Tuesday, December 13, 2011

Hedge Fund Redemptions Surging?

Here is something that caught my attention. Svea Herbst-Bayliss of Reuters reports, Hedge fund redemptions surge after losses:

Hedge fund investors finally seem fed up.

After months of heavy losses, big and small clients asked funds to return $9 billion in October. That number is three times as large as the $2.6 billion (1.7 billion pounds) they pulled out in September, data from BarclayHedge and TrimTabs Investment Research show.

The dramatic jump in redemption requests shrank the industry to $1.66 trillion, its lowest level in nearly two years and well below its $2 trillion peak, the researchers said in a report released on Monday. The redemptions are the largest since July 2009 when $17.8 billion was removed.

Hundreds of hedge funds had a deadline for clients to pull out money in October and dozens of clients opted to use it after seeing five straight months of losses.

Even some of the industry's biggest stars like John Paulson, who have hit home runs with bets against the housing market and on gold, have sunk into the red. Paulson's main Advantage fund was off nearly 50 through the end of September and his investors had until October 31 to say if they wanted to exit.

And while a strong stock market rally helped put most managers into the black at the end of October, the gains did not last long with average losses of nearly 1 percent reported in November, industry data show.

"Investors seem to have lost patience with lackluster hedge fund returns," said Sol Waksman, founder and President of BarclayHedge.

For years investors gave their managers lots of time to let their strategies work. Now they are becoming less generous, especially as they debate whether lackluster returns can offset hefty fees where managers often take 20 percent of the gains and add on another 2 percent management, investors and managers have said.

Investors pulled $2.6 billion out of so-called long short funds that pick bet on and against stocks, the strategies where most of the industry's money is invested.

Macro funds which make big bets on currencies, interest rates, and commodities faced redemptions of $1.8 billion and funds specializing in emerging markets strategies saw investors ask for $1.6 billion back. Funds that apply several strategies to the same pool of capital, so-called multi-strategy funds, took in just over $1 billion in new money.

Meanwhile investors also slowly returned to merger arbitrage hedge funds, after pulling money out for months, the researchers said.

"This is the second-straight inflow in this strategy, which had considerable outflows in the previous 10 months, Leon Mirochnik, analyst at TrimTabs said. "These funds posted the heaviest outflow in the past 12 months at over $5 billion (31.8% of assets) while posting the second highest return out of all categories at 2.6%."

Go back to read my recent comment on hedge funds' fading star. Could it be that institutional investors are finally waking up to the harsh reality that most hedge funds offer mediocre results and are nothing but large asset gatherers? Is this going to be like December 2008 when hedge funds got clobbered and funds of funds faced extinction?

I doubt it. Most redemptions are already done but now we are realizing why losses in Q3 2011 were so savage and why stock markets remain moribund. Don't know if we'll see a Christmas rally after all; this year could be a total writeoff. But don't be surprised if hedge funds come back with a vengeance, especially if markets pick up in the first quarter of 2012.

One hedge fund that is not facing redemptions is Steve Cohen's SAC Capital. Surprisingly, Cohen came out to state that insider trading rules are "vague":

Hedge fund billionaire Steven A. Cohen in sworn testimony earlier this year called the rules on insider trading "very vague" and said sometimes it's a "judgment call" as to whether a tidbit about a public company is inside information.

The founder of SAC Capital Advisors LLC, one of the hedge fund industry's best-known firms, offered up his views on insider trading during two days of deposition testimony in February and April this year as part of a long-running civil lawsuit filed by Canadian insurer Fairfax Financial.

It's rare for Cohen to speak publicly and even rarer for him to share his views on something as controversial as insider trading. Cohen's insights are revealing not just because of his status as an industry titan, but because his $14 billion firm continues to draw attention in an ongoing investigation by U.S. authorities into insider trading.

In the deposition, an extended excerpt of which was obtained by Reuters, the 55-year-old trader says he often leans on his fund's lawyer to determine whether something constitutes inside information and admits to being not well-versed in SAC Capital's own internal compliance manual.

"The answer is when you're trading securities, it's a judgment call," said Cohen, during the deposition that spans more than 600 pages. "Whatever the compliance manual says, it probably doesn't take into account every - every potential situation."

(For more from the transcript see: link.reuters.com/vat55s)

The deposition was taken in connection with a lawsuit filed in 2006 by Fairfax, alleging SAC Capital, Kynikos and other traders took part in a so-called short conspiracy.

The lawsuit alleges the hedge funds bet against Fairfax shares and then spread negative stories about the company in hopes of driving down the stock price. Recently, SAC Capital won a motion to be dismissed from the insurer's lawsuit but Fairfax's claims of improper trading against other hedge funds and traders continues.

Reuters petitioned the court to obtain the transcript. SAC Capital and its lawyers had sought to keep the excerpts of Cohen's deposition sealed, arguing that the contents were trade secrets and information that would be useful to competitors.

A Cohen spokesman declined to comment.

In the deposition, Cohen acknowledges that in the aftermath of Galleon Group founder Raj Rajaratnam's arrest on insider trading charges in October 2009, his public relations firm suggested he begin reaching out to some reporters to burnish his image and "dispel" rumors of improper trading.

In particular, Cohen talked about a December 2009 story in The New York Times on SAC Capital and a subsequent June 2010 profile of Cohen and his wife Alexandra in Vanity Fair.

"There are rumors and what we wanted to do was dispel any notion of that," he said.

When asked by a Fairfax lawyer what rumors he was referring to, Cohen responded: "The rumors you just stated, that people weren't sure how we conducted our business."

In the questioning, Cohen comes off as controlled and well-prepared to engage in a sometimes testy back-and-forth with Fairfax's lawyer, Michael Bowe, over the dividing line between what constitutes permissible and improper trading.

Cohen says the rules on what constitutes inside information are "very vague" and sometimes it can depend on whether the information will move a stock, hurt another trader or can be obtained through another source.

For instance, Cohen said if he got a tip that an analyst is going to downgrade a stock and his fund opts to buy the stock, that is proper "because I'm on the other side of the trade."

Cohen said what is "material" in analyzing whether or not it is inside information often depends on the circumstances.

"You know, I mean, I can argue that someone else could think that a - being short in front of a sell recommendation is a non-event because it's not going to move the stock, and somebody else would think, you know, that's trading on material nonpublic information regardless if it moves the stock or not," said Cohen. "These are judgment calls."

At one point, Cohen shows some of his frustration with all the questions from Fairfax's lawyers about what constitutes inside information.

"We're having this conversation for about three hours about what's material and whatnot," says Cohen. "It's pretty clear that you and I have different views on it."

In the deposition, Cohen also takes issue with the word "edge" to describe SAC Capital's trading advantage over his rivals. Cohen says he "hates" the word and doesn't like to use it to describe SAC Capital's work. Yet he acknowledges the hedge fund talks about having an "edge" in some of its marketing material.

The release of a redacted version of Cohen's deposition came after Reuters went to court to seek access to it and other documents produced in the lawsuit filed by Fairfax in a New Jersey state court.

The Cohen deposition also was recorded on videotape but the judge's order only required the parties to make available a transcript.

A copy of Cohen's full deposition was subpoenaed last year by the Securities and Exchange Commission, which was conducting its own investigation into Fairfax's allegation.

Last week Reuters reported that the SEC closed its investigation in the Fairfax case with regards to SAC Capital and James Chanos' Kynikos Associates. (link.reuters.com/xus55s)

Not sure where the SEC is going with this. Looks like they are out to get Steve Cohen but in my mind SAC Capital didn't do anything different from what other hedge funds routinely do. Were Steve Cohen and his traders always "kosher"? Probably not, but he didn't become one of a handful of elite hedge fund managers by getting involved in petty insider trading scams. That's total rubbish.

The reality is that hedge fund redemptions might be surging, but true alpha is always in demand. Guys like Steve Cohen, Ken Griffin (Citadel), and Tom Meyer (Farallon Capital) are part of an elite group of hedge fund managers that know how to deliver alpha. They got whacked in 2008, but came back stronger. They will survive the next hedge fund hurricane while most of their competitors will disappear.

But for now, I wouldn't worry too much, despite underperforming, plenty of dumb money still piling into hedge funds. Barring a European collapse, which I just don't see happening, there won't be another massive wave of deleveraging à la 2008 due to surging hedge fund redemptions.

Below, Vanity Fair's Bryan Burrough, author of ``Barbarians at The Gate,'' talks with Bloomberg's Margaret Brennan about Steve Cohen, the billionaire who runs SAC Capital Advisors LP in Stamford, Connecticut. Burrough wrote about Cohen for the July issue of the magazine in what is Cohen's second-ever published interview.

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