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Hedge Funds Raise Cash in Rally, Wait to Gauge Effects Bailout

Date: Saturday, September 20, 2008
Author: Katherine Burton and Saijel Kishan, Bloomberg

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Hedge funds raised cash holdings during the biggest two-day global stock rally in history because they aren't sure where markets are headed after the U.S. moved to bail out banks and limit bets against financial companies.

``The rally hurt us quite a bit'' because the firm shorted some stocks in expectation they would fall, said Chris Wang, co- founder of SYW Capital Management LLC in New York, which oversees less than $100 million. ``The best thing for us to do is shrink our books and hold more cash.''

The increase in cash indicates fund managers don't expect calm to return to markets in the next several weeks, said Bill Grayson, president of Falcon Point Capital LLC, a San Francisco- based investment firm. Some funds are seeking to protect the year's gains, while others are hoping to pare losses.

``The one thing I can guarantee is incredible volatility in the foreseeable future,'' he said.

Hedge funds had already increased their cash, stopped using borrowed money and pared bets that stocks would rise amid dramatic swings in stock and commodity prices. The Chicago Board Options Exchange SPX Volatility Index, known as the stock market's fear gauge, climbed to a high for the year of 36 on Sept. 17 from a low of 16.30 in May.

Some managers also sold shares to prepare for client redemptions at the end of the month, causing stocks that are widely held by hedge funds, including Google Inc. and Potash Corporation of Saskatchewan Inc., to tumble earlier this month.

Rescue Rally

The Standard & Poor's 500 Index jumped 4 percent yesterday, capping its steepest back-to-back gain since the aftermath of the October 1987 crash. Markets from the U.K. to China posted their biggest one-day gains ever.

U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke ignited the rally by proposing to shore up banks' balance sheets and guaranteeing money-market mutual funds, while the U.S. Securities and Exchange Commission banned investors from borrowing the shares of 799 financial firms and then selling them in a bet that the shares will fall.

Keith McCullough, who runs an independent research company Research Edge LLC in New Haven, Connecticut, told his 5,000 subscribers yesterday that he recommended having 96 percent of assets into cash.

``I've had a lot of people telling me they were doing what I did today,'' he said of his clients, who include hedge funds. McCullough made his decision after he saw the news of the SEC's ban on shorting financial stocks.

``I do not trust these people, their process or their solution,'' he wrote in his morning note.

Clarium, Atticus

Hedge funds were sitting on a record $156 billion of cash as of the end of July -- according to a report published earlier this week by Mary Ann Bartels, an analyst at Merrill Lynch & Co.

Clarium LP, a San Francisco-based fund run by Peter Thiel, 40, wasn't using borrowed money and had 64 percent of his fund in cash in the last week of August, compared with about 11 percent the previous week. At the end of July, the fund had borrowed almost $5 for every dollar of net assets. The fund was up 27.6 percent through August.

Atticus Captial LP, a New York-based hedge fund run by Timothy Barakett, 43, told investors in the beginning of September that the Atticus Global fund was investing 28 percent of its assets on stocks it expected to rise and 28 percent in stocks it was wagering would tumble. The fund fell 25 percent through the end of August.

Hedge-fund investors said that some funds were keeping their short positions in financial stocks or in the overall markets, even as shares climbed.

Problems Remain

``The government may have averted a systemic risk but the fundamental problems are still there,'' said Cem Habib, portfolio manager at London-based Altedge Capital Ltd., which invests in hedge funds. ``Some of the funds that we invest in that have net short exposures are keeping to their convictions.''

U.S. and U.K. regulators temporarily banned short sales in financial stocks yesterday to curtail a market rout. Shares of Goldman Sachs Group Inc. had tumbled 30 percent in the first four days of this week, and Morgan Stanley's stock had fallen 40 percent. London-based HBOS Plc had dropped 39 percent in the same period.

San Francisco-based Passport Management LLC, the $4.7 billion hedge-fund firm run by John Burbank, 44, had a net market exposure -- or the amount of money used to bet on the rising prices of securities minus the amount used to bet on falling prices -- of 16 percent at the end of August.

The only time the figure was lower this year was in January, when it was 11 percent, according to a report sent to investors. The Global Strategy fund was down 8.3 percent this year through August, with most of the decline coming last month from wagers that financial stocks would tumble.

The fund continues to keep its bets on falling financials stocks, which accounted for 54 percent of net assets at the end of August, said investors in the fund.

Executives at Clarium, Atticus and Passport declined to comment.

To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net; Saijel Kishan in New York at skishan@bloomberg.net;