Run on Hedge Funds

Discussion in 'Wall St. News' started by Trendytrader, Jul 27, 2007.

  1. In the old days during a market upheaval you would get a run on the banks. In today's market upheaval it looks like we are seeing a run on Hedge Funds. Whereas with a bank they can get more cash not so easy with an HF that has to sell dodgy and worthleess CDO assets. Their answer is to freeze HF redemptions.

    I expect us to see more HF issues next week -watch out as they are forced to sell equity assets to offset losses with CDO assets and freeze redemptions.

    $3 Billion Hedge Fund Is Down 10% for Year

    Published: July 28, 2007
    In a sign of the nervousness in the markets, the sale of a block of credit-related securities on Thursday led to speculation about the demise of a multibillion-dollar hedge fund.

    The fund, Sowood Capital Management, which in January had about $3 billion under management, is down 10 percent for the year, battered by credit markets that have hedge funds, their investors and their lenders on edge. Many traders pointed to the fund, with its substantial losses, as the first significant casualty of rocky credit markets.

    Sowood Capital was started in 2004 by Jeffrey B. Larson and Stuart Porter, both of whom worked for the Harvard Management Company, the university’s large endowment. Harvard seeded the fund, which invests in stocks and bonds, with a significant amount of capital, according to two people with knowledge of the fund’s operations.

    Sowood Capital did not return calls for comment yesterday. Mr. Porter now runs Denham Capital, a separate private equity company.

    Speculation about problems at the fund abounded yesterday because of observations by market participants on Thursday that Sowood Capital was selling positions at distressed prices, traders said. While one person with knowledge of the fund’s operations said that the rumors were overblown and that Sowood Capital had met its margin calls, the situation is a telling example of the nervousness in the market.

    Already there have been several casualties among hedge funds that invested primarily in subprime mortgages — those extended to people with weak credit. But problems have now moved into the broader credit markets, which have sold off sharply and are facing significant structural problems.

    Some of the securities in these markets are trading infrequently, which raises questions about whether the pricing portfolios, or “marking” positions, reflect their true value. With illiquid securities, traders cannot know the true value of the securities until they are sold. Bids and offers, or the prices in the marketplace, have been erratic, traders say.

    Market participants say Sowood’s credit securities were sold at a deep discount, which some in the market viewed as a fire sale, leading to speculation that the fund was in distress.

    The fund was up a little more than 1.5 percent through March, according to an investor letter, showing how quickly the markets — and a fund’s returns — can turn. Marketing documents indicate that a little less than 15 percent of the portfolio’s risk is in structured credit.

    For now, the fund appears to be simply selling positions. Investors’ capital is locked up for two years and three months. The fund also has a so-called gate, meaning that once investors have filed to redeem 25 percent of assets, the fund can suspend redemptions.

    But the situation is indicative of a teetering market. The debt market is essentially frozen with concerns that the following scenario emerges: a major hedge fund moves to sell a position, getting a low price or mark. The low price indicates the market is in distress, and the brokers significantly discount the collateral the funds have set aside in order to do business. At that point, the brokers issue margin calls, and the hedge funds sell to meet the calls — into a distressed market — causing investors to panic and redeem their money. And the death spiral begins.

    At this moment, that situation does not seem to have appeared in the markets, though several funds focused on the subprime market, including two large Bear Stearns funds, are essentially worthless.

    Wall Street has also tried to convince the marketplace that recent problems in the subprime sector were contained. In the subprime market, not only were mortgages extended to individuals with very poor credit, but those mortgages were wrapped into different debt products bought by investors looking for high returns.

    But as mortgage lenders have become increasingly bearish about the housing market, and the markets recognized the glut of loans and bonds waiting to be sold to finance the buyout boom, concerns have spread to the credit market.

    Because some of the credit markets have been illiquid, many funds have to sell stock to make margin calls or to meet tighter collateral standards.

    “All of this is mismarked and has been for months,” said one hedge fund investor who was commenting on the market in general and not Sowood. He said the death spiral situation was to be expected; the only question was just who would face it. “This is more likely an outcome than speculation.”

    Not everyone has suffered.

    MKP Capital, an investment company that has hedge funds focused on mortgage-backed and asset-backed securities, bet the market would fall apart and its investors have profited handsomely. MKP Credit, one fund, is up 7.3 percent for July and 22.3 percent for the year, while a distressed fund, MKP Credit II, is up 5.5 percent for July and 13.1 percent for the year, according to a person briefed on the fund’s results.

    A spokesman for the fund declined to comment