Hedge Funds

For a few months now, I have been wondering where all the hedge fund fallout from global market turmoil was hiding. Now it seems that the turmoil in the hedge fund world is becoming more apparent — hedge funds are imploding left and right according to the FT.

This turn of events will mean one more headache for policy makers as they look to clean up this financial mess.

I was on to potential problems with hedge funds when I heard about a lawsuit by a hedge fund named Paramax against UBS in June. In July, I wondered how “to date, hedge funds have stayed out of the limelight as the financials have imploded. The rise in [corporate] defaults may change that,” I said. But, still there were no major news events about hedge funds blowing up. By August I was saying:

To date, we have not seen an LTCM-like blow up. Are these guys good, lucky or is there risk lurking in the weeds? Is the commodity-play unwind just the thing to bring the dead bodies to the surface? The violence of the commodity and currency moves has the faint whiff of panic.

It was only when Ospraie went belly up in early September that the first hint of what was to come surfaced.

Early last month, just after Ospraie’s close, there was major volatility in the currency markets. In repsonse, I said:

It was about 4 weeks ago now that I said I thought the dollar rally was not a fundamental move, but a monster bear market rally which will end up hurting dollar shorts. Back then, the Euro was trading for 1.5164 dollars. Today, the Euro will only get you 1.426 dollars. That’s a move of 9 big figures in 4 short weeks on the Euro-Dollar cross. Some hedge funds are getting slaughtered as we speak, guaranteed. Will we soon see announcements that some hedge funds have collapsed? I think so.

But again, we hadn’t heard peep from the hedge fund world about major blow-ups outside of the Ospraie collapse.

Apparently, that has changed. The FT says in their Lex column today:

Hedge funds

Performance is shocking – down nearly 10 per cent so far this year, according to the HFRX daily index and the worst anyone can remember. Requests for redemptions, which investors have just lobbed in for the fourth quarter, will surely set new records. The numbers of hedge fund liquidations could surpass the previous high in 2005. Leverage is hard, or nearly impossible, to get, limiting funds’ ability to generate absolute returns. With the restriction on short-selling, regulators have torpedoed an important hedging tool, albeit on a temporary basis – one hopes. Oh, and if you have been using Lehman Brothers as prime broker, you might have a job trying to figure out what the bust investment bank did with your collateral, as Olivant has discovered. Could it get any worse?

Of the laundry list, redemptions are probably the most pernicious, because they could shoot good hedge funds as well as ailing ones. Institutional investors in hedge funds are facing pressures from their own constituencies to hang on to more cash – a vicious new twist. Losses, meanwhile, will kill performance fees. That need not sink hedge funds, assuming they were not using those fees to cover run of the mill expenses. But they encourage funds to liquidate, since managers may figure the long haul back to their high-water marks (the fund’s previous high, which it has to reclaim before it can charge performance fees) is too painful.

Compared with these horrors, the regulatory clamp-down on shorting financial stocks and the Lehman debacle are small beer. Big users of shorting, such as quant funds, can shift to shorting other sectors. And it is hard to see the potential for writedowns on collateral parked with Lehman amounting to more than 1 per cent or so of total industry net asset values. For this relief, much thanks.

Financial Times

The Lehman Brothers bankruptcy was like a silent underwater depth charge exploding in a sea of hedge fud companies. Judging from the FT account above and from the volatility in global markets, it is only a matter of time before the dead bodies start floating to the surface.


Related Posts

Dollar weakness
RAB looks to halt redemptions for three years
The dollar rally spells trouble for some investors
Hedge Funds: the bell tolls for Ospraie
Quote of the day: 10 Aug 2008 – trickier than LTCM
Corporate defaults mean more hedge fund blow-ups
UBS legal dispute with Paramax

2 Comments
  1. market folly says

    yup, tons of hedge funds feeling the pain. here’s a list of a ton of major funds performance #s (both september and year to date) if you’re interested: http://www.marketfolly.com/2008/10/affluential-hedge-funds-suffer-in.html

  2. Edward Harrison says

    thanks for the link. that looks like a good list.

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