Hedge Fund Street

Credit Fund Glut Leads To Hedge Fund’s Demise

Nobel Prize winner Robert Merton and hedge funds don’t go together. Well, that’s not me saying, only history. Merton was co-founder of defunct hedge fund Long-Term Capital Management, way back in 1993. Five years later, when Russia defaulted on its debt, it led to a domino effect, which made the fund lose nearly 90 percent of its capital or $4 billion in a matter of weeks. Why am I on about Merton? Well, he’s in the news again – this time for shutting down his firm’s latest funds after just three months because it didn't raise enough money.

Merton's Integrated Finance Ltd. closed the IFL Continuum Fund in June. The fund, which concentrated on credit securities, had collected $30 million since its start in March. So, when the market is totally in favor of credit-oriented hedge funds, how was Merton’s fund unable to raise money? The answer actually lies in the problem itself. In the last 18 months, just too many credit-oriented hedge funds were launched. While some of these did manage to raise quite a bit of money – some more than a billion dollars – experts say the market is now quite saturated. And Merton’s fund seems to have joined the party a bit too late. Most people already seem to have made their allocations, which meant Merton’s fund was bound to lose its money.

So in essence, this meant that IFL Continuum would struggle right from the word go. While hedge funds attracted over $42 billion from April through June, IFL Continuum struggled to hold its own. IFL's credit fund was managed by Peter Hancock, 48, former head of JPMorgan Chase & Co.'s global derivatives group.

Hedge Fund Parts Ways With OSI Chain

Hedge fund Pirate Capital LLC recently dumped its 5.3 percent stake in the struggling OSI Restaurant Partners Inc. chain. Since June 6, Pirate had urged a breakup of OSI in hopes of unlocking a payoff to shareholders of the company's faster-growing, younger chains. Sptimes.com reports:

In June, Pirate threatened to run its own slate of directors in 2007 if OSI ignored its demands to slow the growth of its dominant Outback brand, step up the level of stock buybacks and spin off the three other chains.

Read more:Hedge fund, OSI part ways

Hollywood Magic Casts Spell On Hedge Funds

So, what do you think is the latest investment Mecca for hedge fund managers? No, they are  not looking East for exotic investments -- rather it is much closer home. Hedge fund managers are now pouring billions of dollars into Hollywood, hoping to find block-buster returns in the film business that plain, old corporate investments cannot provide. Timesonline reports:

In the past three years more than $4 billion (£2.1 billion) of hedge fund money has been invested in Hollywood movies, with the lion’s share going to mainstream studios looking for new sources of finance. “Hedge funds are definitely the flavour of the month in Hollywood,” Larry Ulman, the head of the entertainment practice at the Los Angeles law firm Gibson, Dunn & Crutcher, said.

Read more: Allure Of Tinseltown Turns Hedge Fund Heads

Hedge Fund Drama, Hollywood Style

And you thought film stars had it all. Well, in a way they do – common folks don’t invest in hedge funds so they don’t have to face the kind of problems Sylvester Stallone is going through. But when you come to think of it, he and a few others like John Cusack are not suffering because of losses. The ghost of a failed hedge fund has come back to haunt them – and this is quite peculiar even in the quirky world of hedge funds.

So, let me get down to details: In 1997, the actor invested $2.5 million in a private investment partnership called Lipper Convertibles. Four years later, with his statements showing the investment had swelled to about $3.8 million, he cashed out. Fellow actor John Cusack also walked away with big gains, as did former New York City Mayor Ed Koch and a trust fund for the children of investor Henry Kravis. Now, they are all being sued to give money back. Post-gazette.com reports:

What none realized, according to their lawyers, was that Lipper never made all that money. A portfolio manager had inflated profits by at least 40 percent, Lipper discovered in 2002. "We want all the money to be put back in the pool, so we can divvy it up equitably among all the partners," says Thomas Dubbs, an attorney representing the federal trustee overseeing Lipper.

Read more: Failed hedge fund haunts celebrities

Know Your Hedge Fund: Merger Arbitrage

Hedge funds by their inherent nature involve risks. If you are dealing in the market, you are expected to make a few profits and losses. However, there is one tool that is designed to ensure profits regardless of the direction the equity market takes. Sounds intriguing? Called merger arbitrage, this strategy takes advantage of the expected price movements or arbitrage opportunities that occur after the announcement of a merger or acquisition offer.

Now that you know what a merger arbitrage is, let’s examine how it works. Once a company makes an announcement of its intent to acquire another firm, the price of the target company's stock will go up. If you notice carefully, it does rise but usually not to the full offering price. And since there is a risk of the deal not closing on time or at all, the target company's stock may sell at a discount to its value at the merger's closing. This discount usually increases with the expected length of time until closing and the perceived risk of the deal. Now if you want to use the merger arbitrage strategy, you will try to lock in this spread. If the merger involves a cash offer, you will only have to buy the stock of the target company. But if the deal involves a trade of securities, you may also have to hedge against the possibility of the acquirer's stock falling. To do this, you can sell the acquirer's stock short.

You will notice that when compared to the uncertainty of playing the volatile equity markets, merger arbitrage investments can give you quite consistent returns. There is of course the risk of a merger or acquisition falling through. However, a good fund manager is expected to foresee such circumstances since they are quite predictable.

Henderson to Launch Fund Of Its Own Funds

Fund firm Henderson has plans to launch a fund that will invest in a range of its own hedge funds. The Henderson Total Return fund will launch on September 1 and be managed by Bill McQuaker, Director of Multi-Manager Funds. Reuters.com reports:

The minimum investment will be $100,000 (52,000 pounds). The fund, which will be domiciled in the Cayman Islands and listed on the Irish Stock Exchange, will be aimed at institutional investors, high net worth clients, private banks and family offices.

Read more: Henderson to launch fund of internal hedge funds

Is SEC Delaying Hedge Fund Inquiry?

Senator Charles E. Grassley, the chairman of the Senate Finance Committee believes that Securities and Exchange Commission rules are slowing a Congressional inquiry into whether political influence derailed an investigation of the Pequot Capital Management hedge fund. Senate investigators are checking if the S.E.C. suspended its inquiry of Pequot for political reasons. Nytimes.com reports:

Gary J. Aguirre, a lawyer fired by the S.E.C. last year, told the Senate Judiciary Committee in June that he was not allowed to interview the chairman of Morgan Stanley, John J. Mack, while he was investigating insider trading claims against Pequot. Mr. Mack was briefly chairman of the $7 billion fund.

Read more: Senator Presses S.E.C. on a Hedge Fund Inquiry

Hedge Funds: Boring & predictable

Common belief is that hedge funds are supposed to make money the risky way so why is it that hedge fund managers are now fighting shy of taking risks? Their argument is that their customers don’t want them to deal in such investments. So, for fear of losing these customers and more importantly, their fees, which can only be called exorbitant, hedge fund firms are now learning to play safe.

This sudden change in what is essentially a risk-taking business came about slowly. The sector's profile witnessed a change after institutions poured money in and drove worldwide hedge fund assets to more than $1,000bn. This large amount of money has weighed heavily on hedge fund performance and has led to ‘overcrowding’ in many strategies. As they reach critical mass, these firms begin to slowdown their aggressive activity and try to appease their major clients.

Why Beta Aims To Be Alpha

What are these terms doing in hedge funds? If you are new to the world of hedge funds, here are a few more terms you need to be introduced to. Firstly, let’s take a look at the beta because that’s what ordinary investors usually make do with. Beta means basic market returns as embodied by the Standard & Poor's 500 composite index of stocks. So what’s alpha. Well, there’s no hard and fast definition but they represent the outsized returns that come from more exotic investments. These usually come from tempting emerging markets in China and India, say, or commodities.

Now, there’s a new alpha in town – the portable alpha. This is the term investment managers have given to the notion that by moving out of the S&P 500 universe, they can match the performance of George Soros. And why is there such a rush to move to the alpha playground? One reason could be the wildly outsize reward for alpha performance. For the top 26 hedge fund managers, the average pay last year was a whopping $363 million!

This Hedge Fund Has No Use For Managers

Your search for the calmest trading floor in the world ends at Sugar Quay, a former dock on the north bank of the Thames. No, I’m not exaggerating. Here, in the headquarters of the hedge fund giant Man Group, a small number of traders quietly handle tens of millions of dollars at a time, around the clock, following directions generated by the fund’s black-box trading system, known as AHL. Revolutionary? You bet! Until now, hedge fund managers were hailed for their quirky, daring trading styles, which were supposed to be central to their success. So, have these guys, some of the smartest brains in the trade been beaten at their own game by a trio of physics majors?

AHL, named for the initials of its three founders boasts of a brain that is made up of a room full of man-high Hewlett-Packard computers. This system, which was created by three analysts who studied physics at Oxford and Cambridge Universities, boasts an annualized return of 17.9 percent since December 1990. Total returns during that time are more than 1,000 percent. Nytimes.com reports:

Black-box trading systems, as they are known, are responsible for a growing percentage of market trading around the globe, including an estimated half of all United States stock trades and a quarter of worldwide currency trades. AHL, as one of the longest-running, most successful programs on the market, has become the backbone of the Man Group’s rise to a £7.44 billion ($14 billion) market cap company.

Read more: A London Hedge Fund That Opts for Engineers, Not M.B.A.’s

When Hedging Can Be a Big Risk

Its ‘value at risk’ (VAR) models are the pride of the hedge fund industry. However, last month, traders say, some markets witnessed six times the expected range of volatility and the worst part was that the fancy VAR models, based on past experience, failed to predict the actual damage. Washingtonpost.com reports:

The European Central Bank got so worried that it warned this month that hedge funds were the financial equivalent of bird flu and could pose a "major risk for financial stability." And Raghuram Rajan, the chief economist of the International Monetary Fund, cautioned June 8 that hedge fund managers were all chasing the same investment magic they describe as "alpha." This was driving them like a herd into riskier assets and making them all vulnerable to the same potential reversals.

Read more: When Hedging Doesn't Pay Off

Dip, Dip Fund of Funds

I know I’ve been going on and on about fund of funds and about how they are good and a safer investment. But now as I research more about fund of funds, I find that I may have been misguided by the sheen. I mean it may not be as good as it sounds. As the cliché goes, I probably made the mistake of judging the book by its cover. And well there are quite a few out there who probably make the same mistake. When you invest in a fund of funds, you probably believe that your fund of funds manager is doing the best he or she can for your investment. You better think again! At the end of the day, the hedge fund market also plays the fee game. Everybody is in it for the money and the investor is the golden honey pot. Yes, this may sound ridiculous, but look at it this way – hedge fund managers are human too and greed is a typically human trait, isn’t it? Well, I digress again.

It seems the hedge fund community engages in a practice called ‘double dipping’. This means, they may not always be seeking the best manager for their multi-strategy funds. They may be seeking the best marketing deals in each strategy they can get within each strategy. Sounds confusing? Let me explain. These managers glib talk you, the investor, into investing in their fund of fund vehicles. And on the hedge fund side, they offer contract marketing agreements. So, they essentially make money from both ends – the investors and a marketing fee for putting their fund of funds investment with a manager in any given particular strategy.

The problem with this strategy is that while the fund of funds manager makes his/her money, you may be getting a raw deal. I mean this fund of fund manager is probably passing up a good manager in a given strategy to get a better deal with a lesser quality manager. Are you game for such a risk?

Defining hedge funds – the SEC way

I’ve written time and again about the SEC and regulation drama that’s been playing out for quite a few months now. So when I stumbled onto this article on what the SEC thinks a hedge fund exactly is, I pounced on it. Here you can know the SEC definition of a hedge fund. Hedgefundcenter.com reports:

They are not required to register because they generally only accept financially sophisticated investors and do not publicly offer their securities. In addition, some, but not all, types of hedge funds are limited to no more than 100 investors.

Read more: The SEC's Definition of a Hedge Fund

Hedge Funds Don’t Want Extra Returns

The fact that most hedge fund strategies are market neutral is a fact I really don’t need to reiterate. And now, clients of hedge funds have become more careful and want their hedge fund managers to ensure assured returns on their investments. So pray tell me does the alpha—the extra return that active fund managers claim to earn above the market rate – really exist?

For many trading strategies, there is a limit to the amount of money that can be moved around cheaply and briskly. While punting large amounts on the highly liquid foreign-exchange or government-bond markets is easy, betting on illiquid corporate bonds or shares is far harder. And the larger the amounts, the more expensive the bets are. For this very reason, many of the oldest and best-known hedge funds do not accept any new money. Some have even been handing capital back to investors.

Phil Goldstein: One Man Army to Tackle SEC

Phil Goldstein is one angry man and not without cause. The activist hedge fund manager whose court challenge forced the Securities and Exchange Commission to abandon its plan to force hedge funds to register, could not get any of the big players from the hedge fund industry to join him in the court action. Moneycentral.msn.com reports:

"Where were all the other guys?" he asks. "Where were all the hedge funds who didn't want registration forced on them? Why didn't they come in with us?"

Read more: Hedge fund manager decries lack of support

Hedge Fund Bust Could Hurt ABN Amro Badly

Now this one is for the 'I told you so' brigade. Dutch banking giant ABN Amro will have to deal with a $100 million loss from heavily lending to a hedge fund. This problem could even jeopardize the terms of its ongoing $386 million deal with Swiss investment bank UBS. Allheadlinenews.com reports:

Motherrock was the hedge fund managed by Collins. It went bust last week as it gambled investors' money amounting to $450 million on natural gas gone awry. ABN had brokered trades for Motherrock and facilitated the fund to deal with huge amounts of borrowed money.

Read more: Hedge Fund Bust Could Threaten ABN Amro's Futures Sale

$1.5 Trillion And Growing! Now That Makes Me Squirm

I’d recently written about how the hedge fund industry is slowly inching toward being able to manage more pension-fund money. A recent provision in the pension-reform bill could allow hedge funds to do away with a ceiling on how much money they can take from pension plans. These lightly regulated investment pools have traditionally limited the amount of pension-fund money they take to 25 percent of their total assets.

Now this is definitely a time for Wall Street to party. Just imagine, the industry will soon be able to invest the huge resources that rest with pension funds. However, quite a few groups are not too happy with this provision. Labor and other groups believe that hedge funds aren't adequately regulated and could threaten pensions. Of course, the SEC is determinedly pursuing its goal to regulate hedge funds, but until such regulations are in place, hedge funds could be a major cause for worry.

These funds manage about $1.5 trillion in assets and have grown rapidly in recent years. Their future growth plan is also on the upward swing and with this latest move, more funds will become available to these funds. A recent study shows that hedge funds have substantially improved their risk management practices in recent years to reduce threats to the financial system and investor losses from fund failure.

All this did make me feel that we probably don’t need to worry about regulation. But then, when you get back to the over $1 trillion figure, it does make me squirm with discomfort – so much money and no regulation whatsoever!! SEC Chairman Christopher Cox’s assurance to Congress that hedge funds "are not, should not be and will not be unregulated," does make me feel a bit secure, but these words need to be followed by proper action for us to believe that Cox means what he says!

Fund of Hedge Funds! What Was That Again?

I recently wrote on how a fund of hedge funds was a good investment option. But I guess I haven’t explained a fund of hedge funds clearly enough so maybe we could have a tutorial on this aspect of hedge funds. So getting down to the definitions first, simply put, a fund of hedge funds is a diversified portfolio of hedge funds. These funds need not be correlated in any way.

The principle is similar to the ones used on the stock market. If you don’t think you can identify your stocks well enough, you tend to invest in a mutual fund that then invests in blue chip or whatever other types of stocks for you. While the returns are assured, they are not phenomenal. Now going one step further, a fund of hedge funds seeks to deliver consistent returns than even stock portfolios, mutual funds, unit trusts or individual hedge funds.

Since returns are assured, a fund of hedge funds is the preferred investment of choice for many pension funds, endowments, insurance companies, private banks and high-net-worth families and individuals. Yes, if you didn’t know, YOU too can invest in a fund of hedge funds. Only you have to be a high-net-worth individual or belong to such a family.

What are the benefits? Well, since you get access to a broad range of investment styles, strategies and hedge fund managers, your returns are more predictable than traditional investment funds. Another big time benefit is that it allows you access to a broader spectrum of leading hedge funds that may otherwise be unavailable due to high minimum investment requirements.

CalPERS Adds to its Hedge Fund Portfolio

Richard Breeden's activist hedge fund firm Breeden Capital Management, was recently allocated $400 million as part of the California Public Employees' Retirement System's (CalPERS) corporate governance portfolio. The pension fund, which is worth around $211 billion decided to invest in the hedge fund in March but the investment was made public only recently.

Richard C. Breeden launched his hedge fund firm earlier this year and the as of now, the strategy has $106 million. Company executives claim that the firm has already raised $500 million, However, it has only invested $100 million at present. With this latest hedge fund investment CalPERS has increased the percentage of hedge fund investment in its corporate governance portfolio. SPARX Asset Management, one of the fund's first hedge fund investments, still retains $679.5 million of the $3.6 billion program. Blackenterprise.com reports:

SPARX was hired in 2002 to employ corporate governance activism against underperforming, publicly traded Japanese companies. The firm recently was named one of the largest hedge fund firms in Japan in a recent industry survey.

Read more: CalPERS Adds Former SEC Chair's Hedge Fund

Pension Funds Romancing Hedge Funds

It’s no news that pension funds are now increasingly looking to hedge funds to increase their investment returns. What is interesting is traditionally cautious pension funds are changing their portfolios to increase their allocation range for hedge funds. This means, they have seen the returns that hedge funds can offer them not just once or twice but over a period. And the best part is that these returns are consistently high. Much higher than what stock or bonds can offer. Add to this the fact that hedge funds have become more stable and don’t take too much risk, and you have a winning equation for pension funds.

Take for example CalPERS, the largest pension fund in the United States, which has over $210 billion worth of stock, bonds, funds, and private equity. It is now expanding its investment strategy into hedge fund managers. The fund also increased the target allocation range for hedge funds significantly, to as much as 5% of the plan’s global equities portfolio.

Fund of Funds or Single Fund?

If you are a high net worth individual, you’ve probably been through this dilemma: is it better to invest in a fund of hedge funds rather than a single hedge fund? One of the advantages of investing in a fund of funds rather than a single hedge fund is that you get more diversification. Financeasia.com reports:

Risk levels decline as diversification increases. It depends on investors as to whether they want a low risk product. Some fund of funds offer consistent absolute returns. They could offer better transparency and liquidity than some single funds.

Read more: Are hedge funds good for you?

Pension Money and Hedge Funds Make for a Heady Combination

Hedge funds are moving closer to being able to manage more pension-fund money when the House cleared a pension-reform bill late Friday. Negotiations are ongoing about a bill shoring up the nation's defined-benefit pension system, congressional aides said. Marketwatch.com reports:

Under one version of the bill, hedge funds, the lightly regulated investment pools, would be allowed to do away with a ceiling on how much money they can take from pension plans. Wall Street groups have been pushing for the change in the law.

Read more: Hedge funds close in on pension money