16th April 2008

Dear Investor,

Hedge Funds and Mortgage Markets!

The traditional hedge funds work like this. You put up $20. The hedge fund manager uses it to borrow $100 worth of stock (by putting up 20% of collateral). He then sells the stock. Now he uses the $100 he just raised to buy another stock. Net effect, for a $20 stake he has created $200 worth of exposure.

And that's the definition. A lot of firepower for a small capital outlay. No wonder the expression "hedge fund manager" has (used to have) cache. The average hedge fund in Australia gears up about eight times. That means if you put a $10 investment into an Australian hedge fund it creates $80 of exposure for you. It's just gearing, not rocket science.

But if you work the numbers you will soon realise that a 5% fall in the value of the investments then causes a 40% fall in the value of the equity holder's stake. Cripes. In fact a 12.5% fall in the value of the investments delivers the equity holder a 100% loss. Double cripes.

One hedge fund in Sydney this year froze redemptions after the value of the fund fell 3% in a month. That 3% fall caused a 25% fall in value for its equity holders. Faced with that, the investors hit the doors. Redemptions poured in, and redemptions are where the trouble really starts.

With hedge-fund redemptions the gearing works the other way round. To repay a dollar to an equity holder the fund has to sell $8 worth of exposure. Suddenly small requests for a refund translate to big market selling. As the selling starts, the securities the fund is holding and selling fall in value, causing further falls in the value of their funds, further requests for redemptions and further selling. Snowball. The Sydney fund eventually went to the wall despite its "high-yield fund" tag. This is made even worse if the shares are held as margin loans by individuals.

Incorrect assumptions are the root of all major losses, and all the current travails in the world financial markets stem from one "core assumption failure". For the past 18 years we have assumed that people will suffer any deprivation rather than miss a payment on their mortgage. It is an Australian tradition and our mistake is that we have judged others by our own standards. We have been surprised because it turns out that there are billions of dollars of mortgages in the US sold by people who didn't care, to people who didn't care and didn't repay their mortgages. They didn't have our standards. Core assumption failure, the root of all major catastrophes. Add gearing to the failure of "load-bearing" assumptions and you have collapse.

Next time you are surprised by anything, including a share price fall, ask yourself, what assumptions have I made? They are the bedfellows of error and surprise.

Source: An extract of an AGE Article of 15/03/2008 by Marcus Padley a stockbroker and the author of the daily sharemarket newsletter Marcus Today

Equity Markets

It is clear that global markets have gone through a very challenging period. For the March quarter the US S&P 500 is down 9.9%, Germany's DAX down 19.0% and our own local market, the ASX200 is down 15.5%. The table below shows the performance of some key global equity markets over the March quarter and also over the past year. The theme is very similar across most equity markets.

World Equity Markets, 31 March 2008

Index Value

2008 %

Dow Jones Industrial Average
S&P 500 Index
NASDAQ Composite Index
DJ Euro Stoxx
FTSE 100 Index
CAC 40 Index
DAX Index
Swiss Market Index
Nikkei 225 Index
Hang Seng Index
ASX200 Index

_ASX Resources Index


_ASX Financials Index


_ASX Industrials Index


_ASX Listed Property Index


Source: Bloomberg, IRESS

Best regards,
Chris Andrews


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Chris Andrews
Head of Funds Management

t  +61 3 8610 2811
e  candrews@latrobefinancial.com.au

Chris Andrews is the Head of Funds Management for the La Trobe Group and has responsibility for the La Trobe Australian Mortgage Fund.
Read full profile here.

La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 115 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.

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