In particular, equity hedge funds have been building up cash reserves. Merrill Lynch’s March fund manager survey revealed the highest cash positions relative to margin debt since 2003. Survey respondents were less aggressively overweight in April, but still overweight.
In part, the build-up of cash is attributed to deleveraging by several funds. For certain strategies, cash is being built up ready to deploy when new opportunities in distressed assets arise. Some managers are simply liquidating positions while they wait for the markets to become less volatile.
Where this cash is held is becoming an increasingly important decision for managers. Over the past five years, there has been a trend to take cash out of prime brokers’ hands and put it into the coffers of independent cash managers. This trend has accelerated since the credit crunch as managers have become fearful that their prime brokers will seize the cash to meet margin requirements. "From a defensive standpoint, managers want to avoid the risk of a cash grab if there is a disagreement on margin calls and pricing issues. They want more control over that money," says Bob von Halle, managing partner and director of business development at Horizon Cash Management. For similar reasons, managers are also becoming concerned about leaving large unencumbered cash balances with clearing firms.
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Fund managers overweight on cash |
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Source: Merrill Lynch Fund Manager Survey April 2008 |
As managers have tried to diversify where their cash is held, however, several have experienced difficulties. Von Halle says his firm has received many calls from managers and end-investors wanting to better understand the securities used to invest the cash on a short-term basis. "Some managers put their money in enhanced cash funds that were invested in longer-term and less-liquid asset-backed and mortgage-backed securities," says von Halle.
Double-digit losses
Several managers have ended up with double-digit losses on cash balances from investments in mortgage-backed securities. Others have had their cash accounts frozen. BNP Paribas, for example, froze its short-term funds for several weeks last August.
"It is not that these funds are wrong, but rather that they are inappropriate to be used within cash management. Cash should be fully liquid, and invested in high-quality securities," says Brian Hurley, vice-president and director of marketing at Horizon. "Having the word ‘cash’ in the name of the fund sets up certain expectations." Prudent managers are now digging deeper to find out where their cash is being invested and making certain they can access the cash at short notice, says Hurley.