Hedge Funds, Investment Banks and the Value of Liquidity?
On Friday February 9th 2007, Toomre Capital Markets LLC ("TCM") posted a note entitled Dresdner Research: The Great Unwind is Coming. Over the weekend, there has been considerable website traffic resulting from search variations of "Dresdner hedge fund", "Stefan-Michael Staimann" and "Susanne Knips." The unusual interest has been truly world-wide and makes TCM wonder why this particular piece of research is resonating so.
Do not readers already know how dependent the large investment banks have become both reliant on and very much like the hedge fund and private equity industries? A substantial portion of the investment banks' profits -- in new and highly profitable businesses like prime brokerage, mortgage-backed securities, credit default swaps, equity derivatives and investment banking fees from private equity funds -- are a direct result of the growth of hedge funds and other alternative investment funds.
Economic times presently are pretty good world-wide. When the inevitable turn in the vastly more inter-connected global economy next comes, credit spreads surely will widen and the valuation of various financial instruments will come under stress. Are hedge funds (and by proxy the investment banks) prepared for coming "Great Unwind" forecast by Mr. Stiamann and Knips? Some hedge funds inevitably will do very well then, while others will fail, perhaps as spectacularly as Amaranth Advisors did in September 2006.
The financial markets now are full of much liquidity. Are investors, speculators and their bankers appreciating and pricing in liquidity risk? Toomre Capital Markets LLC would suggest that liquidity risk presently is greatly under-valued in the search for "alpha", absolute return and portfolio yield. The stretch to get ten percent return (after fees) appears to be making rational people start to do irrational things. Reader comments and thoughts are welcome.