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The Honolulu Advertiser
Posted on: Sunday, November 16, 2008

Forced selling by hedge funds may start to ease up

By ADAM SHELL
USA Today

Hawaii news photo - The Honolulu Advertiser

Charles Gradante, of Hennessee Group LLC, says the hedge fund industry is headed toward its worst year ever.

Bloomberg file photo

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NEW YORK — It is last call for investors to ask for their money back from poorly performing hedge funds. Whether that is a bullish or bearish sign for battered stocks is anyone's guess.

Wall Street hopes the passing of yesterday's deadline — the last day for many investors to make a request to redeem hedge fund shares payable at year's end — could mark the beginning of the end of "forced selling" by funds to raise cash. If the selling recedes, it could help lift some of the downside pressure on stocks. Forced selling has been blamed for sharp stock price swings and plunging asset values in the financial crisis.

Investors have redeemed an estimated $85 billion from hedge funds through the end of the third quarter, said Charles Gradante, co-founder of hedge fund adviser Hennessee Group.

But some analysts fear the deadline could spark more selling if hedge funds realize they have not yet raised enough money to meet all requests.

"It is difficult for funds to anticipate just how much they will have to sell to meet redemptions," said Ed Yardeni of Yardeni Research. "It is a totally opaque situation. We know there are redemptions, but we don't know the magnitude."

It has been an abysmal year for hedge funds, secretive and lightly regulated investment partnerships that are marketed as being able to post positive returns in both up and down markets.

But because of the economic crisis, the average hedge fund was down 15.3 percent through the end of October, putting the hedge fund industry on track for a record annual loss, said Hennessee Group.

"2008 is on pace for the worst year ever for hedge funds," said Gradante. The average hedge fund still did better than the Standard & Poor's 500 index, which was down 34 percent through Oct. 31.

Unlike the 2000-02 bear market, when hedge fund performance was largely positive, losses in the current market have been met with big redemption requests from shareholders.

Hedge funds typically keep 20 percent of all gains. But they get paid only when they post positive returns. What's more, after suffering declines, they aren't able to keep their chunk of profits until the fund's value rises back above its previous high, known as a high-water mark. With many funds down 20 percent, 30 percent, 40 percent, it is likely that many will liquidate, said Jim Dunn, managing director at Wilshire Associates. He estimates a third of all hedge funds, or about 3,000 funds, will close. Other experts say the failure rate is closer to 15 percent. In either case, it means funds will have to sell all their holdings before giving clients back their money.

In the first six months of the year, an estimated 350 funds have shut down, said Hedge Fund Research. That trend is likely to continue through year's end, said HFR President Ken Heinz.

Meanwhile, five of the world's richest hedge fund managers defended their industry to Congress yesterday, but most conceded they will have to disclose more information to satisfy regulators.

Sen. Chuck Grassley, R-Iowa, said he would reintroduce a bill requiring hedge funds to register with the Securities and Exchange Commission.