Does the Hedge Fund Secondary Market Embolden Funds of Funds?

When we first examined the secondary market for hedge fund stakes, there was only one company in the business, Hedgebay (see related post). Several others jumped into the business early this year and were welcomed with sudden industry growth as hedge fund investors began to scramble for liquidity.

While all hedge fund investors could have used a little more liquidity over the past 12 months, funds of funds were apparently doing most of the scrambling - trying to respond to redemption requests on one side and redemption gates on the other.

Earlier this month the Wall Street Journal reported that the customer base served by HF secondary markets has changed as a result. Reported the Journal:

“‘Last year, it was very much a local story dominated by individual investors in Swiss private banks spooked by actual and alleged links to Madoff funds on top of dismal performance,’ said Elias Tueta, co-founder of Hedgebay, which provides a platform to match up buyers and sellers of hedge fund stakes.

“‘Now, funds of funds, once buyers of stakes, are only selling and there are an increasing number of different buyers, such as pensions and endowments, which have a longer-term view and are willing to invest in more illiquid assets - the market has gone global,’ he adds.

“Not that the buyers are paying anything like the full price to take these assets off the hands of willing sellers - despite a 20% annual increase in the number of assets traded through March 31, not one trade took place at or above net asset value, Hedgebay data show.

“The average discount for March was 20%, steeper than the 15% discount in February, but can vary dramatically depending on why the seller wants out and the liquidity and length of the investment being sold.”

In what will surely warm the hearts of hedge fund haters everywhere, some managers have even launched funds of funds designed to capitalize on the misfortune of their industry brethren.

So you’d think that funds of funds would be a little gun shy when it comes to lock-ups demanded by their underlying funds. But according to a survey by Preqin this month, a healthy majority of funds of funds continue to accept substantial lock-ups. In fact, over half of funds of funds surveyed said they were still open to lock-ups of 2 years or more.

But before you choke on your morning muffin, remember that this chart shows the “maximum accepted” lock-ups, not those actually faced by them. Only a small minority of underlying funds might actually impose the lock-ups while the vast majority may have far lower lock-up.

Still, despite the liquidity mismatch debacle that has played out over the past 12 months, funds of funds are willing to take risks on their favorite managers. You have to wonder if the existence of an exit - even at a 20% discount - is enough to affect the behavior of funds of funds.

Comments

[Old Trader:]

While I can understand the distaste for lockups, I can also see their worth. There ARE strategies that would suffer if there were no lockups, or very short ones. Since hedge funds are supposed to be only available to "qualified" investors, I'd think it falls upon the investor to determine what sort of lockup period they can live with, based on their investment horizon, and invest accordingly.

May 26 08:35 PM