Structural vs Fundamental Causation: A Look at Hedge Fund Redemptions

Depending on what sources you use, hedge funds face redemptions of 10-20% of their assets under management from disgruntled investors. When an investor redeems their capital from a hedge fund, unless the fund has excess cash it must sell some of its positions. If the market is depressed to begin with, and a herd of investors rush for redemptions all at once then we can see how the market could turn ugly quickly (e.g. the last 2 days).

This provides an excellent opportunity to contrast two different classes of causation in the market: structural vs fundamental. Everyone is familiar with a fundamental reason to make an investment decision. An investor could buy a company because their earnings look good. The return on investment might be higher with one company vs another. The economy could be expanding or contracting. These are all fundamental qualities.

Structural causation comes from things like the massive hedge fund redemptions: they are causes of a not necessarily fundamental basis. They may be caused by fundamentals; a rash of redemptions was caused by a fundamentally crappy market. But structural causes often appear disconnected from fundamental reality. The government has intervened in unprecedented scale and scope; net interest margins will be improved by coordinated worldwide rate cuts. But there are some firms that still need to sell things to raise cash. Until they are able to get the cash they need in loans or by selling inventory, the crash will continue.