Wednesday, April 30, 2008

LTCM Redux: Phd's fail yet again

Apparantly they did not learn the first time.... John Meriwether's Long Term Capital Management hedge fund blew up in the late 1990's and was bailed out. It looks like he is well on his way to another failure

Tuesday, April 29, 2008

Has the commodity bubble burst?

Recently, broad based selling swept through the energy, grains, livestock and metals markets.... Has the commodity bubble burst, or is this just another short term correction in a continuing long term trend? The current situation is similar to what I described late last

China Sets Oil Consumption Record

China's oil consumption hits record high in first quarter

Soaring oil prices have not slowed China's consumption of oil as statistics show that China's apparent consumption of crude oil and refined oil products both hit record highs in the first quarter of the year.

According to statistics released Tuesday by the

Monday, April 28, 2008

Europe Braces for Inflationary Shock FRANKFURT: Europe is facing a "very strong inflationary shock" as a result of rising energy and food costs, the top European Union official for economic affairs said Monday as the price of oil neared $120 a barrel.

Joaquín Almunia, the EU commissioner for economic and monetary affairs, said that higher inflation was emerging as "a big punishment to the weakest sectors of society," because it eats away at the purchasing power of people who have seen their incomes stagnate in recent years

Is this really 70's style stagflation?

April 28 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke may have to start talking and acting more like Paul Volcker if he wants to avoid being remembered as another Arthur Burns.

With oil and food prices surging, Volcker told the Economic Club of New York on April 9 that ``there are some resemblances between the present situation and the period in the early 1970s,'' when then-Fed Chairman Burns let an inflation psychology take hold

Saturday, April 26, 2008

The Stock Market Crash Of October 1987

Front Page NY Times October 20 1987
Front Page of the NY Times October 20, 1987 (now a poster in my home office)
Black Monday, Terrible Tuesday: The Stock Market Crash of October 1987: For a few short days in October 1987 the U.S. financial system came perilously close to completely collapsing. Dramatic shifts in the flow of capital between interrelated markets occurred as a sudden swing in expectations from optimism to pessimism among market participants overwhelmed the worlds financial systems. Panic selling led to a complete loss of liquidity and a breakdown in the clearing and settlement process that hindered capital flows between markets (Eichenwald, 1). 

On Monday, October 19, 1987, the Dow Jones Industrial Average fell 22.6%, its greatest one day loss ever:
On the following Tuesday, it was up to the Federal Reserve Bank to pick up the pieces and prevent financial gridlock. There is not much debate today as to what caused the crash, as there were fundamental reasons that did not justify the level of valuation given to the stock market. One of the main factors that pushed stock prices so high throughout 1987 and created the speculative bubble was the large influx of foreign capital, especially from Japan (Solomon, 48). Also, a large amount of highly leveraged corporate takeovers reduced U.S. corporate equity while at the same time raising corporate debt levels to record levels.

Dow Jones Average (10/12/1987 - 10/26/1987)
Going into the fall of 1987, large U.S. trade and budget deficits combined with rising interest rates throughout the world put pressure on the dollar to depreciate and led market players to lose confidence in the G-7's ability to maintain target rates for currency exchange set by the Louvre accord (Soros, 346). There was a series of bad news beginning on Wednesday, Oct 14, beginning with the raising of interest rates in Germany by the Bundesbank, followed by a larger than expected U.S. trade deficit (Solomon, 49)

The rise in interest rates leading up to the crash was creating a large and untenable spread between returns on bonds and stocks. This can be shown by the large rise in the spread between the 30yr U.S. T-Bond yield and the dividend yield on the Dow Industrial Average throughout 1987 leading up to the crash as indicated in the following graph.

Spread between 30yr T-Bond Yield and Dow Ind. Yield% (weekly 6/5/87 - 12/25/87)
Spread between 30yr T-Bond Yield and Dow Ind. Yield% (weekly 6/5/87 - 12/25/87)
Over the weekend immediately prior to Oct 19 1987, a massive, sudden reversal of sentiment occurred from the optimism that current difficulties would be resolved to a sudden pessimism (Toporowski, 3). This change in market psychology dramatically increased the demand for safety and liquidity.Ominously, prior to the U.S. opening on Monday, Tokyo's Nikkei Average closed down -2.5% and London's FT 30-share index fell -10.1%. On Monday morning in the U.S., the market makers were the first firms to suffer from the onslaught of selling pressure (Hertzberg, 1). Volume on the NYSE was three times normal on 10/19 and buyers all but disappeared which left the market makers by themselves in the market, forced to buy stock when there were no other buyers (Hertzberg, 1). This left them with huge inventories that they would have to pay for at settlement, which for stocks was five days hence (Solomon, 66).

Many market makers simply stopped buying from sellers despite their obligation to do so (Solomon, 67). As a result, on Tuesday, many stocks stopped trading and this in turn had a domino effect on the futures and options markets (Hertzberg, 23). The S & P 500, which is a popular hedging instrument for owners of stock who sell futures to protect their stock portfolios against losses, ceased trading from 12:15pm to 1:00pm (Hertzberg, 23). Rumors that the NYSE was going to close put the stock indexes in a further freefall but Fed officials strongly encouraged NYSE Chairman John Phelan to keep the NYSE open despite desperate pleas from brokerages and market makers (Hertzberg, 23).

With sellers outnumbering buyers 40 to 1, arbitrage became impossible as intermarket linkages broke when liquidity dried up in the stock market (Antoniou, 1459). The result of this was a vicious downward spiral in both the stock and stock index futures markets (Antoniou, 1460). The record volume overwhelmed the clearing and settlement systems, creating confusion and significant delays with one system suffering a complete overload, losing both orders and trade reports (Lindsey, 285).

Following the NYSE close on Monday, as foreign markets opened, the result was similar. In Tokyo, 95% of the stocks could not open for trading due to extreme selling pressure and the Nikkei Average closed down -14.9% (Solomon, 82). Australia had no formal pauses in trading but the All Ordinaries Index closed down -24.9%. In Germany on the Frankfurt exchange, Indexes fell -5.08% and in England the FT-30 Index fell -11.7%. In European markets, there was generally no breakdown in trading as there was in the U.S. This can be attributed to more heavily regulated markets and capital controls that made it more difficult for international investors to buy and sell at will (Toporowski, 132). The worst damage may of occurred in Hong Kong, whose stock and futures markets closed for a week. This locked many large brokerage firms into positions that they wanted to liquidate (Solomon, 102). These same brokerages were the underwriters of a large rescue fund that the Hong Kong government used to bailout speculators and reopen the Hong Kong Stock Exchange (Toporowski, 131).

The biggest problems occurred on Tuesday following the crash when differences in the clearing and settlement obligations of the stock, options and futures markets further increased the demand for loans (Garcia, 154). The transfer of funds, or settlement as it is called, occurred in the stock market on the fifth business day after a trade was made. In the options market, settlement occurs at the market open of the next day and in the futures markets, margin calls to firms were payable within the hour (Garcia, 154). Gerald Corrigan, then president of the Federal Reserve Bank of New York said after the crash, "The greatest threat to the stability of the 1987 market break was the danger of a major default in one of these clearing and settlement systems." These asymmetries forced further liquidation as traders scrambled to meet margin and settlement requirements (Garcia, 154). The disruptions in the flow of funds threatened not only br kerage firms, but also central clearinghouses that are vital to the operation of the financial markets (Eichenwald, 1). The large volume of trades on Oct 19 and 20 greatly increased the demand for short-term credit that was needed by market players to fulfill their settlement obligations.

Alan Greenspan was appointed Chairman of the Federal Reserve Bank in August of 1987 and at this time was standing in the shadow of Paul Volcker, whom Wall Street trusted as a tested leader in moments of crisis (Murray, 26). One of the first things Greenspan did upon assuming his role as Chairman was to set up a task force to make sure the Fed was ready for any financial crisis that might arise (Solomon, 47). The result of this task force was a large notebook that became known as the Pink Book (Solomon, 47). The Pink Book described strategies for responding to certain financial crisis, one of which was a hypothesized stock market crash of 150 points (Solomon, 47). This was nowhere as severe as the 508 point drop on October 19, but Chairman Greenspan and other members of the Federal Reserve rose to meet the challenge. Fed officials established a crisis center in an office at the Fed's headquarters where they stayed round the clock and monitored worldwide markets (Murray, 1). There they opened channels to other officials at major exchanges, banks and brokerages to assess the situation.

The Fed officials knew that liquidity would be a problem on Tuesday. As losses mounted, banks became reluctant to extend credit to brokerages and market makers. If credit dried up, securities firms would collapse and economic gridlock would ensue and it was the goal of the Federal Reserve Bank not to let that happen. The crash placed a huge demand for credit on the banking system as securities firms and their customers had to meet margin calls that were 10 times precrash levels (Garcia, 153). At the same time, banks became reluctant to lend out of fear of adverse selection and a further market collapse that would expose them to losses.

Aside from serving as a source of liquidity, the Federal Reserve Bank also played the role of psychologist, trying to restore confidence by sending the message that the system would not be allowed to fail. Particularly important was the role of New York Federal Reserve President E. Gerald Corrigan. Being in New York and connected to Wall Street, Corrigan played a crucial role as the Fed's eyes and ears on Wall Street. He personally urged bankers in New York not to seize up and to continue lending to securities firms (Eichenwald, 1). Because of the Fed's moral suasion and reassurance to bankers that they would not have to worry about running out of funds, the banking system did not turn its back on Wall Street and handled the special needs created by the crash (Quint, 10).

On the morning of Oct 20 at 8:15 am the Fed released a statement that said "The Federal Reserve, consistent with its responsibilities as the nations central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system." (Garcia, 1). The Fed then backed up its words with action by supplying liquidity through open market purchases of U.S. government securities which drove down interest rates as displayed in the following chart.

Yield Curve During the Crash of October 1987
Yield Curve, Daily (10/16/1987 - 10/21/1987)
The actions of the Federal Reserve dramatically lowered interest rates. Not only did the yield curve drop lower, but the Federal Funds rate fell from 7.5% on Monday to 6.75% on Tuesday (Murray, 1). The Fed was liquefying banks who would in turn liquefy securities firms (Soloman, 56). In this way, the Fed could avoid the moral hazard of bailing out the securities firms directly.

U.S. Federal Reserve officials requested that Japanese and German Central Banks follow suit in easing credit conditions (Solomon, 85). The fear was that if the U.S. Fed strongly eased but Japan and Germany did not, the resulting widening of interest rate differentials would cause capital flight from the U.S. and a similar move in bonds resulting in a rise in interest rates (Solomon, 85). In response to this, Japanese officials at the Ministry of Finance encouraged major brokerage houses not to sell and encouraged investors to focus on the fundamentals of the economy (Solomon, 84). The Bank of Japan modestly eased credit and several large brokerage firms agreed to buy shares in the Japanese bellwether Nippon Telegraph and Telephone (Solomon, 84). Further moves to limit selling pressure included the lowering of margin requirements by Tokyo stock exchange officials. As a result of the above moves, the loss in Japan's Tokyo's Nikkei Average was limited to -14.9% on Tuesday. After the close, Bank of Japan Governor Satoshi Sumita issued a statement: "The Bank of Japan is determined to continue to pursue firmly the cooperative framework of the Louvre Agreement" and followed up with foreign exchange intervention for the next few days to prevent a dollar plunge (Solomon, 88).

However, on Tuesday morning, things got worse before they got better. The NYSE opened on time but many sectors were at a standstill. When trading did resume, there was a brief rally during which market makers and major firms unloaded the large inventories they had accumulated. (Hertzberg, 23). This brought a barrage of sell orders which caused the closure of trading in many of the stocks and options as market makers simply stood aside and let them collapse (Hertzberg, 23). All selling and no buying caused the stock index futures to sell at a large discount to the underlying cash value of the stocks.

S&P Cash to Futures Spread vs. MMI Cash to Futures Spread
"Terrible Tuesday" (October 20, 1987) S&P Cash to Futures Spread vs. MMI Cash to Futures Spread
This is an example of how extreme the selling pressure was, there weren't even any arbitragers willing to buy the futures at such a large discount and as a result, trading in the Standard and Poors 500 futures contract ceased from 12:15 pm until 1:00 pm.

The turning point came early Tuesday afternoon when the Major Market Index futures contract on the Chicago Board of Trade, a little known stock index similar in content to the Dow Jones Average index, staged a powerful rally, apparently due to manipulation, driving the futures to a premium to the cash index (Hertzberg, 23). This triggered buying of the underlying stocks included in the Major Market Index as arbitragers attempt to profit by buying the underlying stocks when they are undervalued relative to the futures. Because many of the stocks that comprise the MMI are also included in the Dow Jones Average, the buying carried over to that average as well (Hertzberg, 23).

Also important in reversing the downtrend that Tuesday afternoon were the announcements of stock buybacks by several large corporations, apparantly under the encouragement of major investment banks (Hertzberg, 23). These developments combined with the Fed's actions caused market sentiment to swing to optimism just as rapidly as it switched to pessimism the prior day and at the close on Tuesday the DJIA was up 5.88% and followed through with record gains of 10.1% on Wednesday, October 21.

The dollar held up reasonably well in the days following the crash, due in large part to a capital flight to safety into the most liquid asset available, U.S. Government Bonds.

The crash signaled the arrival of high-speed global financial markets that overwhelmed the credit and settlement processes. Market players wanted more liquidity and when they feared they couldn't get it, panic ensued. The structure of the financial markets in 1987 simply could not handle the volatility during the crash. Prone to excess, the systems structure was outdated. This led the Brady Commission Study of the crash to suggest that a simpler, single mechanism should be developed for settlement in the Stock, Futures and Options Markets (Lindsey, 103). Since that time, there have been many innovations and improvements to the clearing and settlement process that make a repeat of the events of October 1987 very unlikely.

Because of the Fed's quick action in using its lender of last resort power, its quickness in increasing the money supply and their calming effect on the banking sector, a disaster was averted and the crash of 1987 turned into an economic non-event. At the time, there was some fear that the crash would cause a decline in consumption and thus result in a decline in Gross Domestic Product due to the loss in wealth, but it was essentially a financial crash and not an economic crash and did not reflect the real economy (Toporowski, 142). The 87' crash did provide a wakeup call to the world and especially the U.S to modernize its financial systems to be able to handle the coming advances in technology and the speed of information flows. By John Bardacino, CAIA (written in the fall of 1999).


Arbel, Carvell, and Erik Postnieks. "The Smart Crash of October 19th." Harvard Business Review

Bernanke, Ben S. "Clearing and Settlement during the Crash." The Review of Financial Studies volume 3, issue n.1 (1990): 133-151.

Eichenwald, Kurt. "The day the Nations cash pipeline almost ran dry." The New York Times 2 Oct. 1988: F1.

Garcia, Gillian. "The lender of last resort in the wake of the crash." American Economic Review volume 79, issue n2 (1989): 151-154

Laing, Jonathan R. "Taking Stock of the Crash One Year Later." Barrons 17 Oct. 1988:

Murray, Alan. "Fed's new Chairman wins a lot of praise on handling the crash" The Wall Street Journal 25 Nov. 1987: 1.

Quint, Michael. "A crisis manager takes on the mechanics of the market." The New York Times 2 Oct. 1988: F1.

Solomon, Steven. The Confidence Game. New York: Simon & Schuster, 1995

Soros, George. The Alchemy of Finance. 2nd. ed. New York: John Wiley & Sons, 1994.

"Statement by Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, March 31, 1988" Federal Reserve Bulletin volume 74, issue n5 (1988): 312-316

Stewart, James B. and Daniel Hertzberg. "How the Stock Market almost disintegrated a day after the crash" The Wall Street Journal 20 Nov. 1987: 1.

Toporowski, Jan. The Economics of Financial Markets and the 1987 Crash. Brookfield, Vermont: Edward Elgar Publishing Limited, 1993.

Wednesday, April 23, 2008

Food tensions creep to surface in USA

WASHINGTON/NEW YORK (Reuters) - With global tensions over food supplies mounting, prices of world staples rice and corn surged on Tuesday amid strong demand and concerns over slow planting of the new U.S. corn crop.

Meanwhile, the Asian Development Bank warned Asian countries against export controls, and the Inter-American Development Bank said the food-versus-fuel debate had changed the way it evaluates financing of biofuel projects that could siphon off staples like corn or soybeans.

Even in the United States, the world's breadbasket, a leading retailer reported signs of growing concern about rising food costs and dwindling supplies

Tuesday, April 22, 2008

Bargains for high-grade bonds drawing in hedge funds

LONDON (Reuters) - The credit market turmoil is presenting opportunities for funds to snap up investment grade bonds at bargain basement prices, particularly among financials, but the window of opportunity is unlikely to be open for long.

With hedge funds and other nimble investors coming back to the market, and historically wide spreads -- the premium firms pay to borrow money over risk-free bonds -- beginning to narrow, corporate credit at current cheap levels is unlikely to last

Friday, April 18, 2008

China overtakes U.S. to become second-largest exporter

Global trade growth is expected to slow to a six-year low of 4.5 per cent this year but China has overtaken the US as the world's second-biggest exporter, the World Trade Organisation (WTO) said yesterday.

Heavily influenced by the turmoil in financial markets and the sharp economic slowdown in leading western economies, global merchandise trade is forecast to rise by 4.5 per cent this year, against last year's 5.5 per cent.

But the WTO gave warning that a stronger slowdown in global economic growth “could cut trade much more sharply, to significantly less” than the projected level of 4.5 per cent

Google trounces estimates with 30% increase

The slowing U.S. economy did not seem to slow down Google, which reported a surprisingly strong surge in first-quarter profits Thursday.

Google's net income jumped 31 percent to $1.31 billion and revenues swelled 42 percent to $5.19 billion compared to the same period last year.

The report trumped many Wall Street analysts, who had reduced their forecasts for Google's growth based on third-party research that suggested fewer people were clicking on Google ads.

"Google has completely silenced the cynics

Tuesday, April 15, 2008

The Distressed Securities Strategy

This strategy involves investing in the securities of a company that is or is expected to be in trouble. Some distressed securities can trade at large discounts to their actual risk adjusted basis. This is due to the psychological effect that occurs in the marketplace when a firm gets into trouble or files for bankruptcy.

The marketplace can be ruthless when it comes to punishing the prices of troubled firms, oftentimes going too far, and in the process this creates undervalued securities. Part of this is due to the fact that demand for these securities is hurt because institutional investment managers, such as insurance companies, pensions, foundations, endowments, banks, trustees, are prohibited from investing in securities that classify as distressed. This is due to the strict rules that many money managers must follow due to

10 Reasons To Like US Stocks

LONDON (Reuters) - BlackRock, the giant U.S. investment fund with some $1.36 trillion in assets under management, reckons the banking crisis is not over and companies are delaying expansion plans and in some case cutting spending.

But in a note, Bob Doll, the firm's global chief investment officer for equities, says there are nonetheless 10 positive factors underlying U.S. equities.

Here they are

Hedge Funds Buying Distressed Securities

Hedge fund managers are poised to leap into the pool of distressed and incorrectly priced securities created by the credit crunch.

Swiss private bank Union Bancaire Privée and Swiss manager Gottex Fund Management are launching funds that will invest in debt they believe is temporarily undervalued as a result of market conditions.

The opportunity is on a large scale.

The International Monetary Fund last week put the total cost of the credit squeeze to the global economy at almost $1 trillion (€640bn) and figures from BNP Paribas and Bank of America put the global backlog of unsold acquisition finance on banks’ balance sheets—only a part of the overall opportunity—at about $282bn at the end of January.

But even the most bullish hedge fund managers are proceeding with caution, suggesting in the short term they may not make much of a dent in the backlog, or ride to the rescue of asset-backed securities markets.

Meanwhile, private equity firms, some of which have run credit funds for years, are joining in the bargain hunting.

Last week, US private equity houses TPG, Apollo and Blackstone were in negotiations to acquire $12bn of leveraged loans from Citigroup, and the Carlyle Group has launched a fund to do similar deals. This is despite any possible conflicts of interest involved in these firms purchasing debt issued by their own portfolio companies.

Private equity firms are better placed because they have the funds in place, as well as hundreds of billions of dollars in unused commitments from institutional investors—$176bn has been raised so far this year, according to analysts Preqin.

Buyout firms also have a vested interest in getting the debt markets moving. Hedge funds, by comparison, have to spend time and money on the road raising fresh capital.

Some think the effort is worth it.

Union Bancaire Privée, which is one of the world’s largest investors in hedge funds, launched two funds of funds last week to hunt for distressed opportunities, and is seeking to raise up to $1bn from institutional investors and wealthy individuals.

One of the funds will invest across the troubled credit markets, putting 75% of its capital in hedge funds and the remainder in private equity funds. It will look for undervalued bank loans and corporate debt, asset backed securities, as well as opportunities in rescue or turnround situations.

Shoaib Khan, a senior portfolio manager at UBP, said: “While the basket of bank loans trading at stressed and distressed levels may not be attractive, there are situations within the basket that are attractive.

“It is our intention to capture these select opportunities trading at cheap valuations, but have good collateral and covenants in order to provide downside protection.”

The funds will be unleveraged, though some of the underlying managers may borrow temporarily to fund their positions. Khan, who will manage the hedge fund portion, believes net returns of 15% to 20% a year are possible without leverage.

He said: “It is not our objective to have leverage provide us the returns. The funds we are targeting to include in the product do not use leverage.”

February’s collapse of a $2bn fund run by UK manager Peloton Partners illustrated the perils of borrowing to buy too soon.

Peloton took out $7bn of debt from its bankers in order to buy a $9bn portfolio of mortgage-backed securities, but when they fell further in value, the bankers declined to extend their loans.

Other managers are looking to exploit the credit market turbulence using strategies that are less bold. Gottex is raising money for a fund to invest in “recovering” assets, which it defines as high-quality debt that it believes is undervalued by the market. This fund will be unleveraged, and Gottex says it will specifically eschew distressed situations.

Andre Keijsers, a managing director at Gottex, said: “The recovery fund will look for depressed assets, such as mortgages, that have been hammered down together with the rest of their sector but should have higher valuations.

“Out of 100 securities in the sector there might be two or three interesting opportunities, but if you can hold them for the long term, perhaps two to three years, you can ride out the market troubles. Recovery to the mean is a very powerful force and over time it usually happens.”

Gottex has no formal target for the size of the fund but says it has capacity for as much as $6bn.

Three quarters of the assets will be invested in underlying hedge funds but up to 25% will be held directly in debt securities, and there are likely to be redemption restrictions commensurate with an investment horizon of two to four years, Keijsers said.

Managers such as the UK’s Thames River Capital and Swiss-owned GAM, which run funds of hedge funds, have studied the prospects for launching funds to buy bank debt but are holding back for now.

A spokeswoman for GAM said: “The feeling is that it is a little bit too early. We would not launch such a fund unless there was demand from our clients.”


Sunday, April 13, 2008

Bear trend for equities remains dominant

Earnings are bad, inflation is bad, the credit crisis is bad.... But isn't it always darkest before the dawn? Are stock market bottoms not made when the news is the worst and things look bleakest? Yes and yes.
But how does one know when a bottom is in place? It's very simple. The price action will tell you. Looking at long term charts of equities, such as the sp500, dow, etc, in my view the dominant trend remains down and rallies should continue to be sold and a long/short portfolio should be more heavily weighted toward the short side. Eventually things will change, probably at the end of 2008 or early 2009 and the dominant trend will turn bullish.... but for now short positions are in order until the fundamental context and price action prove otherwise. --John Bardacino

Thursday, April 10, 2008

New clouds on horizon for hedge funds

Hedge funds are still reeling after banks unexpectedly pulled credit lines and demanded more security against loans, forcing firesales and heavy losses.
By James Mackintosh, Financial Times

Now they face a new threat: investors are abandoning them, raising the risk that the funds will have to sell assets at any price to raise the cash to meet withdrawals.

So far redemptions are mainly in out-of-favour sectors such as credit funds, small-cap specialists and event-driven funds, which include activists, along with poor performers unexpectedly hurt by the credit squeeze.

But a series of big funds have already been forced to react, restricting withdrawals or restructuring, and more are thought to be considering changes.

“There are two ways you get squeezed running a hedge fund,” says one large investor in the industry. “One is that you can’t get finance from your prime broker. The other is that the clients take their money away and you can’t get enough liquidity [cash] to meet the redemptions.”

Sometimes this is the fault of the fund: big losses tend to prompt panic withdrawals.

But often it is part of a herd mentality that sets in when a strategy falls out of favour, with mass withdrawals from funds that have not been strong performers as investors try to reduce their exposure to that approach.

Recently withdrawals have also come as a result of difficulties at hedge fund investors, who redeem to free up cash to solve problems with other investments.

The growing list of hedge funds hurt by withdrawals lengthened further on Thursday when Tisbury Capital, a $2bn London event fund, received investor approval for a restructuring under which it will return $1.2bn of the $1.4bn of redemption requests. The remaining money, invested in illiquid, hard-to-sell assets, will be held until markets allow them to be sold at non-distressed prices.

New York-based global macro trader Drake Capital is trying to split into a continuing fund and a wind-down operation in order to repay half its investors, who want their money back after big losses from a bad bet on US Treasuries.

Polygon, an $8bn London multi-strategy and event fund, is offering investors new shares which remove a restrictive “gate” that it fears could have prompted a race for the exit by its investors after it received more than $800m of redemptions.

The problem that funds have is a mismatch of the terms they offer investors – typically withdrawals once a quarter or less frequently – and the speed with which they can sell illiquid investments to raise cash.

In the worst case rivals anticipate forced sales, pushing down the price of assets in which troubled funds invest.

Many funds use a gate to avoid forced sales of the underlying assets by imposing a limit on how much can be withdrawn each quarter.

However, investors who do not put in redemption requests can find themselves at the back of the queue for withdrawals, as people who did not get paid in full in the previous quarter get priority with the common “stacked gate” structure. As a result even investors who would otherwise stay put lodge redemption requests to avoid being last to get their money if they later decide to cash out.

“A stacked gate penalises long-term investment thinking,” says Paddy Dear, co-founder of Polygon.

Other funds hit by large-scale withdrawals have also been concocting novel ways to maintain their business while letting investors get at least some of their money back.

Part of the reason to restructure is that investors have traditionally regarded the use of a gate or the full-scale suspension of withdrawals as the death-knell for the fund, and been unwilling to back the manager in future.

But Arnauldt de Torquat, chief executive of London’s Harmony Asset Management, which has $500m invested in hedge funds, says he welcomes moves by troubled funds to restrict withdrawals.

“It is very inconvenient for us not to have liquidity but it makes absolutely no sense to force fund managers to sell illiquid assets in this environment.”

He argues that so many funds are now limiting withdrawals – particularly in the credit sector – that it will not affect their future if their performance recovers.

“Commercially today they are in trouble but this will be very quickly forgotten once markets recover,” he said.