Hedge Funds, Markets, Trading…Where do we go from here?
Hedge funds are about halfway done dumping assets to reduce leverage, and may unload another $200 billion to complete the deleveraging process, according to a new survey. A survey by Sanford C. Bernstein & Co.’s found that 63% of hedge fund managers agreed that the unwinding of assets is at least half completed, while 23% are more optimistic, said the process was three-quarters completed. The survey was based on interviews in with managers of more than 65 hedge funds overseeing a combined $100 billion.
The amount of gross leverage used by hedge funds fell to 142% of assets from 175% in 2006 and 2007, the report said. Fifty-two percent of managers surveyed said the process of investor withdrawals is complete and transfers of money to clients to be done by the end of the first quarter, while 41% said they think half of redemptions are yet to come. About 16% of the hedge funds surveyed invest in emerging markets, 10% in fixed-income strategies and 8% in macro.
As this liquidation runs its course, Uncle Sam is now the worlds largest hedge fund by an enormous multiple over the next largest fund. Borrowing with Treasuries to buy higher yielding MBS and ABS securities means the government has begun putting on the largest carry trade in the history of financial markets. Quite a shock that the mastermind of all this used to run Goldman, which was once called “a major hedge fund with a residual investment banking business.” Obviously, the government will not be charging the taxpayers 2 and 20.
Worsening market conditions and changes to the regulatory landscape will force many hedge funds to close or sell out, according to global consulting firm Watson Wyatt. In a note to its clients, Watson Wyatt said the current crisis will expose hedge funds that are “not structured to add value for investors” and “will provide the most skilled with attractive opportunities and potential for substantial returns in the future.”
However, it added that once the smoke clears, surviving hedge fund managers will be better placed to exploit investment opportunities generated by the market dislocations and lower prices, made easier by banks’ extinct proprietary trading desks. In the long haul, end investors such as pension funds will emerge as beneficiaries of industry changes through improved fee structures. According to the firm, there are early signs pointing to hedge funds becoming more flexible in the negotiation of fees. “While we strongly believe skilled managers should be fairly compensated, fees are generally still too high for the value they deliver, particularly as we enter a lower-return environment,” said Craig Baker, global head of manager research at Watson Wyatt. “Also, performance fees introduced to align interests have been less than effective because they are generally poorly designed and tipped in managers’ favor. For a number of years we have been trying to rectify this situation and negotiate a fairer deal on fees, but only now we are seeing real progress.”
Parkcentral Capital Management, Ross Perot’s hedge fund, is liquidating. The 1992 independent candidate’s family office was burned by the credit crisis. Perot family members are the biggest investors in the six-year-old Parkcentral Global Hub fixed-income fund. Parkcentral Global’s assets are being sold off to pay the fund’s creditors.
Swiss based UBP predicts that the hedge fund industry will contract by between 30% and 35%, creating “some unique opportunities” for those that left. “Only the best will survive and will be able to seize the space left vacant by others,” Jan Erik Frogg, head of alternative investments at UBP, told Reuters. UBP intends to be a survivor, and is positioning itself with that in mind. “Those surviving won’t be the funds with the best return, but the most prudent ones,” Frogg said. “The year 2008 will be the new reference point for the sector.” The industry is in “hibernation but is not dead,” Frogg said, though he noted that trading strategies will become more popular, while arbitrage strategies—among the hardest hit in the recent hedge fund slide—will decline.
The losing streak continued last month for the Iraq-focused Babylon Fund, which dropped 10.4% in October, bringing its year-to-date losses to 18.8%. The largest contributor to the fund’s loss was the Iraqi Holding Company/Qurain, which dove 38%, and the internationally-available Iraqi 5.8% 2028 bond, which stumbled 28%, according to portfolio manager Björn Englund. “The remaining losses were evenly distributed over the rest of the holdings,” Englund wrote in an investor letter. “In fact, in October, not a single position of our overall 40 holdings rose in price—unmatched in our portfolio’s history.” Two-thirds of the fund’s exposure was in equities last month, followed by bonds and credit debt obligations.
