Updated from 4:26 p.m.
It is looking like a bear of a summer for
hedge fund manager Ralph Cioffi.
Wall Street learned Tuesday just how bad the carnage is in two of Cioffi's funds, a month after they nearly collapsed under the weight of bad bets on the swooning subprime mortgage business. The two funds chock full of esoteric securities -- High-Grade Structured Credit Strategies Fund and its sister vehicle, High Grade Structured Credit Enhanced Leveraged Fund -- are now worth less than 10 cents on the dollar, according to media reports.
Sources say investors had been expecting a recovery of around 50 cents on the dollar for the less leveraged fund. Bear shares fell almost 3% in after-hours trading.
The credit markets and parts of the stock market -- particularly Bear's own shares, which are down nearly 20% this year -- have already felt subprime pain. The fear in some quarters is that Bear's pain could have a cascading effect that forces hedge funds and others on Wall Street to offload hard-to-sell assets in a fire sale.
Stock-market bears say such a fire sale could force some selling of all types of securities -- which could lead to a ratcheting up of lending standards and reduce the liquidity that's been such a boon to the stock market.
In this opaque market where valuation is based on models and trading is over-the-counter, not via transparent pricing systems like stocks or cash bonds, the implications of Bear's new information is hard to determine. But "any new information on price discovery is valuable," says Chris Vincent, head of fixed income at William Blair & Co.
Cioffi and his team at Bear have been trying to "mark to market" the subprime securities that primarily make up their collateralized debt obligations -- pools of loans and bonds backed by subprime paper.
The market has been watching the ABX index -- used to hedge bets on mortgage securities -- lose value as more and more problems emerge with subprime debt.
The fall of the ABX index, amid the downgrade of billions in subprime securities by Standard & Poor's and Moody's Investors Service and a foreboding of bad news from Bear, has proved a challenge for the funds as they price the underlying securities, say the traders observing the situation.
"If you're valuing something at the lowest point of the ABX pricing, it's really about perception," says one trader at a bulge bracket firm in New York, commenting on the index hitting its all-time lows.
"The fears surrounding this are all about leverage," adds one fund of funds manager who declined to be named. If more money managers are forced to mark down the value of the assets in their portfolios, banks and brokerages that lend money to hedge funds via the prime brokerage business may be marking up the fees they charge for extending that leverage.
Indeed, the troubles at Bear started when prime brokerages including
demanded the company post more in collateral as the subprime market began to tank.
Bear itself has pledged some $1.6 billion for the high grade fund, but nothing for the more highly leveraged enhanced vehicle.
"If it's a worst-case scenario, the whole subprime issue will come back to the forefront for the stock market," says Art Hogan, chief market analyst at Jefferies & Co.
Bear shares fell $3.94 late Tuesday to $135.97.
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
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