The thing about useful stuff is

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

USD399bn redemptions
USD383bn drop in valuation

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.

Labels: Funds, Hedge fund, Hedge Funds, Investor, secondary markets

posted by John Wilson @ 11:30 AM Permanent Link ,

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Hedge fund braced for large withdrawals Tuesday, September 30, 2008

If Hedge Fund investors decide to lodge large redemption notices this week for the end of December [typical notice period is 3 months, assuming you are not in a lock-in period which is common in the early years of a fund], then we will see additional downward pressure on share prices and a considerable contraction in the trading capacity of funds.

Investor withdrawals are to be expected given a combination of fear about market risk, prompting a flight to safety and the neutralising of popular long/short hedge fund strategies by regulatory restrictions on short selling.

In many cases, the withdrawal of £1 is amplified by 10-20 times as a result of leverage. Hence, to realise cash to pay investors, a hedge fund will have to liquidate say £20 of assets in my example. Such forced sales will contribute to price depression and exacerbate illiquid markets. Depending on the scale of redemptions, some funds may find their funds wither to uneconomic levels i.e. fees generated on a small fund are insufficient to cover their costs, with the result that they are forced to close. In some cases, this could happen with redemption levels of only 40%.

Of course, Hedge Funds could do two things to discourage/stop exits. The first is that they could impose large redemption penalties i.e. heavily discount the price they offer to pay to repurchase units from investors - 25% or so. Secondly they could drop the "gate" on funds and suspend redemptions, which is a power funds often have to ensure an orderly operation of the fund - large exits destabilise a fund to the detriment of all investors.

Labels: Hedge fund

posted by John Wilson @ 9:24 AM Permanent Link ,

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Why having only one prime broker is a bad idea Tuesday, September 16, 2008

When conducting business continuity planning you aim to identify all single / critical points of failure and implement measures to eliminate them to the extent this is possible.

In which case, why did 33 hedge funds in Europe give Lehman a sole prime broking mandate with the result that their assets are now frozen and their prime brokerage contacts are unavailable to assist in almost all cases?

Recent examples at Bear Stearns and MF Global should have provided enough of a wake-up call to every hedge fund about the dangers of concentrating all your business in one place. Whilst those assets should be segregated and hence ring-fenced from those of Lehman, inability to access them in turbulent markets renders the funds hapless.

Setting aside the other benefits of operating with 2 or more prime brokers which is the obvious answer to the identified risk e.g. you remain closely attuned to price/service differences between firms, there are usually higher direct [fees paid] and indirect [netting opportunities foregone] costs to bear from distributing business. Yet one has to wonder if the managers in question were incompetent or plain stupid, since the consequences of a risk event occurring dramatically outweigh versus the costs of cover.

According to the FT, another 67 firms that were prime broking clients of Lehman are also affected by its' demise, but they had in place alternate prime broking arrangements, so are able to access some of their fund assets and continue to trade.

Labels: bear stearns, Broker, Hedge fund, lehman, Lehman Brothers

posted by John Wilson @ 9:07 AM Permanent Link ,

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When Stars implode [your business] Thursday, May 08, 2008

The ramifications of Greg Coffey's departure from GLG will be reflected upon by many other CEOs in the hedge fund and fund management arena. At minimum, it should have forced a review of key personnel risk within their own organisations, if only because they are likely to be asked about it by their own company investors.

Greg, who managed $7bn out of GLG's $24bn of funds under management announced last month that he was leaving the firm to set up his own firm. This initially caused a sharp fall in GLGs share price, which then recovered most of those losses. In leaving, Greg is foregoing $250m of stock options and $300m ish of annual compensation.

Today was GLG's results briefing at which, according to the FT, GLG boss Noam Gottesman spent most of his time fending off questions about the impact on the firm.

Mr Gottesman said in the worst case scenario, he expected about $4bn of the $6bn Mr Coffey managed would leave GLG when he exited in October, adding that he wouldn't be surprised to lose most of Mr Coffey's team also.

Mr Gottesman, who had "spent the last month dealing with the ramifications of Greg's departure", said he "would never have imagined that a few $100m was an insufficient amount to retain somebody".

Asked how much each of GLG's remaining portfolio managers individually controlled, Mr Gottesman acknowledged that in hindsight it was a "risk to the business" for one person to manage as much as Mr Coffey did.

The star culture that permeates through the hedge fund and fund management sectors is actually one encouraged by the employers, who seek to crow about how fantastic their latest hire is or the performance record of particular managers. Intended to encourage new business it specifically sets the firm up to fail when that Star a) under-performs or b) demands higher pay/equity and/or c) elects to leave. Obviously the employees are more than happy to play along since its ups their bargaining power in negotiating for higher compensation.

Having worked with many fund management companies in my career, I've seen instances when it has also created an undercurrent of resentment and bitterness amongst colleagues/teams, which is another key reason why some firms insist on downplaying the importance of any one individual.

Labels: GLG, Hedge fund, Noam Gottesman

posted by John Wilson @ 5:28 PM Permanent Link ,

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Hedge fund secondary markets

Allaboutalpha reports here on a study about secondary market trading of hedge funds based on Hedgebay data.

Having been closely involved in a venture that sought to launch a regulated secondary market for the trading of hedge fund interests via underlying and synthetic instruments, with related clearing and settlement, I found the findings fascinating. Most notable were the size of premiums/discounts operating, which re-enforced my beliefs that investors always prefer to have competitive liquidity venues and the price they pay/accept depends upon their circumstances regardless of underlying reported value, with immediacy of execution being a key determinant.