More Hedge Fund Misery as Euro-Crisis Tightens Credit

December 9, 2011

As if staggering through a year of un-hedge fund-like performance isn’t bad enough, fund managers are now confronted with the realization that the lending markets are tightening up in response to the impending bailout of European banks by the region’s central banks. In Europe cash strapped banks are standing in line for funds from a consortium of central banks as the Euro-crisis comes to a head. Hedge funds, which have, in the past, relied on the credit markets to take on big positions are scaling back in anticipation of a liquidity squeeze similar to the one they experienced in 2008. As a result, any hope of scoring out-sized returns in the remaining weeks of the year, or into the new year for that matter, has all but evaporated.

Fund managers have already taken a precautionary stance by reducing their leverage throughout the course of the year. But the prospect of the spigot being shut off completely looms even larger. And, where credit may be available it is likely to come at a higher cost. As the credit ratings of the world’s banks continue to fall, fund managers must also be concerned with the increase of counterparty risk, so the cost of borrowing could be increased through the need for default insurance. While the current credit squeeze is affecting European funds primarily, the contagion is expected to spread to the U.S. banks which are also under ratings pressure.

The good news is that, this time around, fund managers are not likely to be caught flat-footed, but they are also not going to be able to generate the kind of market-beating returns they need to salvage this year’s performance, and attract or retain the investor capital they sorely need. The other good news is that expectations for 2012 will be extremely low, so the ability of fund managers to adjust and adapt will prove to be the difference between another disappointing year and a year of salvation.

 

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