The main reason for the current losses is that many funds’ trading strategies have come unstuck in a “dash for cash”. Among the worst hit funds are those that engage in convertible bond arbitrage and activist funds, which try to shake up the companies in which they hold stakes.
Other factors have added to the funds’ woes. As their losses build, some funds become forced sellers to meet margin calls on loss-making positions. Investment banks that provide financing have retrenched, been taken over or collapsed.
Leverage has become harder to get, making it difficult for hedge funds to generate outsize returns. Regulatory bans on the short-selling of financial stocks have not helped because they have removed an important hedging tool. The demise of Lehman Brothers swallowed the collateral of funds that used it as a prime broker, adding to the strain. Some clients now want to get out.
Detail: FT: Hard times for hedge funds
Also: the industry’s shrinkage does pose dangers. First, the loss of quantitative hedge funds, which provide a large chunk of stock market liquidity, could add to the volatility in markets. Second, many hedge funds act as venture capitalists, providing small companies with funding they might not otherwise be able to access. Several of the biggest and most successful funds are also playing important roles in recapitalising the shattered banking sector. Barclays, the UK bank, relied heavily on hedge funds in a recent capital raising.
