A Hedge Fund Lesson for the Rest of Us

December 27th, 2009
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Contributed by: Mike Kane, Hedgeable
There are some things in this world that baffle us. One of them is how people who can flush billions of dollars down the toilet get a second chance. Case in point: Kenneth Griffin, who runs Citadel Investment Group. As reported by the Wall Street Journal, Griffin lost investors over $8 billion last year, with a 55% loss in their main fund offered to clients. Now he is on a globe trotting expedition to raise a ton of more money, open up more funds, and even start an investment bank. In any normal circumstances a 55% loss would mean the end of a career. Yet, somehow people believe he deserves a second chance because of his "track record."

It's similar to a woman who has been battered by her husband giving him a second chance. Well, men won't change, and neither will this manager. Someone who can lose 55% of clients' money cannot be trusted. That goes for a hedge fund manager such as Griffin, or a mutual fund or financial advisor that us mere mortals rely on. Was 25%, 35%, 45% not good enough? What's the point of having a "hedge fund" if you aren't going to do any hedging?

There is a huge lesson in all of this for retail investors. We continually hear about the "explosion" in the market this year, and Griffin certainly capitalized on that. His fund is up 58% year to date. Some may think that his 55% loss last year was made up for by his 58% gain this year. He must be up 3% overall.

But with some simple math we all know this is not the case. His fund is still down nearly 29%. In fact, to make up for the 55% loss of a year ago, his fund will need to return a staggering 122%. This is the importance of looking at drawdowns, even when examining a mutual fund, ETF, or an independent advisor's track record. Drawdowns are the peak to trough loss in an investment over a certain period of time. It is the most overlooked and miss-understood of all the investing metrics. For example, the S&P 500 (SPY), has a 55% maximum drawdown over the last 5 years. Gold (GLD) has a 30% maximum drawdown over that time period.The CGM Focus Fund (CGMFX), a popular mutual fund, has a 67% maximum drawdown over the last 5 years. Comparatively, The PIMCO Total Return Fund (PTTAX), run by Bill Gross, has a 7% maximum drawdown, with similar returns.

When you are managing your own portfolio, it is just as important to admit defeat and take a small loss, as it is to make the right trade and lock in a gain. Losses seen by Griffin will sink any portfolio, and there is no smooth talking that can get around that fact. Drawdowns are like quicksand, the more you struggle, the deeper you sink. Don't let anybody fool you, it is never acceptable or necessary to lose that much money.

Disclosure: No Positions
For Detailed Investor Profiles on these Investors, click below:
Citadel Investment Group
Related People: ; Becket Wolf*; Brandon Haley; David Grossman; Derek Kaufman; Jeff Runnfeldt*; Joe Squeri; Kaveh Alamouti*; Kenneth Griffin; Mark Stainton; Ryan Garino; Steve Weller*
Related Entities: Citadel Alternative Asset Management; Citadel Equity Fund; Citadel Kensington; Citadel Wellington; Equiduct; New Castle Re; Sowood Capital*
Related Article Tags: Multi-Strategy, Long Short, Equity, Debt and Global Macro Hedge Fund News; Hedge Fund Resources and Featured Partner News

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