Exits barred at some funds
Some hedge funds that have suffered losses on investments are closing the gate on clients who want to pull money out, a move that could further undermine confidence in already shaky financial markets.
Temporarily barring withdrawals, though legal, also could damage 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 9,700 funds with $1.7 trillion in assets.
“Psychologically, separating people from their money is generally considered to be a hostile way to behave,” said Ron Geff- ner, a partner at New York law firm Sadis & Goldberg.
Fund managers say that withdrawal limits protect their investors by preventing sales of securities at deeply depressed prices. But some analysts say news of unexpected hedge fund suspensions could prompt nervous investors in other funds to demand their money back, fearing that the exit door could slam shut on them in the next few months should stock and bond market losses deepen.
Such a run-on-the-bank scenario also could hurt investors who have no money in hedge funds because forced asset sales could drive markets overall lower.
Brokerage Bear Stearns Cos., which last month shut down 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 won’t be able to cash out for the time being, a spokeswoman confirmed Wednesday.
An Australian hedge fund manager, Absolute Capital Ltd., last week told investors in two of its debt-focused funds that it had barred the door to withdrawals until Oct. 25.
Given the “general lack of liquidity” in 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 portfolios for big-money investors, and conventional mutual funds used by average investors: Mutual funds by law must be willing to honor 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 honor,” said Jay Gould, a partner at law firm Pillsbury Winthrop Shaw Pittman in San Francisco.
But hedge funds face an inherent conflict of interest if they try to keep going even if a large number of investors seek to pull money out, said Marc Freed, a manager at New York-based Lyster Watson & Co., which picks hedge funds for clients.
“The hedge fund says, ‘We think it’s in your best interest that we keep your money,’ ” Freed said. “But how do you know it’s in my best interest?”
For now, most hedge fund investors aren’t likely to face an outright ban on withdrawals, experts say. Investment losses in recent months have been greatest in funds that focus on high-risk mortgage bonds, but buying such securities is just one of many strategies that hedge funds can employ.
Hedge Fund Research Inc., which tracks returns on about 30 fund investment categories across stock, bond and other markets, said the average fund was up 8% in the first half of 2007.
Although markets slumped in July, “this could still turn out to be a very decent year” for many hedge funds, said Ferenc Sanderson, an analyst at Reuters Group’s Lipper unit. Given the portfolios’ gains in recent years, many investors may not feel the need to be too concerned about their funds’ health, he said.
Even so, the secretive nature of the hedge fund business means it’s prone to rumors, particularly in times of market turmoil. That could make for some queasy times ahead for fund investors.
On Wednesday, Caxton Associates, a large New York-based hedge fund manager, sent a reassuring letter to clients to combat what the firm called “unfounded rumors” about its performance, according to Reuters, which obtained the letter.