Beware the “Roach Motel”
Oct 24th, 2006 | Filed under: Hedge Fund Industry TrendsIt seems that many hedge fund managers and institutional investors used to work in the pest-control industry. The most popular analogy at this year’s un-named institutional hedge fund conference (see posting below) is “A Roach Motel”. Many readers will remember the famous insect trap where “Roaches check in, but they don’t check out”. Well, it turns out there may be a few investments out there with similar characteristics (say, um, Amaranth).
As we have discussed in these pages, alpha hunting is best carried out in new and/or inefficient markets. But the inefficiencies that give rise to alpha-generating opportunities often exist because these new markets lack liquidity (Amaranth aside). A lack of liquidity can be particularly painful in times of distress when what little liquidity exists virtually dries up. As a result, you can’t “check out” of your trade.
Several speakers have touched on the fact that portfolio management theory describes only a “normal day” in the life of markets - not a time of extreme distress. After all, market mayhem does not facilitate an orderly run for the exits (witness the scene in the movie Airplane when the passengers were told to “assume the crash position!”). Unfortunately, liquidity only exists when you don’t need it.
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[…] As regular readers may recall, Alpha Male was at a hedge fund conference last fall involving a large number of institutional investors.  While the “main stream media” was not invited, AllAboutAlpha.com was able to report on a few general themes and some of the extra-curricular events. One of the speakers was Robert Zink of behemoth money manager Bridgewater Associates, managers of over $150 billion in AUM (and pioneers of alpha-centric investing). He brought with him a very interesting message, but we ran out of space and time to report on it back in October.  […]