Fallout: The Financial Crisis

Investors line up to exit hedge funds

John Dimsdale Nov 14, 2008
Fallout: The Financial Crisis

Investors line up to exit hedge funds

John Dimsdale Nov 14, 2008


Kai Ryssdal: Hedge Funds. You hear about ’em all the time. How they’re these giant, mostly unregulated, piles of investment capital that make rich people richer. In theory, it’d be great to get in on some of that action, right? Who doesn’t like double digit returns? But maybe it’s just as well most of us can’t because once you’re in a hedge fund, it’s tough to get your money back out.

After fund mangers lock up your cash, you can only get at it a few days during the year. They’re called redemption days. And thanks to the fallout from the financial crisis, there is a big one coming up tomorrow. Sally Herships reports.

Sally Herships: You and I may not be able to invest in hedge funds, but our pension funds and endowments can. And they do. That was fine during the boom years when everything was going up, and hedge funds made jaw-dropping returns. But now everything from stocks to soybeans is trading down, and hedge funds are losing money like everyone else. The average fund is down 15 percent this year.

Chris Geczy teaches finance at Wharton. He says the people and institutions who invest in hedge funds are spooked by the losses. And they want their money back.

Chris Geczy: An investor will call a fund and say look, I’m really scared, I want to go to cash. And the fund manager says, “Well, OK, but I need to get the money first.

But that can take a while. Investors in stock and bond funds are used to getting their money back any time they want it. Hedge funds don’t play that way.

Marc Freed is managing director for investment advisers Lyster Watson. He buys shares of hedge funds. He says hedge funds are only loosely regulated. And they don’t have to give investors their money back immediately, even when they’re asked.

Marc Freed: If our clients ask for their money back from us, we’re caught in the middle a bit, because we will ask, but [laughs] we may find out that some of the funds don’t want to honor our requests.

That’s because honoring those requests means selling assets. Something hedge funds only like to do if they’re making money on the deal. With the markets down, they’re more likely to lose money if they sell now.
Still, many investors want to cut their losses. And hedge funds say they’re getting an unusually high number of redemption requests ahead of tomorrow’s deadline. So many, says Chris Geczy, that fund managers are calling it D-Day.

Geczy: Spread out over a longer point of time, that kind of liquidity demand may not matter, but isolated at a point in time in the short run it can matter a lot. Because you may see some fire sales.

As the economy deteriorates and the markets fall, the assets the hedge funds own are worth less and less.
The more investors that ask for their money back, the more assets the hedge funds have to sell to raise that cash. And the more they sell, the more they push the price of everything down even further. Including their own profits.

Lyster Watson’s Marc Freed says this spiral of selling means everyone loses, whether they invested in hedge funds or not. He says many people and institutions didn’t understand what they were getting into when they put money into hedge funds.

Freed: What people should understand about hedge funds is that they are not short-term trading vehicles.

Freed says hedge funds take risks that pay out over time. They often move against the market, buying when everyone else is selling. Wharton’s Chris Geczy says they want to buy now and make the most of a down market. But they’re tearing their hair out because investors are forcing them to sell instead.

Geczy: Now’s the time that I’m finding the best investments of my lifetime, of an entire century, and now you’re asking for your money back?

Lyster Watson’s Marc Freed says Hedge funds are going to lose about $600 billion this year, but that doesn’t mean they’re extinct. Yes, the average hedge fund is down 15 percent so far since January.
But the stock market is down double that. So for those investors with a strong stomach, hedge funds still look like a pretty good bet.

In New York, I’m Sally Herships for Marketplace.

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