Hedge Funds Face Investor Pruning

Wall Street Journal

After a turbulent 10 months, hedge funds are bracing to hear whether jittery investors will want their money back.

As the year comes to a close, some investors say they are reviewing how their managers have performed through the recent volatility and are making decisions about whether to cash out of underperforming funds. Investors who want out before the end of the year in most cases need to give 45 or 60 days’ notice of their redemptions, setting up a critical period for managers who have suffered significant losses. The hedge-fund industry sees the next two months as the most critical redemption period since the dark days of the financial crisis. Some underperforming funds, both large and small, expect to hear from investors soon. Those funds’ managers « will be punished, and rightfully so, » said Vidak Radonjic of the Beryl Consulting Group LLC, which advises investors on hedge funds. Mr. Radonjic is advising clients to put in some redemption requests in the fourth quarter. These are « scary times for managers who were not positioned well, » he added.

An Oct. 12 survey of 150 hedge-fund investors by Barclays Capital showed that 35% of those sampled either had redeemed recently or planned to soon redeem from managers who had performed relatively poorly. Another 20% said they were still on the fence. It is unclear which hedge funds will be affected most by redemption requests, but the market turbulence has hit big-name funds ranging from Paulson & Co. and Pershing Square Capital Management to Highbridge Capital Management.

The confluence of poor performance and heavy redemptions can turn a difficult year into a catastrophic one for a hedge fund. Just this month, Longacre Fund Management LLC, which at its peak oversaw close to $3 billion in assets, said it would wind down its main funds after many investors pulled their cash. Some investors say they are hearing more frequently from managers now, as some are trying to make the case that their down year is an anomaly, or are laying out strategies for turning things around.

« If they are having a bad year in that returns are down but can explain it in a way that convinces us they haven’t lost their discipline, then we might give them a pass, » said Sam Katzman, the chief investment officer of Constellation Wealth Advisors, which invests in hedge funds and has $4.5 billion under management. Constellation is likely to redeem from some managers who have underperformed this year, he said.

Redemption requests can be doubly problematic for hedge funds and the broader markets. While redemption requests don’t typically cause funds to close, they can force managers to liquidate their holdings to cash out investors. That, in turn, can have a negative effect on financial markets, sometimes causing hedge funds to get lower prices for their assets. To be sure, there was no big rush to the exits in the first nine months of 2011. In the third quarter, when hedge funds had their worst performance since the financial crisis, the industry saw net inflows, meaning investors put in more cash than they took out—despite the uncertainty, according to Hedge Fund Research Inc. Those inflows came as hedge funds on average lost 5.4% in the first three quarters, outperforming the Standard & Poor’s 500-stock index, which lost 10%. Stocks have since rallied, helping some hedge funds also claw back some of their losses.

On a call with clients last week, Philip Vasan, the global head of Credit Suisse’s prime brokerage unit, said he expected redemptions would « spill into and accelerate somewhat in the fourth quarter. » Some big-name hedge-fund managers with track records of making money have had a particularly difficult 2011, causing some investors to consider putting in redemption requests. « There is going to be pain for those who performed unexpectedly poorly, » said Anurag Bhardwaj, the director of strategic consulting for prime services at Barclays.

Lee Ainslie’s Maverick Capital Ltd. has been one of those funds seeking to bounce back from losses sustained during an ugly third quarter. The $10 billion firm, which specializes in betting on and against stocks, is in danger of posting its second losing year in its 18-year history. Some of Maverick’s funds were down nearly 17% through the first three quarters amid untimely stock picks, according to people familiar with the matter. The funds pared those losses to 11% in October as stocks rallied, the people said. Some investors say they plan to redeem their stake in Maverick. A person familiar with the matter said the firm hasn’t received a substantial number of requests ahead of its Oct. 31 deadline.

Mark Kingdon’s Kingdon Capital Management LLC, which is based in New York and trades stocks, has a little more time to turn around its tough year before its investors must decide whether to redeem, with its deadline at the end of November. Kingdon had lost 19% through the end of September, but more recently had pared back losses to about 16%, according to people familiar with the matter. Mr. Kingdon, whose $4 billion firm has produced an annualized return of 16.6% since its inception in 1983, will hold his annual meeting on Nov. 16. Maria Tapia, a partner at Alternative Investment Group, a firm which manages $1.6 billion in hedge-fund investments, said her firm is planning some redemptions in the fourth quarter, but is also sticking with managers where it has confidence. « In times like these, investors will give you a chance if they understand your thought process and strategy, » Ms. Tapia said. One manager who has been in regular touch with investors is John Paulson, whose main fund fell by nearly half though September. Mr. Paulson, who manages about $30 billion, won fame during the financial crisis for reaping billions of dollars by betting against the U.S. housing market. His bullish bets on the markets this year have led to outsized losses.

Last week Mr. Paulson told investors during a webcast that the firm wouldn’t have any trouble meeting redemptions with cash. Laying out a « worst-case scenario, » another Paulson executive speaking on the webcast said the firm would have outflows of 20% to 25% if every investor eligible to redeem their funds did so. The firm’s Advantage funds, its biggest, have an Oct. 31 redemption deadline.


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