"Hedge Fund for a Day," the new parlor game?
Here's the case.
You look at two troubled real estate companies.
Neither seems to be able to do its JV
accounting correctly, and both are late with
their SEC filings. The same auditors are
crawling over the books of both.
Your mandate is to remain market neutral
(equal dollars long and short). So, if you
buy one, you must short the other. Of course,
you can avoid both.
What to do?
Here are the companies:
That's it? After all your smack talking you say the solution is to buy MLS and short SRZ??? And here you got me all ready to learn something about hedging my portfolio. Not only do you not offer any knowledge but let's count the disclaimers and outs you give yourself:
1. I made this "game" up on the fly, with no cannned solution, so don't expect too much.
2. Thursday's solution might not be today's.
3. I'm no authority on this paired long-short hedging technique, though I've dabbled with it.
4. Again, all this could change with one day of trading, or one headline.
Man, talk about over promise and under produce. And what was the point of bringing up 50 bps over 30 day LIBOR as my borrowing rate anyway?
I was actually looking forward to learning something new.
Here is your answer, such as it is.
I made this "game" up on the fly, with no cannned solution, so don't expect too much. In fact, there really is no "solution" as such. Thursday's solution might not be today's.
First a couple of disclaimers. I'm no authority on this paired long-short hedging technique, though I've dabbled with it. A few years ago I made a few dollars going long XMSR and short SIRI, but that certainly doesn't make me an expert.
Second, I am currently long both SRX and MLS. In fact I bought more of both late last week. I am certainly not a member of the market-neutral trading world.
You criticized my not allowing options and I responded to that. Perhaps a bigger criticism would be the equal-dollars-of-each limitation. A better approach is to adjust the purchases for beta to be market neutral. That is, if one company has a beta of 1.0 and the other 1.2, one really ought to commit to 120% of the first, whether long or short, to be market neutral. (Frankly, I haven't even looked up the beta on these two companies and won't since I also think it's voodoo in most respects, again for reasons that I won't describe here.)
My knowledge of these two companies is fairly limited (as all can tell). My philosphy is that there are always investors who know a lot more about every company than I do (not just insiders, though certainly do, but that is another subject). My style is to invest in companies that have major problems (accounting screw-ups, FDA sanctions, bankruptcy for whatever, etc.) so my focus is on the screw-up and not all the other fundamentals. The market is fairly efficient on the other stuff and I could work 36 hours per day and not gain an edge.
So I picked SRZ and MLS for this little game, not because they are similar in every respect, but because they are likely to show high continuing volatility and have some common problems. Somebody said one's a REIT and the other is not, so that makes them apples and oranges. To that I can only respond, "Gimme a break." They mostly face the same fundamental issues (e.g., interest-rate sensitivity) and the same equity market exposure. Pairing hedges are seldom as perfect as XMSR and SIRI.
So what's the "solution"? Buy MLS and short SRZ as part of an overall portfolio strategy that requires market neutrality and has lots of other such pairings.
That doesn't mean I dislike SRZ (remember, I'm long). Based on what I've determined, SRZ is the better company with the superior management (at least, less suspect) and fewer problems.
But MLS has been beaten down more (with good reason) and is far more likely to respond to the upside (less to the downside), near term, to future events (e.g., a buy out). If both companies appreciate over the next month or so, I would expect MLS to beat SRZ. More money would be made on the long than lost on the short. And that's what hedging is all about.
Again, all this could change with one day of trading, or one headline.
I'm sure others with more knowlegde of such things can criticize all of the above. Have at it.
Bart, I could write more. But, as you know, I'm lazy.
Bart responded, "Your question on how to
invest in either and/or both srz or mils
while staying market neutral."
Oh, it's much too early to answer that.
For the record, I bought SRZ early this morning. As always, better lucky than smart.
L.O.L.....and true. We hear that the Edgewater NJ facility has a lot of empty rooms and should be full. It's supposed to have a view of the N.Y. skyline, and tons of $ on both sides of the Hudson river. The real dirt is soon to follow.....Strange
Here are some additional considerations:
Both are expected to have above-market
volatility as the news of their accounting
shenanigans is revealed, likely at about the
same time due to the common auditors.
Both have dramatically rising costs of capital
and one of the companies has placed itself on
the block. Strike lawsuits present a major
risk to both.
You may not trade options. You may employ
leverage equal to 100 percent of your capital
at risk, and your borrowing rate is 50 bps over
the 30-day LIBOR.
wa1cher responded on the MLS board, "The
fundamentals are different; so, although there may be similar admin & acctg issues,
it's like comparing apples and oranges. Until
issues are clarified, it's a speculation."
It's okay if you don't want to play. But the
game is Hedge Fund for a Day, not Cop Out.
Please return the leather chair from your
six-screen trading desk if you don't want to
find alpha without beta. You get a fabric
chair in the accounting department, figuring
out unsettled trades at month-end.
Of course, the fundamentals are different in
many respects. And the bad news has been baked
into the prices in different ways. The idea
is to figure out which one is over-priced and
The share prices can both go up, or both down,
or in opposite directions. The idea is to beat
the market regardless of what happens.
I accept your apology.
Here's my take on your exercise:
SRZ is not a REIT, MLS is. SRZ is in an underserved and growing marketplace. MLS appears to be in retail shopping malls. MLS has lost senior officers apparently tied to actual "shenanigans" and the SEC in involved. SRZ simply came out and said they had a question regarding an accounting rule on how to apply profits among the JV's they create when they open some properties. Have no idea what you're talking about regarding strike lawsuits.
The problem with your case study, in my opinion, is that you've restricted my ability to use options to remain market neutral. MLS has buyers in the wings and a hedge fund accumulating shares, so I would not want to short it or buy puts, nor would I want to buy it because of the crap going on. So, I'd stay away. But I think SRZ provides an excellent opportunity because the accounting issue is not likely to have a material impact on earnings, as stated by the company. In addition, the rapid downward move was set up on several fronts. First, there is a limited float. Second, there have been large short positions in the stock who have been punished over the last several months. Next, our buddy Cramer started talking about the stock and brought in loads of speculartors who drove the stock but were not long term holders. Then Herb Greenberg started chirping about not being able to figure out the balance sheet and talking about the shorts pain. Then the company held off on announcing their quarter and said they were looking at the JV profit distributions. Ther perfect storm was then created and the stock immediately dropped, the short timers bailed, the shorts reuped their position and most all buyers hopped on the fence. The market taking a dump only magnified the effect.
So, I guess if I had to stay neutral AND could use options, I'd buy the stock and buy short term puts just in case the accounting issue went south. If the accounting release came out neutral to positive, I'd dump the puts and ride the long position. If accounting was bad, I'd dump the stock and exercise the puts.