Why a Goldman Sachs Hedge Fund Investment Might Look Attractive

Commenter tinbox has an interesting take on the news that Goldman Sachs (GS) is injecting liquidity into its own hedge funds:

It's wildly implausible that anyone looked at Goldman's fund and suddenly decided it is the best investment opportunity on the planet. That simply didn't happen. Funds down 15%+ do not attract new investors for a whole variety of reasons and this self-serving announcement addresses none of them.

Well, there's at least one good reason why a fund down 15%+ should address new investors, and it's called the high-water mark. If you think that hedge funds are a good investment, you think that they're a good investment after they've taken out their 20%-of-the-profits performance fee. Which means that they're a really good investment if you don't have to pay that fee for the first 35% that your investment goes up.

If the Goldman funds are down 26% from their high-water mark, then they will have to rise more than 35% from their present levels just to get back to it and start earning performance fees again. Which makes investments in these funds some of the cheapest hedge-fund investments available right now.

I reckon there's a very good chance that the $3 billion of liquidity being injected into Goldman's funds won't pay any performance fees unless and until those funds reach their high-water mark. If that's the case, I imagine that quite a few hedge-fund investors would be extremely interested in buying cheap exposure to what has historically been a very high-performance fund.

Comments

[dntee:]

Your analysis is incorrect...the high water mark you refer to is applicable only to the old investors already in the fund; the high water mark for new incoming investors is the NAV/share when they invested (ie current NAV/share) - the mechanics are sometimes accomplished through payment for equalization credits. If the fund performs say 10% from the current NAV/share, then the new investors will pay 2% of that appreciation, whereas the old investors do not pay until the high water mark applicable to them is achived.

Your error is in thinking that performance fees are calculated at the fund level, when in reality they are calculated at the investor level.

2007 Aug 14 11:25 AM

[Woodrebel:]

Thanks for the insight dntee.

2007 Aug 15 01:34 AM

[NO DooDahs:]

About temporary liquidity (properly defined as money flowing through a market and not as "money supply" LOL) lapses and "mark to market," some thoughts.

Buy and holders of bonds don't care about the quote or the market for the bond as much as traders do; they're in it for the yield. Now, the auditor is gonna want the company to get a bid on inventory every once in a while, and will appreciate if they go out and hit the bid a few times a year, but otherwise, they want yield.

Some hedgies playing the yield game may recognize the mark to market in a low-liquidity sitchooayshun will result in paper losses for the fund. When a market returns for the bonds, the mark to market will be UP. So what to do?

That hedgie might choose to recapitalize the fund until such time as the market returns to normalcy.

Does this sound ... familiar?

2007 Aug 14 02:01 PM