ETFs have been encroaching on the turf of active managers for some time and are now taking hedge funds head on. The promise of hedge funds at ETF costs is very appealing but raises the inevitable question: can they do it? The upcoming IQ Arb Merger Arbitrage ETF (MNA) is an example of one that is likely to fail.

The first thought is, of course, you get what you pay for. If this line of thinking has some validity, then alpha-generating talent is well worth paying 2/20 for. The counterargument of the indexers is, of course, that what looked like alpha in the boom turned out to be in many instances either an illiquidity premium or simply leverage. Who wants to pay a performance fee on leverage?

Survivorship and backfill bias in hedge fund returns have been written about extensively. A recent article in Hedge Fund Alert drew our attention to yet another problem with the reporting of hedge fund returns. It turns out that last year’s carnage has left so many hedge funds underwater that the returns posted for this year are not actually what you will earn if you are a new investor.

Hedge funds have high water marks so that managers do not receive the 20% performance fee until the fund has reached its prior high. That is one of the reasons why so many managers simply shut down their funds and launch new ones not subject to that constraint. But it also leads to difficulties with the reporting of returns. Performance fees are assessed not at the fund level but on each investor’s capital account. In other words, if you invest on December 30 you do not have to pay the performance fee for the whole year.

It is doubtful that the buyout of the Hiland MLP [(HLND) and (HPGP)] by billionaire Harold Hamm will get sufficient votes at Tuesday’s shareholder meeting. This is already the second meeting after the October 20 meeting was adjourned when only 43% of the publicly held shares voted in favor. Both Hiland companies have significant upside if the deal falls through.

In our recent Hiland posting we speculated that oil magnate Harold Hamm, the acquirer, would not obtain sufficient votes at the October 20 shareholder meeting to close the transaction. We think the only way to get shareholders to buy into the deal is to follow the recent example of Black Stone Minerals' bid for Eagle Rock Energy’s (EROC) minerals business and increase the price.

At Thursday’s 2009 Investor Leadership Forum hosted by the Argyle Executive Forum and Capital IQ, a speech by Peter Thiel of Paypal and Clarium fame linked future economic growth to innovation and technology rather than government stimulus.

Peter started by noting the difference in the type of questions asked today of emerging markets and the developed world. For emerging markets, the discussion is about how well they will do over the next 20 years. For the developed world, the concern is whether the entire system will collapse within the next six months. Thiel wants to take a different approach and think about the developed world in 20 years. He believes that the growth of science and technology will drive the developed world and will offset the economic headwinds we are facing, including inflation. His overall thought is that science and technology are broken because there is not enough innovation. He contrasts three facts with the bullishness of VCs, startup companies and scientists:

Among the many consolidations of MLPs (recall the mergers of Magellan Midstream (MMP), Atlas (ATLS) or the pending Enterprise/Teppco (EPD)/(TPP)), one deal stands out as a particularly bad deal: the opportunistic squeeze-out of minority shareholders of Hiland Partners (HLND) and Hiland Holdings GP (HPGP) at record low prices by oil magnate Harold Hamm. Management of the two firms seems to be getting increasingly worried about obtaining sufficient votes for the buyout at the October 20 shareholder meeting, judging by the flurry of proxy solicitations that we have received. With the recent recovery in gas prices, the acquisition looks priced too cheaply, and it is no wonder that shareholders are reluctant to support this bad deal.

Billionaire Harold Hamm controls both HLND and HPGP and is squeezing out the public shareholders. He made his initial acquisition proposal of $9.50 for HLND and $3.20 for HPGP on January 15 when natural gas closed at $4.81. As natural gas continued to slide throughout the first quarter of the year, Hamm revised his price to $7.75 (HLND) and $2.40 (HPGP) on April 20, when natural gas traded at $3.67. Today, natural gas trades above $5, or about 5% higher than when the first acquisition proposal was made. Since the decline of natural gas prices was specifically mentioned as a reason for the reduced merger consideration, it is no wonder that shareholders are reluctant to support the deal.

Surprise, surprise! American Community Properties Trust (APO) is selling itself, and you won’t even get market value for your shares. While ACPT trades between $8.35 and $8.50, the buyout will happen at $7.75.

The sudden sale at a discount to the market price comes out of the blue for shareholders, who still remember the failed attempt by the Wilson family, the 50.68% owners, to take the company private in 2007. The Wilsons had engaged a financial adviser, Granite Partners, which was ultimately unable to raise the funds for the buyout. The stock has since underperformed REITs. Since the July 17, 2007 announcement, the Dow Jones REIT index has fallen 45%, whereas ACTP shares have lost 60% of their value.

Wilshire Enterprises (WOC) finally launched its $2 tender offer for 4 million shares, roughly half of the outstanding shares. It is a bad deal for shareholders and we anticipate that worse is to come because public shareholders will be minority holders in a firm whose management has a record of poor decisions, such as the refusal to sell at $8.50 to Mercury Real Estate Partners a few years ago.

The tender offer is the result of a settlement of a proxy fight with Philip Goldstein’s Bulldog Investors/Full Value Partners. Bulldog agreed not to run its slate of directors, and management agreed to provide Bulldog and all other investors with a liquidity event that allows them to sell roughly three quarters of their shares. Unfortunately, Bulldog’s desire to exit their investment will leave everybody in the position of minority shareholders. Even worse, due to the last minute timing of the settlement prior to the shareholder meeting, Bulldog did not vote the proxies that shareholders had entrusted them with and two shareholder proposals, including ours to eliminate the poison pill, were defeated by management’s votes.

It has been a while since we first reported on SPAC liquidation arbitrage in January. The battles over MathStar (MATH.PK) and PetroSearch [PTSG.OB] has prompted us to follow up, as did our annoyance with the slow progress at Cadus (KDUS.OB).

In a surprise move, private equity firm Thoma Bravo increased the price it is willing to pay for Entrust (ENTU) from $1.85 to $2.00 on Friday. We had forecast that shareholders would vote down the transaction in this post last week, and we suspect that a rejection of the $2 buyout will lead eventually to a bidding war over Entrust. Three other bidders expressed interest in Entrust during the go-shop period at prices higher than Thoma Bravo’s, but the board decided that these proposals were not “superior”. Therefore, we think that there is enough interest in Entrust to make it a candidate for a bidding war if shareholders vote down the current deal.

The cancellation of the shareholder meeting coupled with an increase in the buyout price was caused by insufficient shareholder votes in support of the $1.85 deal. Entrust has adopted high pressure sales tactics otherwise characteristic of pump and dump schemes to force through the Thoma Bravo deal. It claims that the increased $2 proposal is the final offer. However, Thoma Bravo has pursued Entrust since September 2007 with the intention of “using the Company as a platform to make further strategic acquisitions” (DEFM14A). So there is value in Entrust not just as a going concern but also as the core of a roll-up strategy. In addition to Thoma Bravo, there are three other potential buyers who have submitted higher bids during the go-shop period.

In another illustration of the pointlessness of “Go Shop” periods, the board of Entrust (ENTU) ignored three buyout offers received in the 30-day go shop period that were higher than that of the the group that includes the CEO. Moreover, the Entrust buyout that includes management shows all that is wrong with buyouts by private equity funds where management remains with the firm and has an incentive to lowball the buyout price.

Shareholders expected an increase of the $1.85 merger consideration, and shares traded as high as $2.10 during the go-shop period. We believe that due to the high level of dissent from shareholders and even a board member, it will be difficult for management to achieve the required approval by 2/3 of the shareholders.

Pershing Square Bill Ackman’s presentation about General Growth Properties (GGWPQ.PK) at the Ira Sohn Investment Research conference has us wondering what he is up to. The tone of the presentation clearly targets an audience that is not familiar with bankruptcy investing. At the same time, his financial projections for GGP are overly optimistic and do not square (no pun intended) with current results. We believe that some of his analysis is very misleading.

As anyone who followed the saga knows, General Growth filed for bankruptcy not only because of poor operating performance, but primarily because of the credit crunch that made it impossible for the company to refinance its debt. Repayment also was not an option because it holds only a few hundred million dollars of cash. So the bankruptcy filing was triggered by a liquidity problem and not by losses. In fact, General Growth even made a small $3 million profit last year and has book value of $1.7 billion. But with $3.5 bn of debt coming due this year and another $7 bn next year, there was little the company could do when it did not gain an amicable settlement with creditors. Most of the debt are CMBS secured by properties, but some debt is unsecured corporate bonds. The unsecured bonds are a result of GGP’s acquisition of Rouse Co in 2004, and are still listed under Rouse’s name.

These days, liquidity is in short supply for all hedge funds, and it comes as no surprise the hedge fund wannabe Porsche (POAHF.PK) suffers from the same liquidity squeeze symptoms as many of its hedge fund brethren. The liquidity situation for Porsche will be critical over the next three weeks.

Recall that Porsche engineered a massive short squeeze of Volkswagen common stock (VLKAF.PK) just a few months ago. Volkswagen’s common had been shorted by arbitrageurs who went long the undervalued preferred at the same time. When Porsche announced that it had acquired 75% of Volkswagen through options and intended to take over the firm, the common stock soared while the preferred didn’t budge. This led to large losses for the hedge funds when they had to cover their short positions in the common.

The shareholder meeting of Wilshire Enterprises (WOC) has been adjourned for the second time. This is actually the third delay of the shareholder meeting, which was originally scheduled for February 26 in Wilshire’s preliminary proxy materials. The meeting was then set for March 24^th and at the last moment adjourned to March 30^th. Monday, the meeting was adjourned again to April 20^th.

Needless to say, we were at first a little nervous about the adjournment. The trick is that because the meeting had been scheduled, it had to be opened and immediately adjourned by a vote of the shareholders. So we were nervous that some other business potentially could be transacted in our absence (we didn’t bother trekking to Delaware just to observe an adjournment). Fortunately, the only business conducted was the adjournment.

The end of the first round is approaching in this year's most under-reported proxy fight, the battle over Wilshire Enterprises (WOC) between Phil Goldstein’s Bulldog Investors and Wilshire’s CEO Sherry Wilzig Izak. Two directors will be elected at Tuesday’s meeting, and shareholders will also vote on proposals to end the staggered board, seek a liquidity event and abolish the poison pill. We have written extensively about the battle previously (here, here).

After management rejected Mercury Real Estate’s acquisition proposal as “undervalued”, Wilshire traded for $5.50 per share and dropped to the $3.80 level when Nick Jekogian attempted to buy it. That changed dramatically when management announced its new value enhancing strategy. The market assigns a negative value to that strategy: with cash on the balance sheet of over $2 per share, Wilshire trades slightly over $1.

Image Entertainment (DISK) went through a change in leadership over the last year with the retirement of Marty Greenwald, who was replaced by ex-COO David Borshell, but one thing hasn’t changed: its bad luck when trying to sell itself.

Readers of this space may recall that producer and entrepreneur David Bergstein, with the financial backing of real estate mogul Ron Tutor, had tried to buy Image early last year for $4.40 per share, beating a $4 bid from Lionsgate (LGF) - which now itself is under attack by Carl Icahn. The deal collapsed when hedge fund D B Zwirn ran into trouble with accounting, valuation and redemption woes and was unable to provide the promised funding.

The battle over Wilshire Enterprises between Phil Goldstein’s Bulldog Investors and Wilshire’s (WOC) CEO Sherry Wilzig Izak is gradually growing into a full scale war, if not a jihad. Amidst a stream of litigation, the shareholder meeting was postponed from this week to March 24^th, giving management crucial time to beef up their defenses that ultimately will be futile.

We have previously chronicled the battle between Wilshire and Bulldog, which ended in a temporary defeat of Bulldog when management declared that “initial bids are in” for a prompt sale of the company. Almost a year after the initial bids, a buyer emerged for $3.88/share, down from $8.50 a few years ago when management rejected a bid by Mercury Real Estate as “undervalued”. Last year’s buyer didn’t have enough funds to acquire Wilshire, and the stock now trades just over $1.

Rosy forecasts were in short supply at the first annual Wharton Hedge Fund Conference. The shock of last year's worst-ever performance still reverberates through the industry. Career plans of students at Wharton are the best indication we have seen to date of how bad things have become for hedgies: one Wharton professor reports that last year, two thirds of his students wanted to get a job in a hedge fund. This year, only one student admitted to hoping for a hedge fund career.

Ray Iwanowski of Goldman Sachs traces the origins of the hedge fund problems back to the summer of 2007, when some quant funds started to struggle as their trades turned out to have been too crowded. We would go back a few more months and take the market slump of February 27, 2007 as the beginning, when HSBC (HBC) wrote off much of its acquisition of Household.

At the first Wharton Hedge Fund Conference, keynote speaker Marc Lasry of Avenue Capital declared that he was still in shock over how his firm got to $22 bn in size. Lasry started his firm in 1995 after breaking off from an entity that is affiliated with the Bass family with $7 million, expecting to run a few hundred million dollars if things were to go well. At its peak in 2007, the firm exceeded all targets with $22 billion in assets under management. The wonders done by a decade of liquidity and leverage helped him grow beyond his wildest dreams.

But it's not his firm's unconstrained growth that sent Lasry into therapy; it is the unwinding of the leverage and lack of liquidity that puts him there. It has depressing prices of assets, and especially those of the distressed type that Lasry meddles in. One of the drawbacks of distressed is that it becomes a little more distressed every day. Last year, he was down 25% (he didn't specify whether that number is performance or AUM).

Mark Fisher, inventor of the technical trading method ACD, sees this market as a pure trading market in which analysis does not matter. This was probably not what some of Wharton’s students, attending its first annual Wharton Hedge Fund Conference, wanted to hear. After all, they have committed to spending a six figure amount on learning how to perform just that analysis. Fisher probably also depressed Wharton’s faculty, whose livelihood depends on a steady supply of students willing to pay ever increasing tuition rates. Not to mention that Fisher himself holds a Wharton MBA.

Instead of analysis, all that counts in Fisher’s world for the foreseeable future are market psychology and spotting turning points. Markets are a chess game in which you have to stay one step ahead. Until December, Obama triggered 11 brief market rallies when he appeared on TV. At his twelfth appearance, the market no longer rallied. Fisher shorted the market and sure enough, it dropped a little later. Fisher thinks Bernie Franks might provide a similar trading opportunity: the day the market does not drop when Franks appears on TV, you should go long as much as you can.

We have been eager for a long time to hear the other side of last year’s mega losses at Société Générale (SCGLY.PK), where a lone trader allegedly gambled away EUR 4.9 billion without anyone realizing it. Having worked at a French bank for a while ourselves, we have always felt that Kerviel’s losses were possible only due to the acquiescence of his superiors, who chose not to look too closely at his stellar track record. The beauty of that strategy, which we have witnessed on a smaller scale in the enterprise we worked at, is that everyone is happy while things go well. But if there is a turn of events to the worse, you can blame it on a rogue trader.

Thanks to the French equivalent of 60 Minutes, sept à huit on the TF1 network, we get for the first time the inside story from the trader at the center of the scandal. Kerviel is visibly not at ease with the publicity surrounding his person. And that observation pretty much sums up the interview: Kerviel yielded to the pressure of the trading room and his bosses to produce profits, and did not feel at ease to stop before crossing the line.