Hedge Funds Concede Errors, Profess Optimism After Worst Losses
2008-10-14 04:00:01.60 GMT

By Saijel Kishan and Katherine Burton
Oct. 14 (Bloomberg) — Hedge fund managers, after enduring
the industry’s worst month in a decade, are seeking to explain
to investors what went wrong and what they are doing about it.
“We clearly underestimated several things, most
importantly the tsunami of redemptions that are being delivered
to hedge funds as investors line up to get out of these funds as
well as record outflows from equity mutual funds,” Jeffrey
Gendell, who runs Greenwich, Connecticut-based Tontine
Associates LLC, wrote in an Oct. 1 letter to clients.
“I am not a nervous person by nature, but should have been
under the circumstances,” wrote Gendell, whose Tontine Partners
LP fund plunged 59 percent in September, leaving it down 67
percent for the year, according to investors. Gendell, 49, had
expected shares of steel, engineering, airline and chemical
companies to appreciate because of falling oil prices. Instead
they plummeted.
Hedge funds, which endeavor to make money whether markets
rise or fall, lost an average of 4.7 percent in September, the
biggest monthly decline since August 1998, according to data
compiled by Hedge Fund Research Inc. Funds fell 17 percent this
year through Oct. 9, compared with the 38 percent decline by the
MSCI World Index of stocks. It was the worst performance by the
lightly regulated private pools of capital since the Chicago-
based firm began collecting data.

Failure Rate

As much as a third of hedge funds may close in the
next two years, according to a Sept. 29 report by Zurich-based
analysts at Credit Suisse Group AG. There were about 3,100 hedge
funds that managed a combined $1.9 trillion as of June 30,
according to Hedge Fund Research. This year’s investment losses
mean many funds won’t be able to collect performance fees,
usually 20 percent of gains, while management fees, usually 2
percent of assets, will shrink.
Managers have been selling assets, both to raise cash for
what they expect to be a surge in year-end redemption requests
and to preserve capital as market volatility has risen to record
levels. The Standard & Poor’s 500 Index yesterday rebounded from
its worst week in 75 years with an 11.6 percent advance.
David Slager, manager of the Atticus European Fund, told
investors that more than 50 percent of his fund is now in cash
or U.S. Treasuries after he lost 43.5 percent so far this year.
“I believe it is prudent to maintain our critical focus on
capital preservation and liquidity,” he wrote in a letter sent
Oct. 1.
Slager, 36, who is vice chairman of New York-based Atticus
Capital LP, told investors that his holdings are now skewed
toward stocks that will fall, while in July, his bets were
mostly bullish because he had anticipated only a mild economic
slowdown in the U.S.

Glad It’s Done

“While in hindsight I wish I had made the decision to sell
sooner, I am glad that it is now done,” he wrote. He said he
would start buying again only after a “climactic selloff” or
when he deems that credit markets have stabilized.
Slager declined to comment.
David Einhorn, who runs New York-based Greenlight Capital
LLC, said external forces were partly to blame for the 17
percent drop in his three funds in September.
While he and his team made mistakes, “we believe that our
portfolio management has been reasonable,” Einhorn wrote in an
Oct. 1 letter to clients.
Einhorn, 39, pointed to the U.S. Securities and Exchange
Commission’s Sept. 18 ban on short sales of financial stocks for
some of the losses in the month. The ban, which expired Oct. 9,
eventually included about 15 percent of the companies in the
Standard & Poor’s 500 Index.

Caught Short

In a short sale, investors sell borrowed stock in hopes of
repurchasing it later at a lower price and pocketing the
difference. A long position is one that an investor holds in
expectation it will rise.
After the ban went into place, the shorts recovered much
more than the longs, he wrote, “especially the financial shorts
abundant in our portfolio.”
Einhorn, who earlier this year was vocal in this view that
shares of now-bankrupt Lehman Brothers Holdings Inc. would
tumble, said he planned to hold onto the short positions in
financial companies “for a good deal of time (providing there
aren’t additional extraordinary legal changes) until they begin
to trade in a normal market environment again.”
In the third quarter, Einhorn’s three funds lost about 15
percent, one percentage point of which came from stocks he had
shorted. Nine companies Einhorn held long, including French
chemical-maker Arkema SA, French bank Natixis SA and Houston-
based oil and gas producer Helix Energy Solutions Group Inc.,
each contributed more than one percentage point to the quarterly

Playing Defense

Einhorn told investors his funds are more conservatively
invested than ever. While almost three-quarters of assets,
including leverage, are long, he has offset those holdings with
short sales that bring the net to 9 percent. Einhorn declined to
Gendell, who also runs a stock fund that buys and sells
banks an other financial-services shares, said he’s expanding
investments in regional banks, “which we think will have a
remarkable period of earnings growth over the next two to three
years.” His Tontine Financial Partners LP fund was up in
September, he told investors in his letter, without providing
Tontine is allowing investors to add to their investments,
without adding to the length of time their money must remain
with the funds, “for those who seek to take advantage of this
decline.” Gendell declined to comment.
Greenlight is also opening its funds to a limited amount of
new investments on Nov. 1 “in order to take advantage of the
investment opportunities we believe will be available in the
coming year.”

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–Editors: Larry Edelman, Tim Quinson