The Hedge Fund Cash Hordes

Date: Friday, November 21, 2008
Author: David Serchuk and Michael Maiello, Forbes.com

The Nov. 15 deadline for end-of-the-year hedge-fund withdrawals has passed, and some big firms are filing form 13F holdings reports. Eyes are now on the $1.5 trillion hedge fund industry, how it's affecting the markets now and what it might do in the future.

Vincent Farrell, chief investment officer for Soleil Securities, wrote to clients Wednesday morning that Tudor Investment has reduced its stock holdings from $5.7 billion to $453 million. SAC Capital cut its holdings of U.S. stocks, options and convertibles from $14.4 billion to $7.7 billion. Atticus Capital's holdings fell from $8.1 billion to $510 million.

Farrell notes that the 13F reports don't tell us whether these are the result of stock sales or declining prices. It's likely both. But some evidence has emerged to support speculation that the big hedge funds have built up sizable cash reserves that could be redeployed into the market next year.

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"Hedge fund guys are as smart as any group around," Farrell writes. "It seems they were selling well in advance of [Nov. 15] so as not to get caught when the door closed." If the fund managers anticipated more redemptions than actually materialized, then they definitely have cash ready to be put back into the market.

On Tuesday, Citigroup analyst Tobias Levkovich estimated that the redemption rate will be about 20% and that in 2009, the hedge fund universe might shrink back down to $1 trillion in assets. In preparation for this, funds have taken large cash positions--up to 40% of assets under management have been sidelined.

The short-term picture remains muddled, though. On Wednesday, Oppenheimer analyst Meredith Whitney noted that the Treasury's recent actions have befuddled the credit markets. CMBS spreads widened as the Treasury abandoned plans to buy troubled assets off of bank balance sheets. "As has been the case over the past two years, such disruption in the credit markets does not portend well for the equity markets, which, surprisingly to us, still have a delayed reaction."

One bit of encouraging news in Whitney's report is that the spread between three-month London Interbank Offered Rate (LIBOR) and the U.S. Three-Month T-Bill, known as the TED spread, has continued to fall. It peaked at 449 basis points on Oct. 10 and is now at 193 basis points. This is still high by historical standards; the TED spread tends to fall between 10 and 50 basis points during saner times.

Because three-month T-Bills are considered risk free and LIBOR measures interbank loans, a rising TED spread means that investors expect more bank defaults. The falling TED is at least a sign that investors aren't as worried about bank viability as they were in October. The spread fell by 15 points during the week ending Nov. 13. At that rate, we're a long way from normalcy.