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Morgan Stanleys Mack Says Some Hedge Funds May Fail

Date: Thursday, October 16, 2008
Author: Christine Harper, Bloomberg

Morgan Stanley Chief Executive Officer John Mack said tumbling markets may drive some hedge funds out of business, prompting his firm to ``resize.''

``Friends in that community say that by year-end, you'll see the number of firms in the hedge-fund area shrink, I've heard as large as 30 percent,'' Mack, 63, told CNBC today. As the industry contracts, ``we need to resize our prime brokerage,'' he said.

Morgan Stanley's prime brokerage unit, which lost clients last month after the bankruptcy of Lehman Brothers Holdings Inc. fueled a global bank crisis, is regaining some customers since sealing a $9 billion investment from Mitsubishi UFJ Financial Group Inc., Mack said.

``Funds that took some of their money, in some cases all their money, are coming back,'' he said. ``Without question those people who pulled out are coming back.''

Others are shutting down. Highland Capital Management LP will close its flagship Highland Crusader Fund and the Highland Credit Strategies Fund after losses on high-yield, high-risk loans and other types of debt, a person with knowledge of the decision said today.

Highland, a Dallas-based firm whose total assets under management dropped to about $35 billion from $40 billion in March, will wind down the two funds in the next three years, said the person, who declined to be named because the decision was confidential. The two funds had more than $1.5 billion of assets.

Market turmoil is affecting even the biggest funds. Citadel Investment Group Inc.'s largest hedge fund, the $10 billion Kensington Global Strategies, fell as much as 30 percent this year because of losses on convertible bonds, stocks and corporate debt, two people familiar with the Chicago-based firm said.

Record Withdrawals

Investors withdrew a record $43 billion from hedge funds in September as they fled distressed-securities and stock funds because of poor performance, Sausalito, California-based TrimTabs Investment Research said today.

Mack lobbied last month to have regulators restrict short selling, a trading tactic used by some hedge funds, arguing that it was hurting his company's stock. Today he said he supports the practice in principle. A three-week ban on short selling imposed by the Securities and Exchange Commission expired earlier this month. Short sellers borrow stock and sell it, hoping to capture a profit by replacing the shares after they decline in price.

``I believe in short-selling, I believe in it today, it's a way that people can express their view on a company,'' Mack said. In ``extreme circumstances'' the practice has exacerbated problems in the financial system and ``it's prudent to have some kind of controls,'' he said.

`Go to Cash'

Morgan Stanley, which became the fifth-biggest U.S. bank holding company, is reducing its ratio of assets to equity, known as leverage, as securities ranging from mortgage debt to corporate loans to stocks drop in value. The firm's leverage ratio, currently slightly below 20 times, will drop into the ``mid-teens,'' Mack said in today's interview.

``There's more de-leveraging to be done'' Mack said of the broader financial community. ``People are scared, and when they're scared they want to go to cash, they want to de-leverage, and they're doing that.''

Mack said the current financial system crisis is the worst he's witnessed. ``I've never seen anything like this or anything close to this,'' he said. ``I think we're in for a rocky road for a while.''

To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net.