Hedge Fund Redemptions May Force Liquidations

First mutual funds, then ETFs, now Hedge Funds. Bloomberg reports that the smartest of the smart money have posted an outflow of $2.9 billion in July, or 0.2% of total assets: the most since January, based on TrimTabs research. "July's number follows an outflow of $2.7 billion in June. The industry has dropped 4 percent since April 2010, according to Trimtabs, which attributed the decline mostly to negative returns in May and June. Flows have now been negative five of the last eight months (see chart, this page), the worst eight-month stretch since the September 2008 to April 2009 period." And for those wondering why hedge funds are counting down each of the remaining 17 trading days with increasing dread, is the following reason from TrimTabs: "Redemptions should resume in September; historically one of the worst months for hedge fund flows. For the year, flows toward hedge funds stand at $1 billion, following redemptions of $172 billion in 2009 and $150 billion in 2008. We believe it is safe to assume this “lost” $320 billion will not come back to the industry any time soon." As is now well known, the July rally was broadly missed by hedge funds which are now underperforming the general market according to the Bloomberg BAIF Hedge Fund Index. The only open question is how many managed to lever into the rally of the first week of September and pull the cord at the very top.

Trimtabs said that hedge funds appear to have missed out on market gains in the S&P 500 Index during July because of conservative positions. The S&P 500 surged 6.9 percent during the month, while hedge funds gained only 1.93 percent. A survey by Trimtabs shows hedge fund managers remain bearish on equities. That may reflect the deteriorating economic landscape and the reluctance of hedge funds to take on risk having only recently recovered many of the losses that occurred in 2008.

It also appears that the hedge fund industry is not at all immune from the same size-scaling issues prevalent everywhere else in finance:

The industry continues to show signs of consolidation. The funds with more than $5 billion in assets have recorded net inflows of $7.7 billion this year, while funds with less than $200 million have seen net losses of $18.3 billion, equivalent to 15.7 percent of assets.

Yet the most damning piece of data is the simplest one: the performance of the hedge fund universe as a whole, which is not only negative YTD, meaning most highwater marks are in major danger of not getting surpassed, but that hedge funds are broadly underperforming the S&P itself, which infuriates LPs more than charges of child porn, embezzlement, and felony theft leveled as the portfolio manager.

(Global Hedge Fund Returns per Bloomberg)
Another observation which validates what we have been saying is that Long-Short strategies are among the worst performers of the year, losing 4.09% YTD, as record implied correlations make traditional hedging impossible. The best strategies of the year: Mortgage-backed arbitrage, Convertible Arbitrage, and Asset backed arbitrage.

There are 17 trading days left in September, and the hedge fund community will be dreading each and every one of them, keeping a close eye on the fax machine and the hated redemption notice by end of trading on September 30.

Hedge Fund Slaughter in May

Will this cause margin calls that could collapse the market again? We'll see!

June 1 (Bloomberg) -- John Paulson, Louis Bacon and Andreas Halvorsen navigated the global market turmoil of 2008 with little or no damage. They weren’t as successful last month as the Dow Jones Industrial average had its worst May since 1940.
Hedge funds lost an average of 2.7 percent through May 27, according to the HFRX Global Hedge Fund Index, as the sovereign debt crisis in Europe triggered declines in stocks, the euro and commodities, and the gap in yields between U.S. short-term and long-term debt narrowed. It was the biggest decline since November 2008, when hedge funds lost 3 percent in the wake of Lehman Brothers Holdings Inc.’s bankruptcy two months earlier.
Almost every strategy lost money in May, according to Hedge Fund Research Inc. in Chicago, as the Dow index of 30 big stocks sank 7.6 percent including dividends amid speculation that Greece’s debt problems would spread to nations such as Spain and Portugal. Some of the best-known funds saw their gains for this year erased.
“Attempting to manage risk in an environment where everything that could go wrong does go wrong seems like a fruitless endeavor,” said Brad Balter, who runs Balter Capital Management LLC, a Boston firm that invests in hedge funds for clients. “The only defense that seems to work in months like these is being in cash.”
Paulson’s Advantage fund dropped 6.9 percent through May 21, dragging it to a year-to-date loss of 3.3 percent, according to investors with knowledge of the results, who asked not to be named because the information is private. Halvorsen’s Viking Global fund fell 3.4 percent in the same span and 2.9 percent for the year. Bacon’s Moore Global declined 7.7 percent as of May 20 and 4.8 percent in 2010, investors said.

Hedge Funds Bet Against EU's $1 Trillion Bailout

May 19 (Bloomberg) -- Kyle Bass, who made $500 million in 2007 on the U.S. subprime collapse, is betting Europe’s debt crisis won’t be solved by the $1 trillion loan package the International Monetary Fund and European Union agreed on last week.
“The EU and the IMF effectively went all-in with a bad hand in the highest stakes game of financial poker ever played with the world,” wrote Bass, head of Dallas-based Hayman Advisors LP, in a letter to clients sent after the bailout was announced.
Bass bought gold last week and took other steps to position the fund for hyperinflation and a “competitive devaluation” by Europe, Japan and the U.S. that he is forecasting, according to the letter. Christopher Kirkpatrick, general counsel for Hayman, declined to elaborate on the comments.
Managers who made short bets on U.S. subprime securities as the housing market was imploding in 2007 and 2008 see similar opportunities in Europe, said Nick Swenson, who manages Minneapolis-based Groveland Capital LLC and profited as mortgages tumbled. In March, he started buying credit-default swaps on Spanish, Italian and Irish government bonds, a sort of insurance that pays off in the event of a default or restructuring.
“It’s asymmetric -- it reminds me of the subprime trade,” he said in a telephone interview.
Yesterday, Germany said it was temporarily prohibiting naked short-selling and speculating on European government bonds with credit-default swaps. Naked short sellers bet against a security without first borrowing it.
Euro Decline
The euro tumbled to as low as $1.2159 after the pronouncement. In February, as some investors forecast that Greece might not be able to pay its debts, French Finance Minister Christine Lagarde said she wanted politicians to take a united approach against “speculators” betting on government bond defaults.
Swenson decided to buy the sovereign CDS after looking at the external-debt-to-exports ratios of the 26 countries that have defaulted on their debt since 1970. The average ratio for those countries was 2.3. As of the third quarter of 2009, Spain’s was about 6.9 and Italy’s was about 5.1, he said.
While the CDS on these bonds rose in April and have since dropped nearer to levels where he bought them, Swenson isn’t selling. He believes the chance that one of the three countries will default or restructure is greater than the 9 percent currently priced into the CDS.
Paulson Stays Out
John Paulson, who made $15 billion betting on the subprime trade, is one manager who may not be replicating the CDS trade he used three years ago. Earlier this month, in a conference call with investors, he called Europe’s debt problems “manageable.”
A weaker euro will benefit French and German exporters, he told clients. Like Bass, he’s been forecasting a jump in inflation, which is why he’s been a buyer of gold and gold producers since at least last year.
For other managers, the potential profits from betting against Europe still outweigh the costs. Swenson pays 1.3 percent annually to put on his bet against Irish, Spanish and Italian debt.
Mark Hart, who runs Fort Worth, Texas-based Corriente Advisors LLC, returned $320 million of the $424 million European Divergence Master Fund LP in February, after betting that some European governments will default on their bonds.
‘Asymmetric’
“The European divergence theme offers an asymmetric risk/reward profile,” Hart told clients at the time. “The sovereign debt problem in Europe is widespread and is not isolated to a single issuer.”
Hart, who also profited from bets against subprime mortgages, didn’t return a call seeking a comment.
Matrix PVE Global Credit Fund, a 110 million-euro ($133.9 million) fund run by Gennaro Pucci based in London, gained 19 percent in April because of bets that Europe’s credit crisis would worsen.
“The ECB is buying debt at artificial levels, but that won’t solve structural problems,” Pucci said in a telephone interview.
Matrix Group Ltd. manages about 3 billion pounds ($4.3 billion) including a half-dozen hedge funds. The credit fund sold most of its CDS positions in the recent jump in prices, and then put some back on at current levels.
“We’re in the aftermath of a financial crisis,” Pucci said. “It’s not unusual for sovereign debt to explode.”

Macro Hedge Fund Betting Against Recovery; A Ski-Jump Recession

from Bloomberg:
Sept. 1 (Bloomberg) -- Paul Tudor Jones, the billionaire hedge-fund manager who outperformed peers last year, is wagering that Goldman Sachs Group Inc. and Morgan Stanley got it wrong in declaring the start of an economic recovery.
Jones’s Tudor Investment Corp., Clarium Capital Management LLC and Horseman Capital Management Ltd. are taking a bearish stand as U.S. stock and bond prices rise, saying that record government spending may be forestalling another slowdown and market selloff. The firms oversee a combined $15 billion in so- called macro funds, which seek to profit from economic trends by trading stocks, bonds, currencies and commodities.
“If we have a recovery at all, it isn’t sustainable,” Kevin Harrington, managing director at Clarium, said in an interview at the firm’s New York offices. “This is more likely a ski-jump recession, with short-term stimulus creating a bump that will ultimately lead to a more precipitous decline later.”
Equity and credit markets have rallied on hopes that government intervention is pulling the U.S. out of the deepest economic slump since the Great Depression. The Standard & Poor’s 500 Index jumped 51 percent from its 12-year low in March through yesterday.
The economy will expand at an annualized rate of 2 percent or more in four straight quarters through June 2010, the first such streak in more than four years, according to the median estimate of at least 53 forecasters in a Bloomberg survey.
Tudor, the Greenwich, Connecticut-based firm started by Jones in the early 1980s, told clients in an Aug. 3 letter that the stock market’s climb was a “bear-market rally.” Weak growth in household income was among the reasons to be dubious about the rebound’s chances of survival, Tudor said.
Yields Drop
Yields on corporate bonds relative to U.S. Treasury benchmarks have sunk to levels unseen since before the collapse of Lehman Brothers Holdings Inc. in September, a positive sign for credit markets. Spreads on junk bonds fell in July to within 10 percentage points of Treasuries, lifting them out of the distressed category for the first time in almost a year.
“We think the recession is ending right now,” Abby Joseph Cohen, senior investment strategist at Goldman Sachs, said in a Bloomberg Radio interview Aug. 17. The New York-based bank forecasts 2 percent growth in U.S. gross domestic product in 2010.
Economists at New York-based Morgan Stanley in the past month have incrementally raised their GDP growth estimate for the current quarter to 4.8 percent annualized from 3.5 percent.
President Barack Obama said a decline in July’s unemployment rate signaled “the worst may be behind us.” GDP shrank 6.4 percent in the first quarter and 1 percent in the second, after a 4 percent contraction in the second half of 2008.
Different Jobless Rate
A focus on misleading indicators is driving markets, macro managers say.
Clarium watches the unemployment rate that accounts for discouraged job applicants and those working part-time because they can’t find full-time positions, Harrington said. July joblessness with those adjustments was 16 percent, according to the Department of Labor, rather than the more widely reported 9.4 percent.
The housing data isn’t as rosy as some see it, Harrington said. As existing U.S. home sales rose 7.2 percent in July from the previous month, distressed deals including foreclosures accounted for 31 percent of transactions, according to the National Association of Realtors, a Chicago-based trade group.
A report by the Mortgage Bankers Association, based in Washington, showed the share of home loans with one or more payments overdue rose to a seasonally adjusted 9.24 percent in the second quarter, an all-time high.
Loaded for Bear
Clarium, which oversees about $2 billion, is positioned for an equity bear market through investments in the U.S. dollar, Harrington said. Falling stock prices will strengthen the currency by forcing leveraged investors to sell equities to pay down the dollar-denominated debt they used to finance those trades, he said.
High unemployment, lower wages and potential missteps by policymakers around the globe may stifle economic growth in 2010, Tudor said. The firm, which manages $10.8 billion, is at odds with 55 economists projecting an average of 2.3 percent growth next year, according to the Bloomberg survey.
Macro managers’ pessimism is fueled in part by the U.S. government’s response to last year’s financial crisis, which they say fails to address the root cause. Banks still hold hard- to-sell assets on their balance sheets, the managers said.
Subdued Credit Growth
“Some critical initiatives have been cut short,” Tudor said. “As a result, toxic assets remain on balance sheets and credit growth is likely to be subdued for a long period.”
Some firms, including Brevan Howard Asset Management LLP, see the recession at its end while dismissing the likelihood of robust growth.
Brevan Howard, Europe’s largest hedge-fund manager with $24 billion in assets, told clients the U.S. could stumble when stimulus spending fades after the current quarter. The London- based firm, whose macro fund gained 20 percent last year, said consumer wealth erosion, scant bank lending and troubled world economies may result in a lackluster recovery.
The U.S. Federal Reserve and other policy makers took unprecedented steps in the past year to stave off financial disaster. The Fed’s Board of Governors used emergency powers to rescue markets for commercial paper, housing bonds and asset- backed securities. The Fed’s balance sheet swelled to $2.08 trillion last week, more than doubling from a year earlier.
Accounting Effect
The Financial Accounting Standards Board voted in April to relax fair-value accounting rules. The change to mark-to-market accounting allowed companies to use “significant” judgment in gauging prices of some investments on their books, including mortgage-backed securities that plunged with the housing market.
Banks are reporting better earnings because they haven’t been forced to account for their losses yet, Clarium’s Harrington said.
“We haven’t fixed the problem,” he said. “We’ve just slowed down the official recognition of it.”
Hedge funds rose in July for the fifth consecutive month, returning an average of 2.4 percent as stocks advanced, according to data compiled by Hedge Fund Research Inc. Bearish stances prevented some macro funds from joining the rally. The category lagged behind the industry average in July, rising 0.6 percent.
Fund Performance
Clarium, whose assets were mostly in fixed income, dropped 6 percent this year through June. Horseman’s fund slid 16.3 percent. Tudor’s BVI Global Fund Ltd. returned 11 percent.
The funds held up in 2008 amid the industry’s record 19 percent loss. Horseman’s Global Fund USD, which focuses on stocks, made HSBC’s private bank list of top 20 performers by gaining 31 percent. Tudor’s and Clarium’s funds fell 4.5 percent.
Macro managers are examining China for hints on how to place currency and commodities bets. Tudor said the country’s spending spree on raw materials inflated commodity prices and weakened the U.S. dollar.
A government mandate forcing banks to make about $1 trillion in loans during this year’s first half is spurring short-term growth that may not last, according to Clarium. China’s banking regulator drafted capital requirements Aug. 19 that may lead banks to rein in lending.
Horseman, with $4.1 billion under management out of London, was investing in long-term U.S. Treasury bonds. The firm believes interest rates will stay low for longer than the market expects, benefiting the asset class.
“Despite every effort by government in North America and Europe to avoid deflation,” Horseman wrote, “the current numbers suggest they are losing the battle.”

Hedge Funds and Index Funds In Commodity Markets

Index fund
Investment fund designed to match the returns on a stock market index. Mutual fund whose portfolio matches that of a broad-based index such as the S&P 500 and whose performance therefore mirrors the market as represented by that index.
Hedge fund
An investment vehicle that somewhat resembles a mutual fund, but with a number of important differences. If the fund is "off-shore", the fund does not have to adhere to any SEC regulations (and can only sell to non-U.S. investors or investment vehicles). These funds employ a number of different strategies that are not usually found in mutual funds. The term "hedge" can actually be misleading. The traditional hedge fund is actually hedged. For example, a fund employing a long-short strategy would try to select the best securities for purchase and the worst for short sale. The combination of longs and short provides a natural hedge to market-wide shocks. However, much more common are funds that are not hedged. There are funds that are long-biased and short-biased. There are funds that undertake high frequency futures strategies, sometimes called managed futures. There are funds that take long-term macroeconomic bets, sometimes called global macro. There are funds that try to capitalize on merger and acquisitions. Another distinguishing feature of hedge funds is the way that managers are rewarded. There are two fees: fixed and variable. The fixed fee is a percentage of asset under management. The variable or performance fee is a percentage of the profit of the fund. There are also funds of funds which invest in a portfolio of hedge funds. Another important difference with hedge funds is that the minimum required investment is usually quite large and, as a result, minimizes the participation of retail investors.

also from Arlan and Bryce at Farm Futures:

A look back at CFTC's latest weekly data on trader positions reveals some of the dynamics that have impacted prices in recent weeks. Corn prices rallied this spring as the trend-following hedge funds added 1.9 billion bushels to their net ownership of the feed grain between mid-February and early June. Index fund managers with long-term inflation concerns added 0.3 billion bushels of ownership during that same period, as the lead corn contract gained $1.00 per bushel.

The latest CFTC data is for the period ending July 14. As of July 14, the lead corn contract had lost $1.11, with another 35 cents since then. During that period, the trend-following hedge fund managers liquidated ownership of 0.6 billion bushels, while index fund managers actually added another 115 million bushels of ownership. Ironically, it's the index funds that CFTC seems focused on.

What does this data suggest that the money flow is telling us? Short-term dynamics are bearish for corn and the long-term dynamics are bullish. It does not however tell us if the short-term dynamics will last another week or for many months. That will heavily hinge on the global economy, the dollar and on the size of this year's crop. Those factors should determine whether the corn chart puts in a "U" shaped bottom or an "L" shaped bottom with low prices for an extended period of time.

Unfortunately, momentum is everything in the commodity markets and momentum is definitely on the side of market bears at this point. Hedge fund managers have little reason to change their strategy until chart signals turn upward. End users have every incentive to be patient as long as prices are coming down to them as well. Chatter of record yields simply add to the selling frenzy, with few traders having the courage to step in front of this train before it shows signs of turning around.