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.
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.
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. Compounding the problem is a surge in notices from investors indicating they want out. Some hedge funds have been hoarding cash in preparation for these withdrawal requests. 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.
Withdrawals from hedge funds and from mutual funds are one factor weighing on stocks, says Mary Ann Bartels, Merrill Lynch's chief strategist. 'It's an overhang for the market,' she says.
The recent rush of withdrawal notices to hedge funds comes as investors, including endowments, pension funds and wealthy individuals, see other investments shrink; in some cases these investors need cash to meet their own obligations. It also marks a sharp reversal of sentiment among these big institutional investors, which jumped into hedge funds and similar investments in recent years.
The result is a downward spiral where hedge funds sell off thinly traded securities such as convertible bonds and corporate loans, driving down their prices, and leading to bigger losses and more demands for cash. Some $4.28 billion worth of corporate loans have been put up for sale in the past month, according to Standard & Poor's. When hedge funds can't meet the demands for cash, lenders seize their assets and try to sell them, further driving down prices and putting more funds in trouble.
Even the most established hedge funds are being hit by -- or girding for -- withdrawals from investors.
Carl Icahn, the billionaire activist, has received $1 billion of redemption notices from investors in his $7 billion hedge fund after posting losses that are a bit lower than the overall market this year. He's putting $250 million into the fund to help avoid selling shares to meet the requests.
'In mid-October, redemption levels were in the 5% range but all of a sudden now it's cranking up to as high as 25% for some funds,' says Gregory Horn, president of Persimmon Capital Management, a $500 million Blue Bell, Pa., firm that invests in hedge funds. The firm has asked for about 20% of its total investments back. This 'is the highest level of redemption requests' for the industry in at least 17 years, Mr. Horn says.
Some investors are withdrawing because they're more wary of hedge funds, which fell 20% this year, through October. That beats the 34% drop for the Standard & Poor's 500 but is nonetheless disappointing for an industry that has returned 13.8% annualized since 1990, above the 10.5% return of the S&P 500. San Francisco hedge-fund firm Farallon Capital Management LLC, which oversees about $27 billion, has seen its biggest hedge funds fall between 23% and 29% on investment declines this year, according to investors. |
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