Hedge funds slash stock holdings to raise cash, adding to global market slide
By NEIL BEHRMANN
IN LONDON
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THE alleged Galleon insider trading scandal has precipitated a major slump in the stock prices of listed hedge fund groups from their recent autumn peaks.
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The furore has also played a role in causing Wall Street shares to decline as well, bringing about falls in Europe, Japan, Asia and emerging markets.
Asset markets, already overbought following strong rallies from their March lows, were extremely vulnerable to the Galleon shock, dealers and analysts say.
According to people familiar with the firm, the Galleon group has sold more than 90 per cent of its holdings.
The firm, with client assets of US$3.7 billion, had undisclosed levels of leverage, which magnified the reported sales of its technology holdings in Apple, Google, eBay and other stocks, according to some estimates.
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Moreover, other hedge funds, fearful of the potential fallout, also decided to be prudent and cut their holdings of stocks to raise cash.
This came as hedge fund groups were experiencing a remarkable rebound from their earlier troughs when the Madoff fraud spooked investors and led to extensive redemptions.
As the hedge fund sector recovered from the Madoff shock, shares of the listed fund groups soared and reached 2009 peaks in September and early October.
Even though none of the large listed hedge fund companies have been implicated in the alleged Galleon scandal, their share prices have since slumped with GLG and Fortress Investment Group sliding by more than 30 per cent and Blackstone, Och Ziff and Man Group tumbling by 10 to 30 per cent.
Despite the recovery from bear market lows, hedge fund stocks are still substantially down from their 2007 peaks.
One worry, industry watchers say, is that the Galleon insider trading case could restrict hedge fund managers in future from obtaining market or company information that would give them the extra edge over tracker funds, exchange traded funds or mutual fund managers.
Yet, hedge fund managers require the extra advantage to justify their fees, which are hefty with annual management charges of around 1.5 to 2 per cent and performance fees of around 20 per cent.
This is especially when the vast majority of hedge fund managers are already underperforming global stock market indices.
As at Oct 29, the year to date return of Hedge Fund Research's HFRX Index showed a gain of 11 per cent, well below the gains recorded on Wall Street and Asian and European stock markets.
In 2008, the HFRX index also lost 23 per cent, contrary to the expectation that hedge funds would usually outperform in bear markets.
Compounding such concerns is an apparent loss in investor confidence in the sector. A well publicised New York University's Stern School of Business study on hedge funds has exposed a depressingly high incidence of misrepresentation within the hedge fund business.
The survey, covering the period 2003 to 2008, gleaned data from 444 due diligence reports, as well as intensive interviews and investigations of hedge fund firms.
It found that more than a fifth of the managers in the study misrepresented their past legal and regulatory problems and 28 per cent of the managers made 'incorrect or unverifiable' representations on other issues.
While the report still showed that the majority of hedge fund managers were honest about their business, the significant incidence of misrepresentation, the persistent scandals, opaque disclosures and the lack of liquidity have all made investors nervous, fund watchers say.
While hedge fund stocks are taking a hit now, the industry is bracing itself for accelerated withdrawals by fund investors.
The hedge fund results that will be published in the first few days of November could put the sector under further pressure.
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