NOT GRAHAM AND DODDSVILLE [by James Grant, from Grant's Interest Rate Observer, November 6, 1998]
New light on the thwarted Warren Buffett bid for Long-Term Capital Management was shed by the Financial Times in a scoop now almost two weeks old. However, as the news is still intriguing, we hereby reprise it. What the FT reported was that the world's greatest value investor "oversaw in July the investment of $270 million in a hedge fund that specializes in the same type of investments as Long-Term Capital Management, which was rescued [in September]." The fund, West End Capital, is managed by Mark Byrne, son of longtime Buffett friend Jack Byrne. Buffett's millions represented 90% of the partnership's capital.
The paper went on: "[T]he disclosure that Mr. Buffett helped to set up a hedge fund using similar convergence investment techniques to LTCM's is likely to raise eyebrows on Wall Street."
Our eyebrows have been raised and locked for almost two weeks. When Buffett proposed to buy LTCM for $250 million (in addition to putting up $3.75 billion of new capital), were his motives offensive or defensive? Was he trying to turn an opportunistic profit? Or protect his reputation (not to mention his $270 million) from a possible severe loss? The FT reported two weeks ago that West End was down in "single digits" in the year to date (a number kindly confirmed by Byrne via e-mail on Tuesday). if Long-Term Capital had been forced to liquidate, what damage would have been inflicted on West End's own positions? And, if the news had been very bad, what would the front page of The New York Times have said? Perhaps: "Buffett hedge fund dealt lethal blow"?
In any case, the FT reported: "Nearly all investment groups specializing in convergence investing have experienced poor performance since August. However, Mr. Byrne stressed that Mr. Buffett was 'a very patient investor."' Buffett? Leveraged 10 to 15 to one speculating on the compression of risk rates? On the convergence of risk arbitrage positions? The mayor of Graham and Doddsville?
Meanwhile, more amazing disclosures are contained in an article in the November 9 Business lVeek-"How Long-Term Rocked Stocks, Too," the headline reads: "It wasn't just the bond market that LTCM endangered."
"It's widely believed that LongTerm Capital Management nearly collapsed because of huge bond trades," write Leah Nathans Spiro and Jeffrey M. Laderman in another LTCM eyebrow-hanger. "But that's only part of the story. Equally important were its gargantuan equity positions. What really shocked and alarmed Wall Street banks and brokerages was the havoc that an LTCM collapse could wreak in the stock market. 'We were most concerned about the equity book,' says Jon S. Corzine, chairman, Goldman, Sachs & Co., referring to LTCM's equity holdings."
David H. Komansky, chief executive of Merrill Lynch, was quoted to the effect that a Long-Term unwind could have unwound the stock market. "The dangers to the market," write Spiro and Laderman, "were exaggerated by the way LTCM executed its positions. Rather than going the traditional route - buying stocks and selling stocks short - LTCM entered into total-return swaps with Wall Street firms. This did two things. It allowed LTCM to pump up its positions using leverage, and it shifted much of the risk from LTCM to its trading partners-the Wall Street banks and brokerages."
Claims that the Federal Reserve secretly manipulates the stock market have been muttered for years. Now it's Out In the open, in Business Week: LTCM was about the stock market after all. Pretty soon, they'll be fluordating the water, too (you know who "they" are).
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Financial Times 10-15-1998
BUFFETT IN HEDGE FUND RUN LIKE LTCM'S Corrigan, Tracy: Lewis, William
Warren Buffett, the legendary US investor, oversaw in July the investment of $270m in a hedge fund that specialises in the same type of investments as Long-Term Capital Management, which was rescued last month.
Berkshire Hathaway, the investment group Mr Buffett controls, contributed 90 per cent of the capital raised in July by West End Capital, according to Mark Byrne, former head of fixed-income arbitrage at Credit Suisse First Boston, who runs the Bermuda-based hedge fund.
West End Capital attempts to profit through bond convergence investing, and is currently leveraging its capital base by 10 to 15 times. Mr Byrne said this was significantly less leverage than employed by other hedge funds, including LTCM. For the year to date, the fund's performance was down by "single figures", he said.
Berkshire Hathaway is the fund's only outside investor, and Mr Byrne argues that because West End is private it is incorrect to describe it as a hedge fund. However, most people in the hedge fund industry view it as a hedge fund.
Mr Byrne also said West End did not use the same type of investment strategy as LTCM, though it had a "similar tool-set".
Nevertheless, the disclosure that Mr Buffett helped to set up a hedge fund using similar convergence investment techniques to LTCM's is likely to raise eyebrows on Wall Street. Nearly all investment groups specialising in convergence investing have experienced poor performance since August. However, Mr Byrne stressed that Mr Buffett was "a very patient investor".
Before the $3.6bn bail-out of LTCM by 14 financial institutions, Mr Buffett, Goldman Sachs and AIG proposed to take over LTCM. The offer was rejected by John Meriwether, who runs LTCM with other partners.
However, Mr Byrne said Mr Buffett would still be interested in taking over LTCM. "At the right price he would still have an interest," he said. Berkshire Hathaway said it did not discuss its investments. .