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August 15, 2007
Reasonable Fear
Sentinel Management Group asked the CFTC to halt redemptions yesterday and the CFTC responded by saying “no authority in this area”. As these events unfolded the onlooker could not help but marvel at the irony of it all: funds that previously basked in unregulated glory seeking the protection of regulators. Classic.
While it is not known whether or not Sentinel had been one the many funds that took an active role in avoiding regulation (until yesterday I had not heard of the fund), what is known is that we have exited a period of hedge fund growth and entered a period of great uncertainty. The questions to be asked are numerous. How many funds will collapse? Will hedge fund liquidations (continue) to impact the financial markets? Can disaster be averted by simply keeping investor funds locked in the funds? How many funds have shoddy redemption guidelines?
Unfortunately, while these questions deserve attention, the fact is we do not have the information required to form the answers. Instead we have a marketplace being driven by fear and greed, and fear has been getting the upper hand of late:
“Investor fear has overtaken reason and has induced a period in which most securities have simply ceased to trade.” Sentinel Letter To Clients, Aug 13, 2007.
Just to clarify, largely unregulated securities that were not readily hedgable have ‘ceased to trade’ (and because Sentinel did not see these events coming they conclude that ‘fear’ is trumping ‘reason’). Sentinel goes on to say:
“We are concerned that we cannot meet any significant redemption requests without selling securities at deep discounts to their fair value and therefore causing unnecessary losses to our clients.”
Since Sentinel cannot sell its holdings at what it believes to be a fair price, stakeholders can not sell there holdings in Sentinel.
Speculators have chased after returns in hedge funds for years, and now - after failing to provide stakeholders with clear ownership rules – funds like Sentinel are trying to turn these gamblers into long-term value investors with exposure to potentially undervalued, albeit completely illiquid, securities. Is it not reasonable to fear a disastrous outcome to this story if liquidity in the untradable assets in question does not quickly return? At what point in time does it become unreasonable for hedge funds to keep a lock on redemptions?
So many questions after yesterday and only one conclusion: ECB President Jean-Claude Trichet calling for calm is not reassuring.
“I call on all parties concerned to continue to keep their composure”
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