With US markets due to re-open today after losing three full days of trading, and a consensus that initial price movements will be down, probably followed by a rebound, concerns that hedge funds could come under financial pressure from margin calls or liquidity shortages have largely been dismissed by commentators and the funds themselves.
Most funds report that they had already been reducing open positions and increasing the cash element of portfolios in the period prior to last week's disaster, and two factors prevented most funds from aggressively exploiting opportunities to take aggressive short positions last week: a gentlemen's agreement not to take advantage of the market in the immediate aftermath of the terrorist attacks, which have hurt so many of the trading firms that were located in and around the World Trade Center; and the difficulty, not to say danger, of trading in highly volatile and thin markets.
One prominent New York hedge-fund manager said: "The way we're looking at this is, our portfolio is what it is. We're not attempting to trade off-board or off-exchange. It's a mistake to make decisions in a vacuum. I don't know what the tone of the market will be. There is uncertainty about the safety of the US."
There had been some discussion towards the end of last week that the SEC should impose restrictions on the ability of hedge funds and other investors to take short positions when the market re-opens, but in the event nothing official is to be done. Some US investment banks however are planning to impose restrictions on hedge funds wishing to short vulnerable stocks when the New York Stock Exchange reopens next week.
The self-imposed curbs are likely to affect trading of a range of companies badly hit by the terrorist attacks in New York and Washington, in particular airlines, hotels, leisure companies and financial services. They may also limit aggressive positions taken against commodities and currencies.
The investment banks acted as it seemed towards the end of the week that some hedge funds were breaking the agreement to refrain from trading aggressively. Analysts said their activity contributed to the 187.9 point fall of the FTSE on Friday.
The Financial Times reported on Saturday that one US bank, one of the biggest names on Wall Street, which declined to be identified, said: "There are going to be some restrictions on short selling by hedge funds. We're just not going to play that game. If a hedge fund comes to us to short a stock big time, then we're not going to take the bargain or we're going to offer a price that would be just too horrible. We're not going to contribute to systemic meltdown: that would be handing a win to the terrorists."
In fact, investors may not find it that easy to profit from the market this week: expected problems for airlines and insurers are fully priced-in to European markets, and if falls in the US are overdone due to shorting pressure, it's a tactic that may quickly rebound on the culprits.
"Any unprofessional short (managers) that go out and play that game, without some real inside knowledge of companies, will be burned. Anybody who does anything aggressive long or short in the near term is playing Russian roulette with their investors' money," said the banker.
Some hedge funds indeed were buying reinsurance companies after the sharp falls they suffered in the immediate aftermath of the attack. While the reinsurers will have to pay out billions, companies such as Munich Re, of Germany, and to a lesser extent, Swiss Re, won't have problems surviving even sizable claims.
Nigel Williams, head of European institutional business at Barclays Global Investors, one of the world's largest fund managers expects the US market to fall in line with other markets when it re-opens: about 4-5%. But he suggested institutional investors, investing for the long term, would not be hurriedly reordering portfolios. "All week investors have been adopting a 'care and maintenance' strategy, just making sure their portfolios are in line with their long-term plans."
What is different this time around, compared with previous market crises, is the sheer weight of money in hedge funds. For a long time they have been able to influence markets when they are at turning points due to the leverage they exercised through taking aggressive positions. Now, the vast sums sloshing around the system (there are more than 6,000 hedge funds deploying at least a trillion dollars in assets) have far greater difficulty finding worthwhile opportunities. As a result, hedge fund investors say, long-short equity funds in particular, have been taking a fairly neutral stance, balancing their long stock positions with short positions and holding a lot of cash. Paradoxically, therefore, hedge funds, which are popularly supposed to be the bad boys of the international markets, may if anything nowadays have a benign and calming influence.
If problems do emerge, they are more likely to be in the convertible arbitrage, bond arbitrage, and merger abitrage markets, whcih could run into liquidity problems as markets re-open. Cantor Fitzgerald, for instance, severely damaged by the attack in New York, is the largest interbank broker in US Treasury bonds. However, monetary authorities around the world have pumped liquidity and the offer of liquidity into the markets.
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