I was going through my archive looking for a piece for the current mentor program when I came across this little gem from the Eifuku Master Fund. By the way the name is not made up. This fund was run by a former employee of Lehmann Brothers in Tokyo.
The letter speaks for itself.
To: Eifuku Investors
From: The Investment Manager
Date: January 15
Re: January 2003 Performance
Jan 2003 Trading Result
It is with deep regret that we inform you that Eifuku Master Fund has experienced substantial trading losses in the first seven trading days of January that have consumed nearly all of the fund’s capital. These losses occurred principally in three position groups. The fund’s portfolio is currently under liquidation with its main prime broker. There are still live positions being sold out/bought back and the Investment Manager is actively working with the fund’s prime broker to preserve and maximize any remaining equity in the fund. There is however a strong possibility that there may not be any equity left at the end of the liquidation.
The fund came into the year 2003 aggressively positioned in three trade groups. To start, the fund held a significant position in a “stub” trade. This market-neutral trade consisted of a long position in a parent company and a short position in a 63%-owned subsidiary of the parent. The two stocks had exhibited a very high degree of correlation and low level of volatility. We considered the underlying merits of the position extremely attractive from both a valuation standpoint and a timing standpoint. In fact, the after-tax 63% position in the subsidiary was approximately equal to the market value of the entire parent company so that by owning this position, you owned the parent company’s valuable core business at minimal cost.
The fund’s second position was a relative value position in the Japanese bank sector, which consisted of long positions in three banks, a short position in one bank and some short index futures as a hedge. The position was established in late November/December as some of the weaker Japanese banks were heavily sold off in a market panic late in the year.
Third, the fund held a significant position in a Japanese tech stock that had also been excessively sold off in the last quarter of the year. We detected not only a large degree of panic selling here, but also aggressive and large short sales of the stock.
Things got off to a bad start immediately in 2003. In the first two trading days of the year (i.e. Jan 6 and Jan 7) the fund lost approximately 15% of its capital. This was very concerning to us as it immediately put us in a precarious margin position and forced us to consider unwinding positions to raise margin. The other concerning issue was that much of the adverse activity in our positions took place in the last half hour of trading each day.
Wednesday’s (Jan 8th) trading result came as a real shock. While trying to raise cash in some of the fund’s positions, the fund sustained a loss of an additional 15% of its capital. There were large adverse moves in the last hour of trading. This loss created a margin call at the fund’s main prime broker that it could not meet. We held discussions with our prime broker throughout the day and they agreed to a day’s grace period.
Unfortunately, Thursday (Jan 9) was as bad as Wednesday and the fund lost another 16% of it’s capital. At the end of the day, we were severely under margin with our main prime broker. Once again, for the fourth day running, much of this loss occurred in the final hour of trading. After the close of Thursday, our prime broker decided to exercise their right to further trading/liquidation in the positions as per the standard prime broker agreement.
We worked with the prime broker Friday (Jan 10) in attempting to raise liquidity by selling positions. We did manage to work out of some size across the various positions, but the liquidation had the effect of further losses in the fund’s positions. The fund ended the day down a further 12% and the week with a loss of approximately 58% of its capital. Additionally, the fund was now significantly under margin at its prime broker.
Over the long weekend (Monday Jan 13 having been a trading holiday in Japan), we had numerous discussions with our prime broker concerning strategy going forward. Eventually, they decided in accordance with the prime brokerage agreement that they needed to liquidate the fund’s two largest positions, the stub trade and the long tech position, as soon a possible. They went into the market and arranged several large block trades with their various customers around the world over the course of Tuesday (Jan 14). These various block trades cleared most of the exposure to the two positions but came at a dear cost and left the fund with a loss for the day of approximately 40%. Equity in the fund was now hovering at the 3% level.
On Wednesday (Jan 15) we continued to sell out the relative value bank trade and clean up some smaller less liquid positions. At the end of Wednesday, we are left with very little equity in the fund, somewhere around 2% of start of year capital.
Where the fund is now
The fund still has positions that total approximately $80 million long and $117 million short. Of the long positions, approximately $15 million is held in lower liquidity stocks that may take some time to properly liquidate. We are still working hard with the prime broker to trade out of the remaining positions in as clean a fashion as possible. We will let you know as soon as possible what the likely outcome will be.
John Koonmen will try to contact each investor individually by phone in the next few days to further explain these unfortunate events and answer all direct questions. In particular, if any investors have questions concerning the logic and analysis behind the positions, John would be happy to answer these questions during those calls.
This letter has been very hard to write. I am sure that it has been equally difficult for you to read. We will be in contact soon.
Eifuku Investment Management Limited
I read with interest that in 2011 there were some 1,113 new hedge funds launched and that during the same year 743 were liquidated. Not all of those liquidations will be failures. Some folks will have just gotten sick of the business and the embarrassment of returning very little whilst charging a lot.
However, I wonder how long it will be before we get another Eifuku.