Even Hedge Funds Doing Well are Facing Redemptions

It's a tough world out there - I saw in the Wall Street Journal the average hedge fund lost 18% in October. Considering what their mandate is i.e. hedge - that is amazing. September was awful as well. We see stories of hedge funds that are performing well (in this market losing 10% in a year is "great") and still facing redemptions because their investors need the cash.... as Ross Perot famously said... there is a "giant sucking sound" in our capital markets.

• In a world hard up for cash, even hedge-fund winners can wind up losers. Such is the fate of major credit fund Blue Mountain Capital Management, whose investors have begun yanking investments despite the fund's performance this year, a modest 2.4% loss, compared with an average 20% loss across all funds. Blue Mountain is a major player in the credit markets, with assets of $5.5 billion invested in bank loans, bonds and credit-default swaps. Its primary fund, the $3.1 billion Credit Alternatives Fund, had lost 2.4% this year through Friday.
• Performance was largely beside the point for many Blue Mountain investors, who need access to cash. The perverse effect is that some investors have begun raiding their better-performing investments, giving the laggards a chance to recover.
• Blue Mountain investors have since lined up to withdraw at least 25% of the fund's assets by February 2009. Quickly selling off the bank loans and bonds to meet those cash requests could sink the fund, while causing more havoc in already-choked credit markets, said people familiar with the matter.
• These investors include "funds of funds," which are facing their own wave of redemptions. Endowments and other big hedge-fund clients are missing payouts normally received from private-equity investments. Those payouts have all but disappeared as leveraged buyouts and initial public offerings have stalled.
• Now Blue Mountain is retooling by halting redemptions until early 2009 and trying to tempt investors to stay through lower fees, the fund told investors in a letter Monday. It also made clear that those who do redeem immediately will face steep losses from assets sold in a weak market.
• Andrew Feldstein, who started Blue Mountain in 2003 and is its chief executive, said in an interview that the firm has a cash cushion -- though he wouldn't say how big it is -- but said that using that cash for redemptions would be too risky in such volatile markets, in case of further losses.

Can't win for losing nowadays...

FT.com has an interesting article - Darwinian Rules Threaten Hedge Funds - it caught my eye because it involved Moore Capital whose top guy is Louis Bacon; a person who from all data points I've been able to read about, has almost identical views as myself from a macro point of view. This Coffey fella is an international superstar and even he has decided against going out and running his own fund. Capital is just not there anymore.

• "Greg Coffey is one of the most impressive trading professionals operating anywhere in the world today," said Louis Bacon, chairman and chief executive of Moor Capital, in a note. Coffey's decision to join an established firm such as Moore, rather than set up his own firm, may be an indication of how hard conditions have become in the $1.7 trillion industry, even for star managers, as funds lose money and investors withdraw cash.

But this story plays out to our prediction of massive closings of hedge funds - either voluntary or otherwise that we highlighted a few months ago. It's happened much faster than I imagined in late summer.

• When Greg Coffey, the sleek-haired hedge fund star, announced at the weekend that he had decided against setting up on his own and would join Moore Capital only days after leaving rival GLG Partners, attention focused on his change of heart amid the worst crisis for the hedge fund sector in more than a decade.
• More surprising, perhaps, is Moore’s move to expand – hiring not only Mr Coffey but a team of 12, just as many of its rivals are predicting a massive contraction in the industry. Already dozens of funds are being restructured, closed to redemptions or simply shut down. And many more are on the way, say both managers and industry analysts.
• Manny Roman, co-chief executive of GLG Partners, said last month: “In a fairly Darwinian manner, many hedge funds will simply disappear.” He predicted the industry would shrink by close to a third.
• Andrew Baker, deputy chief executive of AIMA, says: “There are straws breaking all kind’s of people’s backs at the moment.” Fund managers have been hit by a toxic combination of cash calls from investors and a squeeze on funding by lenders. Deephaven in Minnesota outlined last week the “extreme and unprecedented market conditions, the sudden and material industry-wide changes in margin and financing requirements being imposed by prime brokers along with pending redemption requests”. The banks acting as prime brokers, which provide a range of key services to hedge funds from custody to lending, have become more risk averse and have in some cases withdrawn financing. (I think this is an important point that is sometimes glossed over)
• Several fund managers, particularly those in illiquid markets such as convertible arbitrage and leveraged loans, complain they have had to provide their lenders with significantly higher levels of collateral against portfolios. Brokers are also applying more stringent tests on the type of assets they will accept as collateral. This is forcing funds to raise cash and reduce their exposure to markets or “deleverage”.
• “It becomes a vicious circle,” says the head of one hedge fund group. “And in illiquid markets such as leveraged loans and convertibles it is a huge crisis”.
• Even before the latest bout of market turmoil starting in late September, about $30bn was withdrawn by investors in the third quarter, according to industry insiders. That is from a market of more than 10,000 funds and $1,700bn of assets, according to data providers Hedge Fund Research. If client redemptions add up to 15 per cent in total, says one manager, that could mean funds have to find $255bn to pay back to clients by December. “If the average hedge fund has two-times leverage,” he says, “the industry may be forced to sell $500bn in assets between now and the end of the year.”
• Last week’s leap in the Volkswagen share price, after Porsche claimed to have doubled its VW stake through derivatives, may have hurt as many as 100 funds, according to industry insiders
• Being big and diversified is no longer a defence as correlations increase between markets that were expected to move in opposite directions. Funds, notably multi-strategy funds, which touted the virtues of having many different fingers in different pies, found that diversification was not such a benefit this year. (this is something I've been harping on - nothing - outside US Treasuries sometimes returning nearly 0% - is working the past quarter - for more than a few hours or days at best) They say correlations between markets that have historically moved in opposite directions are now moving in tandem. “No market has been immune,” says a London-based manager of a multi-strategy fund.