Institutional Investor's Alpha Magazine - October 2008 - (Page 48)

Industry Under Siege Fund lost 14.49 percent last month, leaving it down 16.80 percent for the year through September. CQS is among several ﬁrms that have assets trapped in the Lehman bankruptcy because of ﬁnancing positions with the investment bank’s London prime brokerage unit. All have had to scramble to ﬁnd alternative ﬁnancing options while they ﬁght to regain their assets (see box). Some ﬁrms have chosen to lock in capital more ﬁrmly. Last year shareholders in TPG-Axon Capital Management voted to change the terms of its redemption policy so that investors can take out no more than one eighth of their capital in any quarter. “For us, candidly, redemptions are not that relevant,” New York–based TPG-Axon founder Dinaker Sing wrote in his third-quarter investor letter. A more radical possibility is for managers to start lending to one another. Many hedge funds, such as Fortress Investment Group’s Drawbridge Special Opportunities Fund, run by Peter Briger, already act as direct lenders to corporations. “I can see a group of managers stepping into the role investment banks used to play,” says Casey Quirk’s Celeghin. Indeed, cross-hedge-fund lending has begun to happen. Fortress considered lending to troubled hedge fund ﬁrm SageCrest Finance, a Greenwich-based credit fund operated by Windmill Management that ﬁled for Chapter 11 bankruptcy protection in August. And $2 billion London-based Pentagon Capital Management has been a lender to hedge funds in the past. participants in the repo market — not as borrowers but as cash lenders. The very largest hedge fund ﬁrms have long taken steps to diversify their funding sources — among both investors and lenders. Increasingly, these funds look at their balance sheets much as they would at any other large, complex business, raising assets not only through prime brokerage and repo but often also through lines of permanent credit in the form of loans, CDOs and other structured vehicles — and, in the case of Citadel, public bond issuances or, with Fortress, by issuing public equity. Still, UBS’s Ehrlich doubts that hedge fund managers can really ﬁll the void left by banks and brokerage ﬁrms. “There is not enough capital in hedge funds to make a difference,” he says. “It is not a market solution; it is a niche solution. The kind of capital that is needed is going to have to come from massive pools of public capital, such as banks and other ﬁnancial institutions.” Tight ﬁnancing means fewer hedge fund launches, as prime brokers simply have less balance-sheet capacity to go around. “It is going to be tough for smaller funds,” says Michael Rosen, CIO of Los Angeles–based investment consultant Angeles Investment Advisors. “Fewer firms, even in equity, will be able to get ﬁnancing.” Firms specializing in investment strategies that require a lot of leverage — or managers that simply need a large capital injection — may end up merging with funds pursuing other strategies. “Those strategies that suck up leverage are most likely to seek refuge in multistrats,” says Jaeson Dubrovay, senior consultant and head of hedge funds for Cambridge, Massachusetts–based investment consulting ﬁrm NEPC. A multistrategy manager can borrow against other assets in its ﬁrm and, when times are tough, simply get out of businesses that are not working. Robert Hunkeler, director of investments for International Paper Co., who oversees the Memphis-based paper manufacturer’s $8.5 billion deﬁned beneﬁt pension plan, says he is pleased that the hedge funds in which his company invests have reduced their leverage. “We entered into the past year with extremely low volatility, which led to excessive leveraging to get higher yields,” Hunkeler says. “We will return to more-normal levels of volatility that will be beneﬁcial to hedge funds as well as to active management in general.” Hedge funds are already starting to achieve higher yields and wider spreads. In areas where leverage used to be the only way to get adequate returns — like securities loans and convertible bonds — managers have begun to see possibilities that lead the optimistic among them to think they can earn double-digit returns without excessive borrowing. “We believe that the opportunities presented by this dislocation will be long-lasting, meaning that the opportunity set is likely to be robust for years to come,” Eaton Park states in its third-quarter letter. “Therefore our primary objective is to ‘get to the other side’ of the ﬁnancial crisis in good health and be able to capitalize on those robust opportunities.” “The key question right now is: Does the hedge fund industry survive in its current form?” — DANIEL CELEGHIN, DIRECTOR, CASEY, QUIRK & ASSOCIATES Taking the idea one step further is Citadel Investment Group, which already offers hedge fund administration to outside managers through its Citadel Solutions subsidiary. The Chicago-based hedge fund giant, which has $20 billion in assets under management, has been talking about adding prime brokerage for at least six months now. Citadel Solutions president John Buckley, who previously was co-CFO of Europe and Asia for Lehman Brothers Holdings, believes that Citadel can offer a more efﬁcient prime brokerage lending solution. Of course, Citadel right now has its own problems. Its $9.8 billion Kensington Global Strategies Fund fell more than 16 percent in September and is down some 22 percent for the year. Perhaps the most radical notion comes from Citi’s credit strategies team in London. In a report published last month, they suggested that hedge funds, which are currently sitting on more than $600 billion in cash, should become direct 48 • INSTITUTIONAL INVESTOR’S ALPHA • OCTOBER 2008

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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