As Investors Bail, Hedge Funds Sell

Every major business magazine and newspaper is on the hedge fund story. The stories panic investors, making things worse. Think endless spiral down. Investors bail. Hedge funds sell. Stocks fall. Investors bail. Hedge fund sell. Stocks falls. You get it.

From the Economist:
High borrowing and the credit crisis are bad enough for hedge funds. Panicky clients are worse
ON THE trading floor of one of London’s big hedge funds, the banks of Bloomberg screens still flicker with life but the traders are almost silent. “None of us can quite believe what we are seeing,” says a senior manager. A year ago hedge funds were the omnipotent vanguard of financial capitalism. They were uncompromising in their search for returns, and they dominated trading activity in most securities. But the industry has been humbled.

The typical fund has fallen by almost a fifth so far this year, according to Hedge Fund Research (HFR), an analysis firm (see chart 1). “Convertible arbitrage” funds—which try to exploit price anomalies among corporate bonds—have lost a staggering 46%. By some margin 2008 has been hedge funds’ worst year since HFR began compiling records in 1990.

The carnage is indiscriminate. In Asia as well as London and America, hedge funds are closing some or even all of their operations. Few strategies have worked well. Ken Griffin, the boss of Citadel, a fund based in Chicago and known for its quantitative trading techniques, told investors that September was “the single worst month, by far” in its history. Even David Einhorn, an American short-seller who bet successfully on Lehman Brothers’ demise, has lost plenty.

-- The Incredible Shrinking Funds

BusinessWeek --
Stocks, bonds, and commodities will suffer as funds dump assets. Anyone with a 401(k) will get hit.

Investors on Main Street have another reason to fear opening their brokerage statements: the rapidly shrinking hedge fund industry. In the coming months, hundreds of hedge funds may shut their doors, sparking a massive fire sale on all sorts of investments. Just about anybody with a 401(k) or pension plan will feel the pain, since the sell-off will only exacerbate the plunge in stocks, bonds, and commodities—which make up the core of most people's portfolios.
The 10,000 hedge funds with more than $1.7 trillion in assets are caught in a vicious cycle.

Worried investors are pulling out their money—some $31 billion through September, according to Hedge Fund Research. As part of the great deleveraging that's happening across the financial system, lenders are cutting credit lines or demanding that funds come up with more cash in what's known as a margin call. The cash squeeze is forcing hedge funds to dump holdings. "Redemptions and margin calls are exaggerating the market swings," says Timothy M. Ghriskey, co-founder of Solaris Asset Management, a $2 billion institutional fund.

-- The Hedge Fund Contagion.

From Bloomberg:
Oct. 23 (Bloomberg) -- Hundreds of hedge funds will fail and policy makers may need to shut financial markets for a week or more as the crisis forces investors to dump assets, New York University Professor Nouriel Roubini said.

"We've reached a situation of sheer panic,'' Roubini, who predicted the financial crisis in 2006, said at a conference in London today. ``There will be massive dumping of assets,'' and "hundreds of hedge funds are going to go bust,'' he said.

-- Roubini Says `Panic' May Force Market Shutdown

And the Wall Street Journal is reporting that many hedge fund investors are not waiting for redemption. They're selling their holdings on the secondary market. Hedgebay runs a secondary market for hedge funds. I checked this morning. Hedgebay lists far more funds for sale than for buying.

It's not just hedge funds. From Morningstar:
Investors have been selling their mutual funds in record numbers. According to Morningstar's Market Intelligence data, a net amount of $49 billion left mutual funds in September alone. We've been tracking redemption data since January 2000, and that's the largest one-month outflow that we've seen to date. Yet, it looks like October is on pace to beat it. Looking at the first half of this month and only the portion of the mutual fund universe that has reported asset figures to us, we believe a more severe outflow picture is brewing for October. The heavy redemptions are likely due to the widespread losses that haven't been isolated to a few asset classes but have spread to more conservative asset classes and funds.

The heavy redemption activity that we've seen has implications for funds and shows a repeat of investor behavior that seems unlikely to pay off for anybody.

Things we've learned recently:
1. When things are awful, they can get more awful.
2. This is a classic Cockroach Recession. There's always another contagion, just like there's always another cockroach..
3. Big down days do not mean we've reached a bottom. One learned manager wrote last night, "We remain optimistic that we are in a bottoming process, but it is not easy and certainly not painless." I won't even try and figure what the "bottoming process" is.
4. The market goes down big-time one day and the next it might go up. But the trend is unmistakably down.
5. No one should be in this market, except to short. No one with the SPX below the 200 DMA.
6. Latest area to short -- pricey retailers [and Germany]. They're going to have a really lousy Christmas.
7. Never ever have an emotional attachment to a stock. Even gold stocks. They're just bits of paper.

Municipal bonds have some appeal:
Yields are high, and the risks relatively low. The risks are simple: Most municipalities (states, cities, counties) are in big financial trouble. Unless the Federal Government bails them out, many will go broke. The Democrats have said they announce a bail out plan for municipalities the day after Obama is sworn in -- if he wins. Today, the elite, left-wing, pinko newspaper, the New York Times, endorsed him for president. Normally that endorsement would be the kiss of death. In this case, it won't matter one way or the other.