Hedge Funds Weren’t Hedged-Who Knew?

November 8, 2008

Hedge funds are continuing to lose big bucks, suspending redemptions and, in a number of cases, liquidating. They all cite difficult market conditions. Which markets, though? Derivatives have been under the radar lately, yet there have been many events that would force mark-to-market accounting. Recent changes in SEC rules allow banks to defer mark-to-market and keep off balance sheet certain assets. Hedge funds too?

From the Nobel Prize-winning asset managers who brought us Long Term Capital Management, Bloomberg today reports that Platinum Grove Asset Management LP has suspended investor withdrawals from its largest fund after a 29% loss in the first half of October. That’s right, 29% in 15 days. The year to date is higher.

“The decline left Platinum Grove Contingent Master fund with a 38% loss this year through Oct. 15. Funds employing a similar approach of exploiting differences in the value of related securities fell 14 percent last month and 30 percent this year to date,” according to Hedge Fund Research. “Hedge funds are reeling from the worst financial crisis since the Great Depression, losing an average of 20 percent this year. A surge of investor redemptions forced firms such as Blue Mountain Capital Management LLC and Deephaven Capital Management LLC to freeze funds to stem the tide of withdrawals.”

Hedge funds are getting it in both directions. Investors want their money back and prime brokers are demanding higher margin requirements. Platinum is only one more of dozens of funds that have suspended withdrawals rather than sell assets at fire-sale prices, the reason given by the hedge funds themselves. Hedge funds are down 20% this year on average, as measured by the HFRX Global Index.

I thought hedge funds were supposed to make money regardless of how the market did. As Mish points out, “to collectively be down 20%, they had to have been making one-sided bullish bets on something. Where’s the hedge?” Twenty percent or more down is a lot of value lost. On the surface, there are plenty of stocks down big for the year. However, derivatives seem to be under the radar again. We know that hedge funds are big players in derivatives, which, as we also know, are worthless hard to price. Wonder how that’s going to be dealt with for year-end bonus calculations.

Anecdotal reports of 401k participants not being able to switch out of stock and bond funds—especially PIMCO— into money-market funds are increasing. Sounds like a lot of losses going into year end.

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