Hedge Fund Redemp­tions Surging?

by Leo Koli­vakis, Pen­sion Pulse

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 élite 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 élite 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.

Leo Kolivakis is an independent analyst with a Master’s in Economics from McGill University and over ten years experience in the buy and sell-side. He was a senior investment analyst at two of the largest public pension funds in Canada, the Caisse de dépôt et placement du Québec (Caisse) and the Public Sector Pension Investment Board (PSP Investments), where he researched, recommended and invested in traditional and non-traditional asset classes like stocks, bonds, foreign exchange, hedge funds, private equity, infrastructure, commodities and timberland. In 2007, He completed a detailed report for the Treasury Board Secretariat of Canada on the governance of the Public Service Pension Plan. On April 21st, 2009, He was invited to speak at the Standing Committee on Finance on pensions. Feel free to contact me at lkolivakis@gmail.com for specialized consulting mandates on pension investments, or if you have any other inquiries or comments. Read more from the author/contributor here.

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