Stock Hedge Funds Held Record Cash in First Quarter

Date: Wednesday, April 2, 2008
Author: Tom Cahill and Katherine Burton, Bloomberg.com

April 1 (Bloomberg) -- Stock hedge funds, unsure about which direction the markets would move, sat on a record amount of cash as the industry headed for its biggest quarterly decline in almost six years.

Equity managers, who oversee about one-third of the $1.9 trillion in hedge funds, held an estimated $90 billion of cash in January, a hoard that dropped to $64.8 billion the next month, according to data compiled by Merrill Lynch & Co. analyst Mary Ann Bartels. The last time equity funds held cash outside of their trading accounts was in 2004, according to Merrill. At that time, market direction was also unclear, with the Standard & Poor's 500 Index up less than 2 percent through October.

``The data indicates to us the equity hedge funds have de- leveraged and have record cash balances,'' she wrote in a report last week. ``Margin debt has declined sharply in recent months as investors have grown more cautious on the U.S. equity market.''

Hedge funds dropped an average of 2.83 percent this year through March 28, according to Chicago-based Hedge Fund Research Inc.'s Global Hedge Fund Index, which is updated daily with a two-day delay. If the decline holds, it would be the biggest in a quarter since a 3.85 percent drop in the second quarter of 2002 for HFR's Weighted Composite Index.

More than a dozen hedge funds have shut, frozen redemptions or needed to seek outside capital this year as markets tumbled. Peloton Partners LLP liquidated its largest fund after making wrong-way bets on mortgage securities, while JWM Partners LLC, the investment firm run by ex-Long-Term Capital Management LP chief John Meriwether, was hurt by swings in Japanese government bonds.

``Hedge funds have not covered themselves in any form of glory in this quarter,'' said Paul Ross, chief executive officer of London-based Iveagh Ltd., the investment arm for the Guinness family brewing fortune. ``They've been extremely difficult markets for hedge funds in general.''

Volatility Rises

Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising asset prices and participate substantially in profits from money invested.

Strategies that should profit as stocks and bonds decline have also been hurt because of short-term rallies as the U.S. Federal Reserve takes steps to restore confidence after the decline in the U.S. subprime-mortgage market.

That means prices have been jumping around much more than usual. Daily changes of 1 percent or more in the Standard & Poor's 500 Index, the benchmark index for U.S. stocks, have occurred on 51 percent of trading days this year, according to S&P. The last time the percentage hovered at that level was in 1938.

The index jumped 3.6 percent today, the most in two weeks.

``Even if the view has been correct and negative, it's been very difficult in these markets to make money because the moves are violent and the rallies sharp,'' said Ross, who invests a large portion of Iveagh's $800 million in assets with hedge funds.

To contact the reporters on this story: Tom Cahill in London at tcahill@bloomberg.net; Katherine Burton in New York at kburton@bloomberg.net