Hedge Funds And The Credit Markets

Growing number of Hedge Funds trade in the Credit Derivative Markets, such trading has grown particularly in the past few years. In a report by Roger Merritt, Eileen Fahey and Fitch Rating, it was shown that “Hedge funds’ influence on the credit markets clearly has accelerated.. The authors of the report went on to argue that  “Credit strategies, particularly those involving credit default swaps (CDS), were one of the fastest growing segments for hedge funds. As a result, hedge funds now make up nearly 60% of CDS trading volumes”.

In an address to the Credits Markets symposium in Charlotte Virginia, in 2007 by the Governor of the Federal Reserve Bank in Virginia, Governor Randall Kroszner noted that “ The evolution of the credit markets has been spurred by the astonishing growth of new credit instruments, particularly credit derivatives.  The notional amount of credit derivatives outstanding has doubled each year for the past five years; it totaled $20 trillion at the end of June 2006, according to statistics compiled by the Bank for International Settlements (BIS)”

 Last year the average hedge fund gained about 10.2%, according to hedge fund industry tracking firms.Credit Market problems have always rattled Hedge Funds,particularly those funds exposed to that sector. The past credit problems ranging from the French Bank, BNP Paribas, to some US Mortgage lenders have always had ramifications for Hedge Funds exposed to the Credit Markets. One thing we know for sure is that the growing interdependence of world economies means that economic problems of nations may impact the global exchanges of other countries, one way or the other.

The boom on the credit markets, are in part due to Hedge Fund’s growing activities in the credit sector. Hedge fund managers go in and out of the markets helping to increase liquidity in those exchange credit markets. In early 2005, the credit problems of General Motors, and Ford Motors caused problems for hedge fund companies exposed to that sector.Such problem also impacted the ratings of both General Motors and Ford Motors, whose credit ratings were subsequentlt downgraded to near junk bond status. But somehow hedge funds have survived such problems, and for the most part some hedge funds made money out of such negative scenario.

But the growing risks in the credit markets may at some point force hedge funds to unwind their positions in the credit markets, some analysts believe that the liquidity risks in the credit markets are growing, resulting from the financing of growing and very complex positions which are not only illiquid, but mat also be more difficult for valuation purposes  In the past, everal hedge funds have collapsed in part due to their portfolio exposure to the Credit Markets. Some of the recent examples includes Amaranth Hedge fund, RefCo, and Bear Stearns funds, among others.

In August 2007,  the  $2 billion Hedge fund firm, Sailfish Capital Partners withnessed huge losses coming from investor withdrawals from the fund, following rumors about the fund’s impending demise. Within that month, Sailfish lost about 12% of its managed assets, subsequently the managers announced to the fund’s investors through a letter that the fund would begin liquidations proceedings. The letter noted: “Our portfolio was hurt by higher rated securities and a rapid deterioration of liquidity and not by subprime or subprime derivatives. Nevertheless, it was the contagion effects of subprime that spilled rapidly into structured products, the leveraged loan market and all markets in general…and now clearly this has spilled into the equity markets as well”. The managers told the investors that as a result of difficult market conditions, in addition to investor withdrawals, the fund would be liquidating its operations.

Nevertheless hedge funds have done well in the credit markets. A recent published report  shows that out of about 260 various Credit Hedge Funds, the average return posted in 2007 was about 13.1 percent. 77 percent of those funds made money in 2007, while only 23 percent lost money. Hedge fund managers are able to cease opportunities during maket tumoil to choose potential profit opportunities arising out of such market distress. In 2008, one can expect to see few hedge funds that may become casualties of their portfolio exposure to the Credit Derivative Markets, but such losses may not bring down the world’s trading system as some tend to believe, that the pending troubles of the Real Estate sector may  have significant effect on the overrall global markets. Expect to see growing number of hedge funds in the Credit Derivative markets in future nonetheless.

Hedgefundexchange.net Staff writer
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