Hedge funds feel the pain as losses set to deepen

BOSTON Tue Aug 9, 2011 6:06am EDT

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BOSTON (Reuters) - Hedge funds, considered the stalwarts of the investing world, are feeling the pain just like everyone else.

Monday's panicked U.S. stock sell-off, which drove the S&P 500 down more than 6 percent, is affecting investors from average Americans to the world's richest hedge fund managers, investors and fund managers said.

The losses triggered by Europe's debt crisis and the downgrade of America's triple-A credit rating are not expected to be as damaging as the 2008 financial crisis, but they are sure to be very deep and could make 2011 very difficult for the $2 trillion (1.22 trillion pounds) hedge fund industry.

Indeed, through the end of July industry numbers were mediocre at best with the average fund up only 1.55 percent, according to Hedge Fund Research.

Even the investment superstars who outsmarted the housing collapse and battered financial sector might soon be telling their investors that they suffered double-digit losses during the last few days, managers and investors forecast.

"The markets are incredibly stretched and you are going to have this tremendous volatility," said Richard Campagna, chief investment officer at Pasadena, California-based hedge fund 300North Capital LLC. "That means we are not done with this."

WIDESPREAD PAIN

The pain is expected to be widespread across strategies with only so-called short sellers, who bet exclusively on market declines, and some global macro players, who make large calls on currencies and interest rates, being able to boast about gains, investors and managers said.

"The better hedge fund players were fairly defensive and that means you are going to end up sitting on a lot of cash," Campagna said.

For most managers the first seven months had already been hit or miss as the U.S. economy failed to recover as quickly as many had hoped and Europe's debt crisis worsened.

So even the small gains nursed by big hedge funds like Dan Loeb's Third Point, and others at the end of July, are likely to have vanished in the first few days of August.

"All of those small gains were given back, gone, done," said one investor who asked not to be named because he is not allowed to speak about returns publicly.

And for some, like John Paulson, who had already headed into August with losses of 15 percent in his Advantage Fund, the scars are expected to be even deeper.

Bank of America (BAC.N) was a big loser on Monday, nursing a 20 percent drop. And since Paulson had owned more than 120 million shares in the bank at the end of the first quarter, investors reasoned that the billionaire fund manager took quite a hit.

David Tepper, who had made billions two years ago by betting on battered bank stocks, sold off nearly 42 percent of his 17 million shares of Bank of America holdings in the second quarter, according to a regulatory filing. His lack of confidence in the lender was seen as accelerating the drop.

BUT NO BLOODBATH

As talk of losses swirled, rumors swirled about who might have suffered fatal blows. But people familiar with a broad swath of managers said there had been no massive margin calls.

A bloodbath might have been averted because hedge funds took more defensive positions heading into August. They lacked a sense of conviction about the markets and they were worried about politics and whether the U.S. debt ceiling would be raised, investors and fund managers said.

Still, hedge fund investors who remember the rush to exit funds during the financial crisis are taking no chances. Worried that their own investors will pull money out, so-called fund of funds are first in line in handing in redemption notices to hedge funds, people familiar with the moves said.

For funds that have a 45-day notice period, the deadline to say they want out is Monday. Others who are invested through large investment platforms have to give only one month's notice.

"Right now people are angry and confused and no one wants to be the last one without a way to get out," said one investor. "People are putting in notices now and thinking they can pull them back if things should improve."

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