Thursday, December 4, 2008
Hedge Funds and the 10-year note yield
The November collapse in the 10-year note yield has been nothing short of remarkable (3.9% on 10/31 to 2.64% this morning). The press has cited Fed announcements (Fed/Treasury buying Treasuries and Agency MBS), concerns about the economy, fears of deflation, global rate cuts, and a general flight to quality spawned by the financial panic. Very few press reports have explored the role of hedge fund redemptions. 4 major hedge funds have limited client withdrawals in the last few days due to a flood of redemption requests (DE Shaw, Farallon, Fortress, Paul Tudor Jones). Bloomberg is reporting that more than 80 hedge fund managers have recently imposed restrictions on client redemptions. What hedge fund investor is going to keep their assets with a fund once the gate is lifted? Most of these funds will be effectively out of business in the next 12 months. The managers understand this and have been liquidating as quickly as they can to meet the current requests. The liquidated funds are effectively forced into Treasuries because the managers are not in a position to take any risk. Note that the 10-year bond yield really began sliding after November 15, which happens to be the deadline many hedge funds required for redemption requests. A modest easing in any of the factors I cited above will trigger a big sell-off in Treasury bonds. As a result, I would put TBT on the radar as a tactical long candidate. The upside move in bonds looks extended. I believe the risk/reward for TBT looks favorable. The downside risk to holding TBT is that the current panic is exacerbated by the barrage of bad news that is still in the pipeline. Yields could potentially drop below 2% if equities break sharply below the recent lows. But, you would probably lose less money being long TBT than being long equities on a break of the lows.