The rogue
trader story is one that is now all too familiar. A trader appears to be making phenomenal
profits, garnering respect, high bonuses, and power within the financial
institution. Eventually, it is
revealed that the profits are illusory, the trades are fakes or losers, and the
trader has gotten himself, and maybe his firm, into deep – sometimes,
irreversible – trouble. Often the
downward spiral began with losses – sometimes small – that the trader tried to
make up through riskier positions.
Think Jerome Kerviel at Société Générale, Nick Leeson at Barings Bank,
or Joseph Jett at Kidder Peabody.
Now imagine what a hedge fund manager might do if facing
similar trouble. According
to Rick Bookstaber, the same thing:
If he follows the same course as the
trader at the bank, he will try to find ways to take on more risk. Of course,
any investment fund might face the same temptation, but hedge funds have more
tools at their disposal to make good on the try. Hedge funds can lever, delve
into wide-ranging and risky markets and readily employ the so-called innovative
securities to increase risk in ways that are difficult to discern. And unlike
the trader at the bank, the hedge fund can operate without anyone seeing what
it is doing. No one is looking over its shoulder at the trading positions each
night.
Bookstaber closes with a list of
the seven habits of highly suspicious funds that investors should watch out
for.
(HT: Felix
Salmon)