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October very rough on hedge funds
Some funds look set to post big losses under some brutal market conditions, sources say.
October 28, 2005: 6:23 PM EDT
By Amanda Cantrell, CNN/Money staff writer
Hedge funds manage an estimated $1 trillion in assets world wide.
Hedge funds manage an estimated $1 trillion in assets world wide.

NEW YORK (CNN/Money) - After a solid third quarter, October has been one of the toughest months for hedge funds in recent memory, people in the business said Friday.

October is frequently a tough month, but this year it has been particularly brutal, according to people in the industry.

While there's still one trading day left and most funds won't report numbers to their investors until next month, these people said that traditional "long/short" stock funds in particular have taken a beating.

Anecdotal estimates for monthly declines for some of the funds range from 3 to 4 percent, with some seeing losses as high as 8 to 10 percent for the month in extreme cases, these people said.

Long/short equity funds, which buy stocks that fund managers believe will rise and sell short the stocks of companies they feel are overvalued, constitute a good deal of the estimated 8,000 hedge funds worldwide. Shorting a stock is a bet that a company's share price will decline and involves selling borrowed securities with the hope of buying them back later at a lower price and then returning them to the lending broker.

The S&P 500 is down 4.1 percent for the month. Small-cap stocks have had a particularly tough month, with the Russell 2000 Index down 6.6 percent. Long/short equity managers are raising their exposure to the U.S. stock market to historically high levels, according to research from Merrill Lynch.

One event that may have tripped up some hedge funds in October was the meltdown of commodities brokerage Refco. Refco went into bankruptcy when customers began withdrawing assets after chief executive Phillip Bennett was charged with securities fraud on Oct. 12 for allegedly hiding a $430 million debt from the company. The company put Bennett on leave on Oct. 10, when it revealed the debts.

"Several of our managers held long positions in Refco equity (mostly from IPO allocations)," read a statement from the CSFB/Tremont Investable Indices, a set of investable hedge fund indexes, adding that the overall impact on the firm's hedge fund portfolios is expected to be minor. "Some bond positions were also held. Some of our other managers have reported small equity positions but the loss from these positions appears to be immaterial."

Arbitrage funds, another big piece of the industry, have also had a tough time. Simply put, arbitrage managers seek to profit by simultaneously selling and buying separate but related instruments in order to profit from a difference in price.

Merger arbitrage managers trade the stocks of companies that have announced acquisitions. One person familiar with the matter said that some managers following this strategy got hurt when the family that controls Cablevision dropped its $7.9 billion bid to take the company private.

According to Chicago-based hedge fund tracker Hedge Fund Research, its index of 1,600 funds gained 5.6 percent in the third quarter, constituting the majority of the 7.3 percent it estimates hedge funds have returned this year through September.

Hedge funds are having a tough time in comparison to recent years. Hedge funds produced gains of nearly 10 percent last year; 15.44 percent in 2003; and 3.04 percent in 2002, when the S&P 500 was down over 23 percent, according to the CSFB/Tremont hedge fund index, which tracks the performance of 400 hedge funds and is separate from the investable index.

It's also been a tough month for managers across the pond.

British hedge fund manager Gartmore sent a letter to investors saying October had been its worst month ever and that its $1.5 billion AlphaGen Capella fund was down 3.5 percent for the first three weeks of the month, according to a report in the Financial Times.


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