Are the good times already over?

The possibility of hedge fund losses shook the U.S. and European markets last week on rumblings that they had to unwind $8 billion of complex credit derivatives trades.

The rumor surfaced following Standard & Poor’s downgrade of General Motors Corp. bonds to junk status, as well as an offer by U.S. billionaire investor Kirk Kerkorian to purchase 28 million shares of the automaker at $31 a share. The offer gives shareholders until June 7 to accept, and would give the billionaire a 9 percent stake in the company. The downgrade lowered the value of the corporate bonds, and investors who sold shares of GM stock to buy the bonds essentially lost on both ends of the trade.

By the end of the week, however, the market rumor concerning the unwinding of “losing positions” appears to have been unfounded. Nevertheless, the volume of trades that were in play indicates a high level of fear regarding overleveraged hedge funds.

Although the likelihood of a major collapse of another hedge fund — like Long Term Capital Management in 1998 — is debatable, one thing is sure: Several hedge managers have already latched onto a bearish outlook for U.S. equities in May.

The Van Hedge Fund Advisors International on May 2 released its market sentiment indicators for U.S. equities. The sentiment index is based on a survey of hedge-fund managers who employ a macro view and who manage, in the aggregate, in excess of $30 billion in assets. Van Hedge is a global hedge-fund advisory firm that constructs hedge-fund portfolios for international institutions and wealthy investors.

The market sentiment indicator revealed that managers are bearish in their outlook for May, with 63 percent expecting weakness in the S&P 500 to continue. Last month only 39 percent held a bearish posture, compared with just 29 percent in March. Those bullish fell to 26 percent, compared with 44 percent in the bulls camp last month. Managers who were neutral also declined, falling to 11 percent this month from 17 percent in April.

Hennessee Group, a separate advisory firm to hedge-fund investors, said on May 9 that “weak equity markets contributed to negative performance of hedge funds in April, as the Hennessee Hedge Fund Index declined by 1.75 percent, or –1.62 percent year-to-date. The broad market indices — S&P 500, Dow Jones Industrial Average and the Nasdaq Composite — also declined in April.”

This story first appeared in the May 16, 2005 issue of WWD. Subscribe Today.

Charles Gradante, managing principal of Hennessee Group, said that “stagflation” resurfaced in conversations with equity hedge-fund managers.

The Hennessee Long/Short Equity Index also declined in April by 2.19 percent, or minus 3.10 percent year-to-date. Gradante’s firm noted that “poor retail sales, slumping housing costs and low consumer confidence caused a market sell-off, pushing the market to six-month lows.”

The firm’s arbitrage/event-driven index was also down in April, declining 1.32 percent, or –0.71 percent year-to-date, as the convertible bond sell-off continued. Hennessee said the sell-off is creating the worst convertible arbitrage environment since 1994. GM happens to be the largest issuer of convertible bonds.

Macro managers who said they made money, according to Gradante, shorted oil and S&P 500 contracts and held long positions on the yen versus the U.S. dollar.

According to the Hedge Fund Association, the hedge fund industry is estimated at $875 billion, “and growing at about 20 percent per year, with approximately 8,350 active hedge funds.”

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