Friday, September 5, 2008

Hedge Funds to Blame for the Market's Fall?

Part of Thursday's move on the market has been partially blamed on worries about two hedge funds from Atticus Capital. This news comes on the heels of Ospraie Management LLC saying it planned to close its flagship fund. This has some investors betting more hedge fund closures could be on the horizon.

While it has been said that Atticus Capital does not borrow funds like most hedge funds, the hedge fund industry itself has had previous problems with funds leveraging their positions to boost their gains.

What this means is that if a hedge fund has $100 million of investors' money, it may borrow an additional $100 million to make its investments. When the bets are positive, the gains can be large and boost the returns of the investors. When the bets move negatively, the returns are rapidly diminished.

What happens next is what can hurt a fund in a hurry. The fund starts to receive "margin calls" by lenders, and when investors see their returns falling, they quickly try to "redeem" their shares. This means that the fund must sell investments to repay the lenders and the shareholders in short fashion locking in the losses. When this starts to happen, it usually continues and can spell the end of the fund.

The funds are generally small comparatively, but they do put a cloud over the market when these things happen.

No comments: