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Hedge Fund Liquidations: Five Things You Need to Know

A great example of the herd trend in action is the "carry trade."

In the carry trade hedge funds will borrow money in a low interest currency and buy assets in a higher interest currency. For example, selling Japanese Yen (JPY) at 0.5% and reinvesting in U.S. Dollars at 3%. This trade works well as long as the exchange rate between the two currencies is stable. However, once the trade stops working (or as we say in the industry is no longer "setting up") or there is a coordinated exit from the trade, this will result in huge dislocations in the pricing of these assets without regard to the true fundamentals.

Recall the huge rally in JPY last week, as the carry trade was unwound by liquidating hedge funds. Then noticed what happened to JPY this week, once the unwinding ceased.

Your Homework

  • Spot market dislocations related to hedge fund liquidations, as valuations become increasingly cheap and selling seems to become irrational.

    A great example of this type of dislocation was Freeport McMoRan's (FCX - Get Report) stock activity, which was recently subject to hedge funds liquidating en masse.
  • Identify when futures markets are moving by wide margins, without any associated economic or fundamental news. Instead of panicking and be shaken out of the market, use these situations in an opportunistic way.
  • At the time of publication, Rothbort was long AAPL, FCX and MO, although positions can change at any time.

    Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele.

    Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.

    Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Term Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.

    For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at Scott appreciates your feedback; click here to send him an email.
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