Institutional Investor's Alpha Magazine - October 2008 - (Page 44)

Industry Under Siege Good-Bye, Easy Money WITH BANKS NO LONGER ABLE TO PROVIDE CHEAP FINANCING, HEDGE FUNDS ARE HA VING TO REASSESS NOT ONLY THEIR CAPITAL STRUCTURE BUT ALSO THE NATURE OF HOW THEY DO BUSINESS. BY IMOGEN ROSE-SMITH ric Mindich, worried about the unfolding credit crisis, slashed the leverage in his Eton Park Capital Management multistrategy hedge fund ﬁrm by nearly half, from 2.3 to 1.3 times assets, in 2007. But it wasn’t enough; he is now paring the $11 billion New York–based ﬁrm’s leverage still further, to 1.1 to 1.2 times assets. The Eton founder sees plenty of investment opportunities in the market havoc of the past two months, but getting the ﬁnancing to pounce on them is just too hard. “Although we have considerable dry powder for future investments,” Mindich wrote in Eton Park’s third-quarter letter to investors, “some portion of this dry powder remains a function of ﬁnancing availability, an area of uncertainty in the market today.” Financing is destiny for hedge funds, and its disappearance spells bad news for a struggling industry. Consider that Eton Park is one of the rare funds to have held up well during the credit crisis. It lost just 2.7 percent in the third quarter and is down 3.4 percent on the year through September. Most hedge funds, by contrast, are suffering from grim returns and jittery investors: Assets are melting away; this year will likely see the highest level of redemptions ever. “The key question right now is: Does the hedge fund industry survive in its current form?” says Daniel Celeghin, a director with Casey, Quirk & Associates, a Darien, Connecticut, consulting ﬁrm that advises investment managers. “If it does not survive, it will be because ﬁnancing has changed drastically.” For managers with low-levered, highly liquid investment strategies like long-short equity, times have been tough enough. But for funds running arbitrage or macro strategies that require a lot of leverage, things have been far worse. Managers need to be able to borrow money to ﬁnance their strategies, but investment banks are facing extinction, and commercial banks are skittish about lend44 • INSTITUTIONAL INVESTOR’S ALPHA • OCTOBER 2008 ing to anyone. Margins and collateral levels have soared, when credit is available at all. Even as funds scramble to reduce their leverage or to ﬁnd alternative sources of funding, analysts are predicting fund closures and mergers in a sour climate of lower returns. In recent years, when money was cheap, the sources of capital available to leverage-hungry hedge funds seemed almost endless. Funds could look to their prime brokers or the repo markets. They could issue collateralized debt obligations, manage special-purpose investment vehicles, tap the loan markets for lines of credit or even issue public debt or equity. That has all changed. Banks, beset by their own host of problems, can’t or won’t provide cheap money — even with the Treasury’s plan to spend up to $250 billion to buy stock in them. And the assets of many hedge funds have plunged in value, so managers have to put up more collateral to get, in many cases, less capital. Alternative options like CDOs and SIVs are simply no longer viable. “Any strategy that relies on a huge amount of leverage is goint to have a difﬁcult time,” says Mark Astley, CEO of Millennium Global Investments, a $15 billion, London-based currency overlay, hedge fund and fund-offunds manager. Prime brokers estimate that today gross leverage in the hedge fund industry is about, or slightly less than, 1 times

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - October 2008

Institutional Investor's Alpha Magazine - October 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Process of Evolution The Good Guys: Israel's Champion Interview: Fast Lessons for Hard Times Cover Story: Industry Under Siege The New Hedge Fund Economics Good-Bye, Easy Money Caging the Shorts Strategies: Bottom Fishing Profile: Cult of Personalities Research Center: Alpha Awards: Eye of the Storm Alpha Bytes: Funneling the Chatter Unhedged: Commentary: Attention, Hedge Fund Shoppers

Institutional Investor's Alpha Magazine - October 2008

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