Hedge Funds assets dwindle considerably Wednesday, January 21, 2009

For the industry as a whole, [albeit starting from a lower estimate than I've seen elsewhere, which may reflect that their figures do not include assets invested in fund of hedge funds] Hennessee Group has estimated that hedge fund industry assets decreased by USD782bn in 2008 to USD1.21trn, a 39% fall. They divide this up as
Speaking with the boss of small [$100m] hedge fund yesterday, it was apparent that he is bewildered by the environment and uncertain about their survival prospects, something I suspect that is shared by many funds. Moreover, their plight is likely to be exacerbated given that one of the traditional sources of hedge fund capital, namely fund of hedge funds, are almost certain to suffer.

This is because the Madoff case has challenged the notion that the due diligence and monitoring is in any way adequate to warrant their fees. Furthermore, investors notice fees far more when performance is low or negative and will question the value added far more.

Hennessee Group Research says, fund of hedge funds were the largest single source of capital for hedge funds at 32 per cent of the total. Of direct investors in hedge funds, individuals and family offices accounted for 30 per cent, pension schemes 15 per cent, endowments and foundations 12 per cent and corporations 11 per cent.

The hit on fund of hedge funds will affect smaller and less well known funds hardest, since they tend to be weakest at marketing successfully to end investors. Whilst they may get seed money from some wealthy investors to put them in the barely viable $100m range, pushing beyond this without fund of hedge funds assistance is incredibly tough.

One firm in particular, RAB Capital, is having a bad time [not to mention investors in the company and its' funds]. Previously acclaimed, its assets under management fell 74% in 2008 to $1.9 billion at the end of December, compared to $7.2 billion a year earlier, according to Market Watch. As a result, revenues including management and performance fees fell to £51m, a drop of 59%.

Across the industry, there is also an investor backlash from hedge funds that have imposed a "gate" on investments i.e. refused to allow investors to make withdrawals, whilst still demanding their management fees on those same funds. This has been likened to being locked in a hotel room by staff and still being told you have to pay the room rate. In the good times, few investors seemed to care about their liquidity options on such investments. Now it has moved to the forefront of their mind and I anticipate more investors will demand considerably lower fees to lock their money up for long periods.

I confess to some bitterness on this matter of investor liquidity - I was involved in a venture that sought to develop a regulated secondary market for hedge funds that would enable investors to trade with each other, without necessitating redemptions from the funds. Many fund of funds firms we spoke to back in 2007 scoffed at the notion that such a mechanism was useful since "redemptions and liquidity would never be an issue" which is a genuine quote to me from the CIO at GAM. I am hoping to run into him again soon to remind him of those words.

Many hedge funds will also be quietly dying or considering exiting since the likelihood of them receiving performance fees for some years to come looks remote, given that they normally have to hit the high watermarks of past years before they qualify. Of course, management fees may tied them over, but drops in the value of assets will have also pushed these down.

If 2008 was bad for funds, my current guess is that 2009 will not be any better.

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"Am I worth $250m+ ? I think so." Wednesday, April 23, 2008

Greg Coffey is leaving approximately $250m in stock options behind as a consequence of resigning from GLG to set up his own firm. He currently manages about US$7bn of GLG's US$24bn of funds under management, reportedly generating about 60 per cent of its performance fees last year.

Mr Coffey, a 36-year-old Australian, took home $300m (£150m) in pay last year but was reportedly unable to agree a new compensation package. Many articles on the matter can be found here.

The news of his departure initially knocked about $375m off the value of GLG, but the share price has since rebounded.

When I chat with folks outside of capital markets they often challenge me about the spectacular sums paid to individuals in the City. In this case, it's relatively easy to point to the worth the market attached to his value at GLG. Moreover, as a major contributor to the bottom line, his abilities were evidently a major appeal to GLG clients and validated by the performance of his funds.

As for the headline of this piece it was unrelated to me [unsurprisingly] but to Greg who obviously thinks he is, otherwise he wouldn't be leaving behind $250m of stock and a probable $300m of compensation per year to run his own firm. Will his bosses be bitter - perhaps initially but a) they left their employers to set up GLG and b) will probably seed his new fund and thereby continue to benefit from his skills.

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You do the maths Thursday, March 27, 2008

I read with amusement the following from Bloomberg News

Merrill Lynch is likely to pick up a nice number of defectors from rival Bear Stearns. According to ML managing director Jeff Penney in a BN interview, his firm received 20 telephone calls from nearly two dozen hedge funds within days of the BS collapse.

You do the maths, albeit perhaps times are so tough that some funds are sharing telephone calls.

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MF Global clients asked to take a hike Wednesday, March 19, 2008

FT Alphaville has a report that MF Global [where I once worked] has hiked its margin rates considerably. Under the heading "MF Global Reiterates Strong Liquidity Position (and tells clients to get lost)" it notes that

And when we say “hike” we mean a move, typically, from 25 per cent to 75 per cent or more. In fact, for UK small caps the requirement is now 90 per cent.

Those most notably affected are thousands of traders and speculators using CFDs, who have either had to deposit extra funds immediately, move their business elsewhere or liquidate their positions. And then there is MF’s own army of brokers - many of whom are on substantial commission arrangements and who have now lost much of their client base overnight.
According to well placed market sources, this has added “meaningfully” to some of the unexpected price swings seen across the London market in particular over the past 24 hours.

This is an interesting development for the following reasons:-
For the desk heads of the products affected e.g. CFDs, this will be a nightmare for their business, which they have developed and nutured over many years. Inevitably, these hikes will harm their P&L on which they are judged and bonuses paid [always a sensitive matter]. Even a reversal of the policy in a few weeks time, will not restore all of the business lost and whilst its' "quality" may be debated in some quarters, it will have wider implications. For example
For these reasons it will have undoubtedly been a hotly contested matter internally but evidently the senior executives decided the solvency of the firm and perceptions about it necessitated such action.

UPDATE: For whatever reason, FTAlphaville have removed the blogpost, which is almost unheard of. Of course, the post is already floating across the internet via rss, and so it's still showing in my Google Reader. Either they got the story completely wrong or someone didn't like its' tone. Meanwhile, CityIndex has also raised its' margin requirements to 10% on FTSE100 and 20% on FTSE250, but which suggest that collateral requirements in the stock lending market aren't high enough to warrant the increases by MF Global that FT Alphaville reported.

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Making money with other people's money, the Hedge Fund way

Martin Wolf, The FT columnist, offers a helpful example from two distinguished academics, Dean Foster at the Wharton School of the University of Pennsylvania and Peyton Young of Oxford university and the Brookings Institution on Hedge Funds.

They start by asking us to consider a rare event – that the stock market will fall by 20 per cent over the next 12 months, for example. They assume, too, that the options market prices this risk correctly, say at one in 10. An option costs $0.1 and pays out $1.

Now imagine that we set up a hedge fund with $100m from investors on the normal terms of 2 per cent management fees and 20 per cent of the return above a benchmark. We put our $100m in Treasury bills yielding 4 per cent. We also sell 100m covered options on the event [i.e. payout is covered by the value of Treasury bills], which nets us $10m. We put this $10m, too, in Treasury bills, which allows us to sell another 10m options. This nets another $1m. Then we go on holiday.

There is a 90 per cent chance that this bet will pay off in the first year. The fund then grosses $11m on the sale of the options, plus 4 per cent interest on the $110m in Treasury bills, for a handsome 15.4 per cent return [$11m options premium + $4.4m interest]. Our investors are delighted. Assume our benchmark was 4 per cent. We then earn $2m in management fees, plus 20 per cent of $11.4m [$15.4m less $4m assumed min return], which amounts to over $4m gross. Whatever subsequently happens, we need never give this money back.

The chances are nearly 60 per cent that the bad event will not occur over five years. Since the fund is compounding at a rate of 11.4 per cent a year after fees, we will make well over $20m even if no new money is attracted into this apparently stellar enterprise. In the long run, however, the bad event is highly likely to occur. Since we have made huge profits, our investors have paid us handsomely for the near certainty of losing them money.

Now all you need to do is raise $100m and pray the options don't ever payout. But if they do, hey, it's not your capital that will be lost and you can keep your past fees. RESULT!

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"Honey, get a doctor. I've got the confidence virus" Friday, March 14, 2008

Confidence underpins business. Whenever you transact with someone, you demonstrate confidence that they can satisfy their end of the deal e.g. Amazon will deliver the book you ordered online and for which you gave your card details; the butcher is selling you fresh meat.

When confidence is lost, you stop doing business with that person/company and usually share that news with others.

In financial markets, loss of confidence about firms solvency is a primary contributor to the current paralysis - will this firm be able to pay me back or settle any trade I do with them? This is exacerbated by the viral nature of confidence. The demise of Carlyle Capital is now causing worries about the solvency of Bear Stearns, understood to be one of its prime brokers. Amplified by rumours and fears, this knock-on effect [systemic loss of confidence] is unconstrained.

In Bear Stearns case, solvency concerns exist because it is believed they will have seized collateral in the form of mortgage backed securities. Since this have become highly illiquid, so they cannot be easily converted to cash and will sit as idle assets. This is precisely why the Fed moved to offer the asset exchange facility, albeit I doubt they will publish which firms used it and in what size given the potential impact on confidence this may have - the use of such a facility may imply desperation and was the reason the run on Northern Rock began.

Elsewhere the move by the Chicago Mercantile Exchange ["CME"] to raise the margin limits for transacting five- and 10-year Treasury futures and currencies will have risk teams and dealers speculating on who will be hit by this drain on cash. Hence, CME will ask its' members for more margin, who in turn will demand higher margin from their customers. If clients can't meet these calls, they will either have to forcibly close positions and/or sell collateral, hoping that this will cover potential losses. Consequently, brokers like MF Global will be closely scrutinised/monitored in case any of their clients appears to be struggling that may have potential knock-on effects.

At the same time, the "generous" credit lines some hedge funds will have enjoyed will have been slashed by their brokers, reducing their trading capacity and requiring them to adjust portfolios i.e. trade, in smaller increments within the lower headroom they have. Combined with counterparty concerns, this has an effect on the depth of the market and the ability to trade in size [reference to the quantity of shares/units]. Trading in size matters, because if you can't trade in large quantities, then it becomes even harder to sell blocks assets at all or at least without triggering sizeable price falls.

Loss of confidence happens far faster than gains occur, so expect recovery to take a long time.

UPDATE: Just hours after writing this post, Bear Stearns shares collapsed by over 50% and it was forced to arranged emergency funding via JP Morgan with the New York Fed. Alan Schwartz, Bear Stearns CEO said in a statement that the bank’s liquidity had ”significantly deteriorated” in the last 24 hours as counterparties and clients rushed to close positions with the bank and withdraw funds. JP Morgan is provide back-to-back finance as an intermediary between the Fed and Bear Stearns, because technically Bear does not have access to the discount window. JP Morgan, notably, stressed it was just facilitating the deal and providing lending on identical terms to those of the Fed - it wouldn't wish to catch the confidence virus by association! It is hard to see a stand-alone future for Bear Stearns given the market-wide fear of trading with the Bank given its' evident insolvency.

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Bliss for those who can ignore mark to market Thursday, March 13, 2008

Warren Buffett recently warned his investors that, under mark-to-market rules, the funds he runs may encounter volatile earnings on trades that ultimately are safe, since they intend to hold the investments until maturity rather than trade them.

Presently, anyone capable of making long term investments and ignoring current price volatility can find some attractive opportunities. For instance, the imploding Carlyle Capital's portfolio consisted exclusively of $21.7 billion of triple-AAA mortgage backed securities issued by Fannie Mae and Freddie Mac. They are considered to have the implied guarantee of the U.S. government and pay par at maturity. However, because Carlyle Capital finds itself unable to meet margin calls from lenders, the fund is being liquidated and assets sold, with these assets likely to realise much less than par.

Few banks or funds want to buy these assets in the current market as they can't be easily recycled as collateral, except at punitive haircut rates. Hence prices have slumped and concerns about price volatility is discouraging any buying by those who have to report short-term earnings that include mark-to-market adjustments.

Mark-to-market has the key advantage of not allowing firms to hide worthless assets using historic costs, as was the case in the 1990s, and illustrates the approximately realisable value of the investments.

However, provided you believe that these assets will redeem at par, which is likely thanks to an implicit US Federal Guarantee, then buying these assets at a material discount to par locks in a profit, albeit the cashflow is some years hence. Should you need to realise the cash early, you may take a hit, and likewise you may miss out on other more profitable opportunities by trading short term volatility by putting your cash into a "sit and wait" asset.

Setting aside Keynes' famous morbid but accurate comment that in the long run we're all dead, these are opportune times for anyone presently sitting on cash who can afford to take a long term position.

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Locking the Mutual Funds door because of uncertainty Wednesday, March 12, 2008

Back in June, before the credit crunch took hold, I was talking with CIO of one of London's leading Fund of Hedge Fund firms about the issues I saw with hedge fund investors only being able to trade back with the manager. Specifically when you only have one counterparty with whom to trade, that counterparty can control the price, the terms of trade or simply refuse to trade. He dismissed these as theoretical problems, pointing out they had no problems redeeming funds whenever they choose.

Obviously 6 months on and the experience of many investors is very different. Many bond and property funds have suspended redemptions leaving investors unable to sell and exit their investment. Such suspensions have often been attributable to the inability of the fund to quickly realise sufficient cash to meet withdrawal requests either because they cannot find buyers or the price at which they would be forced to sell would be materially damaging to remaining investors in the funds.

However, another scenario exists which is cited by ING in suspending redemptions in two funds yesterday was that they couldn't price the fund in the absence of reliable market prices i.e. when no one is trading, there is no reference price for you to value fund holdings and thereby arrive at a "share/unit" price for the fund. Whilst a "guess" could be made of holding value, a price that was subsequently shown to be materially wrong would either affect the sellers or remaining investors and potentially open the managers to litigation.

A simple example to illustrate this:
In this example, the fund had the cash to pay the redemption and so it was not a fund liquidity issue that presented a problem, but a fair valuation issue - had both investors wanted to redeem then the fund would have faced a liquidity problem.

Leaving aside current market conditions, a similar situation could have historically arisen when a large fund investor wished to redeem. The prices achieved when quickly liquidating a large portfolio of assets to fund such a redemption are likely to be lower than trading small quantities - termed market impact, it is a reflection of few things including supply v demand conditions; the knowledge that there is a large "forced" seller; and the concern that the seller is exiting in a hurry because of something they "know". Consequently, a manager could impose a large redemption penalty [price = assumed fund value less a discount of say 25% to allow for market impact]. However, there may be such uncertainty about the prices that will be achieved that even a 25% discount may be insufficient and so it is considered safer to refuse to redeem. Alternatively, a manager could insist that the redemption be staged over an extended period to allow for an orderly wind down of a fund.

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US Fed tries to fill the liquidity pool and avoid a drought

Yesterday's pronouncements by a global consortium of central banks demonstrated how serious the current liquidity drought is.

The US Fed has further relaxed it's market intervention policies and to offered to accept triple-A rated private label mortgage backed securities (MBS) as collateral in exchange for lending primary dealers up to $200bn in Treasury securities for 28 days at a time.

The following example should helps explain how this helps
It is the recycling of funds that keeps the financial system working and on which the economy depends. Hence, the Fed's effort to oil the recycling system.

Notably, this move doesn't transfer ownership of the credit risk of MBS, which an outright purchase of the MBS by the Fed would do. This remains with the hedge fund in the example above. As I discussed here, falls in the price of MBS assets related to a loss of confidence that the MBS issuer can repay its' loans or make repayments as a result of losses of the underlying mortgages will hit the hedge fund and begin a vicious spiral. It is for this reason that commentators are wondering whether the Fed might ultimately need to actually begin buying the MBS, at which point the Fed [read US Govt] would bear the credit risk and shift lending from the private to public sector.

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Haricuts - new fashion amongst banks Tuesday, March 11, 2008

Continuing my recent theme on banks demanding extra margin, these news clips from Bloomberg illustrate the double whammy being felt by hedge funds

Margin Calls/Haircuts

- On Feb. 24, London-based Peloton Partners LLP gave up a ``night and day'' effort to stave off demands from banks, including Goldman Sachs Group Inc. and UBS AG, for as much as 25 percent collateral for securities that once required 10 percent, according to investors in the fund. Peloton, run by former Goldman partners Ron Beller and Geoff Grant, liquidated the $1.8 billion ABS Fund, its largest.

- Banks usually limit their risk on repos by lending less than the value of the securities used as collateral. Tequesta was able to borrow $95 on $100 worth of AAA rated jumbo prime mortgages in early 2007, meaning the bank took a $5, or 5 percent so-called haircut. By last month, the amount required had risen to as much as 30 percent

- For AAA rated residential mortgage backed securities, banks have raised haircuts 10-fold in the past year to 20 percent, according to estimates from Citigroup credit analyst Hans Peter Lorenzen in London.

- On AAA asset-backed securities, banks are demanding a 15 percent haircut, up from 3 percent last summer. Corporate bond haircuts have gone to 10 percent from 5 percent, bankers said.

- At least one bank has raised Treasury haircuts, which range from 0.25 percent to 3 percent, depending on the length of the loan and the creditworthiness of the borrower, said bankers, who declined to be identified. They said they wouldn't be surprised if the practice becomes more widespread, not because they expect the U.S. government to default, but rather because there have been bigger price swings in the Treasury market, which affects value.

- Christopher Cruden, CEO of Insch Capital Management said. "Prime brokers are there to do business, not be your friend."

As Gordon Gekko said in the film Wall Street "If you want a friend, get a dog".

As shown above, collateral haircuts vary by asset type which is reflective of several factors including price volatility, asset liquidity and potential of asset default. So to illustrate the double whammy, if you have borrowed $95 dollars to buy a bond for $100, [extra being $5 of fund money] the deemed collateral haircut is 5%. If the bond falls in value to $95, you would either have to repay part of the loan or add/substitute collateral.

However, because of the sharp falls in value of the bond which have also hit the fund valuation, the banks now increases the collateral haircut on such bonds to 15%. If similar bonds were used, it would now require bonds valued at $112 to cover a $95 loan. Alternatively the fund could reduce it's borrowings to $81 by repaying part of the loan. In either case, it has to fund the difference from its' own resources but such funds rarely have idle balances on which to draw. So the banks sell the collateral and thus prompt the fund's demise.

Layman explanation
You buy a house for $100k, with a 95% mortgage. When the house falls in value the bank asks you to either repay some of the mortgage or provide it with more security e.g. parental guarantee. When you can do neither, despite you being up to date with interest, they decide to avoid possible future losses and demand immediate repayment. With the deterioration in the housing market you find yourself unable to remortgage on the same terms and so are forced to sell your home.

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That's got to hurt in 117 million ways

Peloton Partners is moving out of its plush London Soho offices, and is looking for tenants quickly to stem further losses. The firm’s three lead partners lost a total of $117 million they had invested in the fallen Peloton ABS Fund, which collapsed last week after failing to meet margin calls.

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Money Funds - Are the harbour walls safe?

With the turbulence in the markets and credit markets in particular, money funds have found themselves awash with cash from investors seeking a home for their cash during the storm.

Money funds are mutual funds that normally carry a triple AAA rating, whose portfolios are made up of short-term financial assets with high liquidity (Treasury Bills, Commercial Paper etc). InvestorWords quotes

The main goal is the preservation of principal, accompanied by modest dividends. The fund's Net Asset Value remains a constant value ($1/£1 etc) per share to simplify accounting, but the interest rate does fluctuate. Money market funds are very liquid investments, and therefore are often used by financial institutions to store money that is not currently invested. Although money market mutual funds are among the safest types of mutual funds, it still is possible for money market funds to fail, but it is unlikely. In fact, the biggest risk involved in investing in money market funds is the risk that inflation will outpace the funds' returns, thereby eroding the purchasing power of the investor's money.

The emphasis is mine, since this point has been under stress for some time.

Sold to both retail and corporate investors across a range of currencies, the marketing of such funds has traditionally focussed upon five things namely:
These funds have been incredibly successful in attracting deposits, especially in the US where such funds exceeded bank deposits some years ago. The industry association, The Institutional Money Market Funds Association (IMMFA), publishes a weekly summary of its' members offerings and at 1 Feb 2008 reported balances of $300bn in US dollar denominated funds (47 funds), Eur70bn in Euro funds (40 funds) and £80bn in stering funds (36 funds).

Obviously investor confidence is of paramount importance especially when competing against bank deposits and loss of capital value would come as a major shock to many investors. Mindful of this, a number of funds have been bailed out by their managers to maintain the capital protection illusion. Back in December, the FT reported that more than 10 North American banks and fund managers have collectively injected $3bn into their money market and cash funds since October to stem losses. It added that not all bail-outs have been made public but more were believed to be being drawn up and that the extent of losses is not yet known.

It takes only a tiny loss to push a fund's value below 99.5% and given that such funds have to mark their asset to market, the continued downward pressure on assets prices of even US Federal backed paper will challenge the pretence. When this happens, some investors may panic causing a "run" on such funds.

In common with banks, such funds also tend to borrow short-term and buy long-term paper whilst maintaining sufficient liquidity to meet investor redemptions. However, in the event of higher than foreseen redemptions, the lack of liquidity in the markets could result in funds either having realise cash by selling assets cheap, thereby incurring losses or suspend redemptions. This latter outcome is like a bank shutting its' doors but it has happened with several money fund managers.

You may think banks would be delighted to see their "competitors" struggle. Not so, since many of them are the managers of such funds having seen the benefits of a large chunk of existing business moving off-balance [removing any capital requirement] whilst generating broadly the same returns.

So the challenge is this - as fund balances swell from inflows, managers have to find more investment outlets. In doing so, they have to be more cautious than most given the imperative of preserving capital and having access to liquidity. Yet finding large assets pools matching this profile in the current climate will be immensely challenging. As a consequence, rates offered may have to be tempered, and whilst high inflow levels might allow for that, managers will still feel the need to competitively price their offering.

Mistakes will be inevitably made in these stormy waters. So will the sea defences hold or might urgent and rapid bailing out of these "safe harbours" be necessary or will the scenes around the South of England yesterday be repeated and the harbour walls be breached? Right now, there are many senior executives probably praying for survival.


UPDATE: Financial News has the following report

Legg Mason has provided support to one of its cash funds with a holding in Cheyne Finance to prevent its investment in the structured investment vehicle from dragging the fund down.

Officials at Legg Mason declined to reveal the size of the fund's holding in Cheyne Finance. In December, Deloitte & Touche—acting as receivers for the vehicle—revealed it had agreed to sell the $7bn portfolio to a new vehicle managed by investment bank Goldman Sachs.

Legg Mason has provided $1.57bn of support to a variety of its money funds, according to analysts at investment bank Keefe, Bruyette & Woods, including posting $440m of cash collateral and the direct purchase of $181m of securities.

In November last year, the firm signed letters of credit worth $238m to keep the high credit ratings on two of its money market funds that had a total exposure of $670m to asset-backed commercial paper issued by structured investment vehicles. In October, it invested $100m in another liquidity fund managed by a subsidiary "in order to provide additional liquidity support to the fund."

Exposure to structured investment vehicles has affected a range of money market funds, forcing some asset managers to spend millions of dollars support them in order to avoid the stigma of "breaking the buck"—where an investor receives less than a dollar for each dollar they originally invested in the fund.

Asset managers Northern Trust, Bank of America, Wachovia, Credit Suisse Asset Management, Janus Capital and Morgan Stanley Investment Management have all faced charges or arranged lines of credit related to keeping their money market funds' value at par.

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Call before its too late Thursday, March 06, 2008

This is not a reference to speaking to friends or parents, but to the growing panic among prime brokers and lenders worried about the viability of some of their hedge fund clients, prompting them to raise their margin requirements on clients and the assets they hold in their portfolios.

Designed to protect the lenders by increasing the deposit they hold against default and to protect against shortfalls in the value of collateral, these margin calls are actually tipping funds into closure. The hedge funds haven't the cash on hand to pay the margin calls and the assets they do hold are proving illiquid i.e. not easily converted into cash to settle the margin calls.

This is the worst outcome for lenders but lenders can lessen the impact on themselves if they are one of the earliest/quickest lenders to seize assets. Unfortunately, concern about being caught out actually encourages early intervention on the part of lenders.

Three high profile casualties in a week

FT Alphaville reported that US mortgage lender Thornburg has filed a material default notice with the SEC. Thornburg's share price crashed on Tuesday after speculation over margin calls hit the press. The lender defaulted on a reverse repurchase agreement with JPMorgan on 28th February, after the bank made a $28m margin call

Carlyle Unit Fails to Meet Some Margin Calls
The company said it received margin calls from seven financing groups that totalled $37m and it was not able to meet four of those requests.

“The last few days have created a market environment where the repo counterparties’ margin prices for our AAA-rated U.S. government agency floating-rate capped securities issued by Fannie Mae and Freddie Mac are not representative of the underlying recoverable value of these securities,” Carlyle Capital Corporation said.

FT Alphaville reported Peloton Partners, the stricken London hedge fund manager, told investors Wednesday that its flagship $2bn fund was worthless and that it did not know how much would be left of its remaining $1.6bn fund after banks seized and sold some of its assets. In a conference call Ron Beller, co-founder, set out reasons for the collapse.

Such collapses have a wider impact though since the market knows that the portfolios have to be sold and the anticipated increase in supply forces down prices. Hence the fund is selling into a falling market, exacerbating losses.

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Hedge Funds asked to play the role of "fish in a barrel" Tuesday, February 26, 2008

In a report this week, the US Government Accountability Office has concluded that the use of multiple prime brokers by a hedge fund could pose risks to the economy since no single broker had a complete view of a fund and its' leverage. According to the report, hedge funds "often declined to share information about specific positions" with brokers.

Duh!

I can certainly understand why the regulators might prefer the simplicity of hedge funds using a single broker. It would indeed allow a broker to better understand what the fund was up to and give the regulator a single broker to blame if things went awry. However, there are many reasons why a hedge fund chooses to use several brokers including
Spreading business between firms is usually more costly to a hedge fund in terms of reduced collateral netting opportunities and higher commission rates, but the merits are evidently considered to outweigh the demerits. Moreover, I can think of few, if any, firms who can claim to have a complete view of their counterparties especially brokers that trade with each other.

To advocate the funds should relinquish these benefits smacks of unfairly favouring one constituency over another to make a regulators life easier.

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If Goldman won't invest, trouble may be ahead Thursday, September 20, 2007

You may recall that recently Goldman Sachs injected $1bn of funds into one of its' funds following a dramatic fall in value during the August downturn. In the couple of weeks thereafter the fund went up 20% - very nice too, thank you.

However, another Goldman fund appears to be less attractive to the firm

Report: No Goldman fund bailout
Wed, 19 Sep 2007, 12:18
CNNMoney

Goldman Sachs Group won't bail out its embattled flagship Global Alpha hedge fund, but it won't close the fund either, according to a published report. The Wall Street Journal reports that the fund managers have sent a letter to investors with promises to better handle borrowing and volatility, to shrink the size of the fund and to "adjust our process." The letter did not say there would be any injecting of Goldman's own money into the fund, according to the report.

Never one to miss a money making opportunity (unless there is a bigger one elsewhere), what should we infer from this one? I had a brief conversation with a friend at a Swiss Private Bank and he advance the notion that the big banks are concerned about setting a precedent of bailing out their funds when they hit problems since this removes moral hazard from investors.

I disagreed with him since Goldman's "bail out" was at prevailing prices rather than pre-crash. Hence, investors had already lost money and weren't being refunded. Instead they were simply benefiting from the firm providing additional liquidity to snap up opportunities in the market, which all fund investors then benefited from.

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Please go away - we're shut for a year

Yet another story about a fund locking the door on investors that might have wished to redeem their investments

Hedge fund firm bars withdrawals by investors
Thu, 20 Sep 2007, 07:11
International Herald Tribune/Bloomberg

Absolute Capital Management Holdings, whose co-founder, Florian Homm, abruptly quit Tuesday, on Wednesday stopped investors from withdrawing money from eight hedge funds that managed USD2.1 billion. The firm told investors that they should not expect to be able to get at their money for a year while it restructures the funds. Seven of the funds hold over-the-counter US stocks that cannot be sold at the prices that the firm has on its books, affecting as much as USD530 million of assets.


Particularly entertaining is the comment that the firm has stock that cannot be sold at prices it is valuing them at - hmmm, perhaps they don't understand the concept of marking the fund to market, clearly prefering to mark to model, in this case THEIRS!

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So much for long term investing Tuesday, September 04, 2007

Hedge fund and fund of fund managers regularly "explain" to me that their investors understand that they are making a long term investment and hence aren't that concerned about short-term liquidity.

Odd then that the FT had this report

Funds of hedge funds selling adds to volatility
Mon, 03 Sep 2007, 21:33
FT.com

Deleveraging by funds of hedge funds as they faced redemptions from investors may have contributed significantly to the stock market turmoil in the summer, according to research by BarclayHedge and TrimTabs. Their data suggest that investors in funds of hedge funds, the most popular vehicles for investing in alternative assets, may have redeemed as much as USD55bn in July, equivalent to almost 5 per cent of their assets.

Some of those redemptions may have been covered by inflows (new investment) or by cash on hand, but a significant chunk will have had to flow through to underlying funds. Given that notice periods on funds tends to be linked to the types of instruments they use and their liquidity, you'll often find that funds that operate using equities or futures offer the shortest notice periods. Hence, redemptions may have been covered by withdrawals from funds that may have been least affected by credit crunch.

Being 5% of assets this won't materially hit the skew of the fund of fund portfolios but chances are some fund of funds will already be planning for further withdrawals and thus kicking of the process of giving notice on some of their more illiquid fund holdings - which in itself puts even more pressure on the underlying funds.

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Speaking the language of hedge funds Thursday, August 16, 2007

This article on MSNBC was a cutting piece on the explanations being offered by Hedge Funds on their current "discomfort".

Some great highlights included

Hedge-Fund Phrase: Challenging
Translation: Run for the hills!

Hedge-Fund Phrase: Unprecedented, unique circumstances
Translation: Stuff happens. But we had no clue.

Hedge-Fund Phrase: Market volatility has produced unfair, unrealistic prices.
Translation: The market is efficient only when it works in our favour.

Hedge-Fund Phrase: Our results were affected by the selling behavior of other firms.
Translation: We made the same dumb trades as everyone else.

Goldman Sachs CFO David Viniar noted that the firm's decision to inject $2 billion into its ailing Global Equity Opportunities fund "reflects our collective belief that the value of this fund is suffering from a market dislocation that does not reflect the fundamental value of the fund's positions." In other words, the losses shown by these funds isn't the fault of the managers, it's the fault of a market that just won't value assets properly. Ironically, you never hear fund managers say that their gains have been unwarrantedly large due to the market's failure to reflect stocks' fundamental value.


Today is also the last day for investors to give their usual 45 days notice to withdraw funds ahead of Q407. So a number of hedge funds are going to find out what investors think about the current situation and their confidence in their managers. Of course, this could well prompt another bout of selling to create cash to fund redemption, which will be amplified by leverage i.e. if you used investors funds as a deposit on leveraged trades say 10x. Then for every hundred dollars they need to be paid, you need to liquidate a thousand dollars of positions.

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Desperate times or price competition is here Wednesday, August 15, 2007

Either they were desperate or Goldman's are starting a pricing revolution in hedge funds

Terms offered on their Global Equity Opportunities Fund to the "bailout" investors - No (2%) management fee, and no incentive fee until the fund performance exceeds 10%. Heck. The bar may have just been raised.

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Be still my bleeding heart & mind the gate Tuesday, August 14, 2007

The Street has another story of how Sentinel Group is dealing with its' investors requests to redeem their investments including this letter sent to the investors.

SENTINEL MANAGEMENT GROUP, INC
August 13, 2007
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 have carefully monitored this situation for the past several weeks and have met regularly to discuss the potential impact it may have on our clients. 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.

Sentinel has always sought to protect your interests and since our inception in 1980, we have
never experienced a situation quite like this one. We will continue to monitor the markets and we will raise cash as opportunities present themselves.

We understand that this will obviously cause inconveniences on your part however, at present, we do not see an alternative and we don’t believe it is in anyone’s best interest if a run on Sentinel took place and we were in a forced liquidation mode.

We value your trust in us these past 28 years and this has been a very difficult decision for us
and we understand the implications of this decision both on you and on Sentinel. We feel, however, that this is the best way to assure you the best possible value on your investment.

We will remain in contact with you and update you as things progress.

Sincerely,

Sentinel Management Group, Inc.


Mind the Gate! It snaps fasts

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