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Tuesday, August 14, 2007 3:24 PM

Excuses at Sentinel Don't Fly

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The USA Today is reporting Sentinel Management freezes $1.5B fund.

Sentinel Management Group on Tuesday froze assets in a $1.5 billion fund, saying too many investors are trying to withdraw their money. Sentinel Management, which boasts on its website that no client has ever lost money in its fund, makes money mainly by betting on overnight interest rates outpacing yields on short-term Treasury bonds.

According to CME Group, formed this year by a merger of the Chicago Mercantile Exchange and the Chicago Board of Trade, the fund manages $1.5 billion in assets. The company's investments include short-term debt and high-quality bonds.

"We have never experienced a situation quite like this one," Sentinel Management said. "Liquidity has dried up all over the Street."

Sentinel is the latest investment manager engulfed in a worldwide exodus from risk. Stung by decaying credit quality, the world's investors last month began to pull back from all kinds of risky instruments, from corporate bonds to credit-default swaps.

The fund, based in Northbrook, Ill., told clients in a letter obtained by the Associated Press that "fear has overtaken reason" and most investments have no buyers. Sentinel said its own clients have joined in the panic by trying to bail out of the fund.

The fund cannot meet investors' requests to withdraw their money without selling investments at a steep discount, the fund said. Sentinel did not respond to calls for comment.

The firm sent a request to the Commodity Futures Trading Commission for permission to stop investors from cashing out. But the CFTC said "We have no role in whether or not the company does this and whether the client accepts this."
If you're looking for the source of the problem here it is: "We have never experienced a situation quite like this one. Liquidity has dried up all over the Street." What happened is that Sentinel thought that just because they have not seen something yet, that it could not happen. This is in essence the same thing that happened to the models at Moody's, Fitch, and the S&P, and various quant models that I talked about in Genius Fails Again.

Earlier today Sentinel asked The US Commodity Futures Trading for permissions to halt redemptions. The request was denied.
The US Commodity Futures Trading Commission is denying a request from Sentinel Management Group to halt redemptions from Sentinel's money-market fund, saying it lacks the authority, according to CNBC television.

'We had previously thought that the market would return to some semblance of order and that our clients would not join in the panic,' Sentinel said in a letter to clients CNBC said it had obtained. 'Unfortunately, this has not been the case.' Sentinel told clients 'we cannot meet any significant redemption requests without selling securities at deep discounts to their fair value and therefore causing unnecessary losses to our clients.'

According to its web site, Sentinel oversees cash for commodity and currency traders, hedge funds, wealthy individuals and other investors. The firm invests that money mostly in the overnight inter-bank lending market.

The firm is not a money-market fund but acts as an investment advisor to clients.

That means it is not a typical money-market fund open to the public and focused on Treasury, government agency or high-quality corporate debt.
What seems to have happened is that no one had the authority to grant Sentinel the right to halt redemptions but no one could stop it either. Sentinel decided on its own to halt redemptions.

Sentinel Letter to Clients
Dear Client:

As you undoubtedly know, the credit markets, along with most other markets, have experienced a liquidity crisis in the past several weeks. Investor fear has overtaken reason and has induced a period in which most securities have simply ceased to trade. We’ve all read the stories about one hedge fund or another suffering losses related to subprime exposure and closing down or being rescued. This fear, while warranted in some cases, has spilled over into the rest of the credit market and liquidity has dried up all over the street. In addition, investment banks and securities firms are stuck with LBO deals they’ve already entered into but cannot find buyers for the bonds so must inventory them themselves.

This liquidity crisis has caused bids to disappear from the market and makes it virtually impossible to properly price securities or to trade them. High grade securities are trading like junk bonds as panicked investors dump names like General Electric at Tyco‐like prices.

We had previously thought that the market would return to some semblance of order and that our clients would not join in the panic. Unfortunately, this has not been the case. We are concerned that we cannot meet any significant redemption requests without selling securities at deep discounts to their fair value and therefore causing unnecessary losses to our clients. We contacted the CFTC today and asked for their permission to halt redemptions until we can honor them in an orderly fashion.

Complaining about corporate bonds are we? Hmmm. Should money market funds be investing in corporate bonds? Obviously not, at least in my opinion, but Sentinel did so anyway. What we don't know is to what extent. The larger the extent, the bigger the problem. Given that redemption are halted, one might make some assumptions about size, and the first assumption is: large enough to matter.

The CME Chimes In

The CME Group issued a statement on Sentinel Management Group, Inc. and CME Financial Safeguards System.
CME Group today provided the following comment on Sentinel Management Group, Inc. and its determination to cease acceptance of new investment funds or redemptions. CME Group also confirmed that its clearing member firms have continued to meet all of their obligations to CME Clearing and remain in good standing. Sentinel has notified the Commodity Futures Trading Commission (CFTC) that it will not accept additional funds for investment and that it will not make redemptions at this time.

Sentinel is not a clearing member of CME Group or any other exchange. Sentinel provides investment advisory and investment services to institutional and corporate clients, including a limited number of CME clearing member firms. Total investments under management by Sentinel are approximately $1.5 billion. None of these funds are on deposit with CME Clearing to support performance bond or collateral requirements.
The CME is essentially saying "No problems here... Please look elsewhere".

Sentinel FAQs

There are some interesting Frequently Asked Questions on Sentinel's Website.

1-How can Sentinel consistently earn high yields on short-term investments without taking excessive risk?
2-How can I be sure my money is safe at Sentinel?
3-That is history. How can Sentinel ensure that such a record will continue?
4-Exactly what happens to the cash invested by Sentinel?

Proposed New Answers

1-We can't. No one else can either. That is what risk is all about.
2-You can't. Liquidity has dried up and we just got caught. That's why we halted redemptions.
3-Part of our original answer was "Sentinel is registered with three regulatory agencies: the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) and the Congressionally-chartered self-regulatory body, the National Futures Association (NFA)." You can easily see that now does not mean much.
4-"Sentinel clients have an indirect, undivided pro-rata ownership interest in a pool of high quality, liquid securities. Sentinel's Treasury Only Portfolio (TOP) consists of direct obligations of the U.S. Treasury. The 125 Portfolio and Prime Portfolio consist of money market securities issued by U.S. government agencies, corporations, or short term bank time deposits, all of which meet Sentinel's requirements for liquidity and low risk." Those most at risk put their faith in the "125 portfolio" and that's where the big problems are.

Who Determines Fair Value?

Let's return to the Sentinel letter to clients for a review of this statement: "We are concerned that we cannot meet any significant redemption requests without selling securities at deep discounts to their fair value and therefore causing unnecessary losses to our clients."

Excuse me, but doesn't the market determine "fair value"? Apparently Sentinel thinks it knows what fair value is but the market doesn't. Recall that Bear Stearns thought the same thing. Bear Stearns locked out clients who wanted to redeem all the way back in January. Those investors would have gotten something back. Perhaps as much as 70 cents on the dollar. Bear Stearns locked those clients in and the Hedge Fund went to zero: totally worthless.

While Sentinel does not like the current offer for those assets, there is no guarantee (or even likelihood) that the market is going to think more of those assets tomorrow than they think of them today. Should Sentinel have seen this coming? I think so, or at least they should have been alerted to the possibility. Instead they stuck with a now failed model that offers these excuses:
  • Investor fear has overtaken reason
  • That the market would return to some semblance of order
  • That our clients would not join in the panic
  • That securities are at deep discounts to their fair value
The amazing thing is the DOW, and the Nasdaq 100, are all still up for the year with the S&P 500 more or less treading water.

(click on any chart for a sharper image)


S&P 500 Weekly Chart

QQQQ - Nasdaq 100 Weekly Chart

Sentinel violated the first rule of panic: Panic before everyone else does. Instead Sentinel locked in investors just as Bear Stearns did. Judging from the markets, there is no panic yet. The key word in that sentence is "yet".

Mike Shedlock / Mish

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