Redemptions and Losses Expected to Hammer US Hedge Funds

"The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months – with half the decline coming from withdrawals and half coming from investment losses"

"The industry, which manages close to $2,000 bn, has experienced outflows during only a handful of months previously, including a small outflow in April of this year."

The Financial Times
US hedge fund withdrawals hit $43bn in September
By Deborah Brewster and Henny Sender in New York
October 16 2008 00:16

Investors pulled at least $43bn from US hedge funds in September as market turmoil led to unprecedented withdrawals, an analysis by a leading research house shows.

The data from TrimTabs Investment Research – which was to be sent to clients late on Wednesday – come as hedge funds are working to prevent far bigger redemptions by the end of the year, when many funds give investors a chance to take out money. (Calling all bagholders - Jesse)

Withdrawals can lead to a vicious circle in the markets, as funds sell holdings to return money to clients, depressing prices and prompting further redemptions.

To prevent such an outcome, some hedge funds had offered to suspend fees if investors kept their money in until March, said Marc Freed, of Lyster Watson, which invests in hedge funds on behalf of institutional and private clients. (Oh yeah that sounds great considering they are getting decimated by the worst bear market since the Great Depression - Jesse)

“Every investor fears other investors will pull their money and so they worry they will be at the back of the line if they don’t also pull,” Mr Freed said. (If you are going to panic, be sure to panic first. - Jesse)

“Nobody will invest in anything illiquid because they think they may not survive long enough to see them rise in value.”

A fundraiser for a major hedge fund said the period “between now and December 1 is a sort of death march” for the industry.

The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months – with half the decline coming from withdrawals and half coming from investment losses.

Conrad Gunn, chief operating officer of TrimTabs, said the $43bn in September withdrawals would mark “the beginning of what we expect to be a series of outflows for the remainder of the year. We expect October outflows to be larger”.

Mr Gunn said the September outflows were based on an analysis of preliminary data and that the final tally would probably be higher because funds with heavy redemptions tended to report data later.

The industry, which manages close to $2,000bn, has experienced outflows during only a handful of months previously, including a small outflow in April of this year.

JPMorgan Chase has estimated that hedge fund outflows could total up to $150bn over the coming year. As investors take their money out of hedge funds, the funds have to sell assets.

But because they use so much borrowed money, the amount of potential asset sales is far larger. For example, JPMorgan expects that an outflow of $150bn will lead to sales of about $400bn.

(The JPM estimates seems a little light. 150 billion in total redemptions based on 43 billion in September alone, with October to be larger, and a 'death march' to year end? They seem to be assuming blue skies by Christmas. Hey, no fees if you hold on until the flesh falls from your bones. - Jesse)

UBS Über Alles

Lose so much in your own trading book that people become afraid and seek your advice for their private wealth management. Nice corporate strategy.

Hubris? Or would it be just a case of "prétention démesurée?"

UBS says crisis vindicates own bank model
Wed Oct 15, 2008 4:33pm EDT

GENEVA (Reuters) - Switzerland's UBS the world's largest wealth manager, said its advice-driven, global banking business model will be a winner as others failed or were rescued by governments during the global financial turmoil.

UBS was hit early on in the crisis and has announced more write-downs on toxic assets than any other European bank.

"It's never been more obvious to clients that they need advice. This is going to be the proof to our business model," Juergen Zeltner, who heads UBS' wealth management operations in North, Central and Eastern Europe, told the Reuters Wealth Management Summit.
UBS has not given up on investment banking despite huge losses on the business and instead has divided its operations into three separate divisions -- wealth management, investment banking and asset management -- to boost transparency.

Banks which heavily relied on investment banking revenues, such as Lehman Brothers, have either gone bust or needed rescues via forced mergers or government aid.

"I strongly feel that the transparency that we put in place was well appreciated," Zeltner said.

Still, Zeltner said the damage to UBS' reputation from the huge losses in its investment banking division was obvious and had resulted in client outflows. The bank will report third quarter results on November 4.

"We lost trust. We do know that there was substantial damage and that will take years to rebuild," he said.

UBS recapitalized itself earlier than any other bank, before the deepening of the crisis in September, and is now in a position to exploit opportunities in markets where other players have failed, such as the United States, he said. (You'll have to compete with our 'national champions' who are getting their subordinated distress funding from the US Treasury - Jesse)
"The crisis gives us unique opportunities in the United States," Zeltner said.

"We want to grow and build market share."

The Practical Risk in the Fed and Treasury's 'Trickle Down" Approach

The 'trickle down' approach being taken by the Fed is in danger of not only failing to sustain the economy, but may precipitate a significant political crisis.

The current plan is to flood a few relatively large banks with public liquidity, without substantially changing their management, their charters, and their regulatory constraints.

What if these banks defer on lending to others as their primary objective, preferring instead to buy up valuable and productive non-financial assets on the cheap for their own speculative purposes? Or to provide the liquidity for their associated off-balance-sheet corporations to do the same, rather than funding organic growth?

Why would the banks limit themselves to commercial banking when they can still act like hedge funds buying assets and investing for their own tradebook and investment portfolios?

The short answer is that they always and everywhere have acted with their own interests first and foremost.

The obvious firms to watch are Goldman Sachs and Morgan Stanley. Why the Fed does not see this obvious moral hazard is astonishing. What is even more astonishing is that no one is calling out Paulson on this, who has a yawning conflict of interest with Goldman Sachs.

The inherent weakness in a centrally planned economy is that it invariably leads in distortion, corruption, and advantageous manipulation by insiders. To expect anything else is to ignore human nature and history.

The banks, our 'national champions,' must be constrained again as they were in the 1930's after their reckless speculation and credit expansion had financially decimated the nation's economy and the great majority of the public.

Gold, Oil, MZM, Credit and the Short Term Liquidity Contraction

MZM is the Fed's broadest measure of liquidity. Although gold is not as 'immediate' as cash due to the need to convert it to currency, nevertheless it is a liquid store of wealth in that there are no time constraints on it such as on Certificates of Deposit or other time constrained instruments.

Stocks are also a liquid store of wealth, but with a larger beta or 'riskier valuation' with respect to their expected growth and earnings. As an aside, some day we hope to see a return to the notion of a risk premium for equities versus debt.

As we have shown before, the correlation between the growth of MZM and the price of gold in dollars is remarkable. There are a few other factors in the regression we are tracking which are not shown here, such as fear-driven volatility as measured by VIX.



Note that in the chart below in the same time period M2, a broad money supply measure, but less liquid than MZM, has shown a sharp spike higher along with its associate, Total Bank Credit.
We think this is a clear indication that we are in a liquidity crunch, but not a deflationary contraction in the the broader money supply.

In other words, funds and individuals are raising 'cash' by selling liquid assets to meet margin calls and support investment assets and short term obligations.


On a cautionary note, the growth in a dollar of Bank Credit is showing less ability to produce a dollar of M2. Again, this is not deflation but the transfer of wealth from one asset class to another, with lags and amongst individuals, and the inefficiency of the ability of an economic system based on wealth transfers and specultation to produce incremental productive savings.


This is not to say that a true deflation is not possible. Quite to the contrary. Deflation is a policy decision, normally caused by an adherence to some non-synchronized external standard, such as gold or the US dollar, ignoring the short term needs of the domestic marketplace.

Does this mean that there is no manipulation in the gold market? No, the price manipulation there is obvious, and we will take the central banks at their word that they wish to discourage gold as an alternative store of liquid wealth, because it is beyond their control and a competitor to their desired fiat regimes. Statists dislike anything that provides competition to their power.

What we do wish to show is that the banks are not fighting the gold trend as much as some might think because of the short term liquidity contraction. When this changes, the move in gold will obtain explosive momentum from which a major rally leg will occur as the banks lose control.

We also believe the same set of conditions applies to Crude Oil based on our current data which we will not include here for the sake of brevity. The price declines in crude oil are not wholly related to a diminished demand or 'speculation' as some would contend. Rather, oil has been serving as a global store of liquid wealth against a declining dollar and increasing dollar inflation. Oil has many of the aspects of 'money' for global trade. Demand and supply for crude oil will prove to be much less elastic than many assume.



We do not hold the same view for all commodities because we have not looked closely at them, but not all have the same "monetary component" as gold and oil.

Interestingly enough, the eurodollar spread (TED) is artificially wide because of the eurodollar assets and liabilities as we have shown before. We wonder what this will do to the euro and its associated currencies in the longer term, since the artificial short squeeze in the dollar is causing some havoc short term with European money supply policy despite the central banks attempts to sterilize the effects.

We expect a sharp rally in gold, oil and the euro once the short term liquidity constraints are overcome with a corresponding sharp decline in the US dollar.

The Fed will likely have to raise interest rates, and perhaps sharply, to counteract this, unless they can rely on foreign central banks once again to 'bail them out.'