Citadel Hit Hard as Hedge Fund Withdrawals Continue

According to Trim Tabs Investment Research, a leading research house, the number of withdrawals from Hedge Funds in the month of September was $43 billion. Given the volatility and market declines we've seen thus far in October, you can assume that this month will be much (if not more) of the same.

Taken from the

Financial Times

,

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.

Even if that prophecy only becomes partially true, that is a massive amount of deleveraging, unwinding, and liquidation. Forced selling is driving this market and will continue to do so. Buying these dips in a scalable manner offers a very promising opportunity for longer-term investors.  It was on a recent hedge fund panel that 'Tiger Cub' Chris Shumway, of Shumway Capital argued this very point.  You can read my post about it here. Recently, Barry Ritholtz, author of 'The Big Picture' blog, also put a small amount of capital to work on the long side. His thoughts, courtesy of Agoracom, can be found in a recent interview.

By no means should you rush out and invest 50% of your capital when the market plunges, as volatility should continue. However, by being constructive in small amounts, like 10-15% of capital, you can accumulate assets that are selling at fire-sale prices and are pricing in the apocalypse. That is not to say that assets cannot get cheaper, because most likely, they will. However, we all know you cannot time the exact bottom, and the market does not bottom in a 'V' fashion.

As I wrote a few weeks ago, the hedge fund redemption bloodbath was just starting. Essentially, this type of forced selling triggers other funds to sell their holdings as they watch their value evaporate. So far, all data points to the continuation of this trend. In a recent hedge fund performance update, we noted the horrid performance of almost every hedge fund we covered, which is all the evidence needed to determine whether or not this trend will continue. The main thing you can learn from this is that we have absolutely no idea how long it will take for the deleveraging and liquidation to stop. However, we do know that the selling won't stop until all the players are wiped out and only the strongest have survived.

Paul Kedrosky recently tossed out his estimates on the hedge fund outflows. He wrote:

In essence, I'm aging hedge fund inflows and saying that we will see a blended 40% (higher in later years, lower in earlier years) demand for redemptions from investors in the 2005-2008 period. I'm not worrying about pre-2005 assets under management, so we could see lower redemptions on new assets and more on the older stuff, taking us to the same place. I'm also positing that initial capital has shrunk by a blended 20% on inflows, which is admittedly on the high side. I then figure that turns into almost $200-billion in outflows, or a little less than $2-trillion in asset sales at an average of 10x leverage. Some say the leverage is lower, some higher. Some argue we will see lower/higher redemptions, or that median versus mean losses will be wildly different. Other say it's inherently a state change issue, where the paradox of deleveraging is that everyone doesn't get to shrink -- some firms just fail outright.

Todd Harrison, a former hedge fund trader and CEO of Minyanville.com was recently on Tech Ticker discussing this very problem. He said he thinks that 50% of the hedge fund space will fall victim, and    investors should invest smaller amounts of capital as a result.  Investors should be nimbler, hedged, and patient.

A case in point is Citadel LP. The oft-respected firm, started by Ken Griffin, is seeing its worst year in its history, and is down anywhere from 26-30%. These people are known for their solid, 18-20% annualized returns. From the Wall Street Journal,

On Wednesday, Kenneth Griffin, head of Citadel, sent a letter to investors.

September, he wrote, was the single worst month, by far, in the history of Citadel. Our performance reflected extraordinary market conditions that I did not fully anticipate, combined with regulatory changes driven more by populism than policy. In coming weeks, Mr. Griffin wrote, the firm's earnings will continue to be volatile, as the world manages the unfolding crisis.

Overall, the numbers are staggering. After recently coming across data from Eurekahedge, DealJournal wrote:

According to its preliminary estimates, hedge-fund losses totaled roughly $79 billion in September, including $44.5 billion of investment losses and $34.5 billion of investor withdrawals. That was only partially offset by about $10.5 billion of new money flowing into the more successful strategies, Eurekahedge figures. In the third quarter, hedge-fund assets shrank by a record $210 billion, or more than 10%, estimates Hedge Fund Research. To put that in perspective, the decline in assets for the quarter exceeded the entire amount of money that flowed into the industry in 2007, which was a record $194 billion. Of those third-quarter declines, more than $31 billion was attributed to investors taking out their money, the largest net capital redemptions on record, says Hedge Fund Research. That left total hedge-fund assets at $1.72 trillion, down from $1.93 trillion at the end of the second quarter.

Therefore, while one could definitely argue a tradeable bottom is in the cards, it still seems as if the unwinding from mutual funds and hedge funds still might have control of this market.

Sources:

• Wall Street Journal
• DealJournal
• Financial Times

Comments

[JasonC:]

Unwind from hedge funds sure, but why throw in mutual funds in the last line, when not a word was said about them in the article? Also, the withdrawals are dwarfed by the simple investment losses.

No one should be surprised that when the end of the world trade blew up, the sector betting on it got clobbered. The only question for the braintrust is what they thought they were doing in the first place. Wrecking the system you live inside is never going to make anyone a buck.

2008 Oct 22 10:59 AM

[Stone Fox C...:]

On the flip side, I've seen mention of numberous hedge funds that have enourmous amounts of cash sitting on the sidelines. Also, I'm perplexed in why funds being down that much is such a shock. Where will the redemption money go? It might leave one hedge fund and end up at another. This fear and panic shall pass. People are too greedy to remain in cash for too long.

2008 Oct 22 12:16 PM

[PocketJJ:]

Re: JasonC,

Citadel lost money because they weren't beting the end of the world... They were doing the exact opposite, they kept on selling those out of the money puts, collecting pennies, and they got taken out because the world did skip a beat during that first week of October.

I read several of your comments on various articles, I gathered that you don't like speculators and especially speculators of inflation and you also are not very fond of people taking on a doomsday view of US markets. I am just curious to what you are invested in. Do you trade any asset classes sepcifically? I am guessing you are invested in AAA corps with relatively decent yields?

I think you have some interesting ideas as to how the next few years will play out. Can you go into more details on that please?

2008 Oct 22 07:27 PM