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Hedge Funds Could Face Big Withdrawals by Investors

For hedge funds, Aug. 15 may be D-Day, when investors rattled by heavy losses demand their money back from big and small portfolios alike.

"We are seeing a 'shoot first and ask questions later' mentality among many investors," said Philippe Bonnefoy, chairman of hedge fund advisory group Cedars Partners, describing how everyone from the wealthy to chief investment officers at endowments are now shunning risk.

Unnerved by heavy losses at some of the $1.75 trillion industry's most famous offerings, including AQR Capital Management, Highbridge Capital Management, D.E. Shaw and Goldman Sachs, many people want out before things get worse.

But exiting can be a difficult process in an industry where managers routinely lock up money for months, if not years, and often require 45 days' advance notice before returning it.

To pull out at the end of the third quarter, investors will have to notify their managers by Aug. 15.

"Everyone always waits until the last second to get out, and (Wednesday) is the last second," said Mike Hennessy, managing director at hedge fund of funds Morgan Creek Capital.

Redemption notices began piling up weeks ago at hedge funds that specialize in subprime mortgages after two prominent Bear Stearns funds collapsed.

Now, what seemed like a contained problem has spread from credit-focused strategies to a broad range of funds, including one with a so-called market-neutral focus, that are not
supposed to see huge losses, analysts and investors said.

Market-neutral funds, which hope to exploit market discrepancies by buying undervalued securities and taking an equal, short position in a different and overvalued security, returned nearly 6 percent during the first seven months of the year, delivering some of the industry's more robust performances. But the stock market's recent quick-paced decline, followed by a brief rally and then more losses, erased all gains and left the group with losses, according to
investors who have seen weekly numbers.

"I expect there will be a lot of redemptions in market-neutral funds," said Andrew Fisch, a portfolio manager for funds of funds at SSARIS Advisors. "The reality is, you will probably see redemptions across the board."

Investors said that while the race away from risk is not limited to hedge funds, it is being felt hard in this asset class.

Because hedge funds can use leverage, or borrowed money, and sell securities short, losses can add up faster here than in mutual funds, for example.

"No chief investment officer is going to get fired for deciding to get out of hedge funds right now," Cedar Partners' Bonnefoy said. "You can always reinvest later on."

Industry sources said it is impossible to estimate how much money will leave hedge funds at the end of the third quarter, but they agree the sums will be large. Hedge funds took in
$60.2 billion in new money during the first quarter, with funds specializing in distressed securities, arbitrage and event-driven strategies seeing the bulk of inflows, data from
Hedge Fund Research show.

The last time hedge funds suffered net outflows was during the fourth quarter of 2005, according to HFR.

For the money coming out, there may be no better investment options, investors agreed. "When people pull out because they are scared, they go to cash," said SSARIS Advisors' Fisch.

But some industry advisors are urging people not to throw in the towel quite yet because problems in portfolios will be repaired. "While there are certainly funds that will suffer now, I think when we look back on this period it will turn out to have been a very good one for hedge funds," said Thomas Whelan, chief executive of Greenwich Alternative Investments, which tracks performance in the hedge fund industry.