Pallotta Says Market Turmoil `Crushed' Raptor Fund's Stock Bets

Date: Friday, August 24, 2007
Author: Jenny Strasburg, Bloomberg

Aug. 24 (Bloomberg) -- James Pallotta's $8.5 billion Raptor hedge fund fell 8 percent this year through Aug. 15 as bets against some stocks failed to protect him amid a global stock- market selloff.

``Some of our core longs were simply crushed,'' Pallotta, who manages Raptor from Boston for Tudor Investment Corp., wrote in an Aug. 21 letter to investors obtained by Bloomberg News. ``Compounding matters, our short book failed us, which was enormously frustrating because historically it has been more volatile than our long book.''

The list of hedge funds reporting losses this month has been dominated by quantitative managers such as AQR Capital Management LLC, which uses computer programs to pick trades. Pallotta is a long-short manager who buys shares he expects to rise and hedges those bets with short sales of stocks he expects to fall.

``For the first time in the history of our equity strategy, we received virtually no performance contribution from our short book against the backdrop of a precipitous market decline,'' Pallotta wrote. ``While we believe conditions will revert to `normal,' it will take time.''

In a short sale, an investor usually sells borrowed stock in expectation of repaying the loan with shares repurchased at a lower price.

Pallotta, 49, also called deeper economic troubles ``likely'' in coming months.

`Consumer Recession' Likely

``All bets are off in a recession or a climate characterized by fear of recession,'' according to the letter. ``It is now our view that a consumer recession is likely -- if not happening already.''

A credit crunch that started with U.S. mortgages to borrowers with risky credit spread to stocks in July and August. The Standard & Poor's 500 Index lost 9.2 percent in the month ended Aug. 17, including the biggest one-day drop since February on Aug. 9. At the same time, prices made big swings up and down, with the benchmark for U.S. stock-market volatility -- known as the VIX -- doubled to the highest level since April 2003. Simultaneous selling by many funds pushed prices of stocks and bonds sharply lower.

Pallotta has posted an annual return of 19.2 percent since Raptor opened in October 1993, almost double the S&P 500. Raptor had been down 2.9 percent as of July 27.

Tudor, founded by billionaire trader Paul Tudor Jones, 52, manages a total of $20 billion. Shawn Pattison, a spokesman for the Greenwich, Connecticut-based firm, declined to comment.

More Conservative

``Currently, we believe that having more cash is prudent in the short run,'' Pallotta said in the Raptor letter. ``Our response to the drawdown is exactly that expected by our investors and demanded by the Tudor `playbook.' Gross and net exposures have been reduced dramatically and may shrink further.''

Raptor's managers are ``cash flow-obsessed stock pickers,'' he wrote. ``Hence, we will be more discriminating until there is, for better or worse, greater clarity about both the functioning of the capital markets and the path of economic growth.''

Growth in economies around the world in recent years could help limit damage from market declines in the U.S., according to Pallotta.

``Many economies around the globe are humming in unison with domestic and consumer demand as a driving force, which is supportive of their ability to weather this storm (albeit taking more body blows than ever before),'' he said in the letter.

Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets and participate substantially in profits from money invested. Industry assets have almost tripled to $1.7 trillion since 2002.

To contact the reporter on this story: Jenny Strasburg in New York at jstrasburg@bloomberg.net .