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Opening doors to closed hedge funds

Date: Tuesday, May 1, 2007
Author: James Mackintosh, Financial Times

Many of the biggest names aren't taking any more money. But there are ways to gain access.

Call it the Groucho Marx problem: Investors trying to put money into hedge funds frequently find that the managers they want do not want their cash.

Just as Groucho complained that he would not join any club that would accept him as a member, even very wealthy investors can find themselves faced only with hedge funds they do not want to invest with. As a result, some investors are resorting to devious tactics to get stakes in the best hedge funds.

Many of the industry's biggest names Steven Cohen of SAC Capital, Paul Tudor Jones of Tudor Investment, Louis Bacon of Moore Capital, Steve Mandel of Lone Pine Capital and others do not need to expand existing funds further and often believe that more cash would hurt their returns. Even when they find they have the capacity to take more money, they typically turn to their existing investors first.

" 'Capacity' has definitely become one of the buzzwords in the hedge fund world," said Eleonore Dachicourt, head of the hedge fund advisory business at Credit Suisse's British private bank.

Too much money chasing too few opportunities has reshaped the hedge fund industry, and not necessarily for the benefit of investors.

The first, and most obvious, effect has been to squeeze returns. Although the average hedge fund made double-digit percentage returns for seven out of 10 years during the 1990s, there have been only two years of higher than 10% returns this decade, according to Chicago-based Hedge Fund Research Inc.

The second effect of the mismatch of supply and demand has been the tendency of successful fund managers to jack up their fees to 3% a year and 50% of profit in the case of SAC Capital and impose long lock-ins, preventing customers from getting their money back for as long as five years.

The final effect, though, has been the most frustrating for many investors: the refusal of managers to take money from just anyone.

"We try to pick the investors we want," says the manager of one $2-billion London-based hedge fund.

But investors who know the tricks of the industry might be able to find cracks in the door. The most obvious way to get into a closed hedge fund might appeal to Groucho, but most people would shy away from it: Simply send your money to the fund's depositary bank and rely on the fund's automatically issuing units.

"It is incredibly annoying," says a manager of one closed London hedge fund that gets several unwanted money transfers a year. It has now set up a monitoring system to double-check that investors are approved before money is accepted, although wealthy investors are often flabbergasted to have their deposits returned.

Less blatant methods might hold more appeal for investors considering putting hundreds of thousands or even millions of dollars into a hedge fund. Those with patience can put their names on the waiting list. Apart from a tiny number of funds that are trying to shrink, most closed funds take in money to replace redemptions.

The trick is to get to the top of the list, with managers preferring investors seen as likely to leave money untouched for the long term. Hedge funds prefer endowments and pension fund investors. What they call the "hot money" from Geneva-based funds of hedge funds is relegated to last place, with wealthy individuals somewhere in between.

"You really have to build a relationship with the investor relations person [at the fund] if you want to move up the list," says one big hedge fund investor.