'Smart Money' Stays on the Sides

Some hedge-fund titans have yanked most of their money out of the stock market, a bearish sign amid Monday's euphoria and an indication of how the hedge-fund business is changing amid chaos.

Steven Cohen

In recent days, Steven Cohen, the hedge-fund manager who runs the $14 billion SAC Capital Advisors, moved about half his funds, or about $7 billion, into money-market and other short-term securities, eliminating much of his fund's exposure to the stock market, says a person close to the fund. Mr. Cohen plans on sitting on the sidelines for the rest of the year -- trading a small portfolio himself but keeping shuttered most of the stock portfolios of his other managers.

Israel Englander, who runs the $14 billion Millennium Partners fund, has shifted about $6 billion from the stock market into cash, a person close to the fund says.

Meanwhile, John Paulson, manager of $35 billion Paulson & Co. -- who made a spectacularly successful bet against the housing market last year -- has much of his fund in cash equivalents.

John Paulson

The retrenchment by Wall Street's "smart money" crowd is part of a larger effort by hedge funds that have put a total of as much as $400 billion into cash equivalents recently, according to David Kostin, an analyst at Goldman Sachs Group Inc.

Of course, much of the smart money has been wrong in the credit crisis. Many hedge funds have lost big money in the past year. That said, Messrs. Paulson, Cohen and Englander have fared better than most: Mr. Paulson's main fund is up about 20% this year; Mr. Englander's main fund is down 0.5%; and Mr. Cohen's main fund is down more than 9% through September. This compares with a 29% loss in the Dow Jones Industrial Average, year to date.

Goldman's Mr. Kostin says some hedge funds are being forced to sell to meet investor redemptions. For their part, Messrs. Cohen and Englander have moved to cash because of extreme market chaos and investor panic, according to people familiar with their thinking.

"There is a lot of uncertainty out there and some people may be saying from a timing point of view they are more comfortable on the sidelines," Mr. Kostin says, though he declined to comment on the strategies or positions of the three managers.

The moves come amid stricter new regulatory limits on short selling, a strategy of betting against stocks, which is popular with hedge funds. The Securities and Exchange Commission twice this year imposed a partial ban on short selling.

Regulators also have called for more transparency and oversight of hedge funds. The SEC also is working on a rule that would require investors, including hedge funds, to disclose their short positions to the SEC.

An email from from Richard Fuld Jr., Lehman Brothers Holdings Inc.'s chief executive to Lehman General Counsel Thomas Russo on April 12, 2008, shows why hedge funds are so worried. In the email, Mr. Fuld, summarizing the points from a dinner with Treasury Secretary Henry Paulson, said Mr. Paulson wants to "kill the bad HFnds + heavily regulate the rest."

A spokesman for Lehman declined to comment. The email was released by congressional investigators last week examining the reasons behind Lehman's collapse and bankruptcy filing.

A large part of the selling by some hedge-fund managers has come since the beginning of October, helping to fuel the sharp selloff in stocks this month. Mr. Cohen, for instance, sold near half of his stock holdings last week, closing out the positions of roughly 50 managers who work for him because he felt they "weren't seeing the ball," says a person familiar with the situation.

Mr. Cohen's decision was made at the end of September and comes from an attempt to stem this year's losses. He now plans to keep that money on the market sidelines for the rest of the year, though he is still trading a small portfolio, along with a few other managers. The managers whose portfolios were shut are feeding Mr. Cohen short-term trading ideas, the person says.

Mr. Cohen has been one of the hedge-fund industry's most successful short-term stock-market traders, trading in and out of the market, and other traders sometimes look to him for direction. Mr. Cohen could conceivably jump back into the market quickly. Managers in cash Monday missed out on the Dow's biggest one-day point gain ever.

About 10% of Mr. Englander's market sales also were placed in the past several weeks. The rest were made in the summer, the person close to the fund says.

Mr. Paulson has been unwinding his positions for the past year; it is unclear how much has been done in recent weeks. Mr. Paulson has been raising a new fund to buy stakes in financial firms, though he has yet to do any buying, anticipating weak markets.

Even as Messrs. Cohen and Englander have been able to suck cash out of their investment portfolio, they are stuck holding some "illiquid," or difficult to trade, investments. Mr. Cohen, for instance, has 3% of his assets in a private-equity portfolio, which he accumulated over the last several years.

The pullback is a sign of how the hedge-fund industry could change amid the seismic shifts in the financial landscape. The number of hedge funds, which currently stands at around 8,000, is likely to shrink and those that remain will likely shrink in size. That represents a major reversal from recent years, when hedge funds sought to attract as much money from investors as possible, posting big profits though asset management fees they charge as well as the hefty cut in profits they take from their investors.

The move by the three managers steals a page from old-school hedge-fund managers like Michael Steinhardt, Julian Robertson and George Soros, who would quickly pull in their horns when the market moved against them and remain on the sidelines until conditions improved.

"Steinhardt would routinely go to cash," says John Lattanzio, who was Mr. Steinhardt's head trader at Mr. Steinhardt's hedge fund, Steinhardt Partners, for 25 years. "When he wasn't sure of what was happening, he'd say, 'Sell everything. Let's go to cash.' "