General Motors Trade Opened

[ducati998]

GEN MOTORS (NYSE:GM) Delayed quote data

Last Trade: 26.77
Trade Time: 4:01PM ET
Change: 0.76 (2.92%)
Prev Close: 26.01
Open: 25.82
Bid: N/A
Ask: N/A
1y Target Est: 24.56

Day's Range: 25.80 - 26.79
52wk Range: 24.67 - 50.04
Volume: 10,696,700
Avg Vol (3m): 11,032,363
Market Cap: 15.11B
P/E (ttm): N/A
EPS (ttm): 0.00
Div & Yield: 2.00 (7.69%)

 

[LION63]

Ducati998,

You seem to be a Value Investor (a dying breed in these gogo times) and your research cannot be faulted and one can probably deduce that your analyses is very time consuming. How many trades did you do during the calendar year 2004 that were along the lines of your GM trade? What kind of businesses were they etc.?

 

[ducati998]

LION63,

A dying breed...........I hope so, less competition.
Time consuming, sure I guess that in reality it probably is, and it will vary from about a weeks worth of research @ a couple of hours a day prior to opening a trade, to an hour or so a day during the trade being open.

During calender year 2004 I completed 9 trades. Of those 9 trades only 1 was a direct match for the GM trade.

They are all currently unpopular, out of favour, bankrupt, nearly bankrupt, or fears of bankruptcy consuming the business. Only when the herd are frightened, can I sneak in for a bargain.

The businesses are from all areas.
cheers d998

 

[ducati998]

GM under there CEO has a definite restructuring strategy for the company.
Here is their attitude to "BLOGS"

2:22 p.m. It sounds like the joke answer on a multiple-choice exam. Name a leading company in blog communications: General Motors?

That's right. For a company that's slipping in the auto biz, GM is showing a surprisingly nimble touch with blogs. GM uses them on occasion to steer past its own PR department and the mainstream press.

In January, Vice-Chairman Bob Lutz launched his own FastLane Blog. Bloggers applauded, and car buffs flooded Lutz with suggestions and complaints. Lutz posted lots of barbs from outsiders and won points for balanced responses. Like his answer to criticisms of new Pontiacs: "Did you take a look at seat tailoring? Carpet fits?...hood gaps, hem flanges? We used to be bad at those, too."

But Lutz is only part of GM's blog strategy. In April the company yanked $10 million in advertising from the Los Angeles Times and demanded that the Times make retractions. Journalists asked GM for specific complaints, and the car company held off. It said it wanted to work quietly with the Times and not battle it out in the press.

How to get the word out through a back channel? GM directed journalists to a blog, AutomoBear.com, that detailed GM's beef. (It had to do with a comparison between two cars, which GM thought was unfair.) Both GM and Miro Pacic, the blogger at AutomoBear, say that GM provided Pacic with information but that no money passed hands.

Fair enough. But even if GM doesn't pay for positive coverage in blogs, just consider the possibilities in this new footloose media world. There's little to stop companies from quietly buying bloggers' support, or even starting unbranded blogs of their own to promote their products -- or to tar the competition. This raises all kinds of questions about the ever-shrinking wall between advertising and editorial. We'll cover that later, when we get to the blogs' impact on our own business -- the media.

 

[ducati998]

The essence of the GM strategy is restructuring, or cost cutting.
Mr Wagoner, CEO, of GM has placed Gary Cowger in charge of reducing costs.

Market share has dropped from 30%, down to 26.7%, and "Oldsmobile" has been delivered the coup de grace.

GM's problems run from shopfloor resistance to flexibility and production standards needed to compete with the Japanese, to huge pension and health care costs.

The question is does GM still have earning power?
The answer is an emphatic yes. With the Fiat fiasco now resolved, liabilities are the problem, not a loss of earning power.

With such huge leverage in favour of the common, any reduction in costs, will flow through to the common immediately, and be magnified via the leverage to substantial earnings.

COST OF SALES represents 75% of GM revenues.
A 5% reduction represents $7.23B, or a massive $14 a share pre-tax earnings on the common.
Now, if they can trim the fat, and there is PLENTY of fat, 5%, might be a go number.
At a PE of 10, that is a stock price of $140

Now none of this will happen overnight, and without the unions kicking and screaming, but it can be done. If it is, then the upside potential is there.
cheers d998

 

[ducati998]

Earning Power, still there............trim the fat!

General Motors Honors Yazaki Corporation as Corporation of the Year
Saturday April 23, 10:00 pm ET


DETROIT, April 23 /PRNewswire/ -- General Motors Corp. named Yazaki Corporation as its Corporation of the Year at the 13th annual Supplier of the Year celebration held Saturday in Detroit. In addition to being named the 2004 Corporation of the Year, the company was been recognized as a GM Supplier of the Year.

"In 2004, Yazaki demonstrated the strong capabilities of being a global supplier, enabling them to support our production needs throughout the world," said Bo Andersson, GM Vice President, Global Purchasing and Supply Chain. "They performed exceptionally well on our vehicle launches, including the Cadillac STS, and met or exceeded all their global performance metrics. In addition, within two hours of the deadly tsunami sweeping through Asia, Yazaki notified us that their employees and facilities in the region were safe."

Yazaki Corporation is among 78 suppliers representing the global automotive community that were honored at this year's celebration.

"We are extremely pleased to have been recognized by General Motors as their 2004 GM Corporation of the Year," said Riku Yazaki, president of Yazaki's General Motors Business Unit. "GM is a very important customer for us, and their appreciation of our services is a valuable reward for our efforts. Yazaki's commitment to GM's future success is strong, and we are confident that our partnership will improve both of our positions in today's challenging environment."

The GM Supplier of the Year program began in 1992 and each year, a global team of purchasing, engineering, manufacturing and logistics executives determines the winners. Its decisions are based on supplier performance in the areas of quality, service, technology and price.

General Motors Corp. (NYSE: GM - News), the world's largest automaker, has been the global industry sales leader since 1931. Founded in 1908, GM today employs about 321,000 people around the world. It has manufacturing operations in 32 countries and its vehicles are sold in 200 countries. In 2004, GM sold nearly 9 million cars and trucks globally, up 4 percent and the second-highest total in the company's history. GM's global headquarters are at the GM Renaissance Center in Detroit.

 

[ducati998]

Unions are not yet onboard, but there was a very similar stance and attitude at Delta Airlines last year, and in the end they caved in, allowing Delta to avoid Chap.11

GM will need to bring these guys onboard to facilitate the reduction in costs required to bring the common back into profit.

GM expects to get little relief from the United Auto Workers union, which said last week it won't reopen its contract to negotiate lower costs. The union said it will do what it can within the four-year contract, which expires in 2007, to help GM lower costs.

"In our view, the deterioration in GM's financial condition is not yet serious enough to scare the rank-and-file at the union," Merrill Lynch analyst John Casesa said in a research note.

Ford, GM's crosstown rival, also has been hurt by high health care and materials costs and earlier this month lowered its profit forecast for 2005. Ford is expected to announce further production cuts when it releases first-quarter earnings results Wednesday.

cheers d998

 

[ducati998]

Probably a market GM need to get serious about.

Associated Press
Hybrid Car Sales Rise 81 Percent in U.S.
Monday April 25, 12:09 am ET
By Dee-Ann Durbin, AP Auto Writer
Hybrid Vehicle Sales Nearly Double in the United States Last Year As Gas Prices Soar


DETROIT (AP) -- Hybrid vehicle sales nearly doubled in the United States last year as gas prices soared and a wider variety of models attracted consumers.
New hybrid vehicle registrations totaled 83,153 in 2004, an 81 percent increase over the year before, according to data released Monday by R.L. Polk & Co., which collects and interprets automotive data.

Still, hybrids represented less than 1 percent of the 17 million new vehicles sold in 2004. But the U.S. hybrid market has grown by 960 percent since 2000, when 7,781 were sold, according to the Polk data, and major automakers are planning to introduce about a dozen new hybrids during the next three years.

Lonnie Miller, director of analytical solutions for Southfield-based Polk, said federal and state tax credits for fuel-efficient vehicles have helped spur hybrid sales. More people also are buying into the idea that driving a hybrid is socially responsible, he said.

"What's different about this than other types of vehicles is that hybrids are about what people want to give back and what they want to feel they're doing with their vehicles," Miller said.

Despite the arrival of Ford Motor Co.'s Ford Escape hybrid in showrooms last year, Japanese automakers continued to control the vast majority of the U.S. market, Polk said. Japanese brands accounted for more than 96 percent of the hybrid vehicles registered.

Toyota Motor Corp., which was the first automaker to commercially mass-produce and sell hybrid cars, continues to dominate the market. The Toyota Prius, which went on sale in the United States in 2000, occupied 64 percent of the U.S. hybrid market last year, with 53,761 new Prius cars registered, Polk said.

Toyota is on track to double Prius sales again this year. The company sold 22,880 Prius cars in the first three months of the year, more than double the number it sold in the first three months of 2004, according to Autodata Corp. Toyota has said it plans to produce 100,000 Prius cars for the North American market this year.

The Honda Civic hybrid was second with 31 percent market share. Honda Motor Co. also sold several hundred Accord and Insight hybrids, which each commanded 1 percent of the market.

Ford sold 2,566 Escape hybrid sport utility vehicles, or about 3 percent of the market, Polk said.

Automakers are introducing hybrid versions of several models this year, including the Lexus RX400h, Mercury Mariner and Toyota Highlander SUVs. General Motors Corp. and DaimlerChrysler AG already sell hybrid pickups, but the system they use is less fuel efficient.

Hybrid vehicles are powered by internal combustion engines but also are equipped with batteries that are recharged while driving and an electric motor to assist with power. They typically cost $3,000 to $4,000 more than traditional models.

California was again the top state for growth in hybrid vehicle registrations. More than 25,000 new hybrids were registered in California, a 102 percent increase over 2003. Virginia, Washington, Florida and Maryland rounded out the top five states for hybrid registrations, the same as in 2003.

R.L. Polk: http://w

 

[ducati998]

Associated Press
GM Recalling More Than 2 Million Vehicles
Monday April 25, 1:19 pm ET
By Ken Thomas, Associated Press Writer
General Motors Recalling More Than 2 Million Vehicles Due to Seat Belt Design Problems


WASHINGTON (AP) -- General Motors Corp. said Monday it is recalling more than 2 million vehicles, including nearly 1.5 million sport utility vans and pickup trucks that have seat belt design problems.



The recall represented the latest challenge for the world's largest automaker, which last week reported $1.1 billion in losses in the first quarter, its largest quarterly loss in more than a decade.

GM has cited the financial burdens of providing health coverage for its workers and retirees amid lackluster car sales. Sales of the automaker's popular SUVs and large trucks have been off, in part because of high gas prices.

The company said there were only a few minor injuries associated with the six separate recalls and said owners would be formally notified of the problems by mail in the coming weeks.

Among the vehicles affected, the company was recalling 1.48 million SUVs and pickups from the 2003-2005 model years, including the Chevrolet Silverado Crew Cab, Suburban, Tahoe, Avalanche; Cadillac Escalade, Escalade ESV, Escalade EXT, GMC Sierra Crew Cab, Yukon XL, Yukon, and the Hummer H2s.

GM spokesman Alan Adler said the center safety belt in the second row of the SUVs and pickups, typically used for child seats, was riding high on the occupant's stomach or abdomen. He said there could be a reduced protection in that portion of the body in the event of a crash.

Adler said there have been no crashes or injuries connected to the problem.

"We want people, if they have a safety recall, we want them to get it fixed," Adler said.

The company also announced recalls for the following vehicles:

-- More than 330,000 1500 Series Chevrolet Suburban and Yukon XL from the 2000-2001 model years for potential overheating of fuel pump wires that could lead to engine stalling. There were no known crashes or injuries related to the problem.

-- More than 142,000 1500 Series Chevrolet Silverado and GMC Sierra pickups from the 1999-2002 model years and 2500/3500 Series pickups from the 2001-2004 model years with manual transmissions for parking brake friction. Adler said there were 26 crashes and 1 minor injury connected to the problem.

-- More than 69,000 Buick Lacrosse and Buick Allure 2005 models from Canada for a bent clip that holds part of the brake. If the clip comes off, it would lead to brake loss and a crash, Adler said. There has been one minor crash from the issue.

-- More than 39,000 Buick Rendezvous and Pontiac Azteks from the 2004 model year for intermittent stalling or failure to start because of a faulty ignition relay. GM said it was aware of one minor crash but no injuries.

-- More than 22,000 Saturn L Series Wagons from the 2002-2004 model year because they were built with a center and passenger side rear seat belt anchors that do not comply with U.S. and Canadian safety standards.

The company said the problems will be corrected for free.

In midday trading Monday, GM shares were down 52 cents, or 1.94 percent, to $26.22 on the New York Stock Exchange.

 

[ducati998]

Associated Press
Toyota May Increase Car Prices in U.S.
Monday April 25, 2:41 pm ET
Toyota Chairman Says Company May Increase Car Prices in U.S. to Help Support Ailing U.S. Peers


TOKYO (AP) -- Toyota Motor Corp.'s chairman suggested Monday the Japanese carmaker may consider raising the prices of the cars it sells in the United States to help support its ailing U.S. peers, Kyodo News reported.



At a news conference as the head of the Japanese business lobby Keidanren, Hiroshi Okuda, who is also Toyota's chairman, suggested the possibility of price hikes in the United States after U.S. car manufacturers General Motors Corp. and Ford Motor Co. reported weak earnings results last week, Kyodo reported.

Japanese daily Asahi Shimbun reported Okuda told reporters that the U.S. auto makers' problems could cause a backlash for Toyota and other foreign carmakers.

"I'm concerned about the current situation surrounding GM. Although a trade conflict, like ones happened in the past, may be avoided, there may be some impact (on Japan's car industry) because the car industry is symbolic in the U.S. economy," Okuda said.

He said Toyota "may need to adjust prices," hinting that it may increase the prices of its cars in the United States.

 

[ducati998]

GEN MOTORS (NYSE:GM) Delayed quote data

After Hours (RT-ECN): 26.75 0.00 (0.00%)

Last Trade: 26.75
Trade Time: 4:00PM ET
Change: 0.01 (0.04%)
Prev Close: 26.74
Open: 26.77
Bid: N/A
Ask: N/A
1y Target Est: 24.56

Day's Range: 26.02 - 26.79
52wk Range: 24.67 - 50.04
Volume: 10,139,900
Avg Vol (3m): 11,195,000
Market Cap: 15.10B
P/E (ttm): N/A
EPS (ttm): 0.00
Div & Yield: 2.00 (7.48%)


Well just keeps on trucking. Although $0.04 hardly worth getting too excited about.
At this rate I may be called on some Options, and that was not really part of the plan, however, I would expect some profit-taking soon, so we'll see a retracement, and even a move lower possibly.

cheers d998

 

[shortrank]

With the US interbank rate at 2.75%, an 8.0% yield is attractive.

Any ideas how to factor in the sector risk premia to arrive at a fair value?

 

[LION63]

Very difficult and subjective. As Ducati pointed out earlier in the thread, it all comes down to how the individual values the enterprise ie. cash flow, assets, going concern, sum of the parts, replacement value and the list goes on.

Fortunately for any of us that may be interested in General Motors on the buy or sell side, he has done all the work for us.

 

[ducati998]

Shortrank,

That is a tough question. The short answer is yes I do. However, as with a lot of theoretical based calculation, how effectively it performs in reality is always interesting.

I'll post the calculations later ( after I've done them )
Cheers d998

 

[ducati998]

MarketWatch
Has GM stock fallen enough to be attractive?
Tuesday April 26, 12:01 am ET
By Mark Hulbert


ANNANDALE, Va. (MarketWatch) -- If the time to buy is when the blood is running in the streets, as contrarians assert, then they ought to be buying General Motors stock.
After all, the company's blood has been running down Wall Street for several weeks now.




Not only did the company lose more than a billion dollars during the first quarter, the firm has declined even to project how bad its full year results are likely to be -- leading many to suspect that it will lose money over that period too. The credit agencies are considering whether to give GM a junk rating.

Some even have begun wondering whether the company -- 3rd on the Fortune 500 list -- can avoid bankruptcy.

Not surprisingly, (NYSE:GM - News) General Motors' stock has slumped to levels not seen in more than a decade. GM bonds yields have risen to levels once thought unimaginable.

It takes courage to buy in these circumstances, needless to say.

So how many newsletters are currently exhibiting that courage?

Just two -- or three, depending on how you count.

But the good news, at least from the point of view of those holding GM stock, is that these newsletters have good long-term track records.

The first newsletter is The Prudent Speculator, edited by John Buckingham. This newsletter is in first place for total profit over the past 25 years among those newsletters tracked by the Hulbert Financial Digest. Its portfolios on average have produced a 19% annualized return since mid-1980, vs. 12.8% annualized for the Wilshire 5000.

While acknowledging all the negatives, Buckingham points out that "the company has $23 billion in cash on its balance sheet, providing ample liquidity for the foreseeable future, and a very profitable finance arm in GMAC." Buckingham also points favorably to GM's high dividend yield, currently 7.5%.

The second newsletter is The Buyback Letter, edited by David Fried. This letter hasn't been around for as many years as The Prudent Speculator, so the HFD doesn't have a 25-year track record for it. But the newsletter has been one of the best performers since 1997, which is when the HFD began monitoring it.

Over the period since then, Fried's average model portfolio has produced a 16.5% annualized return, in contrast to 7.5% annualized for the Wilshire 5000.

To be sure, Fried has held GM in one of his model portfolios for several years, so he has not just recently decided to purchase the stock. Nevertheless, he has chosen to hold onto the stock in the face of the stock's recent travails.

One of the most contrarian newsletter editors of all is George Putnam, editor of the Turnaround Letter. He often recommends companies that are in deep financial distress and even bankruptcy, on the theory that in many such instances the markets have overreacted and pushed these companies' stocks and bonds down to unjustifiably low levels.

Since 1988, when the HFD began monitoring Putnam's newsletter, his average recommended portfolio has outperformed the Wilshire 5000 by a margin of 14.6% to 11.9%, annualized.

Though Putnam is not currently recommending GM stock or GM bonds for any of his model portfolios, the company's recent financial distress prompted me to e-mail him to get his thoughts. This is his reply:

"Any rating downgrade is a negative for a company and its securities, and there is usually nothing special about crossing the imaginary line between 'investment grade' and 'junk' other than modest damage to one's reputation. However, in GM's case, a downgrade to junk status could roil the bond markets for a brief period because the GM bond issues are so large and actively followed. In bonds as in equities, indexing has become increasingly important, and if GM drops to junk all of the investment grade indexers will have to sell the bonds and all of the high yield indexers will have to buy them.

"Bond investors must have been anticipating some of this turmoil because last week many of the GM bonds dropped to levels where they yielded more than 11%, which is considerably worse than most junk issues. They've bounced back a little, but I think if you can buy the GM bonds with yields above 10%, you will ultimately do quite well (but it may continue to be a bit of a bumpy ride for a while)."

So if you're a contrarian, now may be your chance.

To be sure, it may feel a bit lonely to buy right now, with just a few newsletter editors on your side.

But then, if you have too much a problem with loneliness, you shouldn't be a contrarian in the first place.


Bear facts: The best performing newsletters right now are significantly more bullish than the laggards.

Performance scoreboards, most/least popular stocks and funds, market exposure among timers

Profiles: Bob Brinker's Marketimer, Dow Theory Forecasts, The No-Load Fund Investor and OTC Insight

 

[LION63]

Ducati998,

You must have graduated from the same university as Kirk Kerkorian. Good on you.

 

[nigelpm]

fantastic call ducati!!

;-)

 

[ducati998]

Thanks chaps,

Trade closed at $32+
cheers d998

 

[ducati998]

Kerkorian could be GM's wake-up call


The influential investor's offer for a bigger stake in the automaker at least set a floor for the stock. It also might force management to actually change the company.

By Robert Walberg

News that billionaire investor Kirk Kerkorian's Tracinda Corp. offered to pay roughly $870 million to acquire an additional 5% stake in General Motors (GM, news, msgs) sent the stock of the beleaguered auto maker racing to its biggest one-day gain in over 20 years. Given Kerkorian's long track record of unleashing value, and considering the scope of Wednesday's gain in GM’s stock, does the news signal a bottom for GM's stock? In a word, yes.

No, Kerkorian's investment doesn't change the fact that GM is faced with high health care costs, rising raw materials costs, declining market share, stagnant product lines and a lousy credit rating that could easily be lowered to "junk" on any given day. But in launching a tender offer rather than simply acquiring the stock in the open market, Kerkorian sent a strong signal to management that it must take more aggressive action in righting the ship, or face the consequences from increasingly hostile shareholders. Banks and insurers
check your credit.
So should you.



Don't forget that Tracinda already owned 3.9% of GM at an average price of $26.33 per share. Odds are Kerkorian hasn't been all that happy watching the stock's value decline by nearly 55% over the last 18 months. It's also very unlikely that he was appeased by management's recent plan to reverse the company's fortunes, a plan that relies heavily on improved marketing of its cars and trucks.

The real problem
A lack of marketing isn't GM's biggest problem. Unappealing designs, too many lines, copycat styling across lines and a relatively high cost structure are the big structural problems management seemed unwilling, or unable, to address. Well, the heat is on now; management will have to address these issues quickly or face the potential of some ugly board fights down the road.

Lest we think Kerkorian's investment is all about the auto business, note that GM's financing arm, GMAC, has been the big driver of income over the past few years. In 2004, the financing unit accounted for roughly 78% of the $3.7 billion earned by GM. The automaker expects GMAC to post net income of about $2.5 billion this year. Clearly, one of Kerkorian's aims is to unleash the value of this unit.

How GM would go about separating the non-auto financing businesses from the rest of the company remains to be seen, but today's action will almost certainly accelerate the process. According to a research note by Merrill Lynch analyst John Casesa, the value of these non-core assets is about $25 per share.

Worth more than few bucks
If true, then the auto and auto financing parts of the business were being valued by the market at zero last month when the stock briefly dipped below the $25 level. I'm no big fan of the way GM is handling its auto business (see "GM's woes are just beginning" and "GM's best offense could be defense"), but there's no question it's worth more than a few bucks per share.

Maybe that's why Kerkorian stepped in and made his move now. Of course, it didn't hurt that the stock was being shorted heavily by investors turned off by the recent quarterly loss ($1.1 billion) and the 7.7% decline in April sales. In hearing Wednesday's announcement by Tracinda, short-sellers scrambled to cover their positions, thereby stoking the flames of the historic rally. In the process, the 22 million shares already owned by Kerkorian just increased in value by approximately $97 million -- not a bad day's work.

But let's not be so cynical. Assuming Kerkorian is in this for the long haul and that he truly wants to enhance shareholder value, then it's probably safe to assume that the $31 offer price of the tender should be close to the stock's new floor.

Yet don't mistake an improved outlook for the stock for an improved outlook for the company. As I've written, GM still faces some major near-term obstacles, including the possibility of its credit rating being slashed, which would increase its financing costs.

Finally, a sign
Nevertheless, what investors have been longing for is some sign, any sign, that management would adopt something other than the usual marketing/design/cost-cutting plan to fix the problems. Kerkorian's investment is just that sign. GM management is now on notice -- act aggressively or prepare for a fight over control of the company.

There might not be much additional upside in the stock over the short term, at least not until investors get a better sense of how management plans to improve operations and enhance shareholder value. But the downside risk has been significantly reduced by the Kerkorian news. In fact, the news cycle for GM has just gone from miserable to positive. We all know the negatives. Now we're faced with the potential for some good news for a change, and that's very, very good news for long suffering shareholders.

 

[ducati998]

Billions of dollars in hedge-fund money disappeared into thin air amid the GM mess. What they have to do to recover could test the whole market.

By Jon D. Markman

It is a perverse fact of life in the market for financial instruments that the well-intentioned quest for safety very often leads to the worst sort of dangers.

Almost 20 years ago, the great crash of 1987 came about in large part as a result of stock market participants’ purchase of a kind of portfolio insurance that paradoxically caused the very type of volatility it was intended to prevent.

About seven years ago, the Long-Term Capital Management hedge-fund crisis sprang from a wrongheaded theory by prize-winning economists that tons of money could be made with little risk by betting that the sovereign debt of various European countries’ would converge.

And now we learn that one or more major hedge funds may have suffered substantial losses this month -- and potentially ignited a “contagion” -- as a result of blown-up trades related to U.S. automakers in esoteric risk-avoidance instruments called collateralized debt obligations and credit-default swaps.

The trouble this time is unlikely to be as deeply pervasive as the first two, in which a passion for risk aversion by well-capitalized institutional investors heaped billions of dollars of losses on the public. But because these instruments have never been stressed in a real-time crisis, it’s hard to know exactly how they will act. We may discover that they could ultimately batter the public just as soundly.

Why should you care? It’s tempting to view hedge funds harshly for any misjudgments they may have made. After all, in the popular imagination they are cowboys on the risk-taking fringe only out for themselves.

Yet the reality is quite different. The hedge funds at the root of the problem may actually have been working on your behalf -- and at any rate were tripped up by pretty conservative trades that went terribly wrong. The trouble that they encountered was the investment equivalent of getting hit by a truck while crossing the street at a well-marked intersection. Maybe you didn’t look both ways, but the fact that you got crushed is more bad luck than bad karma.

The emergence of hedge funds
To understand what happened, let’s dial back and consider what hedge funds are and the background of their transactions.

From the time of their invention through the mid-1990s, hedge funds were primarily partnerships limited to investments by rich people that focused on profiting from both positive and negative moves in stocks, bonds, currencies and commodities. There are dozens of different types of specialist funds, but the purpose of most is to provide steadfast returns uncorrelated with the trend of the market on which they focus. The funds’ members, or limited partners, pay managers up to a third of the profit for annually delivering the holy grail of investing: Great results in good times or bad.


In the early part of this decade, amid a raging bear market, a handful of major corporations -- led by General Motors (GM, news, msgs), ironically enough -- grew concerned that their pension funds would never meet their investment goals if they continued to focus strictly on long-only stock-and-bond strategies. So they directed their pension managers to put billions of dollars on behalf of their retired blue-collar workers into “alternative investments,” which is a term of art for hedge funds.

Broadly speaking, pension funds try to maintain a balanced allocation of 60% stocks and 40% bonds. The idea of that split is that they’ll get more bang for their buck out of stocks -- and yet if equities are soft, returns will be cushioned by nice, safe bond yields. The problem has been that the Federal Reserve’s expansive money policy of the past few years created a financial regime in which bond yields were extremely low -- and yet stock returns haven’t been too hot, either.

Bundling up bonds
So what’s a pension manager to do? Well, in pursuit of returns of 8%-10% in a negative or flat market, many sought out bond hedge funds that promised to use new mathematical modeling techniques to seemingly manufacture money out of thin air.

When you hear the word “bond,” you probably think of a U.S. government or corporate debt instrument that pays holders an annual interest payment whose size is related to risk and duration. Short-term U.S. Treasury bills backed by the government’s taxing power pay the smallest amount of interest, while the long-dated obligations of iffy companies with poor credit -- known as “junk” bonds -- pay the most.

But between those two extremes are a wide range of debt products. To make it simpler to buy and sell them, investment banks came up with the idea to “securitize,” or bundle up, a lot of different types of bonds into instruments called “collateralized debt obligations,” or CDOs. These are in turn sliced up by banks into smaller pieces, generally categorized by risk, that are known by the French word “tranches.”

Something like 90% of all corporate bonds are securitized and resold in this way -- spreading out the risk in a way that helps issuers get financed and grow.

New financial models
Now enter the hedge funds seeking to provide dependable returns to pension managers. A new breed of math geniuses entered the scene not too long ago with financial models that they believe help them understand when certain tranches are undervalued relative to other tranches. The big idea is that if you can figure out which ones are overpriced and likely to lose value, and which ones are underpriced and likely to gain in value, you can short one and buy the other and make a few bucks as their prices converge.

One of the big trades that hedge fund managers working on behalf of your pension put on in recent years has been to buy the “mezzanine,” or medium-risk bond tranche of CDOs and short the equivalent amount of money in the equity tranche or equity of the company. The amount of money involved in these trades is quite enormous; because the trading environment was so tame up until quite recently, the equity tranches were leveraged by as much as 17-to-1, according to Peter Petas, research director at the corporate capital-structure research firm CreditSights in New York.

Automakers are among the biggest sellers of bonds in the United States, so they are overrepresented in even the most diverse CDOs. And now we get to the heart of the matter.

Enter Kirk Kerkorian
What happened last week that imperiled a number of hedge funds’ carefully constructed credit-spread compression strategies was the very unusual span of two days in which Los Angeles financier Kirk Kerkorian first announced a significant bid for General Motors stock at a premium, and then debt-rating agency Standard & Poor’s downgraded GM bonds to junk status. As you might recall, GM shares went straight up and then its bonds went straight down -- blowing up a trade that was leveraged to the hilt. In the space of a few hours, an unknown amount of highly leveraged hedge-fund money that probably totaled well into billions of dollars went poof!

No hedge fund has admitted yet that it was on the wrong side of this trade, but it will eventually come out. And the reason that it can have a "contagion" effect is that the funds at risk will undoubtedly face a large number of redemption requests from their members -- and failure of a fund could have a combustible impact on its counterparties and prime brokers, which are big investment banks.

Fallout -- and bankruptcy?
Funds are required by contract to provide "liquidity" -- that is, cash -- to members either at the end of a month or a quarter. So many in the investment community are holding their breath now waiting to see how many funds need to liquidate stock and bond portfolios in order to meet a flood of redemptions.

One serious issue is that CDOs may be widely sold, but they are not terribly liquid. There is no easy market for these things, and they can typically only be sold back to the organization from which they were purchased. Plus, since they are just sitting on the funds' books for long periods of time, they are usually not marked to market, or priced, until the time of sale. And that is why no one really knows how much money is at stake.

"We have seen that these sorts of trades only work until they stop working," said Peter Petas, of the capital structure research firm CreditSights. "It is not the most tested market, but guys are taking these trades anyway to get yield in a low-volatility environment."

If we see big up days in the market followed by big down days, you can be sure that funds are using every uptick to unload inventory to meet their obligation and avoid bankruptcy. At times like this, the Federal Reserve and other central banks have learned to flood the system with money to avoid big disruptions. So from now until the end of the month, or quarter, there may be an interesting battle between the private forces of fear and the public forces of balance. Stay tuned: it could be your money.