Hedge fund braced for large withdrawals Tuesday, September 30, 2008
If Hedge Fund investors decide to lodge large redemption notices this week for the end of December [typical notice period is 3 months, assuming you are not in a lock-in period which is common in the early years of a fund], then we will see additional downward pressure on share prices and a considerable contraction in the trading capacity of funds.
Investor withdrawals are to be expected given a combination of fear about market risk, prompting a flight to safety and the neutralising of popular long/short hedge fund strategies by regulatory restrictions on short selling.
In many cases, the withdrawal of £1 is amplified by 10-20 times as a result of leverage. Hence, to realise cash to pay investors, a hedge fund will have to liquidate say £20 of assets in my example. Such forced sales will contribute to price depression and exacerbate illiquid markets. Depending on the scale of redemptions, some funds may find their funds wither to uneconomic levels i.e. fees generated on a small fund are insufficient to cover their costs, with the result that they are forced to close. In some cases, this could happen with redemption levels of only 40%.
Of course, Hedge Funds could do two things to discourage/stop exits. The first is that they could impose large redemption penalties i.e. heavily discount the price they offer to pay to repurchase units from investors - 25% or so. Secondly they could drop the "gate" on funds and suspend redemptions, which is a power funds often have to ensure an orderly operation of the fund - large exits destabilise a fund to the detriment of all investors.
Labels: Hedge fund