Hedge Fund Withdrawals Stress Market; Citadel Reassures Clients

Date: Saturday, October 25, 2008
Author: Saijel Kishan and Katherine Burton

Hedge funds are aggravating the worst market selloff in 50 years as they dump assets to meet investor redemptions and keep lenders at bay.

U.S. hedge-fund managers may lose 15 percent of assets to withdrawals by year-end while their European rivals shed as much as 25 percent, Huw van Steenis, a Morgan Stanley analyst in London, wrote yesterday in a report to clients. Combined with investment losses, industry assets may shrink to $1.3 trillion, a 32 percent drop from the peak in June.

With the average hedge fund down 18 percent this year, as measured by the HFRX Global Index, managers are selling assets to repay departing investors and meet demands from lenders for more collateral. Others including Paulson & Co. and Winton Capital Management LLC are hoarding cash to soothe nervous clients and wait for signs the worst is over. When stocks rally, hedge funds take advantage to unload what they can.

``I have never seen a market as full of panic as I've seen in the last seven or eight weeks,'' Kenneth Griffin, founder of Citadel Investment Group LLC, a Chicago-based hedge-fund firm, said yesterday.

Citadel, addressing investor concerns that its funds may be forced to liquidate, said yesterday it has $8 billion in untapped bank credit, 30 percent of its assets in cash and ``modest'' client redemptions.

The firm had no material losses from trading partners as its main Wellington and Kensington funds fell about 35 percent this year through Oct. 17, Chief Operating Officer Gerald Beeson said on a conference call with bondholders. Year-end redemptions will be a ``few percent'' of assets.

Worst Year

Griffin, 40, who started Citadel in 1990, has posted the biggest losses of his career in 2008 after increasing wagers on loans and bonds before the markets plunged.

Most of the funds' declines occurred in the four weeks after Lehman Brothers Holdings Inc. went bankrupt, Beeson, 36, said. Kensington and Wellington lost money holding convertible bonds, high-yield bonds and bank loans, and investment-grade bonds, which were hedged with credit default swaps that protect the buyer in the event of a default.

Citadel was betting that the gap between the default swaps and the bonds would narrow. Instead, they widened as lenders left the market and investors bet that more companies would default.

``Even the healthy hedge funds are being forced to sell,'' Mohamed El-Erian, co-chief executive officer of Pacific Investment Management Co. of Newport Beach, California, said in an interview yesterday with cable-television network CNBC.

Shake-Out

John Paulson, whose New York-based Paulson Advantage Plus Fund climbed about 25 percent this year through September, was about 70 percent in cash at the end of last month, according to investors. David Harding, founder of London-based Winton Capital, said he is holding about 95 percent of assets in U.S. Treasury bills and cash or cash equivalents.

``What we're seeing now is an acceleration of the shake- out that should have happened a long time ago,'' said Peter Rup, chief investment officer at New York-based Orion Capital Management LLC, which invests in hedge funds.

The HFRX Global Index fell 7.76 percent this month through Oct. 22, according to Hedge Fund Research Inc. in Chicago. Hedge funds lost 5.4 percent last month, the most since the implosion of hedge fund Long-Term Capital Management LP a decade ago.

Passport Management LLC's Global Strategy fund fell 27 percent this month through Oct. 15, and 34 percent for the year, as investments in commodity stocks slumped, according to an investor letter. The $4.5 billion hedge-fund firm is run by John Burbank III in San Francisco.

Calming Investors

Platinum Asset Management LP, a Rye Brook, New York-based firm, lost as much as 29 percent this month through Oct. 15, bringing its year-to-date decline to 38 percent, according to investors.

Investors withdrew a record $43 billion from hedge funds last month, according to TrimTabs Investment Research in Sausalito, California.

``There's a bigger push by hedge funds to mitigate risk,'' said Matt Simon, analyst at New York-based Tabb Group, a financial-services consulting company. ``Funds are trying to keep jittery investors calm.''

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