This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
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
Cramer's Action Alerts PLUS - See his portfolio and get alerts BEFORE every trade. Learn more NOW!

Hedge Fund Liquidations: Five Things You Need to Know

On the other hand, many hedge funds are levered through offshore facilities and in derivative contracts, whereby they can obtain leverage far greater 2-to-1. So what? Smaller losses have far greater impact on the equity of the fund.

Let's say a hedge fund's leverage is 5-to-1 and it's redemption time. In order to meet those redemptions, the hedge fund will have to sell at least $5 of investments for every $1 of required redemptions.

As redemptions tend to be clustered, the impact on individual stocks from hedge funds liquidating their holdings (to meet those redemptions) will be a magnified and concentrated hit on those stocks, and potentially the overall market.

Since the hedge funds are more concerned about creating liquidity than preserving the integrity of their portfolios during a crisis, the higher priced stocks tend to get sold first. It is far easier to create $10,000,000 of cash by selling smaller amounts of a $200 stock (say Apple (AAPL - Get Report)) than larger amounts of a $25 stock (say Altria (MO - Get Report)). And before you know it, that $200 stock has become a $100 stock. "Classic" valuation is thrown out the window.

4. The Futures Effect

Liquidating large amounts of stock for an individual fund can be a complex task:

  • Many of these hedge funds have outsized positions.
  • When another hedge fund sees a commonly held position begin to sell off there is a tendency to also enter the fray, causing a run on the stock.
  • Sometimes, there are hedges on the other side of the liquidation. Both sides have to be unwound simultaneously. In a fast or disjointed market this can cause confusion and risk management issues.
  • And when many hedge funds liquidate simultaneously, we have a rush to exit the markets as if there were a fire in a movie theater.

    In order to "front-run" the need to liquidate, some hedge funds will sell index futures in order to hedge or anticipate the required liquidation. (Don't miss " Five Things Every Investor Should Know About Index Futures")

    2 of 4

    Check Out Our Best Services for Investors

    Action Alerts PLUS

    Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

    Product Features:
    • $2.5+ million portfolio
    • Large-cap and dividend focus
    • Intraday trade alerts from Cramer
    Quant Ratings

    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
    Stocks Under $10

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

    Product Features:
    • Model portfolio
    • Stocks trading below $10
    • Intraday trade alerts
    14-Days Free
    Try it NOW
    Only $9.95
    Try it NOW
    14-Days Free
    Try it NOW

    Check Out Our Best Services for Investors

    Dividend Stock Advisor

    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
    • Updates with exact steps to take - BUY, HOLD, SELL
    Trifecta Stocks

    Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

    Product Features:
    • Model Portfolio
    • Intra Day Trade alerts
    • Access to Quant Ratings
    Options Profits

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

    Product Features:
    • Actionable options commentary and news
    • Real-time trading community
    Try it NOW
    Try it NOW
    Try it NOW
    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!
    SYM TRADE IT LAST %CHG
    AAPL $126.41 -1.66%
    FCX $20.19 -3.26%
    MO $55.50 -0.52%
    FB $81.21 0.39%
    GOOG $575.33 0.34%

    Markets

    DOW 18,135.72 +38.82 0.21%
    S&P 500 2,101.04 +2.51 0.12%
    NASDAQ 4,982.8090 +15.6680 0.32%

    Partners Compare Online Brokers

    Free Reports

    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