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New Danger Emerges

Investors already have plenty of potential risk factors to worry about.

We don’t need another.

But we have one…

Hedge fund selling could be the next thing to hammer stock prices.

Hedge funds already had a bad name, mainly due to their exorbitant fees and expenses and the fact that they don’t deliver much in the way of “alpha” — or excess returns.

But their reputation in recent months went from bad past worse to really awful, as you can see in the graph below:

Hedge Funds

Source: Bloomberg

Not only did hedge funds as a group not properly “hedge” their clients from the recent stock market turmoil, but they actually performed WORSE than the overall stock market.

Even before the October sell-off, while the S&P 500 rallied to new record highs from July–September, hedge funds were lagging badly.

During the recent correction, highlighted above, hedge fund performance fell off a cliff.

The HFRI Equity Hedge (Total) Index plunged 4.25% in October. That’s the worst monthly decline for the hedge fund universe since January 2016!

And hedge funds focused on highflying FAANG and other technology stocks dropped even more, down nearly 5% last month.

So there’s no question hedge fund losses contributed to the depth of the recent stock market decline, but they could come back for even more selling.

Why?

Because hedge funds are private pools of capital. They don’t trade every day like mutual funds or ETFs, and this week investors get a rare chance to cash out.

Considering the recent poor performance, hedge fund clients may jump at that chance.

You see, it’s standard practice in the hedge fund industry to restrict when investors can withdraw their money. This is often limited to quarterly redemptions, just four times a year, and typically clients must give a 45-day advance notice of their intent to sell.

That’s precisely why this poses a clear and present danger to stocks.

As if hedge fund investors needed any more reason to cash out than high fees and poor performance, the recent stock market plunge has handed them another excuse to take their money and run.

For hedge fund investors eager to cash out at the end of December, the usual deadline to do so was yesterday, Nov. 15th, 45 days prior to quarter-end.

Naturally, large hedge fund redemptions would likely force more selling of stocks for fund managers to raise enough cash to meet those redemptions by year-end.

The catch is we are unlikely to know the full extent of it until well after the fact; hedge funds are very secretive about that.

But already this year investors have pulled $11 billion out of hedge funds, according to Bloomberg, and that’s before the recent correction. There’s likely more to come.

In fact, the last time hedge funds performed this poorly was 2015–16, and clients withdrew over $77 billion as a result.

By itself, forced hedge fund selling may not tank the market. After all, $170 billion worth of corporate stock buybacks are slated for this month too, which should provide a nice offset.

But this is yet another risk factor to keep an eye on in order to keep your assets safe.

Here’s to growing your wealth,

Mike Burnick

Mike Burnick
Chief Income Expert, Mike Burnick’s Wealth Watch

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Mike Burnick

With over 25-years of professional investment experience, Mike Burnick was a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. Mike joined Weiss Research in 2002 as an analyst and writer, and in 2008 was named Director of Research and Client Communications at Weiss Capital Management, where he assisted...

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