Friday, October 17, 2008

Hedge Fund Redemptions Creating Problems

From the Financial Times:

Troubles mounted for some of the world’s biggest hedge funds on Thursday as Highland Capital Management told investors it was shutting down two of its funds and details emerged of big losses at TPG-Axon.

The problems in the sector have set in motion a vicious cycle in the markets as hedge funds sell holdings to return money to worried investors, triggering further price declines and prompting more withdrawals. Investors pulled at least $43bn from hedge funds in September, according to TrimTabs Investment Research.

“Unfortunately, selling has begat selling as risk reduction and unwinding create spillover pressure on other funds with overlapping holdings,” Dinakar Singh, the founder of TPG-Axon said in a letter to investors at the end of September.

This explains some of the recent volatility in the markets. Fund X has a big holding in a particular security that has dropped. Fund X sells its holdings in that security to stop the loss and raise cash for anticipated withdrawals. This leads to further deterioration in the various stock prices leading to more investors wanting to pull money from hedge funds ... you get the idea.

Roubini has argued the next wave of problems will come from hedge fund related issues. Whether this is true or not only time will tell. But it does make sense in the current environment.