The US Securities and Exchange Commission (SEC) and the UK Financial Services Authority (FSA) have taken temporary and concerted emergency action to prohibit short selling in financial companies.

The prohibition bans the creation of a new net short position or an increase in an existing short position in publicly quoted financial companies. It applies to both naked and covered short-selling.

SEC Provisions

With regards to the US, the SEC action affects short selling in 799 financial institutions and is effective until 2 October 2008. The order may be extended beyond 10 days but not for more than 30 calendar days in total duration.

The SEC also has instituted the following:

Firstly, temporarily requiring that institutional money managers report their new short sales of certain publicly traded securities. These money managers are already required to report their long positions in these securities.

Secondly, temporarily easing restrictions on the ability of securities issuers to re-purchase their securities. This change will give issuers more flexibility to buy back their securities, and help restore liquidity during this period of unusual and extraordinary market volatility.

FSA Provisions

In the UK, the provisions of the FSA affects short selling in 29 financial institutions and will remain in force until 16 January 2009 but will be reviewed after 30 days. The FSA additionally requires any net short positions in excess of 0.25% of the companies' ordinary share capital to be disclosed on a daily basis effective from 23 September 2008.

Hector Sants, chief executive of the FSA, said: "While we still regard short-selling as a legitimate investment technique in normal market conditions, the current extreme circumstances have given rise to disorderly markets. As a result, we have taken this decisive action, after careful consideration, to protect the fundamental integrity and quality of markets and to guard against further instability in the financial sector."

Jonathan Pain, HFA's Chief Economist and publisher of the Pain Report, has issued a special one page Special Edition in light of the extraordinary events of the past few days. In his report he outlines why he believes we are in a bear market that has further to run, and that the pain in Wall Street has now migrated to Main Street and the economic outlook has therefore worsened. For a full copy of his report, download the file below.

It seems almost impossible that the US can avoid a recession, and unlikely that Europe won’t suffer the same fate.  Australia might courtesy of our dual speed economy and distance from the storm’s epicenter, but that might depend on India and China avoiding the fallout also.  There are still some other train wrecks waiting to either happen or show themselves.  CDO’s may have become a well known terms in the last month, but watch out for Credit Default Swaps, Conduit Funds and Counter Party Risk joining the party.

Specifically for the Hedge Fund sector, there’ll be frantic activity as funds which used Lehman’s as their Prime Broker try to establish alternative arrangements, literally overnight.  Hedge Funds use their prime broker for a range of services, including trade settlement, stock borrowing, funding, trading platforms, systems and capital introduction.  Larger funds might employ more than one prime broker and will find it easier to switch, but for others it won’t be as easy. 

On a more positive note for Australian based funds, Lehman’s were not directly active in the local prime brokerage market, but it won’t prevent a tightening of credit lines and risk limits from the main Prime Brokers, the leading players in Australia being UBS, followed by Goldman Sachs, Morgan Stanley, ABN Amro and Merrill Lynch.

In reality there aren’t too many local funds over leveraged at present, but any change in a fund’s credit or other limits will certainly result in the unwinding of some trades, putting further downward pressure on markets.

Otherwise, some hedge funds (and their investors) will not only ride the storm out, but benefit from it also.  The local industry has a wide disparity of performance, with the majority not only outperforming the ASX200 year to date, but approximately one third handing in positive returns.  The volatility of the past two months, along with the sharp retracement of resource prices, will test some managers who thought the bull market would last forever.  With approximately 50% of results now in, the local industry is currently positive for August, with September shaping up to be an interesting month.

Absolute Return funds surveyed by InfoHedge have started to report their August results and preliminary analysis indicate that the losses experienced in July have been reversed. To date the average return for the month is +2.34% (funds reported so far approximate 25% of InfoHedge's database) compared to July's result of -2.11%.

The best performing strategies have been equity-based with these funds returning in excess of 3%. This result coincides with positive gains in the equity benchmarks with the ASX200 ending 3.08% ahead for the month and the S&P500 up 1.20%. The worst performing strategy was Commodities in line with a continuing retracement in those markets.

In results reported to date the best performing fund was PM CAPITAL Absolute Performance Fund AUD returning 13.70% using an Equity Long/Short strategy.

The below chart shows the monthly average return of all funds surveyed against the movement in the ASX 200.

July proved to be a challenging month for absolute return funds with nearly all strategies experiencing negative returns. The average return for the month was -2.11% in comparison to a fall of -4.78% in the ASX200 and -1.00% on the S&P500. This performance mirrored the June result of -2.01% bringing the average cumulative YTD return for Absolute Return funds to -4.15%. This contrasts to the equity benchmarks which still remain considerably lower for the year with the ASX200 down around 27% and the S&P500 down nearly 16%.

On a strategy / asset class breakdown the only funds to achieve a positive result were Equity Buy Write +0.12%, Fixed Income +0.13% and Carbon Assets +1.75%.

With a continuing volatile year across most markets and regions, the July 2008 YTD returns reflect that strategies in Commodities are performing best with Equity-based strategies the worst. On a geographical basis, North American mandates have fared better than locally-focused funds and those of other regions.

News of the decision by New York based Ospraie management to wind down its commodities based hedge fund could be causing some anxiety for local resource companies. Ospraie has reduced its holding in Iluka from 10.8 to less than 5 per cent over the last few months, but still holds 14.7 per cent of Mineral Deposits, 19.5 per cent of both Great Southern and Consolidated Rutile. A US service that can be used to work out who owns what says that there are at least 10 listed Australian companies whose share prices will come under pressure as the fund is unwound.

The 2008 Alternative Investment Management Association (AIMA) Awards were held in Sydney on Thursday 4th September recognising achievement and excellence within the Australian hedge fund industry.

The awards were well attended by industry participants and coincide with the annual Hedge Funds Rock charity evening supporting Cure Our Kids in raising funds for the Oncology Unit at Westmead Children's Hospital.

Over 200 funds were judged from which 15 finalists were chosen across 8 categories.

The Australian Hedge Fund of the Year was awarded to Fortitude Capital Absolute Return Trust, a multi-strategy market neutral fund specialising in Australian listed equities and derivatives.

Other awards included Mathews Capital Sabra Fund Best Long Short Absolute Return Fund; Bennelong Long Short Fund Best Market Neutral Fund; Kaiser Trading Fund SPC Best Global Macro/Futures Fund; Kapstream Absolute Return Income Fund Best Emerging Manager; and Investor Select Advisors Global Opportunity Best Fund of Funds.

TelstraSuper was rated the Best Investor Supporting Australian Managers and Kim Ivey, the Chairman of the Australian Chapter of AMIA, was recognised for his long-standing contribution to the Australian Hedge Fund Industry.

As speculated late last week, Ellerston GEMS Fund will put a proposal to its unit holders next month recommending that the fund be delisted from the sharemarket. In a press release the company says that shareholders will be able to progressively redeem units at a price equal to a 7.5 per cent discount to the then NAV. Ellerston Capital's chief executive officer, Glenn Poswell, said that the move is a win-win for unit holders to unlock value now compared to the price the market has been prepared to trade their units.

Listed investment company Ellerston GEMS is expected to be delisted after a shareholder campaign. EGF listed last year at $2.50 per unit and at the end of June had a net asset value (NAV) of around $2.40 per unit but, like many listed investment trusts, has been trading at a discount, closing yesterday at $1.78.

Shareholder John Dalley, who owns 1.35 per cent of the trust, sent letters to other unit holders seeking support for his calls to wind up the fund saying that he expects they would be able to realise about $2.33 per unit if it occurred now. It is believed that he succeeded in getting the required additional 99 unit holders to support his motion.

Challenger Financial Services is added to its range of boutique fund managers, buying stakes in a new fixed interest manager and a hedge fund manager. Challenger will own 30 per cent of a fixed interest boutique that will launch later this year and has bought 27.5 per cent of the Australian equities hedge fund manager WaveStone Capital.

WaveStone was established in September 2006. Challenger will provide the manager with seeding for a new offshore absolute return fund based in the Cayman Islands which will push WaveStone's total funds under management past $100 million.