First we have the Bear Stearns melt-down with two of its billion dollar hedge funds losing everything after making wrong bets on subprime mortgages.

Now, word is coming out of Australia that a $2 billion fund called Basis Capital, which was voted the #1 hedge fund in Australia in 2006, has suffered significant losses in its fund. From Bloomberg:

In a letter sent to investors July 6, Basis Capital said its investments in collateralized debt obligations, or CDOs, had been tarnished by “guilt by association.” Less than a week later, the Sydney-based hedge fund, which had assets of $1 billion in May, said its two funds lost 9 percent and 14 percent last month. Withdrawals from the funds have been frozen and some margin calls have been missed, research firm Zenith Investment Partners Ltd. said in an e-mailed note today.

It doesn’t sound as bad as what was happening at Bear Stearns, but it doesn’t sound great either. As the Sydney Morning Herald put so eloquently today:

A couple of scary points about Basis Capital: the first is that investment products in its troubled hedge funds were available on investment platforms of two of our large and reputable financial institutions, BT (the funds management arm of Westpac) and Macquarie Bank. This is mainstream stuff and investors would have taken comfort in the fact that these are two of the major financial products supermarkets in the Australian system.

The second worrying feature is that several rating agencies were simply gushing about these Basis Capital funds.

They were given five-star ratings with no suggestion that they were in any way dangerous. So why didn’t the ratings agencies sound any alarm bells? It’s simple - they didn’t appreciate the nature of the investments.

They ask a good question. Who DID understand them then?

Yes- they were sold to little old ladies in pension funds. Sound familiar? (Enron,Pets.com, Worldcom etc.)

Why can’t everyone just buy GE and walk away? Because it’s not glamorous? Because it won’t make them rich? But it will. I’m not saying sophisticated hedging strategies can’t make people a lot of money. They can. But for the average investor (and, apparently, some supposedly not so average hedge fund managers) most hedging investments carry a lot of risk and too many people don’t understand the complications that can arise.

The question now becomes, how many more funds are out there that have the losses? It cannot be simply these two funds. And who will pay for the losses?

Basis Capital was not run by some fly-by-night managers. It was highly respected in the industry. Outside of winning fund of the year in 2006, the fund was also highly regarded by fund rankings:

In a research note posted on Basis Capital’s website until last Friday, Standard & Poor’s gave the Basis Yield Fund five stars, its highest rating. Another S&P report described Basis Capital as having “a highly experienced, well-resourced investment team led by (Steve) Howell and principal Stuart Fowler”.

Who can you trust anymore? Apparently no one.

Where there is smoke, there’s fire. I’m seeing some smoke right now- no matter how hard the Street tries to say the contagion can be “contained.”