Last week broker/dealer MF global was downgraded by Moody’s Investors Services and promptly declared bankruptcy this past Monday. MF Global’s sources of funding dried up like a kitchen sponge left in the sun, which stemmed from a loss of confidence mainly attributable to a sizable $6bn+ European sovereign (PIIGS countries) debt book. In addition, according to the company’s second quarter 2011 financials the firm had total asset of $45.9B and equity capital of $1.3B. This implies leverage of 35x (Bear Stearns and LTCM were both at 33.5x when they failed) with $21B of their holdings classified as Level II assets, meaning these assets do not trade on an exchange so they are not the most liquid and easy to price securities, such as common stock.
My point is that from a 10,000 foot view this company reminds me of a hedge fund with a high frequency trading book (aka market making) and a buy-and-hold book (speculation and proprietary positions). I must confess that I have not done a full evaluation of this case, so this is me thinking of the cuff. BUT, it begs the question, as an equity investor there is a very real downside to investing in a publicly traded financial company with proprietary positions vs. investing in a hedge fund.
Gasp… Is this guy crazy??
Consider the table below. When you run down this list you immediately feel better about the risk profile of a broker/dealer relative to that of hedge fund. Broker/dealers have better disclosure, regulation, scrutiny from rating agencies, permanant capital, etc… yet, there are far more failures of regulated entities than unregulated entities. True, you likely hear much more about the publicly-traded, press and analyst covered failures.
So, what’s more risky, investing in a hedge fund that you perceive to be very risky from the start and act accordingly OR investing in a publicly-rated, publicly traded broker/dealer that is just as leveraged but perceived to be less-risky?
I would love to hear your feedback on this one!
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