Hedge Fund Withdrawals Continue & Citadel Feels the Pain ~ market folly

Tuesday, October 21, 2008

Hedge Fund Withdrawals Continue & Citadel Feels the Pain

$43 billion. That was the number of withdrawals from Hedge Funds in the month of September, according to leading research house Trim Tabs Investment Research. And, given the volatility and market declines we've seen thus far in October, you can assume that this month will be much (if not more) of the same.

Taken from the FT,

"The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months – with half the decline coming from withdrawals and half coming from investment losses."

Even if that prophecy becomes only partially true, that is a massive amount of deleveraging, unwinding, and liquidation. Forced selling is driving this market and will continue to do so. Buying these dips in a scalable manner offers a very promising opportunity for longer-term investors. And, 'Tiger Cub' Chris Shumway of hedge fund Shumway Capital has argued just that at a recent hedge fund panel which I wrote about here. Barry Ritholtz, author of 'The Big Picture' blog has also recently put a small amount of capital to work on the long side. You can see his thoughts in a recent interview, courtesy of Agoracom. By no means should you rush out and invest 50% of your capital when the market plunges. Volatility should continue. But, by being constructive in small amounts, say 10-15% of capital, you can accumulate assets that are selling at fire-sale prices and are pricing in the apocalypse. That is not to say that assets cannot get cheaper; because they most likely will. But, we all know you cannot time the exact bottom and that the market does not bottom in a 'V' fashion.

As I wrote a few weeks ago, the hedge fund redemption bloodbath was just starting. Such forced selling essentially triggers other funds to sell, as they watch their holdings evaporate in value. And, all data thus far points to this trend to continue. Recently, in our hedge fund performance update, we noted the horrid performance of nearly every hedge fund we covered. This is all the evidence you need as to whether or not this trend will continue. The main thing to take away here is that we have absolutely no idea how long it will take for the deleveraging and liquidation to cease. But, the selling won't stop until all the players are wiped out and only the strongest have survived. Paul Kedrosky has recently tossed out his estimates on the hedge fund outflows. He writes,

"In essence, I'm aging hedge fund inflows and saying that we will see a blended 40% (higher in later years, lower in earlier years) demand for redemptions from investors in the 2005-2008 period. I'm not worrying about pre-2005 assets under management, so we could see lower redemptions on new assets and more on the older stuff, taking us to the same place. I'm also positing that initial capital has shrunk by a blended 20% on inflows, which is admittedly on the high side. I then figure that turns into almost $200-billion in outflows, or a little less than $2-trillion in asset sales at an average of 10x leverage. Some say the leverage is lower, some higher. Some argue we will see lower/higher redemptions, or that median versus mean losses will be wildly different. Other say it's inherently a state change issue, where the paradox of delevering is that everyone doesn't get to shrink -- some firms just fail outright."

Also, Todd Harrison, former hedge fund trader and now CEO of Minyanville.com recently was on Tech Ticker discussing this very problem, saying he thinks that 50% of the hedge fund space will fall victim. Hence, keep capital invested smaller, be nimbler, be hedged, and have patience.

Case in point: even Citadel, the oft respected firm started by Ken Griffin is seeing its worst year in its history, down anywhere from 26-30%. They are well known for their solid 18-20% annualized returns. From the WSJ,
"On Wednesday, Kenneth Griffin, head of Citadel, sent a letter to investors.

September, he wrote, was the "single worst month, by far, in the history of Citadel. Our performance reflected extraordinary market conditions that I did not fully anticipate, combined with regulatory changes driven more by populism than policy."

In coming weeks, Mr. Griffin wrote, the firm's earnings will continue to be volatile, "as the world manages the unfolding crisis."

Overall, the numbers are pretty staggering. After recently coming across data from Eurekahedge, DealJournal writes,

"According to its preliminary estimates, hedge-fund losses totaled roughly $79 billion in September, including $44.5 billion of investment losses and $34.5 billion of investor withdrawals. That was only partially offset by about $10.5 billion of new money flowing into the more successful strategies, Eurekahedge figures. In the third quarter, hedge-fund assets shrank by a record $210 billion, or more than 10%, estimates Hedge Fund Research. To put that in perspective, the decline in assets for the quarter exceeded the entire amount of money that flowed into the industry in 2007, which was a record $194 billion. Of those third-quarter declines, more than $31 billion was attributed to investors taking out their money, the largest net capital redemptions on record, says Hedge Fund Research. That left total hedge-fund assets at $1.72 trillion, down from $1.93 trillion at the end of the second quarter."

So, while one could definitely argue a tradeable bottom is in the cards, it still seems as if the unwind from mutual funds and hedge funds still might have control of this market.

Sources: WSJ, DealJournal, & FT

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