market folly

We wanted to take a second to highlight these two stories as they are very reflective of what is going on in the hedge fund industry. We all know that redemptions were rampant. And, to that point, they probably still are winding down. It was postulated that December could have possibly been the halfway point in redemptions. But, if the market tanks yet again, that could undoubtedly set off another wave of redemptions. People need capital. That's all there is to it. In such an environment, cash, quite literally, is king. Case in point: Short seller Jim Chanos has undoubtedly had a solid year given that the market has declined so much. Yet, despite his performance, he is still seeing clients redeem almost 20% of their investment in his Kynikos Associates hedge funds. Chanos cited that, "We were like an ATM machine." Doug Kass, another short seller and hedge fund manager, has recently said that markets cannot recover until redemptions ease.

Many funds out there have suspended redemptions, or 'gated' investors from pulling out their money. As such, investors were left scrambling to pull money from wherever they could. Luckily, some funds have started to release those gates and Citadel addressed this issue in their latest letter to investors. Additionally, investments in funds that have been obliterated are now pretty much worthless. So, what do those investors do when they need capital? They sell their winners. And, Chanos' funds are the perfect illustration of this. Despite his great performance, he still saw outflows due to market conditions and the overall cash crunch.

Secondly, we've also seen that Perry Capital has cut its performance fee to those willing to pay it immediately. Apparently, the offer is to cut the performance fee on their International fund in half, to 10%. If investors accept this cut, they will basically begin paying the performance fee right away, despite the water mark. Such a move illustrates yet another casualty of the markets: performance fees. Hedge funds raked in the gains when they were printing money left and right. But, with many funds having lost money in 2008, they didn't receive their performance fee. And, not only did they not receive this nice bonus, but they dug themselves a ditch in terms of a high water mark. In order for them to collect performance fees going forward, they will need to recoup all their losses from last year and more.

Simply put, cash is king. And, we're not just talking about from an investment standpoint here. Investors need their cash after many of them lost some in 2008. Hedge funds aren't making the cash they once were due to lack of performance fees in many instances. So, they're searching for new ways to generate cash flow. Its interesting to see the industry adapt on the fly like this, as we face a crisis on multiple fronts. And, only time will tell how the industry morphs going into 2010. But, we do know one thing: 2008 certainly expanded the hedge fund graveyard.