Fund-linked hedging bolsters redemption requests
The rise in redemptions across the hedge fund industry is being exacerbated by the hedging of fund-linked options and constant proportion portfolio insurance (CPPI) products, according to dealers.
"Investor redemptions were widespread and indiscriminate across fund strategies, regions, asset sizes and performance dynamics," the firm said.
While the bulk of the outflow stems from disgruntled investors, dealers attribute part of it to hedging activity involving common fund-linked trades.
Both options and CPPIs linked to funds of funds have been popular with institutional investors over recent years. Hedging these products generally involves dealers taking stakes in the underlying funds - with dealers buying shares as the underlying fund's net asset value (NAV) rises and selling them as the fund's NAV falls.
Bankers say such forced selling activity contributed to record redemptions towards the end of 2008, as the performance of the industry took a dive.
Eric van Laer, London-based European head of fund-linked derivatives at Credit Suisse, said: "The bad performance of hedge funds has caused deleveraging across the board, both for CPPI books as well as leverage books. This has contributed to the redemption flows that have increased dramatically across the last couple of quarters."
Not all dealers have been able to redeem shares in order to hedge, however. Many funds and funds of funds have had to restrict investor outflows to protect their remaining investors, by constructing liquidity gates, suspending redemptions or creating side-pockets, for example.
Sources say this was not widely anticipated in the documentation of many fund-linked trades, resulting in nasty losses for some hedging desks. "Now banks are locked in funds of funds where they won't get a certain amount of redemption orders from the end of last year until February or March," said Laurent Le Saint, global head of sales for hedge fund-linked products at Société Générale Corporate and Investment Banking.
With some funds of funds exposed heavily to New York-based broker and fund manager Bernard Madoff, the combination of a sharp drop in NAV with a freezing of liquidity is believed to have badly charred some banks' hedging books.
Along with market volatility, Madoff's alleged $50 billion fraud has conspired to give the industry its worst full year since HFR began tracking it in 1990. The firm's HFRI Fund-Weighted Composite Index has declined 18.3% in 2008, while its Fund of Funds Composite Index is down 19.97% for the year.
See also: History repeating
Madoff fraud puts focus on fund due diligence
Hedge Fund Derivatives House of the Year - Deutsche Bank
Only users who have a paid subscription or are part of a corporate subscription are able to print or copy content.
To access these options, along with all other subscription benefits, please contact info@risk.net or view our subscription options here: http://subscriptions.risk.net/subscribe
You are currently unable to print this content. Please contact info@risk.net to find out more.
You are currently unable to copy this content. Please contact info@risk.net to find out more.
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Printing this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
Copyright Infopro Digital Limited. All rights reserved.
You may share this content using our article tools. Copying this content is for the sole use of the Authorised User (named subscriber), as outlined in our terms and conditions - https://www.infopro-insight.com/terms-conditions/insight-subscriptions/
If you would like to purchase additional rights please email info@risk.net
More on Regulation
One year on, regulators still want a cure for bank runs
Broad support for higher outflow assumptions on uninsured deposits, but that won’t save insolvent banks
Watchlist and adverse media monitoring solutions 2024: market update and vendor landscape
This Chartis report updates Watchlist monitoring solutions 2022 and focuses on solutions for sanctions (name and transaction) screening and monitoring adverse media and its related elements
Basel Committee reviewing design of liquidity ratios
Focus on LCR and NSFR after Silicon Valley Bank and Credit Suisse, but assumptions may not change
Risk, portfolio margin, regulation: regtech to the rescue
A white paper outlining the complexity of setting the course for risk, margin and regulation
Prop shops recoil from EU’s ‘ill-fitting’ capital regime
Large proprietary trading firms complain they are subject to hand-me-down rules originally designed for banks
Revealed: the three EU banks applying for IMA approval
BNP Paribas, Deutsche Bank and Intesa Sanpaolo ask ECB to use internal models for FRTB
FCA presses UK non-banks to put their affairs in order
Greater scrutiny of wind-down plans by regulator could alter capital and liquidity requirements
Industry calls for major rethink of Basel III rules
Isda AGM: Divergence on implementation suggests rules could be flawed, bankers say
Most read
- Basel Committee reviewing design of liquidity ratios
- Breaking out of the cells: banks’ long goodbye to spreadsheets
- Too soon to say good riddance to banks’ public enemy number one