Another Wave of Withdrawals Expected to Hit Hedge Funds

The race for the door at hedge funds isn't letting up.
With financial markets in disarray and the alleged fraud by money manager Bernard Madoff casting a pall on the industry, investors have been demanding their money back at a relentless rate in the first weeks of 2009. That is forcing some of the world's best-known hedge-fund managers, who had hoped that massive withdrawals in December would be the worst of it, to brace for another wave.

Among the managers expecting withdrawals are New York-based D.E. Shaw & Co. and Och-Ziff Capital Management Group LLC, which together manage more than $50 billion in assets. Huw van Steenis, an analyst at Morgan Stanley in London, says he has seen "no deceleration" in investors' requests to pull money out of hedge funds. As a result, he estimates that assets under management in the global hedge-fund industry will shrink by as much as 30% this year due to withdrawals, following a 20% decrease in the second half of last year. That leaves total assets at less than $1 trillion, down from their peak of more than $1.9 trillion in mid-2008.

The exodus comes at a time when hedge funds are under fire on a number of fronts. Policy makers, seeking to root out the causes of the financial crisis, have subjected hedge-fund managers to public grillings and are planning greater regulatory scrutiny. Meanwhile, many hedge-fund investors were caught up in the alleged Ponzi scheme run by Madoff, further tarnishing the industry's reputation.
Overall, investment performance at hedge funds has shown signs of improvement this year.

Hedge funds as a group were flat for January after a 19% decline in 2008, according to data tracker Hedge Fund Research Inc.
Part of the explanation for the wave of withdrawals lies in the way hedge funds work. Many hedge funds, particularly U.S.-based funds, allow investors to take their money out only at quarterly intervals, requiring two to three months' notice. That means that investors who discovered in mid-December that they had lost money in the Madoff case and needed to raise extra cash wouldn't have been able to submit their requests in time for the end of last year.
Also, many U.S. hedge funds are playing catch up with their European peers, which bore the brunt of withdrawals late last year. In Europe, managers typically have shorter notice periods and rely heavily on money from high-net-worth individuals, who have moved more quickly to pull out money than the pension funds, college endowments and other institutions that make up a large portion of U.S. hedge-fund investors. Mr. van Steenis estimates that European funds had redemptions of as much as 30% of their assets during the second half of 2008, compared with as much as 20% in the U.S. Roughly three quarters of the industry's assets are in U.S. funds.

Morgan Stanley estimates that Och-Ziff investors could withdraw $2.1 billion during the first half of 2009. That comes on top of the $5.4 billion of net outflows Och-Ziff experienced during 2008, reducing its assets under management to $22.1 billion as of Jan. 1. "We believe that the industry-wide redemption cycle is not yet over," Chief Executive Daniel Och said in a Feb. 12 conference call with analysts.

D.E. Shaw has had more requests for withdrawals for the period ended March 31 than it did for the end of last year, according to people familiar with the matter. The money manager's assets shrank by $9 billion in the second half of last year to $30 billion, due to a combination of investment losses and withdrawals. Late last year, it placed limits on withdrawals from two of its funds after receiving requests for more than 8% of assets in one of them and more than 6% on the other.

In Europe, some fund managers are enjoying a respite. "We've actually seen a dramatic slowdown in the pace of redemptions," Noam Gottesman, co-CEO of London-based GLG Partners LP, said in a Feb. 12 conference call with analysts. He attributed it to the fact that GLG had been hit earlier than many funds because of the loss of one of its key managers last year. GLG's assets fell by $9.6 billion, or about 40%, last year to $15 billion. Still, he said, "it will take some time to win people's trust back."

In the U.S., the "extreme level of redemptions" is pushing New York-based Jana Partners LLC to set aside hard-to-sell assets to prevent them being sold to meet withdrawal requests for March, the firm told investors in a recent letter. Investors have asked to pull 20% to 30% of assets in March, coming on top of the 35% of assets the firm paid out in January. Jana will honor those requests, it said -- minus the illiquid assets that it is setting aside until markets improve.