Sensible Investing

Hedge Fund Liquidations

December 21, 2008

Hedge funds redemptions and liquidations contribute significantly to current market declines. According to a recent article from CNN.money, hedge fund failures are up 70% compared to a year ago; 7% of them are now gone.  The problems in the industry are threefold.

First, similarly to mutual funds, hedge funds are flooded with redemption requests from panicked investors and are forced to sell their holdings to generate cash.  Second, many hedge funds are highly leveraged, and severe drops in the market cause margin calls, forcing even more selling to meet margin requirements.  And finally, hedge funds sometimes have so-called “high watermark provision”, which means that they can’t charge performance fees unless the fund’s net asset value exceeds its previous peak value.  With little prospects of attaining previous highs anytime soon, many fund managers opt to close down completely, and therefore have to sell all of their holdings, and quickly.

The last two problems are unique to hedge funds — hence the problems with these particular investment vehicles are so severe.  The end of the deleveraging process in the hedge funds industry will help to stabilize the market, and many quality companies that have been oversold due to the reasons stated above will bounce back.

Entry Filed under: Market Conditions. .