Friday, October 17, 2008

A Simple Hedge Fund Outflow Model

A few people have asked, so here is my (very) simple hedge fund outflow model. I think it is fairly conservative, but the assumptions are obviously key and open to wide disagreement.

In essence, I'm aging hedge fund inflows and saying that we will see a blended 40% (higher in later years, lower in earlier years) demand for redemptions from investors in the 2005-2008 period. I'm not worrying about pre-2005 assets under management, so we could see lower redemptions on new assets and more on the older stuff, taking us to the same place. I'm also positing that initial capital has shrunk by a blended 20% on inflows, which is admittedly on the high side. I then figure that turns into almost $200-billion in outflows, or a little less than $2-trillion in asset sales at an average of 10x leverage.

What does it all mean? Well, with TrimTabs saying that we had $43-billion in September outflows, and assuming managers expect at least a 50% higher figure in October, that means another $60-billion in selling. We are then about half-way through the unwinding -- assuming no major uber-levered fund failures.

Some say the leverage is lower, some higher. Some argue we will see lower/higher redemptions, or that median versus mean losses will be wildly different. Other say it's inherently a state change issue, where the paradox of delevering is that everyone doesn't get to shrink -- some firms just fail outright. Sure, fine, good -- but this is was what got me thinking about it.

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Lunch is for wimps

Lunch is for wimps
It's not a question of enough, pal. It's a zero sum game, somebody wins, somebody loses. Money itself isn't lost or made, it's simply transferred from one perception to another.