Bloomberg reports that stock hedge funds carried unprecedented levels of cash in the first quarter, which is usually considered to be a highly bullish sign. However, note that their cash levels fell by 28% from January to February due to deleveraging (which may not have been entirely voluntary given new tough-mindedness on behalf of prime brokers).
Some observers anticipate that there will be a large number of hedge fund closures this year, so high cash levels in hedge funds may not be a conclusive a bull market indicator as high cash balances in more conservatively managed mutual funds is.
Stock hedge funds, unsure about which direction the markets would move, sat on a record amount of cash as the industry headed for its biggest quarterly decline in almost six years.
Equity managers, who oversee about one-third of the $1.9 trillion in hedge funds, held an estimated $90 billion of cash in January, a hoard that dropped to $64.8 billion the next month, according to data compiled by Merrill Lynch & Co. analyst Mary Ann Bartels. The last time equity funds held cash outside of their trading accounts was in 2004, according to Merrill. At that time, market direction was also unclear, with the Standard & Poor’s 500 Index up less than 2 percent through October.
“The data indicates to us the equity hedge funds have de- leveraged and have record cash balances,” she wrote in a report last week. “Margin debt has declined sharply in recent months as investors have grown more cautious on the U.S. equity market.”
Hedge funds dropped an average of 2.83 percent this year through March 28, according to Chicago-based Hedge Fund Research Inc.’s Global Hedge Fund Index, which is updated daily with a two-day delay. If the decline holds, it would be the biggest in a quarter since a 3.85 percent drop in the second quarter of 2002 for HFR’s Weighted Composite Index…
“Hedge funds have not covered themselves in any form of glory in this quarter,” said Paul Ross, chief executive officer of London-based Iveagh Ltd., the investment arm for the Guinness family brewing fortune. “They’ve been extremely difficult markets for hedge funds in general.”….
Strategies that should profit as stocks and bonds decline have also been hurt because of short-term rallies as the U.S. Federal Reserve takes steps to restore confidence after the decline in the U.S. subprime-mortgage market….
“Even if the view has been correct and negative, it’s been very difficult in these markets to make money because the moves are violent and the rallies sharp,” said Ross, who invests a large portion of Iveagh’s $800 million in assets with hedge funds.
Update 4/2/08. 12:00 AM: A reader e-mailed us:
Corporate buybacks have been the single biggest support to the market for some time now, and they didn’t slow in the last quarter of the year, when over $1.1 trillion at an annual rate was plunged into the market by non-financial corporations. In doing that, they bought back 9.6% of their year-end market cap. Over the course of 2007, non-financials spent 150% of their net income on the combination of buybacks and dividends. With those profits falling, with debt on balance sheets rising, and with credit tightening, that is not going to continue. Just look at the financials. TMA’s money raising adventure on Monday, the “success” of which gave its stock a nice 20% boost today, took their shares outstanding from 172 million to 4 billion. Them’s serious dilution. Lots more of those coming.
And speaking as a hedge fund that’s holding a ton of cash, I’m nowhere near the point where I’d deploy it, and in fact when I get close to that point, I strongly suspect that I’m going to be looking at Japan and Thailand and Brazil, and not at the United States.