Rational Advisor

New York Post reports: Hedge-fund executives say the next blow to hammer their industry will probably come from a wave of hedge-fund redemptions driven by highly-leveraged funds that invest in other hedge funds. (Hedge Fund-of-funds)

One bellwether of how this may play out in coming months can be seen in the performance of two key European-hedge funds that have had sharp losses because of their exposure to some of the most problematic investment strategies in this summer’s hedge-fund sell-off. Fix Asset Management’s Canary Fund Ltd. and Fairfax Fund Ltd. - each of which have $3.5 billion under management - have suffered a brutal three months.

Their fund-of-fund portfolios have dropped between 16 percent and 18 percent between June and August. While it could not be determined which hedge funds had investments from Canary and Fairfax, given the size and timing of their monthly losses, it appears likely that the two funds had significant exposure to funds employing statistical arbitrage, credit arbitrage and merger arbitrage strategies.

The problemo for the hedge-fund biz, according to a vet hedge-fund capital provider, is that Fix’s Canary and Fairfax funds are likely not the only fund-of-funds that used borrowings to enhance their performance. Several hedge-fund executives told The Post that a next wave of hedge-fund redemptions would likely be fueled by highly-levered fund-of-funds needing to redeem their investments to meet margin calls.

So, could this be the trigger for the next down movement. In fact, it’s more rational than people think. There was a lot of leverage into these “hot” products, and a lot of it chased the sub-prime markets.

As these hedge funds have to come up with the cash, they have to sell their good stocks. That means more sells than buys, and therefore a possible drop in the markets. Rational investors will understand this and be able to find good bargains.

Rational - Word to the wise: If a recipe calls for allspice, Old Spice is not an effective substitute.

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