Hedge Funds in deep trouble

The Hedge Fund Industry was worth $1.8 tril. at the peak in real money. Those numbers are/were diminished by 2 effects, they lost on average 20% this year so far and have to face redemptions in the same magnitude. Assuming $720 bil. of real capital is gone would mean if we further assume an average use of leverage of 300% that $2 tril. of buying power are gone. The assumption of the redemptions and leverage could and likely might be bigger going forward. On top of that, the prime-brokers are asking for more collateral for the remaining positions, hence the leverage of the remaining capital needs to be decreased bringing it to a round number $3 tril. buying power lost. A quite substantial part of this $3 tril. is about to be liquidated in the next 6 months.

Excerpt from WSJ:

Hedge funds are sitting on a record amount of cash, estimated at about $400 billion, money that eventually could make its way into the market. Other managers are hoping that investors have second thoughts and don’t go through with the withdrawals, or are telling their investors that they will sell securities over time rather than dump them as the market falls. But either way, the wave of requests is keeping money out of the market as hedge funds figure out their next moves.

Hedge Fund Selling Puts New Stress on Market

Hedge funds are selling billions of dollars of securities to meet demands for cash from their investors and their lenders, contributing to the stock market’s nearly 10% drop over the past two days.

The Dow Jones Industrial Average fell 443.48 points on Thursday, bringing its two-day drop to 929.49 points, its biggest two-day decline since Oct. 20, 1987. Coming amid steep drops in the retail and auto sectors, the decline wiped out a strong rally that ended on Election Day, and now the market is only 6% away from its lowest close of the year.

[Ken Griffin] Phil McCarten /Landov   

Kenneth Griffin

One of the biggest hedge funds, $16 billion Citadel Investment Group, is being asked by several major banks to post additional collateral to cover big losses on its investments, according to people familiar with the situation.

Citadel, which is run by Kenneth Griffin, was until recently considered a possible savior for troubled Wall Street firms. But his biggest hedge fund has fallen nearly 40% this year, prompting the firm to hold conversations with lenders including Goldman Sachs Group Inc., Deutsche Bank AG and Merrill Lynch & Co. that finance Citadel’s trades.

Citadel executives say the calls for more cash are a normal part of business when securities they hold fall in value, and they emphasize they have significant amounts of cash to satisfy their lenders. They say they have met all the demands for collateral. Rumors that the firm was having problems led it to hold a conference call two weeks ago in which it said it was holding 30% of its capital in cash and Treasurys and had $8 billion in credit lines it has yet to tap. The firm also said some of its businesses are doing well this year, that it has reduced risk and its use of borrowed money, and that performance has improved recently.

Citadel Investment Group

SIZE: $16 billion

CEO: Ken Griffin, 40

YTD RETURNS: Biggest funds down about 39% through last Friday

HISTORICAL RETURNS: 18%-20% a year

NUMBER OF EMPLOYEES: More than 1,200

HISTORY: Mr. Griffin founded the Chicago-based firm in 1990 with $4.6 million, one year after graduating from Harvard University. The fund is known for buying assets of other investment firms in distress.

KEY INVESTMENTS: Assets of E*Trade, Enron Corp. and hedge funds Sowood Capital and Amaranth

Lenders are hoping regulators would orchestrate a settlement among the companies involved in Citadel’s loans if necessary, according to a person familiar with the situation. “Citadel is a valued client, and we continue to do business with them as usual,” said Ed Canaday, a Goldman spokesman.

Deutsche Bank spokesman Ted Meyer said, “Citadel is a valued customer and our relationship is business as usual.”

Hedge funds have emerged as the latest serious problem in the global financial system. As their losses mount, they’re selling off securities to meet demands for cash from lenders and investors.

To be fair Hedge Funds had to deal with extraordinary circumstances as the best short ideas (financials) were banned from the SEC- like in 1932 – and some lost fortunes in single trades, which were theoretically the right trade like being short in VW, the German car maker.

Excerpt from WSJ:

The German sports-car maker said Friday that its pretax profit in the fiscal year ended July 31 soared 46% to €8.57 billion euros, or about $10.9 billion. Eighty percent of that came not from making cars but from sophisticated financial instruments connected to a protracted takeover bid Porsche Automobil Holding SE has been pursuing for a company many times its size, Volkswagen AG.

Porsche’s profits on those trades totaled more than the current combined market values of beaten-down General Motors Corp. and Ford Motor Co. The outsize gains were scored by a potato-loving chief executive and his Kafka-reading chief financial officer. They teamed up with the offspring of the Beetle creator to engineer an audacious takeover bid — and outfox hedge funds at their own game.

Porsche is raking in money through a form of options that helped it build up a huge stake in VW since 2005, while keeping other market participants in the dark. The strategy led late last month to a soaring price for VW shares after a Porsche disclosure showed the company, had, in effect, cornered the market on most VW shares.

That put investors who had bet against VW stock in the classic bind called a short squeeze. This one was acute: VW’s stock spiked so high that VW briefly was the most valuable public corporation in the world.

Hedge funds that had shorted VW shares — borrowing them and selling them, hoping to replace them later with cheaper shares — lost billions over a few frantic hours last week as they wrestled each other to buy the few remaining shares available and unwind their bets. Funds affected, according to people familiar with them, include Greenlight Capital, SAC Capital, Glenview Capital, Marshall Wace, Tiger Asia, Perry Capital and Highside Capital.

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~ by behindthematrix on November 10, 2008.

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