The news that Bear Stearns has halted withdrawals from a third hedge fund — one that sounds much less risky than the two that collapsed — is a reminder what happens when people suspect lies.
The two Bear funds that collapsed did so suddenly, as seen by their investors. The valuations given to investors did not indicate the end was near, but it was. In hindsight, those valuations appear to have been a tad optimistic. So now investors may be tempted to check out before there is proof of troubles.
With the Bear fund doing this, will investors in other funds run by different sponsors be tempted to follow suit?
Yesterday was July 31, and hedge funds that issue monthly reports will have to estimate the value of their holdings. “It is likely,” says Richard Bernstein, the chief investment strategist at Merrill Lynch, “that many hedge funds will be shocked by how low their marks are. The combination of a down market and liquidity drying up in many debt instruments is likely to make many intra-month evaluations now appear quite rosy.”
Some hedge funds routinely do not allow withdrawals, and thus will escape the pressure of immediate withdrawals. But others, particularly those that invested in fixed-income markets and derivatives, face a real risk: If they put out rosy numbers, will investors see that as a chance to bail out before bad news is admitted? On the other hand, if they put out gloomy figures, will investors see that as proof of a decline so severe it could not be finessed away with valuation techniques, and see that as a reason to flee?
