Emerging Managers Face a Bumpy Road in 2009

Most fund managers are casting a weary eye toward increased regulation from the new president-elect. Many are predicting this will have a negative impact on the profitability of their respective funds. This is not to say, of course, this is a prosperous time for emerging managers, hedge funds or fund-of-funds without this increased regulation.

Rothstein Kass CPA firm recently conducted a telephone survey through interviews with 313 hedge fund Senior Partners at U.S.-based organizations, 70% of whom had $100-750 million in assets, while the remainder had over $750 million. The survey found 98% of hedge managers believe the new administration is likely to increase government surveillance on the hedge fund industry, over 75% anticipate increased regulation on Transparency, 84% Asset Valuations, 81% Capital Raising and 84% anticipate increase regulation on Counterparty Risk. Meanwhile, 77% of the participants agreed that the overall impact of these regulations would be negative.

Senator Chuck Grassley is leading the initiative for increased regulation with his recently reintroduced legislation requiring hedge funds to register with the SEC. The bill will be modeled after S.1402, the Hedge Fund Registration Act introduced in May 2007 which was never brought up for consideration when it was introduced. According to Grassley, "It's up to Congress to take action and clear the way for the Securities and Exchange Commission to achieve transparency with hedge funds…."

These regulations would only add to the turmoil and difficulty managers are currently having raising funds. Man Group shares, for example, lost over a third of their value while net income dropped 79% to $507 million. Additionally, first-half pretax profit was down 24% to $622 million, shares in the hedge-fund manager slumped 34% and manager risk reduction led to a $3.5 billion decline in funds under management. This has resulted in analysts cutting Man Group earnings forecasts by 15-16% over the coming months.

Herman White, an emerging manager himself and co-founder of CrossBridge Venture Partners, disclosed emerging managers "….should buckle down and focus on portfolio survival, investor relations, liquidity, and deal-flow…." given, to what he refers as, "….the current, once-in-a-century global financial crisis."

White also wrote:

The interest downturn in investment funds] effects cross-border investments involved in global trade, pension funds, sovereign wealth funds, foundations, strategic investors and family offices. [Emerging managers face] lower valuations and extended periods to exit and will have to make some hard decisions over the next few months.

These hard decisions include in which portfolio companies to continue investing, which ones to continue supporting, and methods of increasing liquidity. By this, White suggests managers take a hard look at expenses, head-count, office space, inventory, A/R and available bank lines of credit to increase the life of the portfolio company.

All, however, is not lost. Former Pequot Capital portfolio manager and founder of the New York-based Riptide Capital, Gregory Spiegel, is launching a long/short hedge fund intended to explore opportunities in the mid-to-large-cap space by the end of this year. With this, Spiegel intends to focus on value and growth companies in the technology, media, telecommunications, consumer, and industrial sectors for investment in companies with market capitalizations over $1 billion.

Spiegel admits the downturn in financial markets has made it extremely tough for emerging managers to fundraise, but argues there's no shortage of capital. "Guys want to see how things shake out over the next few months, and a lot of funds of funds have probably gotten a lot of redemption notices. In the current environment, some guys think it's a great opportunity while others are scared to death, but that's what makes a market."

The incoming administration is sure to crack the whip on fund managers, especially with the SEC falling asleep at the wheel lately. This was made most apparent with the independent exposure of the Madoff hedge fund investment fraud. Aside from this, given the fast-diminishing liquidity and the overall difficult economic climate, these next few years are surely not being painted as the most hospitable for emerging managers.

Disclosure: Long.