying/demanding liquidity. but then i am coming from this from a relatively illiquid otc market perspective.

[FDAXHunter]

This generally happens in any market. Traders are like sharks in the water, if they smell blood. This isn't out of malice, but out of knowing that the supply/demand curves will shift (possibly drastically).



Firesales are usually quite indiscriminant with regard to price sensitivity, it's hard for the market not to take advantage of that. Smiley



As to forcing a fund out to be able to pick up their assets, I'd categorize that as an "urban myth". There's way too much uncertainty/risk in seeing a strategy like that to fruition (from moving the market sufficiently, to the fund actually liquidating, to being able to snap up the assets. That's a lot of ifs).



Edit: Crossed posts with Jaxx.

[Jaxx]

agreed - all very market dependant - in my experience you generally tend to see a drop in the bids with very little volume going through - rather than people actively trading things lower. often the snap back on a liquidation when the market know's its over can be very brutal so i personally don't try and be too cute with these things.

[Randumb]

Did you ever here the story about George Soros and the Bank of England?



Just like in football or soccer, when you find out someone has a weak knee, you sucker punch (kick) their knee.



However, sucker punching as an investment strategy may be a little risky.  But if the opportunity comes along, take em out.

[rowdyroddypiper]

Cheap shots are a good way to end up with a cleat to the balls.  I doubt very much that someone is going to have the knowledge or confidence necessary to drive another shop to close in order to buy their remaining assets on the cheap.  We are actually getting a lot of calls from people that are investors in our deals as a result of basically picking assets from defunct funds and they really have no clue what they are buying, they just don't think they can get hurt at the level they own them.  Not exactly the mark of super genius capable of forcing competitors to fold.

[kr]

part of the issue with the idea is that it is still econ 101 and supply vs. demand. If you blow up an investor, then you have reduced the right side of the equation for the forseeable future, and also created an excuse why future demand will not be so high (i.e. b/c investors can get burned, esp. by other market participants). This goes against the idea that you are putting on a mean-reversion trade.



Apart from that it sort of views the problem in a vacuum, when in fact the whole street might have gotten burnt. So if you front-ran something idiosyncratic like the energy derivs guy who sold his stash to citadel, that's one thing, but in todays abs market it is a completely different story.

[Johnny]

If you blow up an investor, then you have reduced ... etc to ... goes against the idea that you are putting on a mean-reversion trade.



Very nice insight, K.

[SirAppleby]

There are examples of prime brokers gunning for their clients in times of market turmoil (e.g. Askin, Ellington). Broker assigns absurdly low value to assets, tells hedge fund to post more collateral (which fund does not have) - then proceeds to sell the positions.



Especially neat is the auction process where broker brings in some shills to make unrealistically low bids, then broker buys the securities for his prop account on the cheap. This is Wall St. at its finest! Smiley

[rowdyroddypiper]

While you are right that this is not an uncommon initial tactic it is very rarely successful.  The risk is that they are buying themselves a lawsuit.  The idea is that you come in with a shock and awe number and the client is happy when you come back with a requirement for half of the initial call.  Just like everything else it is a negotiation.  If all else fails BK and let the courts settle things.  That happened in 98 and it can happen just as easily now.  The US court system is surprisingly friendly to borrowers that get over their skis.



As for Ellington, I'm not in the loop enough on that situation but my understanding is they just couldn't get marks.  As someone who deals in illiquids, this is totally plausible.  We've heard and experienced dealers refusing to mark even their own issues.  It's ridiculous but it's where we are.