Hedge fund redemption requests bode ill

The bad news is in for hedge fund managers.

Come Dec. 31, many could lose up to one-quarter of their assets if investors indeed take back all that they've requested.

The final redemption window of the year closed on Nov. 30, and requests average between 20% and 25% of assets for the majority of hedge funds, said industry sources, based on their conversations with the managers in their portfolios and data bases.

That news comes on top of a performance decline of 16% as represented by the return of the HFRI Fund Weighted Composite index year-to-date through Nov. 30.

As a result, hedge fund assets are predicted to be between $1.1 trillion and $1.3 trillion at the end of 2008, a decline of 35% to 45% from June 30 and as much as 42% from the $1.9 trillion at the end of 2007, according to researchers at London-based Morgan Stanley in a Nov. 28 report.

Sources estimated that hedge funds of funds will on average see redemptions of between 5% and 10% by year-end, mostly because of client rebalancing and liquidity needs for institutionally oriented managers. These sources think that rate of redemption likely will be repeated in the first quarter as institutional investors continue to rebalance out of relatively better performing allocations, like hedge funds, to replenish severely depleted domestic and international equity targets.

Looking at the amount investors actually asked to be returned by hedge fund managers as of Nov. 30, consultant Michael Rosen said the situation is fairly grim.

“The working number for redemption requests is 25% from the managers I've been talking to. Managers think the actual rate will probably be less than this, but not a lot less,” said Mr. Rosen, a principal and the chief investment officer of Angeles Investment Advisors LLC, Santa Monica, Calif., which invests in hedge funds in discretionary accounts managed for the firm's clients.

“Managers still don't know for sure what the actual withdrawal will be because a certain percentage of the redemption requests are provisional. It won't be certain right up until the last day, Dec. 31, what managers will have to return when they reopen for business on Jan. 2,” Mr. Rosen said.

Hedge fund consultant Donald A. Steinbrugge had a slightly lower year-end hedge fund redemption estimate — 20% on average — but he said redemption rates will differ geographically, by client type and by strategy. Mr. Steinbrugge is managing member and founder of Agecroft Partners LLC in Richmond, Va.

He said European hedge funds likely will see higher withdrawals because of a greater concentration of high-net-worth clients and more use of leverage by funds of funds. By contrast, he said “the U.S. market place had approximately 40% less in withdrawals which is attributed to the large amount of assets institutional investors have invested in hedge funds both directly and through funds of funds.”

The Morgan Stanley research team broadly agreed and further quantified probable redemption rates. Their prediction is that European and Asian hedge funds will have higher redemptions with estimated outflows of 25% to 30%. European fund redemptions will be greater because of more liberal liquidity terms and the funds' client bases being biased toward high-net-worth investors and more retail-oriented hedge funds of funds. However, U.S. hedge funds with liberal redemption terms — those that have not imposed redemption restrictions — also will experience redemptions of 15% to 20%, according to the research report.

Mr. Steinbrugge said the highest redemption requests are coming for hedge fund strategies that have had the most difficult time navigating the markets these past few months, such as convertible bond arbitrage, fixed-income arbitrage and other highly leveraged strategies.

“The carnage was pretty bad in these strategies, but in line with what should have been expected given what happened in the capital markets. Many firms will go out of business due to either large withdrawals or performance well below their high water mark,” Mr. Steinbrugge added.

As news of individual hedge funds and fund companies' redemption levels begins to trickle out, sources are stunned at the level of potential bloodletting at some very high-profile firms.

One source who asked not to be named, for example, said he was “absolutely shocked that Paul Tudor Jones has to restructure that flagship fund of his. I mean, he's one of the greatest hedge fund traders in the world!”

Tudor Investment Corp., New York, will ask investors to approve a restructuring of its $10 billion multistrategy hedge fund BVI Global Fund Ltd. in the first quarter, according to an investor letter obtained by Pensions & Investments.

In response to difficult market conditions and client redemption requests for Dec. 31 totaling $1.4 billion, the fund's board temporarily suspended redemptions until March 31. If approved, the fund will be split on that date into a liquid and an illiquid master fund, each represented by a different share class. Shares of the liquid Tudor BVI Master Fund will be subject to the firm's normal redemption terms while the illiquid Legacy Master Fund cannot be voluntarily redeemed by investors. The illiquid portion of the BVI fund comprises primarily private equity investment and uncalled capital commitments, some of which now are not tradable, according to the investor letter. The illiquid portfolio will represent approximately 29% of the fund's assets on March 31.

The firm's founder, Paul Tudor Jones II, wrote to clients that “we expect that distributions from this class will be made to investors quarterly as realizations/liquidations occur of underlying assets,” and that the first distribution likely will be on June 30.

Steve Bruce, a Tudor spokesman, declined to comment about the restructuring.

Angeles' Mr. Rosen said many hedge fund managers will need to learn to live with a changed landscape, noting that 2009 likely will be “the big year, the one where the confluence of many factors will result in a completely different environment, one that very few hedge funds have navigated well. After several years of hedge funds making a lot of money, 2008 was one in which most of the industry has had losses. Hedge funds could look a lot different going forward. On average, hedge funds (no longer) add value after fees and expenses. We're moving into a period of major difference where most hedge funds won't produce alpha from a time when many could. Investors will be questioning, evaluating the value of the vehicle next year, I think.”

That said, a majority — about 68% — of the world's institutional investors have not reached their target hedge fund allocation and likely will continue to fill out their allocations, according to new survey data from Preqin Hedge, London.

While 11% of respondents said they were unlikely to invest in hedge funds in the next 12 months, 21% said they were at or close to their target allocations but would continue to invest opportunistically or to maintain their allocation, according to the survey report, “Overview of the Global Hedge Fund Institutional Universe.”

Preqin researchers said in their report that their analysis identified 160 investors that are “poised to make their first investments in hedge funds in the (next) 12-18 months.”

The report is based on a survey of 2,023 institutional investors from around the world conducted from August through October this year and analysis from its institutional investor data base.

Preqin's predictions about continued institutional investment in hedge funds might be at least partially supported by the view of the Morgan Stanley researchers, who wrote that they expect to see hedge fund assets rise again by the end of 2009 to $1.6 trillion.