Redeeming Redemption Notice Day

It’s not the end of the world. Yet.

Oh dear. Certain quarters of the financial media have counted the pages in their little desk calendars—as NakedShorts did about two weeks ago—and clocked that Sep. 30 is just 45 days away, effectively marking the hedge fund redemption notice deadline for the third quarter. But it’s a bit early to be getting all excited:

• The fact that tomorrow is redemption notice day doesn’t mean a calamitous fire sale starts Thursday. Managers will need time—some more than others—to count the damage and begin making the ‘Are you sure you really want to do this?’ calls. And nobody, but nobody, will stand up and announce, at least on Thursday, that they’ve had 72 percent of their capital called.
• A redemption notice is not a redemption. The notice period is intended to give managers time to plan the orderly adjustment of their holdings; during that period, redemption notices can be, and often are, withdrawn or amended.
• Most managers, certainly those trading substantial portfolios in relatively illiquid—at the best of times, which these are most certainly not—instruments, have gate provisions that limit withdrawals to a certain percentage of portfolio assets over a certain period. In recent years, the sound of slamming gates was normally associated with single manager events; many more will be invoked this time around, dampening the selling pressure.
• Many managers also still have ‘payment-in-kind’ provisions. While rarely invoked—like gates, their activation is not conducive to any future relationship—the mere threat of finding a pile of unfamiliar and unknowable, but obviously too-long-in-the-hot-sun, securities landing in an account can pressure investors to reconsider their options.

This redemption season will be much more active than most, particularly in the most seriously brutalized styles—fixed income and merger arb, for two—but if the financial world ends Thursday, hedge fund redemptions will not be the proximate cause. Some other things to think about on the dark side.

• Estimates vary, but about 30 percent of hedge fund assets are in funds of hedge funds, many of which have 65-day notice periods. That window slammed shut in late July, when the issues in Fixed-Incomefundland were clearly evident, but before the wider breakdowns in quantitative strategies, and the fun-and-games over whether or not some big deals are actually going to get done, had yet to become evident.
• Many managers may already have begun the process of raising cash. Evidence? The recent surge in options volumes, and selling pressure—winning days have come on lower volumes, and sometimes negative breadth, classic signs of distribution—is a pointer, according to one experienced manager.
• As well, the delevering of stat-arb and various related strategies after last week’s wizard prang inadvertently took care of at least some selling pressure that might otherwise be concentrated in September.
• Perhaps as much as 20 percent of hedge fund assets are covered by some form of lock-up. Investors will have to consider whether or not to take the haircut, usually of around five percent, to hit the road early, even if the manager chooses to exercise his discretion and turn the key.

Some version of redemption Armageddon may be around the corner. But, for the next few weeks, those managers who do comment will probably be calmly reassuring. A Sowood-style re-run, or even two, will stir the waters, but Labor Day will be just a memory before anybody gets a too-solid handle on how this plays out.

Comments

[tom C.]

How will firms that deal largely in agency-backed mortgage debt hold up in this credit disinflation? Firms like [NLY] Annaly Capital Management would seem to benefit from widening yield spreads between 2yr and 10yr T-bills but they may not be able to drum up new business in this battered housing market.
Any thoughts?