Karl D'Cunha's  Instablog

By: Houlihan Smith & Company, Inc

A deer in headlights usually gets run over! Hedge funds and their advisors are facing unprecedented challenges: redemptions, illiquidity of assets, and historic market volatility. All which may cause an ordinarily positive-minded advisor to want to stay in bed each morning. So what are a hedge fund and its manager to do? Action can be broken into two parts: triage and planning for the future.

Triage. Most funds regardless of strategy have experi­enced redemptions, some representing a significant portion of fund assets. Redemptions, whether they be attributable to performance, leverage providers no longer providing for­bearance, or investors using the more liquid strategy funds as ATMs, forces managers to focus on one thing — creating liquidity. The reality is that unless the fund was invested in a liquid strategy, it has most likely instituted gates and/or suspended redemptions and NAV’s.

Absent the ability to raise new capital, managers must find other ways to deal with the significant amount of redemptions. The credit environment has made it nearly impossible to sell assets. Previously under-read Limited Partnership Agreements, Bylaws, and Articles and Memorandum of Association are being scoured to find creative alternatives to deal with the redemptions. Themes are emerging including creating some type of side-pocket or liquidating entity to hold illiquid assets. As these assets mature or liquidate, proceeds are paid to redeemed investors. In some circumstances, fund managers are creating funds within funds by establishing redemptive share classes. In varying scenarios, redemptive investors are allocated their proportionate share of investments and interests are then transferred into Special Purpose Vehicles (SPV’s) or held at the fund level. As the assets liquidate, investors receive their proceeds. Certain funds have informed investors that this liquidation could take several years or longer. In conjunction with creating a redemp­tive share class, a new share class is created to accept new subscriptions and allow the fund to put on new trades. This ensures that new capital will not be used to fund redemptions. Some funds are simply choosing to close and start over. Some skeptics believe this is to avoid the high-water-mark issues cre­ated during the past year.

Managers are reaching out for help beyond the usual fund advisors. Investment banks and advisors are becoming a good source of capital and exit strategies. There is money in the market looking to invest in both illiquid and distressed assets. In addition, new investments are bringing the expected higher yields with better quality collateral as one would expect in a tight credit environment. Matching willing buyers and sellers requires fund managers to think outside the box.

The Future. So who has survived so far? Funds with no leverage that generally provided complete transparency and put down good relative or absolute returns received fewer redemptions. Funds with fewer fund-of-hedge-funds as investors fared better if only due to the fact that the majority of FOFs were levered and were forced to redeem to pay off their leverage. These funds, while shaken, are well posi­tioned for growth. Many have lost significant AUM and are seeking alternatives for new capital or mergers with other fund advisors. The market has seen an increased number of parties interested in purchasing funds and their advi­sors. Many fund advisors are sorting through the emotions of selling the firm and what the future would hold for them under such an environment. Some are faced with the dif­ficult decision of taking additional seed capital in exchange for a portion of their business. In all these situations, advi­sors should seek advice on valuing their business and the alternatives available to them. For those managers whose funds have closed, seeking strategic partnerships may be an alternative to begin the process of rebuilding your business. For fund managers that want to start anew, understanding the new structures that investors are seeking, including hybrid closed-end funds with callable periods and tails, is essential. And throughout, better transparency will be a requirement, as well as dealing with any additional regulation that will be imposed on investment managers as a result of current and pending legislation.

In my 12 plus years of experience in the alternative investment industry, I have taken part in a number of good events and a few great events.  With the additional responsibilities I have undertaken as a thought leader at Houlihan Smith & Company, Inc., I haven’t had the time to get out and participate and enjoy events in a fair amount of time.  The Commodity Investment World USA Conference this past December made the wait well worth it.  The conference was an exciting and informative event that could have set the standard for being well organized.  The distinguished speakers included Laurence B. Siegel of the Ford Foundation, Michael Dubin of the LongChamp Group, Tom Heck of the Ball State University Foundation, Francois Bonnin of John Locke Investments, and Brad Cole of Cole Asset Management.

I would like to personally thank Idan Deutsch for informing me about this excellent event.  The speakers raised my awareness on many issues currently facing the commodities industry and enhanced the level of service I was able to provide my clients.  The speakers were exceptionally well versed in the intricate operations of commodities investing from both an investor’s perspective and also an advisors perspective.  Brad Cole of Cole Partners Asset Management and Michael Dubin of the LongChamp Group offered key insights into asset management and investment strategies.  The questions the attendees were asking the speakers were even more impressive.  The attendees inspired the speakers to go beyond general explanations, which instantly elevated the discussion to reflect the hands on skills they could have only developed through operating in an experienced practice.

As an industry expert I was not only engaged by the speakers, but I was also refreshed by the audiences understanding of the complex nature of commodity investing and trading.  I thoroughly enjoyed my experience at the 2008 Commodity Investment World USA Conference in New York and look forward to experiencing similar unique opportunities in the future.