Hedge Funds To Be Tested Tuesday

Posted In: Financial Sector, Hedge Funds, Stocks, U.S. Government

Have you ever seen those television commercials that consist of “real life” testimonials for products? I remember watching TV in the late nineties and “John Smith,” stockbroker, would rave about some great vacation destination. After stocks came crashing down, “Jane Zinfandel,” real estate investor, took up the baton and went on about how much she loves her exercise equipment. When the U.S. housing market collapsed, “Joe Brown,” hedge fund manager, appeared on my TV set and let me know who makes the finest luxury automobile. The “coolness” factor of these occupations rose exponentially while hot money flowed their way. Once the flow reversed, however, it became a different story. And for hedge funds, this reversal of fortune might have been reached. Louise Story of the New York Times wrote yesterday:

First, the money rushed into hedge funds. Now, some fear, it could rush out. Even as Washington reached a tentative agreement on Sunday over what may become the largest financial bailout in American history, new worries were building inside the nearly $2 trillion world of hedge funds. After years of explosive growth, losses are mounting — and so are concerns that some investors will head for the exits.

No one expects a wholesale flight from hedge funds. But even a modest outflow could reverberate through the financial markets. To pay back investors, some funds may be forced to dump investments at a time when the markets are already shaky.

The big worry is that a spate of hurried sales could unleash a vicious circle within the hedge fund industry, with the sales leading to more losses, and those losses leading to more withdrawals, and so on. A big test will come on Tuesday, when many funds are scheduled to accept withdrawal requests for the end of the year.

“Everybody’s watching for redemptions,” said James McKee, director of hedge fund research at Callan Associates, a consulting firm in San Francisco. “And there could be a cascading effect, where redemptions cause other redemptions.”

Recent performance for the industry has not been stellar. Story noted:

Now, the heady returns of the industry’s glory days are over, at least for now. This is shaping up to be the industry’s worst year on record, with the average fund down nearly 10 percent so far, according to Hedge Fund Research…

Returns are not in yet for September, but hedge fund managers say this month is even worse than the summer. Some funds were hurt by new rules from the Securities and Exchange Commission on short-selling, a tactic for betting against stock prices. The commission made it more difficult to short all stocks and temporarily banned the strategy in more than 800 financial stocks. In particular, this hurt convertible-bond managers, who often buy bonds that can be converted into shares and short the underlying stocks.

The short-selling ban lasts until Thursday evening, but it is widely expected to be extended.

As a result, some hedge funds are going under. According to Story:

A growing number of hedge funds are closing down. About 350 were liquidated in the first half of the year. While hedge funds come and go all the time, if the trend continues, the number of closures would be up 24 percent this year from 2007.

Source:

“Hedge Funds Are Bracing for Investors to Cash Out”
Louise Story
New York Times, September 29, 2008

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