Hedge Fund Street

Hedge Fund CEO Fined $2.25 Million

I have spoken time and again about regulations and how they may not be all that good for the industry. Recent events seem to have reinforced my views. External regulation may definitely not work in this industry. One reason is that hedge fund managers prefer to keep their dealings to themselves and generally don’t like external meddling.

But what if someone from within the fraternity committed a fraud, which caused loss of money to the public? You know what is the worst part about a fraud of any kind – innocent investors losing a great deal of money and something more important, their faith in the system. Probably someone from within the industry should play police? Now that’s something I welcome wholeheartedly.

What am I coming to? The recent imposition of $2.25 million fine by securities regulators on Paul Saunders, the chairman and CEO of hedge fund James River Capital Corp. Reason: He allegedly used deceptive practices in trading in the long-term investments known as variable annuities.

The National Association of Securities Dealers, the brokerage industry’s self-policing organization, imposed this civil penalty. The over $2 million penalty is supposed to be the largest fine ever imposed on an individual. It includes restitution of some $750,000 in illicit profits that Saunders allegedly personally made.

Mr. Saunders is alleged of conducting improper market timing -- frequent "in-and-out" trading. He will also be suspended for 60 days from working as a broker. As of now, Saunders has neither admitted nor denied the NASD's allegations. Market timing is not officially illegal. However, it is widely restricted because it tends to skim profits from other shareholders.

A Frank Look At The Hedge Fund Industry

Heard of Barney Frank? Chances are, you haven’t. But you will not have to wait for long – Frank is set to become chairman of the powerful House Financial Services Committee, chaired until recently by Michael Oxley, joint author of the Sarbanes-Oxley Act. This new appointment is going to have some effects on the hedge fund industry.

Hedge fund regulation is likely to feature highly on the committee’s agenda if the Democrats take control, though there is no consensus about reforms. According to certain highly placed officials, Frank has expressed concern about the size and influence of hedge funds and their lack of regulation. Focus will be on the scope of the risks that hedge funds present – particularly for public pension plans.

Fund Of Funds Lack Luster, Complain Investors

I always thought that fund of hedge funds would be the mutual funds of the hedge fund industry. They would be reliable and would ensure decent returns to investors. So, the fact that investors were unhappy with these fund of funds, just didn’t sound right. But then if you don’t perform, even a monarch will face pressure from his/her subjects, right?

Investors want these fund of funds to demonstrate their investment value. Recent disappointing performances have made investors re-assess the value proposition offered by fund of hedge funds, according to a Fitch report. Many investors are even wondering whether it is worth paying an extra layer of fees only to experience a disappointing performance. The main reason is that funds of hedge funds have been unable to effectively diversify their risks. Investmentexecutive.com reports:

“Funds of hedge funds now face increased competition, greater scrutiny from investors and are increasingly constrained by limited capacities and a higher correlation of hedge funds,” says Aymeric Poizot, director at Fitch.

Read more: Fund of hedge funds face investor pressure due to disappointing performance

Film Fever Hits UK Hedge Fund Industry

What’s it about movies and hedge funds? The trend began in Hollywood and has now spread to the UK film industry. Recently, Simon Fawcett, chief executive of Aramid Capital Partners, announced that they are spearheading the launch of a hedge fund to provide finance for independent British films. Timesonline.co.uk reports:

Aramid works by offering “bridge finance” to UK producers. Under a new tax scheme to encourage film-making in Britain, producers can gain tax credits depending on how much of a film is produced in the UK, but they may have to wait some time to receive the money.

Read more: Fawcett spearheads hedge fund launch

No Proxy Fights Please

Fine, at least we have some mature people in the hedge fund industry. Recently, plastics company A. Schulman Inc. and hedge fund Barington Capital Group on Thursday said they had reached an agreement that will avoid a proxy contest at the annual meeting. Way to go boys! Reuters.com reports:

Previously the New York-based hedge fund had asked the company to put itself up for sale to improve value for its shareholders. Schulman said Barington will not nominate directors for the company's board.

Read more: A. Schulman and hedge fund avoid proxy fight

Strategizing Volatility

The past few weeks saw so much activity on the hedge fund front, it felt more like the nail-biting finale of a thriller rather than the mundane world of finance. I know hedge funds are anything but mundane. But I’d be lying if I said that the Amaranth collapse had me gripped. Would the market collapse? What would other fund managers do? What strategies would they employ? … too many questions.

It was around this time, I realized that not everybody understands hedge fund strategies. I know you must be wondering if you really need to know about hedge fund strategies. Well, one of the simplest and most basic reasons to study them is because it helps you know the difference between various hedge funds. Investment returns, volatility, and risk vary largely among the different hedge fund strategies.

There are some strategies, which are not correlated to equity markets and are yet capable of delivering consistent returns with extremely low risk of loss. And then, there are others that may be as or more volatile than mutual funds. In case you want to have a successful run in the industry, you should be able to recognize these differences and blend various strategies and asset classes together to create a more stable long-term investment return.

Most hedge funds primarily aim to reduce volatility and risk while at the same time preserving capital. And irrespective of the market conditions, they want to consistently deliver positive returns. This is quite a tall order and hence it makes it doubly interesting to know how you can manage the volatile with the stable to ensure consistent returns.

Protecting The Human Face

I’ve talked so much about the Amaranth collapse and its aftermath, and the logistics involved. But somewhere along the way, I forgot the human face – the investors. What can you do to avoid losing your money in a hedge fund collapse? Firstly, ensure that no more than 10 percent of your asset total can go into a single hedge fund. And no more than 35 percent of all your assets should be placed in hedge funds.

This would force hedge funds to "know YOU – the customer" that much better. It would also diversify investors. This would also would allow regulators to keep the bulk of their focus on those investments that are common tools for average investors.

Outsourcing Of Hedge Fund Functions May Provide Transparency

To cut costs and improve the service to clients, hedge funds have of late been outsourcing certain key functions. These functions include confirmation of over-the-counter derivatives trades, reconciliation of trades done across multiple prime brokers and daily profit and loss reporting. Financialnews-us.com reports:

The shift is likely to provide the Securities and Exchange Commission, the US regulator, with more transparency about trades done by the estimated 8,800 US hedge funds. Third-party providers will supply verification of a hedge fund's assets - something that was lacking while hedge funds kept the middle office in-house.

Read more: Hedge fund transparency

Thomas Lee Plans Hedge Fund

Thomas H Lee Capital Management recently said that it plans to float its fund of funds hedge fund, Lee Diversified Opportunities Limited, on the London Stock Exchange. The main focus of the fund will be on mitigating risk and preserving capital, by investing in at least 45 individual hedge funds selected by the holding company. Lse.co.uk reports:

The company said that it intends to issue three classes of shares, denominated in US dollars, euros and sterling, respectively, with quarterly conversions permitted between the three classes. The company hopes to achieve returns of 22.1 pct, and it is taking LIBOR as its benchmark, which it aims to outperform by 850 basis points.

Read more: Thomas H Lee plans to float hedge fund

Hedge Fund Gets Political Legitimacy

Back in the good old days when black was black and white was white, hedge funds were the bad guys who had all the fun. They still have fun, but the lines are somewhat blurred now. On the one hand you have the Amaranth collapse and the SEC bid to regulate the industry. The regulation attempt is being portrayed as reining in a wild horse. Well!! Anyways, when you look at the flip side, you have pension funds and even the Nobel institution (the ones that instituted the Nobel Prize) investing in hedge funds. This grants them much needed legitimacy.

With this background in mind, what would you make of a politician who has put more than half of his campaign treasury into a hedge fund? Andrew M. Cuomo, the Democratic candidate for attorney general, is one of the few New York politicians to invest campaign money in anything riskier than a sure bet. And there’s also an interesting aspect to this story. The hedge fund in which Mr. Cuomo invested was directed by one of his largest financial backers, a man who also handled Mr. Cuomo’s personal money. Mr. Cuomo, who had invested $750,000, got a return of nearly 20 percent after one year.

So how are the government and SEC reacting to this new trend of investing campaign money in hedge funds? Well, there is a lot of concern. The main reasons being cited are their unregulated nature and their secrecy. So, a high return could also be a campaign supporter’s efforts to evade contribution limits by padding the return of a favored campaign account.

Pequot Capital Escapes Charges

Pequot Capital Management Inc. can breathe a sigh of relief now. The Securities and Exchange Commission may have decided not pursue insider trading charges against $7 billion hedge fund. In the SEC spotlight were the firm, its management team, and former chairman John J. Mack. Regulators had been investigating a probable tip-off from Mack to Pequot officials five years back. This was in relation to a looming merger between General Electric Capital Corp. and Heller Financial Inc.

While the authorities have not formally closed the investigation, it would end soon, Pequot officials believe. Pequot’s investigation may have been part of the SEC’s regulation drive. The agency has been investigating the trading practices of several hedge funds for some time now. Washingtonpost.com reports:

SEC enforcement chief Linda Chatman Thomsen told the Senate Judiciary Committee last week that insider trading by hedge funds is "an area of significant concern to the commission." Thomsen testified that the agency had brought five such cases against hedge funds or their advisers in the fiscal year that ended last week. But without e-mails, documents or an outright admission by someone involved in a case, insider trading charges can be difficult for regulators to prove.

Read more: Hedge Fund Escapes Charges

Volatile! Who Us?

There is a common belief or should I say misconception that hedge funds are volatile by nature. People who don’t know much about these funds believe that hedge funds use global macro strategies and use lots of leverage to place large directional bets on stocks, currencies, bonds, commodities or gold. Sadly, reality is not so romantic. Less than 5 percent of hedge funds can claim to be global macro funds. Most hedge funds use derivatives only for hedging or don’t use derivatives at all. And most importantly, many funds use no leverage.

Most hedge funds primarily aim to reduce volatility and risk while at the same time preserving capital. And irrespective of the market conditions, they want to consistently deliver positive returns. This is quite a tall order and hence it makes it doubly interesting to know how you can manage the volatile with the stable to ensure consistent returns.

Amaranth Tries To Stem Bleeding

Amaranth Advisors has suspended redemptions in order to sell off its remaining assets after losses at its two main hedge funds continued last week. Redemption requests scheduled for the end of September and the end of October will not be honored, preventing investors from withdrawing any money for at least another month. Iht.com reports:

"Our current intention is to dispose of the remaining positions in the funds' portfolios in an orderly fashion over time, seeking to maximize sale proceeds and to make periodic cash distributions to investors on a pro rata basis," Amaranth's founder, Nicholas Maounis, wrote in the letter, sent late Friday.

Read more: Fund that lost $6.5 billion tries to stop bleeding

Yawn... Yet Another Go At Regulations

Legislators recently got the perfect excuse for taking another whack at regulating hedge funds. There is one big problem though: widespread hedge fund regulation is both impractical and unnecessary, especially when there are easy solutions that could keep ordinary consumers out of harm's way. Chicagotribune.com reports:

For individual investors, the solution for hedge fund protection is simple: raise and change the accredited-investor standards, going beyond net worth or paycheck size to create a rule requiring that no more than 10 percent of that asset total can go into a single hedge fund, with no more than 35 percent of all assets placed in hedge funds.

Read more: New hedge fund regulations not good investment