Run on a British Bank parallel Run on Hedge Fund

Britain‘s fifth-biggest mortgage lender, Northern Rock saw its share price tumbled 27 percent, adding to its 32 percent plunge on last Friday, when it issued a profit warning and tapped the Bank of England (BOE) for emergency funds. Scores of customers queued up over the weekend to withdraw their money from Northern Rock. (Reuters News 17 Sep 2007).

 

It was estimated that withdrawal of £2 billion was made which represented about 8% of its deposits. (Reuters News 18 Sep 2007)

 

Even with the assurance from the BOE that it will provide emergency funds for Northern Rock, this did not stop depositors from withdrawing their savings from the mortgage lender. These are the people with lower appetite for risk and their fear and actions are typical of a run on a bank.

 

This is the same with hedge funds. Investors will redeem units in a hurry and pull out their money from the hedge fund once they have news that the hedge fund was exposed to the sub-prime mortgage problems.

 

One recent case is the two highly leveraged hedge funds belonging to the US Investment Bank, Bear Stearns. The underlying securities of these funds were nearly worthless.

 

Investors will not be kind to continue to support the hedge funds because the current investment values tumbled. The result is a permanent diminution in value and that there is slim hope of it rising in the future. The run on these funds can be swift and no actions by the fund house can stop the investors from abandoning these funds.

 

The moral of the story is not to put ALL your hard-earned money in hedge funds.

 

Written on 9/18/2007 10:06 AM

 

Copyright © 2007, the author known as LKT in Singapore.

 

The material presented is intended to be general and written in layman’s language as much as it is possible. The author shall not be liable for any direct or consequential loss arising from any use of material written. Please seek professional advice from your financial advisor or financial institutions on material written covering financial matters.

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