Institutional Investor's Alpha Magazine - March 2008 - (Page 16) Adam Herz, president of Hunter Advisors Corp., a New York–based search firm specializing in the alternative asset management industry, says subprime ills have set the stage for a spate of Darwinism. “Maybe a star person who went to a not-so-premium shop that is hitting the skids is now available,” he says. “It’s an opportunity for hedge funds to hire some of the best talent.” — K.C. After Bear T he sudden collapse of Bear Stearns Cos. and its equally swift buyout by JPMorgan Chase has caused at least a shudder across the prime brokerage landscape. In recent years Bear Stearns, one of the first Wall Street firms to get into the prime brokerage business, had struggled to retain its third-place market share behind Morgan Stanley and Goldman, Sachs & Co. Investment and commercial banks alike view prime brokerage — built for catering to hedge funds — as an increasingly valuable niche. Hedge fund clients fled Bear Stearns during the week of March 10, when the bank’s fading liquidity ended in a Federal Reserve Board–sponsored bailout of the 85-year-old institution. That raises questions about which fi rms will take Bear Stearns’ place among prime brokers. Deutsche Bank and Credit Suisse look well positioned. Others, like UBS, which have been more se- verely hurt by the credit crunch, are weaker candidates. And it remains to be seen what JPMorgan, a newcomer to the traditional equity prime brokerage business, has planned for Bear’s platform. The Bear Stearns saga may hold bigger implications for hedge funds, whose financing can take up significant bandwidth on a lender’s balance sheet. Recent market events have reminded banks everywhere to do a better job of protecting their balance sheets, a stance that can discourage lending, though borrowed money is the lifeblood of many hedge funds. Moreover, prime brokerage in and of itself is not necessarily profitable, especially when it involves handling transactions that go beyond what the typical long-short hedge fund does. The hedge funds mostly likely to bear the brunt of cutbacks on lending, of course, are the creditinvestment funds whose strategies rely on a lot of leverage to produce results. Some banks are already reconsidering their policies on lending to hedge funds. Charlotte, North Carolina– based Bank of America, for instance, has its prime brokerage business up for sale. Hedge fund lending, then, could exit this market crisis a very different animal from how it went in — certainly less robust and even temporarily endangered. Not that it will matter much to Bear. The firm’s High-Grade Structured Credit Fund and High-Grade Structured Credit Enhanced Leveraged Fund both failed last summer, early victims of the credit meltdown. They were among those most aggressively seeking alpha in the mortgage and structured-credit markets. — I.R.-S. CLASS REVIEW Short Success hort-sellers got to strut their s tuf f in Januar y. W ith the S t andard & Poor ’s 5 0 0 index down 6 percent on the month, a short- bias strategy was the way to go, up 4.18 percent, according to Chicago- based Hedge Fund Research. Most hedge fund strategies were in negative territory in January, as measured by the 2.4 6 percent loss in HFR’s fund weighted composite index. Years of unrelenting up marke t s have weeded ou t man y short- sellers. Those that remain have learned to plumb a specialized niche. Dustin Kicinski, portfolio man ager for Clear water, F lorida – based Emor y Capi t al Management’s Emory Par tners fund, achieves short positions by arbi traging options on S&P 500 S futures rather than trading the actual stocks. This strategy delivered a 4.60 percent return in January, the best performance among the 20 short-sellers followed by HFR. “In volatile or bear markets, that’s where we really shine,” says Thomas Wright, a partner at Emory Capital. The fund had a 12-month return of 2.35 percent, beating the S&P’s 2.31 percent loss, but it was outdone by the 6.10 percent average return among hedge funds and the 12.35 return on the short index. “January was the perfect month for our strategy to work best,” Wright says. The HFH ShortPlus Fund, run by Highland Financial Holdings Group in New York, delivered a 4.17 percent return, the second best in the HFR short-bias survey. But it is the fund’s 200.3 percent return over one year that underscores the success of its strategy of exploiting weaknesses in mortgage credit. Dean Smith, a managing director and senior port folio manager at Highland, says that the firm took its stance before it was fashion- able. And it stuck with its bearish view when others took their money off the table last fall. “The idea of shorting mortgage credit wasn’t viable until recently,” Smith says. “It was really a matter of taking aggressive advantage of a new financial tool that allows us to express a very bearish viewpoint.” — F.D. Short-Selling Return (%) One year Three years through through January* January Three-year annualized standard deviation Benchmark January HFRI short-bias index HFRI fund weighted composite index Standard & Poor’s 500 index * Annualized. 4.18% –2.46 –6.00 12.35% 6.10 –2.31 3.60% 9.87 7.28 7.98 5.13 8.52 Source: Hedge Fund Research. 16 • INSTITUTIONAL INVESTOR’S ALPHA • MARCH 2008
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