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The Impact Of The Liquidity Crisis On The Hedge Fund Industry

The Impact Of The Liquidity Crisis On The Hedge Fund Industry

Courtesy of Tyler Durden

Much has been written about the consequences of the liquidity crisis on the hedge fund industry: if there is one thing everyone learned is that no matter how stable, how great one’s reputation, or just which cool Greenwich, CT building one is based in, when the global liquidity tide ebbs, everyone is left without speedos (and, of course, that fund of funds are the most worthless things ever conceived by man). For those who recall the dire days at the bottom of the crisis, the consensus was that the hedge fund industry as such would not survive in 2009, let alone 2010. Well, courtesy of Obama’s wealth transfer agenda, it not only survived, but flourished. Yet is it identical to before? The attached study by Citi’s Prime Brokerage Services analyzed the impacts of the liquidity crisis on hedge fund industry participants, explores the participants’ responses to these issues over the past 18 months, assesses the likely impact of recent changes on the industry. A must read for everyone in the business, we were particular taken by the following chart which is truly at the core of every hedge fund investment philosophy nowadays: liquidity, liquidity, liquidity, or why 20 stocks will soon account for 80% of all volume.

Hedge funds are no longer hedging in the true sense of the word, as investors no longer wish to take on liquidity risk. Everything has to be liquid, and has to be sellable at a faxed-over redemption notice. It is only a matter of time before credit and maturity risk are seen as the other two concepts that hedge funds are massively mispricing. Until then, happy 2 and 20s.

Also, here are some of the borader responses from the hedge fund industry over what the key items learned have been:

“We were in bed with [two largest prime brokers]. People were like, ‘Okay, that’s a good diverse place to be.’ In September 2008, our prime brokers said you have to be in fully paid securities or out. There were points we thought we’d be out of business. Every day we were getting calls to take down our levels.”
– <$1.0 Billion AUM Hedge Fund

“What came out of the crisis was that managers had positions in the portfolio that were to the detriment of the investors in a stress period. Assets like private equity or unrated corporate debt. Many times, these assets were not even in the manager’s mandate.”
– Fund of Fund & Seeder

“The biggest lesson learned in the past 18 months has been that the agreed upon liquidity terms of a subscription agreement don’t really matter when the markets are in distress—it’s not a guarantee of when you’ll be liquid.”
– Pension Fund

“Now we are focused on obtaining investor allocations from Sovereign Wealth Funds and Pension Funds outside the U.S. Previously, we had a higher percentage of Fund of Fund money because we were a relatively young hedge fund. Now, we’re trying to broaden that set of investors to have more geographic diversity and more diversity by type of investor.”
– >$1.0 Billion AUM Hedge Fund

“We came away from 2008 with a greater ‘know your customer’ emphasis and a commitment to
diversify our marketing footprint. We are now much more interested in having a mix of investors.”
– >$10.0 Billion AUM Hedge Fund

“Top of the list in terms of lessons learned has to be the requirement to have multiple prime broker relationships.”
– <$1.0 Billion AUM Hedge Fund

“We addressed our investor liquidity concerns by offering them more options. You can continue to do business with us at the same terms and the same fees, but if people are willing to pay up on fees for more liquidity, we are offering them an opportunity to do so through new series.”
– >$1.0 Billion AUM Hedge Fund

“We developed our own proprietary risk application and have integrated our risk system as part of the research and investment decision-making process.”
– <$1.0 Billion AUM Hedge Fund

“We invested heavily in IT … We built a parallel system that captures a mirror accounting process and a mirror reporting process. We’re not relying on one individual or one team. We want dual sets of eyes on everything.”
– >$1.0 Billion AUM Hedge Fund

“Another thing we get kudos for is documenting every single procedure … We don’t hand it out, but when we pull out a 200-page document with that much detail, people go, ‘Wow!’”
– <$1.0 Billion AUM Hedge Fund

Yet this pearl takes the cake, as it basically confirms that for the longest time the entire industry was a Ponzi scheme:

 
 

“There were accepted practices going on in the industry up until 2008 that in retrospect look like a problem. Funds were using the liquidity of incoming investors to pay out the established investors without testing the investments themselves. It was hard to see this until everyone hit the exit at once and everyone starting asking for their money back at the same time.”
– Fund of Fund & Seeder

Full report below

 

The Liquidity Crisis Its Impact on the Hedge Fund Industry (July 2010)

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