Hedge fund clients face a nervous wait to see if firms betting on the troubled Chinese and Greek markets can avert emergency measures that give them power to lock away investors' cash. Both China and Greece have taken steps in the last month to curb sell-offs in their stock markets by imposing trading restrictions. Hedge funds exposed to the two markets are now finding it tough to value their holdings.
At least two hedge funds - APS Greater China Long/Short and Horizon Growth Fund - have told investors that they can no longer withdraw their capital. The APS fund is exposed to China and Horizon Growth is exposed to Greece. Hedge funds fear that geopolitical flux might prompt some investors to pull their money out, leaving the remaining investors stuck with holdings that are hard to sell, should Greek and Chinese stocks remain inaccessible for long.
The move is a stark reminder of similar actions during the 2008 crisis, which led some hedge funds to create "side pockets" or mini suspended funds in which to park illiquid assets. Investors are restricted from exiting them, making side pockets unpopular. Meanwhile, funds could calculate a separate net asset value (NAV) for assets that can be valued, allowing them to accept fresh subscription or redemption requests.
"That's how hedge funds have dealt with these types of situations in the past," said Ryan McNelley, managing director at Duff & Phelps that advises fund firms on asset valuation. "A side pocket where they don't get fees based on valuation is one potential way to isolate the problem," he added.
The Greek market has been shut since June 29. In China, meanwhile, 1,300 stocks had announced trading halts last week, making roughly $2.4 trillion worth of stock market assets inaccessible to investors. The two countries pose different risks. While Greece is a tiny market - research firm eVestment estimates institutional investors have just $1.7 billion invested in Greek stocks - no one knows when its market will reopen.
In China, most trading suspensions are not expected to last long, but the sheer size of the market means liquidity problems could pile up for funds with exposure. Potential foreign participation in the mainland stock market through two government programmes that give direct investment quotas to foreign firms totalled $139 billion as of June 29. A third avenue was launched last year to trade China shares through a Hong Kong office, totalling up to 300 billion yuan ($48.32 billion), although it is not yet utilised fully.
Trading suspensions are a problem for funds that are required to accurately value their portfolios, which means if they last too long, the fund is forced to put in place contingency measures. Side-pockets are generally put in place only when funds face heavy redemptions, which investors say is not the case at this time with prominent US funds that are invested in Greece.
However, smaller funds whose bets in Greece form a relatively larger part of their total overall exposure, may be considering such moves, investors said. "June NAVs are usually done by the end of July. If by that time Greece is not open, people will have to write down Greece exposure or do side pockets, especially funds with more than 2-3 percent exposure," a London-based hedge fund investor said. Funds resorted to creating side pockets in 2008 as buyers for many assets disappeared and investors wanted money back.
Assets worth up to $400 billion were parked in side pockets, gated or restructured during the crisis globally, according to Hedgebay, a secondary market for hedge fund stakes. "To justify side pockets you really need close to zero liquidity in the assets, and of course there are investments which have done 'a 2008' and for which there is practically no market to mark against," Savvas Savouri, chief economist at London-based hedge fund Toscafund told Reuters. "And as we saw in the period post 2007, investors can be nasty litigators and unforgiving for the future," he added.
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