SAN FRANCISCO (MarketWatch) -- The liquidation of a big hedge fund or investment-bank trading portfolio is wreaking havoc in some parts of the hedge-fund business, according to managers and investors.
Black Mesa Capital, a hedge-fund firm that uses computer models to track down investment ideas, said that at least one large hedge fund or investment bank is liquidating "massive" trading portfolios, according to a letter the Santa Fe, N.M.-based firm sent to investors Wednesday.
The warning is causing disruptions and triggering big losses among other so-called market-neutral hedge funds, Black Mesa said in its letter, a copy of which was obtained Thursday by MarketWatch.
"Clearly, something is amiss in the markets that few in our strategy, if anyone, have experienced before," Black Mesa's managers, Dave DeMers and Jonathan Spring, wrote. DeMers declined to comment Thursday.
The firm's hedge fund, which has about $1.9 billion in long positions and $1.9 billion in short positions, was down roughly 7.5% this month through Aug. 7. Those losses could grow to as much as 10% for August so far, Black Mesa noted.
Black Mesa told investors Wednesday that other market-neutral hedge funds had suffered losses of between 5% and 15% so far in August.
Black Mesa said it started reducing its leverage and selling positions to raise cash on Monday. As of Aug. 8, the firm said it had between 50% and 100% of its portfolio in cash and had brought leverage down to 0.5 to 0 times its assets, according to the letter.
The market disruptions began on July 25, when Black Mesa spotted signs of a major liquidation by another market participant. That continued through the week, handing the firm its biggest losing day ever, when it was down 3% on July 27.
The firm analyzed what caused its losses over that weekend and concluded that the behavior of the markets were similar to mid-September 2006, when giant hedge fund firm Amaranth Advisors liquidated its market-neutral equity portfolio to meet margin calls triggered by energy trading losses, Black Mesa explained.
As August began the selling continued, the firm said in its letter.
"Either the original liquidators had just paused, and/or others had begun to liquidate their market-neutral books on Wednesday, August 1," DeMers and Spring wrote. "By Friday, August 3, there seemed to be no abatement in the liquidations and over the weekend, we confirmed with other market-neutral managers that they were suffering similar losses."
Black Mesa then began to wonder whether others in the market-neutral space, having learned of these liquidations and having lost money themselves, could start cutting leverage in their own portfolios too.
"There was (and is) the possibility that, as great as liquidations had been so far, that it was just the beginning of a spiral of me-too liquidations," DeMers and Spring wrote.
The two managers said they didn't know now long such dislocations could last, noting that it could be two days, two weeks, two months or even two quarters.
Black Mesa said there are now "enormous profit opportunities" but the firm said it remains on the sidelines until signs of liquidations in the market dissipate.
