Deleveraging by funds of hedge funds as they faced redemptions from investors may have contributed significantly to the stock market turmoil in the summer, according to research by BarclayHedge and TrimTabs.
Their data suggest that investors in funds of hedge funds, the most popular vehicles for investing in alternative assets, may have redeemed as much as $55bn in July, equivalent to almost 5 per cent of their assets.
TrimTabs, a California research group whose estimates of mutual fund flows are already closely followed in the market, estimated that funds of hedge funds posted an estimated outflow of $55bn in July – or almost 5 per cent of their assets.
Hedge funds that received direct investment posted an inflow of $23bn, meaning the sector as a whole had an outflow of $32bn.
Charles Biderman, president of TrimTabs, suggested that growing worries about the subprime sector in May triggered requests for redemptions. Typically, investors must give 30 or 60 days’ notice, so this would have led to outflows in July.
He added that some funds of funds may have been forced to pay down debts they had taken on to leverage up returns they offered to their investors.
Estimating that more than 10 per cent of fund of hedge funds’ assets had been borrowed from banks, he said: “We believe deleveraging and risk reduction by funds of hedge funds was a major cause of the turbulence in the credit markets and the equity markets in July and August.”
He also said that the worst of the selling in the hedge fund world was probably finished, barring a further increase in volatility this month.
“Regardless of the sub-prime problem, leveraged funds of hedge funds adds volatility to the global markets. Then when hedge funds themselves use already leveraged cash and add leverage on top, that geometrically increases volatility.”