By Samual Jones (FT)
John Meriwether, the hedge fund manager and arbitrageur behind Long-Term Capital Management, is in the process of setting up a new hedge fund – his third.
The move comes barely three months after Mr Meriwether decided to close his second fund manager, JWM Partners, which was wound down after clients saw the value of their investments fall by more than 44 per cent over the course of the financial crisis.
JWM Partners was set up soon after the collapse in 1998 of Mr Meriwether’s first – and most infamous – fund, LTCM, which triggered a wave of panic across the world’s markets and prompted the US Federal Reserve to take the then-unprecedented step of orchestrating a multi-billion dollar bail-out.
Mr Meriwether’s new venture, named JM Advisors Management, will, like both of his previous hedge fund management companies, be based in Greenwich, Connecticut.
People with knowledge of the situation say the fund has not yet started accepting outside investments, however. According to HFMWeek, an industry publication, the fund will open to investors in 2010.
The fund is expected use the same strategy as both LTCM and JWM to make money: so-called relative value arbitrage, a quantitative investment strategy Mr Meriwether pioneered when he led the hugely successful bond arbitrage group at Salomon Brothers in the 1980s.
The strategy, described by the Nobel Prize-winning economist Myron Scholes as being akin to a giant vacuum cleaner “sucking up nickels from all over the world”, can be highly successful in periods following market dislocations.
Relative value trades profit by betting on unusual pricing relationships between securities, anticipating a return to an historically modelled “normal” state between them.
Traders say the strategy has the potential to deliver huge returns in the current market, with many banks’ proprietary trading desks having scaled back their operations and far fewer hedge funds in existence.
Their absence is leading to “inefficiencies” according to many market participants.
The swap spread on 30-year Treasury bonds – the difference between the cost of a 30-year bond and the cost of an interest-rate hedge against it – is still negative.
However, as Mr Meriwether’s experience shows, relative value strategies are not without their pitfalls.
The strategy typically has a high “blow-up” risk because of the large amounts of leverage it uses to profit from often tiny pricing anomalies.
At its peak, LTCM borrowed 25 times more than it had in investor’s capital in order to ratchet-up its returns.
JWM boasted a more conservative 10 times leverage ratio.
The hedge fund industry average is estimated at between two and three times.