Hedge funds face worst year

Date: Wednesday, October 1, 2008
Author: Deborah Brewster and Anuj Gangahar in New York, FT.com

Hedge funds on Tuesday closed out one of their worst-ever quarters as US managers braced for an extension of the short-selling clampdown which has robbed them of one of their most popular strategies.

The hedge fund business has been left reeling by the combined forces of greater regulation – including the banning of short selling on certain financial stocks by the US Securities and Exchange Commission and other regulators across the world – the threat of investor withdrawals, a flight from risk and a squeeze on leverage.

According to latest figures from Hedge Fund Research, the industry data provider, the hedge fund market is on course for its worst year of performance since at least 1990, when its records began.

The ban on short-selling of certain financial stocks, although only temporary, has led many in the hedge fund market to question the very basis of their business model.

Funds that make money from short selling are also constrained on another front: stock lenders have been recalling their stock, and some, such as Vanguard, have suspended their stock lending programmes altogether.

This has made it harder to find stocks to borrow, or it means the fund must pay a higher price to borrow stock.

Short sellers borrow their stocks from long-only investors such as mutual funds and pension funds, through stock lending programmes.

The International Securities Lending Association (ISLA) issued a statement last Friday calling for its members to keep lending stocks, especially financial stocks.

“Any wholesale withdrawal of financial shares would have highly unwelcome consequences for liquidity in the cash equity and derivatives markets,” it said.

Hedge funds had net inflows of $12.5bn in the first six months of the year, according to Hedge Fund Research.

That was a slowing of their pace of growth. However, the evidence on third-quarter inflows is mixed, with some investors saying talk of big redemptions is an exaggeration.

Karl Wellner, the principal of Papamarkou Asset Management, which specialises in alternative investments for wealthy clients, said on Tuesday that none of his clients had pulled out of hedge funds or cut back.

”We have had no redemptions whatsoever . . . in fact, no redemptions from any asset class,” he said.