Goldman's Cash Infusion Not A Bailout (GS)

By Wayne Pinsent | August 15, 2007 AAA

The recent volatility in the markets has created problems with many quantitative hedge funds that rely on computer models to make trading decisions.

On Monday, Goldman Sachs (NYSE:GS) announced that its Global Equity Opportunities (GEO) Fund will receive a $3 billion cash infusion from Goldman and other investors. At first it seems scary that one of Goldman's fund needs cash to break out of a slump, but looking beneath the surface, this is a smart investment by a smart company.

Why Are Quants Getting Crushed?
Quant funds are based on computer models that signal what to buy and sell based on fundamentals. If the market is behaving rationally, fundamentals should rule, and computer models take the emotion out of trading, which is good. However, lately the market has not been trading on fundamentals, and the models could not adapt. (For more on these computer controlled trades, see The Power Of Program Trades.)

The Quant funds hit hardest were market neutral strategies. Many metrics that these funds trade on became too highly correlated and the funds could not achieve their objectives. Other problems have stemmed stocks with good fundamentals performing worse than stocks with poor fundamentals as of late.

Goldman's GEO fund, like many other quants, got crushed during the recent market downturns. The fund plummeted an estimated 35% during the week of August 6, and its down about 30% YTD. Goldman's well known Global Alpha fund has also suffered, down 27% YTD.

Not a Bail Out
Bear Stearns
(NYSE:BSC) indicated that it would throw $1.6 billion at one of its two failing hedge funds in attempt to bail it out. This is not the same news from Goldman. Instead, Goldman is making a $2 billion equity investment in the GEO fund, with an additional $1 billion coming from a group of individual investors. In Goldman's conference call, the company indicated that the trouble with the quant funds, which has suppressed returns over the last few weeks, is slowing down and is probably 75-100% complete. By making this investment, Goldman is showing confidence in the GEO fund and the market. When the leading investment bank makes a move like this, it is a positive sign for the market as a whole.

Discount Brokers
Recently, investors have been putting the whole financial sector on the chopping block. Goldman is down 20% since July 13, and now trades at a 7.9 P/E ratio, compared to an industry average of 11. But every financial at Goldman impresses. The company has $86 billion in cash and cash equivalents on the books. Even if Goldman had major problems with its funds, it has the cash to cushion it. And in a market where debt is a concern, the company has a current ratio of 1.3, which is strong compared with Lehman Brothers (NYSE:LEH) current ratio of 1.16 and Bear Stearns at 1.2.

Another important note is that, due to its recent slip, Goldman is trading at less than twice its book value, while it recently produced an impressive 29.25% return on equity with Morgan Stanley (NYSE:MS) at 25.7% and Bear Stearns at 15.32%.

Current Market Risks
Financials have a bad aura around them, and this may continue, but in my opinion it is only for the short term. Another risk is that Goldman could experience more problems with its hedge funds or its subprime exposure. But barring a complete catastrophe, Goldman has plenty of cash to absorb small occurrences and can write them off without any serious long term problems.

Metrics indicate to me that financials, overall, have been oversold, but Goldman stands out. Goldman Sachs is the premier name on Wall Street, with an incredible track record for making money in all areas of business. I think this is a great opportunity for the long-term investor to buy a great stock at an attractive price.

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