How you know it may be time to rip off the Band-Aid…

hedge fund secondary marketIt’s among the most common of mistakes an investor can make: holding on to a stock or security because it’s a great company, because it produces great products or services or because eventually, one day, it’ll go back up in value.

Hedge fund managers are apparently no different. According to Hedgebay Trading, prices paid for hedge fund assets on the secondary market fell to an all-time low in December, with sellers getting less than 80 cents on the dollar.

While the dispersion between the highest and lowest trades narrowed to 41 points, the average price was the lowest in the 11-year history of the secondary market. Just one trade took place close to NAV, at 97%. The lowest trade during December was at 56% of NAV. (See Hedgebay chart below for historical NAVs)

Source: Hedgebay Trading

Source: Hedgebay Trading

What the activity may suggest is that even after almost a year of market recovery behind them, hedge funds may still be holding on to stockpiles of illiquid and potentially “toxic” assets – and not moving very quickly to do anything about them.

What it also suggests is that there remains disillusionment among managers with respect to what their illiquid assets might be worth at some stage – particularly in contrast to how they are likely currently marked in their portfolios.

Like any prudent investor, the only true way out is to bite the bullet, rip off the band aid, pull back the wax strip and sell. “The choice that investors face when they find themselves with unwanted illiquid assets is slow bleed versus cut your losses and move on,” says Hedgebay co-founder Elias Tueta.

In turn, the “dead weight” makes achieving performance targets “very difficult” he notes.

History speaks for itself. Prices on the Hedgebay Global Hedge Fund Secondary Market Index – which had remained near or above NAV since its inception in 1999 – plunged in the summer of 2008. After a brief recovery in mid-2009, when prices topped 90% of NAV, the index again tumbled, sinking below 80% for the first time.

In December, not a single trade was completed at or above NAV; the closest was 97%. (see second illustration below.)

Hedgebay1

Source: Hedgebay Trading

So what’s the moral of the story here?  There may be two.

One, never let emotion dictate holding on to an asset, particularly when it’s detrimental to health of the rest of the portfolio; and two, when activity on Hedgebay starts to heat up again, it may just be the sign of a final purging of illiquid or “toxic” assets.

Editor’s Late Breaking Addendum: It looks like D.E. Shaw sees the obvious opportunity here.

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