Hedge Fund Redemption Suspensions–Tax Bills are Adding Insult to Injury

You’ve probably read about the seven Hedge Funds controlling $5.4 Billion have been forced to liquidate or suspend redemptions in the past month. Many of their investors had been leaving their full principal intact, quarter after quarter. In many many cases they want to continue to “let it all roll”, so they then used other funds to pay the tax bills on their hedge fund earnings. But now, with redemptions (cash outs) halted, not only will they lose most or all of their principal, but they must also pay the 2007 income tax on the “gain” for the calendar year. What a bitter irony.

I know one couple that has 2/3s of their net worth tied up in very well-known and long-established a hedge fund. Despite the dramatic and unprecedented collapse of the global credit market, this couple is in denial that the value of their fund could ever decline. Despite my repeated urgings, they have now missed their opportunities to cash out, though two quarterly redemption windows.

Back in September and October of 2007, I warned specifically about the ability of hedge fund managers to suspend redemptions without notice. This is now exactly what is happening, on a grand scale. I often say that markets are alternately driven by greed and fear. Now, the fear index is clearly rising. But many of the investors that still stubbornly hang on to their greed-driven investments are about to pay the piper. And then some extra tax, on top of that.