Hedge funds navigate maze of redemptions

[Joanne98]

Investors are looking at future profitability by buying stakes in managers

Millionaire hedge fund manager Andrew Lahde might have got it right. The man whose valediction last month to his industry peers announced that “with all due respect, I am dropping out”, left the industry while the going was still relatively good.

Admittedly, at the time of his speech, nine out of every 10 hedge funds were not able to take 20% of their profits as a performance fee, and the average hedge fund had lost about 19% of its value, reversing at least the two previous years’ gains. But hedge funds face withdrawals at year end that will match or exceed third-quarter record redemptions of $31bn (€24bn), according to data provider Hedge Fund Research.

The disappearance of incentive fees, the reduction of set charges based on assets, poor performance and redemptions, could be the final straw for many funds. HFR estimates 700 funds will close down this year. Sophia Brickell, fund of hedge fund investment specialist at asset manager GAM, estimates the eventual total will be nearer 900.

Tom Brown, European head of investment management at advisers KPMG, said the credit crunch had made it paramount to run a tight ship by reducing optional expenses.

However, as cash-strapped managers seek to survive, a growing number of investors are going against Lahde’s decision to “throw the BlackBerry away and enjoy life”, by buying into what they see as healthy future profitability. They are doing so by taking stakes in hedge fund management firms.

Patric de Gentile-Williams, chief operating officer at Financial Capital Advisors, the fund-seeding arm of $15bn hedge fund investor FRM, said: “Taking stakes in asset management businesses may make sense in the current environment.” He said some managers might plan to recruit people or launch products, but find the risks of doing this using only the management firms’ own money too great.

De Gentile-Williams said hedge fund investors might analyse more keenly the amount of capital managers set aside in their business before investing in their funds. He said: “It could be prudent to raise money for your capital base to solidify your company. Instead of, say, six to 12 times operating capital, managers may want to keep 12 to 24 times in the capital base and therefore it may be their sensible and legitimate requirement for capital is greater.”

FCA provides seeding capital for hedge funds rather than acquiring stakes in their managers. While de Gentile-Williams does not rule out doing so in the future, many investors already do.

Petershill, a fund established by Goldman Sachs last year, has acquired stakes in at least five managers, including London’s Capula Investment, Longacre Fund Management, Trafalgar Asset Managers and Winton Capital Management. Lehman Brothers was raising up to $5bn for a rival vehicle before it went bankrupt. Aladdin Capital also plans to raise $3bn to take stakes in 30 to 40 hedge fund managers.

US, European and Japanese banks have bought stakes in at least 15 management firms, according to US bank Jefferies Putnam Lovell. Furthermore, in the summer the alternative asset management arm of Switzerland’s Credit Suisse bought a controlling stake in Asset Management Finance Corp, which provides loans to hedge funds among others.

Aaron Door, managing director at Jefferies Putnam Lovell said alternative asset managers preferred to take minority stakes. Graham Phillips, partner at consultancy PricewaterhouseCoopers, said he expected further consolidation among asset managers.

However, not all stakebuilding has been mutually beneficial. The acquisition of the fund of hedge funds IAM by Dutch bank ABN Amro in 2006 was reversed this year by its management buyout from Dutch-Belgo bank Fortis, which had bought ABN Amro’s asset management arm holding IAM. The buyout was supported by UK financier Sir Ronald Cohen, who separately took a stake in manager Millennium Global Investors.

While purchasers’ motivations are typically based on profit, James Woolf, partner in transaction services at KPMG, said vendors often wanted to retain control of the business, “and not go back to the type of corporate environment many of them left to start hedge funds”.

He said the hedge fund manager might look for a business partner at least in part as an avenue for product distribution. Woolf said: “Big banks may have clients interested in accessing new hedge fund products, and there may be value to a hedge fund in having the business associated with a big-name bank.

“But when it comes to negotiating a deal everyone has to know what they want out of the transaction. If they’re not clear how it will work there’s not much sense in going further.”

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Hedge Funds Limit Redemptions

With hedge funds, you can get in, just don't think you can easily get out. Dozens of Hedge Funds Have Blocked Redemptions.
Dozens of hedge funds have told investors they cannot get their money back right now as managers try to limit a wave of redemptions to safeguard all their clients' investments -- as well as their own futures.

"Everyone is looking at their gate provisions (mechanisms that limit redemptions) and what rights they have to close their gates," said Timothy Mungovan, a partner who advises hedge funds at law firm Nixon Peabody LLP. "It is a phenomenon that has been occurring for some time and is picking up pace now."

On Thursday, Knight Capital Group's Deephaven Capital Management halted redemptions at two of its hedge funds.

Recently, hedge fund firm Basso Capital told investors it was postponing redemptions. Hedge fund firm Ore Hill Partners imposed a gate in late August.

Before that Drake Capital Management and Pardus Capital Management began restricting clients' departures and Ellington Capital Management stopped allowing investors to exit one of its portfolios last year.

"Restricting redemptions allows the managers to withhold selling into unfavorable markets," said Michael Tannenbaum, a partner at law firm Tannenbaum Helpern Syracuse and Hirschtritt LLP, explaining that panic selling in these markets can be "harmful to both sides: the investor and the redeemer."

Spooked by hedge funds' worst-ever returns at a time the average fund has lost 20 percent this year, pension funds and wealthy individuals alike are leaving hedge funds faster than ever before, lawyers and managers said.

Between July and September, investors pulled out a record $31 billion, which helped shrink the industry 11 percent to $1.7 trillion. And more redemptions are expected to flood in by November 15, the deadline to get money back by year's end, industry lawyers and investors said.
Case Against Hedge Funds
No transparency. You have no idea what the fund is doing or holding.
Leverage is a two way street. Excessive leverage is now exacerbating losses.
Exit restrictions. You cannot get out when you want to.
Whopping fees. Hedge finds take 2% off the top plus 20% of profits. That 20% of profits encourages excessive risk taking. If the fund blows up the manager just starts another one.
Hedge funds are supposed to make money no matter which way the market goes, or so they claim. To collectively be down 18%, they had to have been making one sided bullish bets on something. Where's the hedge?
A massive and long overdue consolidation in hedge funds is coming in 2009-2010. I concur that a 30% reduction in the number of funds may be optimistic. A far bigger reduction in assets under management is nearly guaranteed.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

http://www.howestreet.com/articles/index.php?article_id=7899