Hedge funds’ lost aura of invincibility

The next wheel to come off in the financial markets.. If you wondered why your stock is gyrating up and down (but mostly down), look no further for an explanation than here. One consolation, it has little to do with fundamentals..

Hedge Fund Bloodbath Begins
Friday, November 7, 2008 10:52 AM

  • The aura of invincibility around hedge funds, the investment pools for the super-wealthy, has been eroded by the global financial crisis, and the fallout has helped fuel ongoing market chaos.
  • Analysts say the industry — often maligned for its secrecy and short-selling tactics, but lauded for its lucrative returns — has struggled in the economic meltdown despite its aim to thrive in both bull and bear markets.
  • At the same time, the industry’s aggressive attempts to recoup losses and the flight of capital from investors worried about poor returns has helped fuel the swings on the world’s stock markets.
  • Some funds have already collapsed, and more are under pressure with analysts predicting that consolidation is inevitable.
  • You are already seeing a pretty phenomenal change in the industry,” said Rob Lance, chief executive officer of Hong Kong-based hedge fund DragonBack Capital Limited.
  • There will be a reduced number of asset management companies, as there are already reduced levels of capital to go round.” Hedge funds are private investment pools that are typically run on behalf of a limited group of wealthy investors.
  • The global industry, which is worth around 1.7 trillion US dollars, has become notorious for the huge fees the funds charge, on the basis that their returns will be so spectacular that they beat conventional investments.
  • But the funds lost an average of 7.7 percent in the first nine months of this year, according to data from Eurekahedge, a Singapore-based company that monitors the industry.
  • The worst-hit funds were those in Asia. Excluding Japan, the Asian funds have lost more than 20 percent in the first nine months of 2008, and more than six percent in September alone, EurekaHedge found.
  • “I think there is going to be a lot of pain within the industry,” said one Hong Kong-based hedge fund manager, who added that although such a downturn was “inevitable”, the speed had taken many people by surprise.
  • The dire performance has taken the lustre off the industry, which had attracted increasing amounts of capital in the last five years. It has also led investors, including huge institutional bodies such as pension funds, to cut their losses, forcing some hedge funds to cash in their holdings at a loss just to pay the redemption requests. As a result, stock prices across the world have been dragged down.
  • The tough times for the hedge funds come on top of a deleveraging process that was already under way, under which they have been forced by troubled banks to quickly pay down the huge borrowings they took on to maximise their bets.
  • “Deleveraging of big funds is one of the biggest factors responsible for such a bad month on world stock markets,” said Rajeev Baddepudi, a senior analyst at Eurekahedge.
  • The fallout has hit some of the world’s biggest blue chip firms, including banking giant HSBC, which had avoided much of the recent turmoil in the banking industry.
  • Its Hong Kong-listed shares fell 15 percent on Monday to its lowest close since September 2001, before rebounding 20 percent the following day.
  • “HSBC is one of the core stocks many of these funds hold. Because some of them had to liquidate on Monday, you saw the fall,” said Peter Lai, sales director at DBS Vickers, who said short-selling was also to blame for the chaos.
  • Short-selling, where funds bet the price of the stock will fall, is one of the key tactics of hedge funds, that allows them to prosper even in collapsing markets.
  • The practice has been banned in many countries for exaggerating market falls, but even where it is permitted, it remains high-risk.
  • This week, hedge funds that bet the share prices of German carmaker Volkswagen would fall faced catastrophic losses, as Porsche moved to take over the firm, sending the stock into the stratosphere.
  • The hedge funds and other investors were forced to buy back the stock at hugely inflated prices, leading some analysts to worry it could lead to the collapse of some funds.
  • “The losses will be extreme. I don’t think it is going to bring down a big fund, but it will probably bring down some small ones,” one unnamed hedge fund manager told the Financial Times.
  • Baddepudi said around 150 funds had already folded, and that medium-sized firms — holding between 50 and 500 million dollars in assets — were at greatest risk, as investors looked to more established names.
  • Even one of the world’s highest-profile funds, US-based Citadel, was forced to issue a statement earlier this month insisting it retained strong liquidity, after reports said investors had raised concerns after some of its funds fell 35 percent this year.
  • But despite the turmoil, some funds have prospered.
  • DragonBack’s volatility fund was one of the world’s top performers in September as it managed to correctly pick the direction of the markets, and Lance said only the best and bravest funds will survive.
  • “It will be about getting through this cycle and coming out the other end, retaining capital and staying consistent to your strategy,” he said.