Hedge fund investing is generally restricted to investors meeting minimum asset levels (i.e. rich people, the thinking being that they'll be all right if they lose a bunch of money) or those making large minimum investments (the thinking being that investors who plunk down $150K on an investment will do their due diligence, unlike the typical retail investor). But for all intents and purposes, it appears that Quest Capital (QCC) is trying to convert itself into a quasi hedge fund.
Long-time readers of this site will already know that Quest Capital has been a stock favorite of ours for a while now. In a move to increase its returns and stock price, Quest appears to be changing business lines, and is taking on a lot of characteristics that one normally associates with hedge funds. Hedge funds are known for their high, but incentive-laden compensation structures and high management ownership levels, with the idea of aligning shareholder interests with those of managers. Quest is emulating this strategy with its proposed move.
Rather than pay salaries and offer bonus/option plans to managers, Quest will pay a management company 2% of its asset value (annually), and 20% of the excess returns it generates. Furthermore, this company will make a $25 million investment in the firm, thus better aligning its interests with those of shareholders. Unfortunately for existing shareholders, this investment will happen at a price that is below the company's current book value, thus diluting the shares of existing investors.
Quest shares rose around 15% yesterday on the news, further reducing the difference between this company's market value and its book value. But while the market cheered the news, value investors should be cautious going forward. The company is now entering a new line of business, and will have exposure to commodity prices. Commodity prices are inherently volatile, and their prices are very difficult to predict. If prices drop sometime in the future while Quest has a full book of loans receivable, there could be a slew of defaults and a significant loss in value.
For shareholders who are not interested in being a part of this new line of business, Quest is offering to buy back a number of investor shares tendered in a Dutch auction. Unfortunately, the maximum price for this auction is still a good 10% below book value, putting shareholders who want out, but who feel the price isn't quite right, in a bit of a quandary.
Disclosure: Author long QCC