One More Hedge Fund Suspends Redemptions - Just Another Crack in the Ice? |
Date: Thursday, July 5, 2007
Author: StockPatrol.com
Imagine you were standing at the center of a beautiful, tranquil, ice-covered pond. Life is blissful and, for the moment, prosperous. Suddenly cracks begin to appear on the surface, in every direction. The sun is shining brightly and soon the ice will melt. Anxiety begins to build. You know that disaster is only moments away. You want to get off safely, but you know that with each step the tiny cracks will become fissures, the ice will begin to break, and order will be replaced by chaos. You contemplate the prospect of plunging into the freezing water and wonder, is there any hope of escape.
Now, consider an equally disturbing scenario. You have invested in a highly-leveraged hedge fund. The fund has grown significantly in recent years, riding a seemingly endless wave of investor confidence and unprecedented (some would say, unjustified) optimism. Fund managers are riding high – just like their brokerage firm counterparts did a decade earlier, enjoying unfathomable incomes and lavishing themselves with planes, ships and other accoutrements of their new-found wealth.
But there is cause for concern. The fund's assets are tied up in illiquid assets, like, for instance, sub prime mortgages. The fund managers have leveraged your investment by borrowing from investment banks and other financial institutions. Those lenders have been getting nervous – quite understandable as sub-prime mortgages fail with increasing frequency and confidence in the mortgage market continues to decline. Small cracks, to be sure. But are they signs of fissures to come?
The latest news from the Horizon ABS Fund may offer new cause for concern. Horizon ABS Fund, which focuses on bonds backed by home loans, has suspended redemption requests by investors. The Fund supposedly was up about 40% last year, which might leave investors feeling quite flush – if they could get their hands on their money. Ordinarily, the Horizon ABS Fund allows investors to redeem their stakes in the fund once a quarter on 90 days notice.
Just not now.
In other words, if you are an investor in the Horizon ABS Fund and you want to reap the rewards of that fund's growth by withdrawing your money – you can't. Now, no doubt, the fund's offering documents allow the fund managers some leeway to suspend withdrawals. That, however, may be little comfort to nervous investors who are left to wonder when they will be allowed to remove their funds.
This drastic action by the managers of the Horizon ABS-Fund reportedly come on the heels of a request for withdrawal by one investor, who accounted for approximately one quarter of the Fund's purported $650 million assets. Horizon ABS Fund investors may be asking why the Fund would allow itself to be so significantly dominated by a single investor who could jeopardize the stability of the Fund if he elected to collect his money and leave the table.
The Horizon ABS Fund
is just one of the investment products under the Horizon umbrella,
managed by John Devaney, who runs United Capital Markets Holdings, Inc
of Key Biscayne,
According to a Bloomberg report on July 3, 2007, Horizon funds "last month sold off a 'large amount' of securities and also closed out derivative bets on subprime-mortgage bonds at a loss." That, as Bloomberg explained, is in keeping with Devaney's stated strategy, which "is to buy subprime-mortgage bonds and other asset-backed securities when they've fallen out of favor."
Sub prime mortgages certainly have "fallen from favor" in recent weeks, as evidenced by the near-collapse of two Bear Stearns hedge funds late last month. One of the Bear Stearns funds reportedly suspended redemptions in May.
There would appear to be a potentially fatal flaw in Mr. Devaney's strategy. Lenders are unlikely to share his aggressive approach to shaky markets. As fund assets become increasingly concentrated in dicey illiquid securities, lenders call for more collateral. Uneasy lenders may demand additional collateral – or simply sell fund assets to pay-off loans. Merrill Lynch & Co. seized about $800 million in mortgage securities from the Bear Stearns funds
United Capital says that Merrill Lynch is the prime broker for the Horizon ABS Fund.
The benefits of the Fund's extraordinary growth could soon be lost. United Capital says that the Fund declined in value in April and May; further losses are expected for June and the entire year. Meanwhile, investors can only watch their assets decline.
In a statement, United Capital said that it expects "to resume processing these redemptions as soon as is prudent, which we hope will be in the very near term."
Will that be enough to keep angered investors at bay? Or will they soon start dialing their attorneys? At some point investors will grow weary of the cracking ice and take steps to protect themselves from the icy plunge.