Funds Cash Crisis Adds To Turmoil

ZURICH -- Fund of hedge funds may have trouble finding enough cash to cover an expected sharp spike in redemptions as the hedge funds they invest in are themselves increasingly locking in client cash as a barrage against such outflows, experts say.
In most countries, fund of hedge funds are unable to lock in investors in the same way as hedge funds because one of their key attributes is a pledge to provide investors with high liquidity.

Without that option, fund of hedge funds can only stockpile cash or tap bank credit lines, while at the same time they are themselves locked into poor performing hedge funds that are being forced to dispose of assets at fire-sale prices to cover margin calls.

As a result, experts now believe hedge fund lock-ins, or gates, are playing a greater role in deepening market turmoil than had so far been acknowledged.
`A risk from fund of funds is that hedge fund gates prevent them from securing the liquidity that they need to meet redemption requests,` the Bank of England said in its financial stability report last week.

Redemptions, or client withdrawals, are expected to hit both hedge funds and fund of hedge funds hard in the wake of a historically bad performance in recent months. The number of hedge funds making use of temporary gates to halt the withdrawal of funds is on the rise, a person in the industry said.

As a group, funds of hedge funds returned minus-12% to investors, while the performance of hedge funds was minus-10%, according to data from Chicago-based Hedge Fund Research.
Because fund of hedge funds typically offer greater liquidity than hedge funds, experts say companies that offer them such as Man Group PLC (EMG.LN) and Geneva-based Union Bancaire Privee may have trouble meeting redemptions.

Swiss-listed Gottex Fund Management Holdings AG (GFMN.EB) recently gave an early indication of how widespread withdrawals are when it posted a 13% third-quarter asset decline, while industry giant Man will be scrutinized Thursday, when it reports interim results.
Swiss brokerage Helvea on Monday downgraded Partners Group Holding AG (PGHN.EB), saying redemptions in listed private equity funds may lead the company to warn on managed assets this year. Unlike other, more specialized firms, Partners' activities are spread across private equity, real-estate and private debt, as well as fund of hedge funds.

The imbalance has been growing, with fund of funds offering frequent -- even daily -- liquidity to better compete for clients, as the hedge funds underlying those instruments move in the opposite direction, imposing restrictions with lock-ins or up to 180-day notice periods to exit, according to experts.

`The liquidity of fund of hedge funds coupled with investor stability has increasingly become a main focus on fund managers and is now a determining factor in the resilience of fund of hedge funds,` Fitch Ratings said in a recent industry note.

Also hitting fund of funds is the fact that their investors have become more skittish, taking flight as soon as performance slides, ratings agency Fitch said.

To be sure, hedge funds themselves are under pressure from fund of hedge funds that are clamoring for their money back, Fitch said. However, many fund of funds are bracing for an expected slew of redemptions by piling into cash, several people at fund of hedge funds said. They can also partly pass the buck to banks by tapping credit lines if they don't have the funds to meet withdrawals, the Bank of England noted in its stability report.

Regulators and experts say the search for liquidity by hedge funds may explain the performance of some emerging markets recently, where securities dropped sharply in September and October.

Until now, regulators have shown little inclination to tackle the issue, except in France. Its AMF financial markets regulator launched emergency measures allowing fund-of-fund managers to introduce gates and stiffen withdrawal conditions.

While the steps don't solve liquidity problems and shaky investor confidence, they do ultimately protect those investors who remain in the funds. That is because funds would sell their most liquid assets first, which in turn would hit risk, strategy, diversification and ultimately performance, Fitch analyst Charlotte Quiniou said.

Source : Dow Jones Newswires