Hedge Funds are not a homogenoueous group – individually they pursue many different strategies. However, one thing you will consistently hear from people in the hedge fund industry is that such funds are not closely (or in some cases, not at all) correlated with major market indices i.e. just because the markets go down doesn’t mean funds will be affected i.e. the measure of correlation or “beta” is weak.
It is for this reason, investors are told, that hedge funds charge 2 & 20 (2% annual management charge on funds under management and 20% of gains made), rather than the paltry 10bps or less for index trackers.
So, it must have come as a shock to many investors to read headlines such as
Hedge funds forced into equities fire sale
Tue, 14 Aug 2007, 00:11 The Times
Goldman Sachs has made the announcement that everyone has been waiting for. The investment bank admitted yesterday that three of its high-profile hedge funds had off-loaded massive equity holdings following days of stock market turbulence. In recent days, whispers at rival fund managers had blamed a fire sale at Goldman Sachs for the devastating downward spiral afflicting global financial markets. The truth is that the bank was not alone. Almost every big quantitative fund using a strategy similar to Goldman’s – known as an equity market neutral (EMN) strategy – was suffering in its own way. The result has been a rout of one of the most popular types of quant fund. Hedge Fund Research’s EMN index had lost 7.6 per cent by last Thursday and undoubtedly saw further points shaved off during Friday’s plunge in equities.
Unsurprisingly it is anticipated that a large number of investors will curtail future investments. More importantly the industry is bracing itself for withdrawals of investment at the next pricing point (assuming funds can even be valued in the current climate – many fund administrators are clashing with managers over the value to place on illiquid instruments in the current environment). This potential exodus is significant for a number of reasons. Most importantly, how many funds will simply close the “gate” and deny the investors the ability to withdraw funds, as I posted on recently? Equally important though, is that if funds are forced to liquidate positions to satisfy redemptions then this will have a market impact as Merrill Lynch found when they sold Bear Stearns collateral.