Hedge funds to suffer further in scramble for cash

Date: Wednesday, March 11, 2009
Author: Laurence Fletcher, Reuters.com

The hard-hit hedge fund industry will shrink back to 2005 levels of around $1 trillion (728 billion pounds) this year as cash-needy investors, rocked by the Bernard Madoff scandal and further performance losses, get a chance to exit.

There is little relief from redemptions in sight for funds as U.S. institutional investors pull out cash to meet commitments to private equity, while portfolios that had locked up investor money last year will shortly see disillusioned investors leave.

"I think we'll have two quarters of significant redemptions," Chris Manser, global head of fund of hedge funds at AXA Investment Managers, told Reuters.

"Because of Madoff and very difficult performance a lot of funds will be receiving high levels of redemptions."

Hedge funds saw outflows of $152 billion, or 9 percent, in the fourth quarter of last year, according to Hedge Fund Research, bringing down total assets in the freewheeling industry to $1.4 trillion at the end of the year after performance deteriorated in the second half.

Since December's redemptions, investors have been able to weigh up full-year numbers, which show a record loss of 19 percent.

The performance rebound some managers were hoping for has failed to materialise -- the average fund is down 0.59 percent in the first two months of the year.

The alleged $50 billion fraud by Bernard Madoff came too late for December redemptions but, with investors nervous of similar scandals and lack of vigilance by some funds of funds, executives think it will fuel further redemptions.

"I think March will in percentage terms be as big a redemption date as December," said Cem Habib, fund of hedge funds manager at Altedge Capital.

LESS THAN A TRILLION

Redemptions of 10 percent in March and June would reduce the industry's assets under management to around $1.1 trillion, before including any performance losses or second-half outflows. That could leave the sector, estimated at $2.7 trillion just last June by Hedge Fund Intelligence, holding under $1 trillion.

Morgan Stanley analysts expect redemptions of 15 percent to 30 percent and the industry to shrink to $950 billion this year, with a bear case of just $500 billion and a bull case of $1.2 trillion.

Some individual firms are bucking the trend with positive inflows -- Christopher Fawcett, chief executive of Fauchier Partners, said his fund of hedge funds firm had seen small inflows from pension investors and noted "the number of (industry) redemption decisions taken in 2009 are substantially lower than in the fourth quarter of 2008".

But many investors who tried to get out of funds last year, only to find funds had temporarily limited or barred exits, will have their requests granted this year as the restrictions end.

Big institutions such as U.S. endowments, which tend to move slower than the more nimble wealthy individuals who led redemptions last year as fund returns deteriorated, are likely to head for the exit this year with their substantial holdings.

OVER-COMMITTED

"We do fear increasing U.S. institutional redemptions, particularly from ... institutions who have over-committed to recent vintage private equity/real estate," analysts at Morgan Stanley said in a note.

University endowments such as Harvard and Yale's have been big investors in hedge funds for some time, but some U.S. endowments had committed money to private equity.

Some endowments had committed money to private equity funds, expecting them to continue to be able to pay out as these funds sell out of earlier investments.

But with trade sales and initial public offerings harder or at unattractive prices, private equity funds are finding exits tougher and many investors are no longer getting cash back.

This means many have to sell other holdings, such as hedge funds, to fund their ongoing commitments into private equity.

One hedge fund executive who declined to be named said one U.S. endowment, whose inflows from private equity had largely balanced out its payments into new private equity funds and to the university, had seen inflows recently fall to zero.

"Now there are no realisations and many funds are calling down capital, part of this is being financed by the sale of hedge funds," said Fauchier's Fawcett. (To read the Reuters Hedge Fund Blog click on blogs.reuters.com/hedgehub; for the Global Investing Blog click here)

(Editing by Jon Loades-Carter)