The numbers are in and it appears that hedge funds lost about 5% last month (see sidebar of this web page for full listing of hedge fund indices). Bad, but looking relatively good with every passing day on global equity markets. Excluding the long-biased energy and emerging HFR sub-indices, the number is closer to -4%.
In a recent note to clients last week, research firm Oxford Analytica expressed surprise at the apparent resilience of the hedge fund industry:
“Whereas banking sector difficulties have provoked a host of policy responses…no hedge fund problem has yet necessitated a similar systemic response. The apparent resilience of the sector is particularly striking given that recent estimates suggest that the 2 trillion dollar hedge fund industry accounts for approximately 30% of US equity and bond trades…”
A “Run” on Hedge Funds?
But at least one economist says this is just the calm before the redemption storm. Nouriel Roubini wrote in the FT last week that:
“…unlike banks, which are sheltered from the risk of a run – via deposit insurance and central banks’ lender-of-last-resort liquidity – most members of the shadow system [hedge funds, PE funds, structured products etc.] did not have access to these firewalls that prevent runs.”
…a bank-like run on hedge funds is highly possible.”
But for now questions remain about a) whether a “run” on hedge funds is, in fact occurring, b) if so, whether the industry’s reported $600 billion of cash (will be enough to satisfy it and c) whether so-called redemption gates will mitigate it.
Redemption Fears Exaggerated?
While we’re still waiting for asset flow numbers, there are early reports that talk of mass redemptions may have been at least slighty exaggerated. The FT reported last week that:
“…the evidence on third-quarter inflows is mixed, with some investors saying talk of big redemptions is an exaggeration.
Karl Wellner, the principal of Papamarkou Asset Management, which specialises in alternative investments for wealthy clients, said yesterday that none of his clients had pulled out of hedge funds or cut back.
“We have had no redemptions whatsoever . . . in fact, no redemptions from any asset class,” he said.
Another wealth manager specialising in advising individual clients on hedge funds said that it likewise had had no client redemptions.
It appears that fund of funds, which have more institutional than retail investors, are expecting redemptions.
That’s cold comfort for single-strategy hedge funds who count fund-of-funds among their largest clients. Some managers have told us that funds of funds clients are even being preemptive with their redemptions just to avoid getting caught if and when the “gate” falls.
Even Investors and Regulators Advocating Gates Now
Such preemptive withdrawals make matters worse for the industry and for fellow investors in the same fund. As amazing as it may sound, some of those investors are now encouraging their managers to close the gate. This morning Reuters reports:
“Hedge fund investors are increasingly demanding longer lock-ups for their money — a move almost unheard of a few years ago — as fears of big withdrawals start to outweigh the need to get out of badly-performing funds. While hedge fund performance has been poor this year…many investors are more worried about the survival of funds they invest in.”
In fairness, funds of funds are stuck between a rock and hard place. But their fellow investors aren’t the only ones concerned about the propensity for these investors to cut and run in an effort to manage their liquidity. On Monday, the International Organization of Securities Commissions (IOSC) issued recommendations on “the methods by which funds of funds deal with liquidity risk”.
Unfortunately, like many other “recommendations” from working groups and multilateral institutions, these ones are self-evident to the point of absurdity. For example, the report recommends that funds of funds:
“…make reasonable enquiries in order to be in a position to consider if the fund of hedge funds’ liquidity is consistent with that of the underlying hedge funds, particularly in order to meet redemptions.”
The original June 2008 study upon which this recommendation was based contained the following observation about so-called “redemption gates”:
“…It is in particular recommended that the use of “gates” be made in exceptional circumstances only for the purposes of protecting the interests of unitholders/shareholders who remain invested in the fund in the case of major redemptions.”
Fear of redemption gates is usually based on a belief that the manager simply wants to hold onto investor’s money a little longer in order to charge more fees. But let’s face it, any manager who slams a gate probably isn’t going to engender a lot of investor loyalty going forward anyway. Managers want gates because their money is also at stake and they know what could happen if forced to unload the portfolio in a forced sale.
While they make for great headlines (“Hedge funds refuse to/are unable to give money back to investors!”), we are beginning to see that redemption gates may actually serve a valuable purpose after all.
Late Breaking Addendums: Infovest21 reports today:
“Speculation exists that hedge funds saw massive redemptions on September 30, the first chance since Lehman Brothers’ failure for investors to ask to redeem. Large-scale redemptions could force hedge funds to sell leveraged positions and exacerbate already steep market declines.
“But funds of funds doubt redemptions at hedge funds have been at the root of the selling.
“‘There might be some of that in there,’ Ed Rogers, the founder of Rogers Investment Advisors said. ‘But everybody in the world is selling equities in the world right now…This is not hedge fund related. This is global financial crisis related.'”