The New York Times is reporting Hedge Funds Are Bracing for Investors to Cash Out.

First, the money rushed into hedge funds. Now, some fear, it could rush out. After years of explosive growth, losses are mounting — and so are concerns that some investors will head for the exits.

The big worry is that a spate of hurried sales could unleash a vicious circle within the hedge fund industry, with the sales leading to more losses, and those losses leading to more withdrawals, and so on. A big test will come on Tuesday, when many funds are scheduled to accept withdrawal requests for the end of the year.

“Everybody’s watching for redemptions,” said James McKee, director of hedge fund research at Callan Associates, a consulting firm in San Francisco. “And there could be a cascading effect, where redemptions cause other redemptions.”

This is shaping up to be the industry’s worst year on record, with the average fund down nearly 10 percent so far, according to Hedge Fund Research. Famous traders like Steven A. Cohen, who runs SAC Capital Advisors, are losing money, and even Kenneth C. Griffin, the head of Citadel Investment Group, is down in one of his funds.

Returns are not in yet for September, but hedge fund managers say this month is even worse than the summer. Some funds were hurt by new rules from the Securities and Exchange Commission on short-selling, a tactic for betting against stock prices. The commission made it more difficult to short all stocks and temporarily banned the strategy in more than 800 financial stocks. In particular, this hurt convertible-bond managers, who often buy bonds that can be converted into shares and short the underlying stocks.

The short-selling ban lasts until Thursday evening, but it is widely expected to be extended.

Typical Hedge Fund Model

  • Hedge Funds take 2% assets under management
  • Hedge Funds take 20% of the gains
  • There is no transparency. You cannot see what they are doing.
  • Your money can be locked up for extended periods of time.
  • Hedge Funds commonly use leverage.
  • Hedge Funds supposed to make money in up and down markets
  • The average hedge fund is down 10% this year.

A big hedge fund redemption is certainly warranted. Also, the entire industry is under scrutiny of the SEC in an absurd with hunt against short sellers. The irony is the biggest short sellers are Goldman Sachs and Morgan Stanley, the last places the SEC will look in any witch hunt.

Mike “Mish” Shedlock
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