This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Hedge Fund Liquidations: Five Things You Need to Know

During the stock market decline (or "crash") of October 2008, various media outlets have loudly identified the impact of massive hedge fund liquidations as a key ingredient to the huge equity sell-off.

However, as an "average" individual investor, how well do you really understand how or why these mysterious investment funds have acted in such a brazen manner?

So as a follow-up to "Hedge Funds and You: What Individual Investors Need to Know," let's explore five things that you need to understand about hedge fund liquidations.



1. Meeting Redemptions

A hedge fund does not have to continually invest, as a mutual fund does. Rather, a hedge fund will allow its investors (typically "limited partners") to redeem all or part of their investments on a periodic basis. These redemptions usually follow very strict guidelines in accordance with the hedge fund operating agreement.

Typically, limited partners can only withdraw funds on a quarterly or annual basis. Furthermore, advanced notice (30 or more days) for redemption to the hedge fund manager is often required. Just as there may be a "run on a bank" there can also be a run on a hedge fund -- especially when performance is poor. Thus when redemptions occur they tend to be clustered across the entire hedge fund industry in a small window of time.

2. The FOF Effect

There are certain hedge funds which are set up as portfolios of other hedge funds. These are referred to as fund of funds (FOF). The concept is to diversify amongst many hedge funds. However, when a FOF is in redemption mode it has a decision to make: Either the FOF redeems an equal amount of investments across all of its hedge funds or it pulls out larger amounts from a few hedge funds.

Selling a small amount of many funds may have little impact on the liquidity of a single fund. However, liquidating a large portion from one fund could have dire consequences upon that individual fund.

3. Leverage

Average investors are subject to Federal Reserve Regulation T. Under Regulation T an investor can purchase a stock by borrowing money from a broker-dealer in a margin account. Under the margin rules the investor has to put up 50% of the purchase price in cash or other margin collateral. The other 50% is borrowed from the broker-dealer. Thus under Regulation T the investor has 2-to-1 leverage. Theoretically, the investment has to depreciate by 50% in order for the investor to be wiped out of their equity.

1 of 4

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 16,919.59 +80.85 0.48%
S&P 500 1,981.60 +9.86 0.50%
NASDAQ 4,527.5140 +19.2020 0.43%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs