Death march of the hedge funds

The rich are running scared, and dragging global markets down as they panic

By Andrew Leonard
Published October 16, 2008 1:36PM (EDT)

This is what a bear market looks like: Investors pulled $43 billion out of U.S. hedge funds in September, and an even larger outflow is expected for October, according to an analysis by TrimTabs Investment Research, reported in the Financial Times.

A fundraiser for a major hedge fund said the period "between now and December 1 is a sort of death march" for the industry.

The chief executive of a leading alternative investment manager said he expected the hedge fund industry to shrink by 50 per cent in coming months -- with half the decline coming from withdrawals and half coming from investment losses.

Hedge fund withdrawals have been widely cited as a contributing factor to recent stock market declines. When investors demand their money back, hedge funds are forced to sell assets into a down market, which inevitably forces prices even lower. The hedge fund industry manages about two trillion dollars worth of assets, so a 50 percent decline would have far-reaching consequences.

Perhaps most interesting -- hedge fund leverage accentuates the downside. Hedge funds are notorious for borrowing money to make their bets. When forced to redeem investor money, they also have to sell assets to pay back some of the borrowed money as well. The FT reports that "JPMorgan expects that an outflow of $150 billion [in withdrawals]  will lead to sales of about $400 billion."

Conclusion? Of all the regulatory reforms likely to be considered by the next administration, limits on leverage could be one of the most significant, in terms of tamping down both bubbles, and crashes.

Andrew Leonard

Andrew Leonard is a staff writer at Salon. On Twitter, @koxinga21.

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