naked capitalism

One sign that the credit crisis is accelerating: Nouriel Roubini’s forecasts are coming to fruition faster.

In the past, Roubini has too often played the role of seemingly mad prophet in the wilderness until he is proven correct. His calls that the housing bubble would collapse in a nasty way, that subprime was most certainly not contained, that Freddie and Fannie would get in trouble, that total credit crunch losses would reach $2 trillion, all sounded apocalyptic and were generally ignored, to the detriment of those who failed to take heed.

The time between Roubini making a dire forecast and it coming to pass has just collapsed. From yesrday’s Financial Times:

The next stage will be a run on thousands of highly leveraged hedge funds. After a brief lock-up period, investors in such funds can redeem their investments on a quarterly basis; thus a bank-like run on hedge funds is highly possible. Hundreds of smaller, younger funds that have taken excessive risks with high leverage and are poorly managed may collapse. A massive shake-out of the bloated hedge fund industry is likely in the next two years.

In today’s Independent (recall that London is an even bigger hedge fund center than New York/Fairfield County):

Hedge funds could have an unprecedented level of cash pulled out by investors this quarter, according to insiders, just as they faced millions of pounds of losses from last week’s shock regulation of short selling. It has been a tough year for the industry with high-profile funds blowing up, clients increasing redemptions, as well as public fury over short selling and increased threats of regulation.

One hedge fund expert pointed to The Hedge Fund Implode-O-Meter (HFI) as how he judges the state of the industry. The HFI was set up online in the wake of the credit crunch “to track as hedge funds learn the double-edged-sword nature of the often extreme leverage they use”.

The group’s “imploded funds” list has hit 51 companies…..It has 34 stocks on its “ailing/watch list” of those that have suffered significant value declines or temporarily halted redemptions. According to EuroHedge, a hedge fund data provider, 272 individual funds strategies were launched during the first six months of 2008, the lowest for nine years. In the same time, 243 funds have been liquidated, the highest in a six-month period…

The redemptions seem to have started in earnest, although currently the evidence is mainly anecdotal. One UK hedge fund manager confided that last week had the highest number of investors rushing to withdraw funds that he has known. The industry will know for sure whether it is a drip or a deluge when the data providers release their statistics for the third quarter, next month. One market analyst said: “I know even the good hedge funds have been suffering withdrawals recently. Investors are very nervous.”

Performance numbers are also under pressure. Some have done well out of the market disturbance, but on average the performance numbers are at a low ebb. Andrew Baker, the deputy head of Aima, the hedge fund trade body, said: “The performance is undoubtedly soggy. There are not many strategies that stand out.”

Yves here. Note that short strategies had been a lone bright spot, But now that short sellers are being pursued with a vehemence that would warm Torquemada’s heart, let’s just say that their past results may not be indicative of future performance.

EuroHedge revealed that strategies that have done particularly badly this year include several run by Naissance Capital, once bankrolled by the Habsburg families, which are down a fifth and Pico Fund, which is down 32 per cent. At Endeavour Fund, set up by former Salomon Smith Barney traders, the second fund has fallen by 40 per cent, while its third fund is down 38.79 per cent in 2008. In the emerging markets, PharmaInvest Fund’s investments in emerging markets are 38.16 per cent down.

Other funds have sought to lock in investors by halting redemptions. The latest example was RAB, with its flagship Special Situations Fund, as it was so desperate to prevent exits after a 22 per cent drop in performance that it offered vastly reduced fees in return for a lock-in period of three years.

One of the main problems experienced by hedge funds is the extent of leverage in the industry. The funds were able to take on huge amounts of debt, with little capital needed as security, to boost returns. One observer said some of the leveraged strategies were like “picking up pennies in front of a steamroller, and that only takes a turn in the market to cause severe problems”…..

At the same time, hedge funds, like the banks, have had to write down exposures to investments in risky instruments including collateralised debt obligations and asset backed securities, and also been exposed to the huge swings in the market.

Another issue is the regulators sniffing around. There have been wider calls for transparency and official controls of the industry, which has already been stung by the shock short-selling rules…

Stuart McLaren, financial services partner at Deloitte, said: “When the dust has settled, I expect the regulators to look at the role that hedge funds have played in the current issues. I expect there will be increased calls for regulation, but I doubt much will come from it.”