Here is one piece of the perfect financial storm...
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Hedge Funds Hit the Wall
By Mark DeCambre and Liz Rappaport
Staff Reporters
7/31/2007 4:58 PM EDT
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July couldn't end soon enough for most investors, but hedge fund watchers say the worst could be yet to come.
Hedge funds have bet heavily on the junk bond market, which just completed its worst month in five years. As some heavily leveraged funds count up their month-end profits and losses, some observers fear they know all too well what will follow.
"Having amplified returns on the way up, leverage now amplifies the declines," writes Jeffrey Rosenberg, head of credit strategy research at Bank of America. He adds that "month-end marks and tightening of leverage terms now challenge hedge fund liquidity -- potentially leading to an existential crisis for many."
July ended with a thud for stocks. The Dow Jones Industrial Average dropped 146 points Tuesday after earlier being up as many as 138 points. Much of the swing took place after the market learned of the latest casualty tied to the collapse of the subprime mortgage business, American Home Mortgage (AHM - Cramer's Take - Stockpickr - Rating).
American Home shares plunged 89% after the lender told investors it was seeking an orderly liquidation of its assets, following a series of margin calls that essentially put it out of business.
American Home's plunge came a day after the implosion of a much bigger player, Sowood Capital Management. The hedge fund collapsed under the weight of different issues -- specifically a widening of credit spreads, or the difference between the yields on safe government debt and risky corporate securities.
But even if this week's blowups aren't explicitly linked, market observers say they point to a coming reckoning for credit-oriented hedge funds. Rumors are already flying about more hedge funds meeting with huge declines for July, and bid lists circulating through the bond markets.
"This stuff is more widely held than just a handful of firms have reported," Peter Goldman, managing director at the money management firm Chicago Asset Management, says of distressed debt. "I would be surprised if there weren't more skeletons in the closet."
While credit markets have rebounded this week after Citadel Investment Group swooped in Monday to buy the credit assets of Boston-based Sowood, the Sowood story is not so different from the story of the two Bear Stearns (BSC - Cramer's Take - Stockpickr - Rating) hedge funds that collapsed in June.
Sowood's demise may provide credit investors with more information about how risk is being repriced in the market, and it may also be a harbinger of more collapses yet to come as month-end margin calls from prime brokers are likely to roll in.
"We're definitely worried about month-end performance issues for hedge funds," says Paul Ocenasek, high-yield bond portfolio manager at Thrivent Financial for Lutherans.
The end of the month is when hedge fund managers mark to market their investment to holdings -- meaning they value them on the basis of the prices of comparable transactions. They report their performance to their counterparty lenders, or prime brokers. If they've lost enough money, the prime brokers can demand more collateral. This is what led to blowups of Bear Stearns hedge funds and to Sowood's declines.
With July having turned into an even worse month for the credit markets than June, investment managers may soon have to face the music. Money manager Jeremy Grantham told Bloomberg that credit-market declines may force as many as half of all hedge funds to close in the next five years.
The Merrill Lynch High Yield Master II Index had dropped 3.86% in July through Monday's close. That made July its worst month of the year, bringing the asset class into negative return territory for the year. July 2002 was the last time the high-yield market saw as big a loss.
Ocenasek notes that the last time the market sold off on hedge fund trades gone bad was after the junk-ratings cuts of General Motors (GM - Cramer's Take - Stockpickr - Rating) and Ford (F - Cramer's Take - Stockpickr - Rating) in 2005.
"But there is a lot more leverage in the system now than even two years ago," Oceanasek warns.
Ocenasek remains cautious on the credit markets, citing what he says seems like forced-selling pressure. He believes the sellers in the market are unloading some of the higher quality securities in order to meet margin calls, rather than really adjusting for risk by selling the weak credits and loading up on quality.
"The recent declines have been steep, kind of breathtaking," he says.
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and this !!
http://www.smh.com.au/news/business/hedge-funds-slam-the-bag/2007/08/02/1185648060034.html
Hedge funds slam the bag
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Tom Petruno
August 3, 2007
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SOME hedge funds that have incurred losses on risky securities are closing the gate on investors who want their money back, a move that could further undermine confidence in already shaky financial markets.
Temporarily barring withdrawals, though legal, also could do damage to the image of the hedge fund industry, which in recent years has attracted hordes of well-heeled investors seeking high returns.
The industry has mushroomed to 9,500 funds with $US1.7 trillion ($2 trillion) in assets.
"Psychologically, separating people from their money is generally considered to be a hostile way to behave," said Ron Geffner, a partner at New York law firm Sadis & Goldberg.
Fund managers say withdrawal limits protect their investors by preventing sales of securities at deeply depressed prices. But some analysts say news of hedge fund suspensions could prompt nervous investors in other funds to demand their money back, fearing that the gate could slam shut on them in the next few months, should stock and bond market losses deepen.
Such a scenario also could hurt investors who have no money in hedge funds, because forced asset sales could drive markets overall lower.
Brokerage Bear Stearns, which has shut two hedge funds that owned mortgage-backed bonds, has told investors in a third fund that it will keep the $900 million portfolio going - but investors will not be able to cash out for the time being, a spokeswoman confirmed.
An Australian hedge fund manager, Absolute Capital, last week told investors in two of its bond-focused hedge funds that it had barred the door to withdrawals until October 25.
Given the "general lack of liquidity" for certain securities, "a temporary closure of the funds is the best defensive measure to protect the longer term interests of our investors", Absolute Capital said in a statement.
The decisions highlight a key difference between hedge funds, which are largely unregulated investment portfolios, and conventional mutual funds: mutual funds by law must be willing to honour redemption requests in full as soon as they are received.
Hedge funds, by contrast, typically can fully or partly limit investors' right to flee, both in terms of dollar amounts and by restricting redemptions to specific dates. At most hedge funds, the manager "has great flexibility in terms of how much of a withdrawal request they will honour", said Jay Gould, a partner at law firm Pillsbury Winthrop Shaw Pittman in San Francisco.
But hedge funds faced an inherent conflict of interest if they tried to keep going even as investors sought to pull money out, said Marc Freed, a manager at New York's Lyster Watson Management, which picks hedge funds for clients.
"The hedge fund says, 'We think it's in your best interest that we keep your money'," Mr Freed said.
Los Angeles Times
http://www.boston.com/business/personalfinance/articles/2007/08/02/state_pension_system_takes_hit_in....
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The Boston Globe
State pension system takes hit in hedge fund collapse
Loss of $30m dwarfed by Harvard endowment, which had $250m erased
By Christopher Rowland, Globe Staff | August 2, 2007
The Massachusetts state pension system lost $30 million with this week's collapse of Sowood Capital Management LP, the first evidence that public money also went down the drain when the $3 billion Boston hedge fund lost more than half its value in July.
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It is the second hedge fund closing to take a toll on the state's $50 billion pension fund in less than a year. In September, the state lost more than $50 million when energy-oriented hedge fund, Amaranth Advisors LLC, shut its doors.
Sowood liquidated its fund and sold its remaining assets to Citadel Investment Group LLC on Monday.
The biggest loser so far appears to be Harvard University, which is maintaining an official silence on the issue. Harvard's endowment lost at least $250 million, which is half of the original $500 million it invested at Sowood's inception in 2004.
Securities regulators working for Secretary of State William F. Galvin sent a letter yesterday asking Sowood for an explanation of how the fund, which was run by former star Har vard endowment manager Jeffrey Larson, lost so much money so fast. Galvin was unavailable yesterday, said his spokesman Brian McNiff. In the past, Galvin has questioned the prudence of investing state pension money in risky hedge funds.
The executive director of the state Pension Reserves Investment Management Board, Michael Travaglini, confirmed the $30 million loss but defended the investment. Hedge funds represent only about 5 percent of total Massachusetts pension investments, he said.
The money the state lost on Sowood was indirectly invested through Arden Asset Management LLC, of New York, a so-called "fund of funds" that invests in hedge funds. Similarly, last year's Amaranth losses were incurred through the use of funds of funds.
"The autopsy on Sowood won't be complete for some time, but obviously we will be working with Arden to determine what if anything we should change about our existing program going forward," Travaglini said.
Sowood was invested in corporate bonds and related securities that have been weakened by failures in subprime mortgages. The fund borrowed heavily to buy its investments -- a strategy that increases potential rewards but also increases risk. It could not meet its obligations to lenders when the value of its holdings plummeted.
Instead of dumping its investments at fire-sale prices, which could have triggered a broader sell-off in debt markets and produced even more fund failures, it cut its deal with Citadel last weekend. Terms were not disclosed.
"We are very sorry this has happened," Larson said in a letter to Sowood investors who lost their $1.5 billion.
Specialists looking over the wreckage said that whatever safeguards Sowood had in place didn't work to prevent massive losses.
"These guys were a victim of problems in the subprime market that bled over into another market," said Timothy W. Mungovan, a lawyer in the alternative investment division of Nixon Peabody, a law firm with offices in Boston. "I don't think that we've seen the last fund failure as a result of problems in bond markets."
Seesawing prices in the stock market also are giving hedge funds a tough ride, as the ripple effects widen.
Tudor Investment Corp.'s Raptor Fund, managed in Boston, lost 9 percent in July as stock prices fell worldwide, Bloomberg News reported yesterday.
"We've had an extraordinary withdrawal of liquidity from the credit markets that's affected every type of paper. The nervousness from the credit markets is spilling over into the equity markets," Virginia Parker, who helps oversee about $1.8 billion at Parker Global Strategies LLC in Stamford, Conn., told Bloomberg.
Christopher Rowland can be reached at crowland@globe.com.
© Copyright 2007 Globe Newspaper Company.
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