Funds braced for further outflows after July withdrawals

An estimated USD55bn was withdrawn by investors from funds of hedge funds in July, the worst month for redemptions in seven years, according to a new report on hedge fund investment flows. The report is produced by TrimTabs Investment Research, which already publishes information on mutual fund and ETF flows, from data supplied by hedge fund research firm BarclayHedge.

According to the TrimTabs BarclayHedge Flow Report, overall outflows from the industry amounted to about USD32bn after taking into account net inflows into single-manager hedge funds. The report, which will in future be published monthly, tracks the monthly flows of 15 hedge-fund sectors and is based on the BarclayHedge database of more than 5,500 hedge funds. Total hedge-fund flows are estimated by TrimTabs drawing on the Barclay data.

TrimTabs says the July outflows amounted to about 5 per cent of the USD1.2trn in total assets held by funds of hedge funds, which attracted net inflows of USD162bn in the first six months of the year. The firm's chief executive Charles Biderman attributes much of the turbulence in the credit and equity markets over the past two months to deleveraging and risk reduction by funds of funds, which in turn triggered asset sales by underlying hedge funds.

'In our opinion, funds of hedge funds - even those that do not use leverage - make financial markets more volatile than they would be otherwise,' the report was quoted by AP as saying. 'To justify their fees, funds of funds tend to trade their assets frequently. In addition, many funds of funds leverage their assets using bank debt. Add leverage to an industry in which countless imitators copy yesterday's unique investment style, and the law of unintended consequences rears its ugly head.'

Given that notice periods for redemptions range from 30 to 60 days, the report warns, requests for redemptions were in fact made in May and June. Figures for redemptions in August, September and possibly beyond may be higher, reflecting concern by investors as turbulence in the market increased dramatically in late July and early August. However, TrimTabs says that assuming there is no further spike in market volatility, the worst of the deleveraging and asset sales is probably over.

However, concern remained about the lasting effect of the liquidity crisis on interbank lending as the three-month sterling Libor fixing rate rose to 6.74 per cent on September 3, its highest level since December 1998, in the aftermath of Russia's debt default and the collapse of Long Term Capital Management. Rates reached a new peak of 6.8 per cent two days later despite a promise by the Bank of England to intervene in the markets to ease short-term liquidity. Euro and US dollar Libor three-month rates also reached their highest levels since 2001.

Cheyne Finance, a USD8.8bn structured investment vehicle run by London-based hedge fund manager Cheyne Capital Management, was placed in receivership on September 5 as Moody's cut its credit rating from A3 to Caa2, eight levels below investment grade. The ratings agency said it was also considering cutting the ratings on debt issued by other SIVs managed by German state bank WestLB and US managers TPG-Axon Capital and Ceres Capital, with a total of USD14bn in debt facing downgrading.

Moody's says investment vehicles that rely on the issuance of short-term commercial paper for funding have found financing impossible or achievable only at 'exorbitant' rates, as well as having to mark assets to a market that has all but seized up. Although most SIVs are continuing to issue debt, in a number of cases this is thanks to financial support from the vehicle's manager or originator.

Last week Barclays Capital agreed to provide a so-called SIV-lite, Cairn High Grade Funding I, between USD1.4bn and USD1.6bn in loans to pay off its commercial paper as it matures over the next five years. Barclays and the vehicle's manager, Cairn Capital, say the loan is not a rescue and is being made at commercial rates. The investment bank is reported to have obtained a credit default swap to protect its position in the event that the Cairn vehicle is unable to repay.

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