A front page story in the Wall Street Journal discusses how continued forced selling by hedge funds was the proximate cause of the sharp selloff of the last two days (um, the simply lousy economic news. such as lousy payrolls, horrific retail sales, no sales of credit card bonds in the last month, and similarly not-so-cheery news from overseas had nothing to do with it).
Deleveraging is destructive to asset prices. Some had hoped with the big October credit default swap settlements past (Freddie, Fannie, Lehman, WaMu) that th impetus for hedge funds dumping assets would be largely past. We weren’t so certain. First, most hedge funds have quarterly redemptions, and their investors were expected to ask for their money back in large numbers, in many cases because performance has been bad, but others factor are that investors want to reduce risk and (quelle surprise!) may need the cash. I am told typical arrangements are that withdrawal notices are due by 45 days after the end of the quarter and payment is to be made no later than 45 days after that. And unless the funds are very heavily in cash (not likely given their return ambitions), they need to sell SOMETHING to pay investors back.
However, that pressure may not be as great as thought because some hedge funds are refusing or limiting redemptions. Why this does not fatally tarnish the entire concept is beyond me (I take honoring contractual agreements seriously), but All About Alpha tells us in “Stigma of redemption gates fading fast“:
Apparently, the stigma associated with closing redemption gates is quickly disappearing. As Thomson reports,
Blocking investors’ exits, even if only briefly, was once a highly unusual move that often signaled a hedge fund was on the verge of collapse, managers and investors acknowledged…That is changing now as ever-more managers and investors engage in a tug of war over who can receive money right now.”
Wealth Bulletin cites 6 hedge fund managers that have suspended redemptions and several that have offered “sweeteners” for investors to stick around. The list of new gates includes: Centaurus Capital, Polygon Investment Partners (old news), Gottex Fund Management, Wermuth Asset Management, Auriel, and Atlantis Investment Management. According to the publication, favorable fee sweeteners have been offered in exchange for locking-in capital at: RAB Capital, Ramius Capital, BlueBay Asset Management and Henderson Global Investors.
Guess I am old fashioned. “Fool me once, shame on thee, fool me twice, shame on me.” Anyone who sticks with a firm that unilaterally changed the rules and abused their position of privilege once they have the freedom to take their money gets what they deserve.
But back to the main event. Even if hedgies have managed to hold calls for dough in abeyance, they still are more CDS related stresses in the offing to buffet the markets. The Iceland settlement is in the wings, and GM may go into bankruptcy. And any time a big hedge fund barfs and takes down a market, other firms can be forced to sell by virtue of margin calls on assets whose prices just tanked.
From the Wall Street Journal:
Hedge funds are selling billions of dollars of securities to meet demands for cash from their investors and their lenders, contributing to the stock market’s nearly 10% drop over the past two days.
The Dow Jones Industrial Average fell 443.48 points on Thursday, bringing its two-day drop to 929.49 points, its biggest two-day decline since Oct. 20, 1987. Coming amid steep drops in the retail and auto sectors, the decline wiped out a strong rally that ended on Election Day, and now the market is only 6% away from its lowest close of the year.
One of the biggest hedge funds, $16 billion Citadel Investment Group, is being asked by several major banks to post additional collateral to cover big losses on its investments, according to people familiar with the situation.
Citadel, which is run by Kenneth Griffin, was until recently considered a possible savior for troubled Wall Street firms. But his biggest hedge fund has fallen nearly 40% this year, prompting the firm to hold conversations with lenders including Goldman Sachs Group Inc., Deutsche Bank AG and Merrill Lynch & Co. that finance Citadel’s trades.
Citadel executives say the calls for more cash are a normal part of business when securities they hold fall in value, and they emphasize they have significant amounts of cash to satisfy their lenders. They say they have met all the demands for collateral….
Hedge funds have emerged as the latest serious problem in the global financial system. As their losses mount, they’re selling off securities to meet demands for cash from lenders and investors. Compounding the problem is a surge in notices from investors indicating they want out. Some hedge funds have been hoarding cash in preparation for these withdrawal requests. Hedge funds are sitting on a record amount of cash, estimated at about $400 billion, money that eventually could make its way into the market….
Withdrawals from hedge funds and from mutual funds are one factor weighing on stocks, says Mary Ann Bartels, Merrill Lynch’s chief strategist. “It’s an overhang for the market,” she says.
The recent rush of withdrawal notices to hedge funds comes as investors, including endowments, pension funds and wealthy individuals, see other investments shrink; in some cases these investors need cash to meet their own obligations. It also marks a sharp reversal of sentiment among these big institutional investors, which jumped into hedge funds and similar investments in recent years. The University of Virginia, with an endowment of $4 billion in mid-October, recently said it plans to sell $400 million of its $1.8 billion in hedge funds in the next couple of years to fulfill commitments to other investments.
The result is a downward spiral where hedge funds sell off thinly traded securities such as convertible bonds and corporate loans, driving down their prices, and leading to bigger losses and more demands for cash. Some $4.28 billion worth of corporate loans have been put up for sale in the past month, according to Standard & Poor’s. When hedge funds can’t meet the demands for cash, lenders seize their assets and try to sell them, further driving down prices and putting more funds in trouble…
“In mid-October, redemption levels were in the 5% range but all of a sudden now it’s cranking up to as high as 25% for some funds,” says Gregory Horn, president of Persimmon Capital Management, a $500 million Blue Bell, Pa., firm that invests in hedge funds. The firm has asked for about 20% of its total investments back. This “is the highest level of redemption requests” for the industry in at least 17 years, Mr. Horn says.
Some investors are withdrawing because they’re more wary of hedge funds, which fell 20% this year, through October. That beats the 34% drop for the Standard & Poor’s 500 but is nonetheless disappointing for an industry that has returned 13.8% annualized since 1990, above the 10.5% return of the S&P 500. San Francisco hedge-fund firm Farallon Capital Management LLC, which oversees about $27 billion, has seen its biggest hedge funds fall between 23% and 29% on investment declines this year, according to investors..