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The Next Blow to Hedge Funds (October 4, 2007)

Location: New York
Author: Lenny Broytman
Date: Thursday, October 4, 2007

In a world filled with regulatory confusion and constant change, many insiders within the hedge fund sector are saying that the next blow to their industry will most likely come in the form of hedge-fund redemptions.

According to the New York Post, these redemptions are driven by high-leveraged funds that invest in other funds.

With this in mind, experts have pointed to the recent performance of two European hedge funds that have been exposed to some rather unfavorable investment tactics that have resulted in some substantial losses. These two funds, Fix Asset Management's Canary Fund Ltd. and Fairfax Fund Ltd., each have an estimated $3.5 billion under management and have suffered tremendous losses. The Post reports that the two institutions have fund-of-fund portfolios that have each dropped between 16 and 18 percent between the months of June and August.

While the summer have proven to be rather detrimental for the pair of funds, the Post reported that despite the heavy losses and the use of leverage, the fund has not had any margin calls.

As a result, "there has been no need to redeem from underlying funds," Fix executive Panos Katsambas told The Post.

It is likely that both of these doomed funds had rather substantial exposure to those funds that employ some level of statistical, credit or merger arbitrage. When trouble struck, these funds outsized exposure by (with the aid of much-needed leverage) losing bets locked in losses.

And that's when the calendar turned to August. In a month that turned out to be a rather disastrous one for both funds, the Canary Fund Class A Euro portfolio dropped 10.11 percent, with the Fairfax Fund Class A portfolio lowering a dismal 9.89 percent during the same month.

Taking both of the troubled hedge funds into account, many experts from within are saying that Fix's Canary and Fairfax are most likely not the only fund-of-funds that relied on lending to enhance their portfolios in the past.

According to the Post, the future of hedge fund redemptions will most likely be driven by highly-levered fund-of-funds that are looking to redeem their investments with the assistance of meeting margin calls.

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