More hedge fund managers in rush to float

Gottex, which has more than $14bn (€10bn) in assets under management, took the unusual step of floating the management company, rather than an individual fund, arguably making it the only publicly quoted, pure fund of hedge funds group.

To date, the estimated 1% of total hedge funds assets that are public is in so-called permanent capital vehicles – quoted closed-ended single-manager funds or funds of funds – and a small number of management companies.

The Swiss fund manager’s shares fell on its first day of trading from an offer price of Sfr73 to Sfr69.95 and was last week trading at Sfr65.75. The underwriters have the option to sell an over-allotment of shares. The offering gives Gottex a total market capitalization of $1.9bn.

Mark James, executive director for global markets at ABN Amro, predicts that more fund of hedge fund groups as well as single manager funds will go public as part of an increased flow of funds going to the market. “The sector is growing,” he said.

The number of publicly quoted funds has increased rapidly since 1996. There are 47 permanent capital hedge fund vehicles managing assets of £8.3bn (€11.8bn), quoted primarily on the London, Euronext and Zurich exchanges, according to ABN Amro.

Last year was the high water mark for hedge fund flotations, 12 initial public offerings were completed, including Goldman Sachs Dynamic Opportunities, Dexion Alpha Strategies, Boussard & Gavaudan and the Marshall Wace MW Tops float, which raised €1.7bn ($2.5bn) on Euronext.

This year, market activity has slowed, perhaps because many funds that considered going public “are now watching to see what’s happening with the funds that have already listed”, according to Robin Bowie, founder and chairman of Dexion Capital.

Before the Gottex flotation, seven hedge funds went public, the largest of which, Brevan Howard’s BH Macro, raised £525m on the London Stock Exchange.

The argument for going public is compelling. From a hedge fund’s point of view, a permanent capital vehicle could be “the most perfect set-up”, according to one manager.

John Millar, managing director of investment banking covering hedge funds at Merrill Lynch, agreed. He said: “It is extremely attractive to issuers. By locking in capital, it helps better match duration of funding to investments; it helps with the fund’s credit rating; and it secures the fee stream. From an issuer’s standpoint, it’s a dream.”

Additionally, and perhaps most importantly, permanent capital means just that – money raised through an IPO can’t be redeemed by investors giving 30 days or 90 days’ notice that they want their cash back, as it can in an ordinary open-ended hedge fund.

For investors, too, a listed fund would seem ideal. It gives them daily mark-to-market pricing and potential for secondary market liquidity. It gives the benefit of regulation by the Financial Services Authority or a similar body.

It can be tax efficient, requires a lower minimum investment than a direct allocation to an ordinary hedge fund, and is transparent. But the single most important benefit is access, according to Millar.

He said: “If you have a private fund with a successful strategy and you were raising new money, quite often it will come mostly from existing investors. Consequently, an ordinary institutional investor rarely gets access to the best-performing hedge funds. Public listing is a way of democratizing access.”

However, there are downsides. One investment manager said the “dirty, ugly secret is that they’re closed-ended funds”. While permanent capital is a boon to a hedge fund manager, who no longer needs to worry about redemptions wiping out his fund, it’s not so great for investors, whose only way out of the fund is to sell their shares.

Millar said: “An investor in a closed-ended fund has two things to worry about. First, what’s performance going to be like? And then, where’s the share price going to trade in relation to net asset value?” Often the answer to that last question is “at a discount”.

Bowie agreed: “Discounts are a problem. The best way to mitigate against it is to perform. Performance finds buyers. Second, you have to have continued marketing, with dedicated salespeople finding new buyers. And third, you need to make sure investors are taken care of.”

In the case of Dexion, which manages four quoted funds of funds with total assets in excess of £1.2bn, taking care of investors has led to what the firm calls a discount control mechanism.

Pioneered by Dexion and ABN Amro, its corporate broker, it enables investors to wind up a fund and get their money back at NAV less costs if the fund trades at an average 5% discount over a calendar year.

For Colin Clark, director of Aida Capital, “looking after the shareholders” involves redeeming shares when they are on offer. He said: “When shares go to a discount, it becomes unattractive to investors. We try to ensure that the net asset value and the share price are similar at all times. You cannot issue more shares if the company is trading at a 30% discount.”

To some extent, this active share management has worked: discounts of quoted funds of hedge funds have narrowed since 2002, when they averaged about 10%. Over the past two years discounts have hovered at around zero, with a period of premiums in 2005-2006.

Other downsides include size constraints and liquidity. Many of the quoted funds of funds are too small – 20 have assets under management of less than £100m.

Perhaps because the holders of shares in funds are in it for the long term, market turnover of quoted hedge funds is up to 80% lower than other shares . An investment banker said: “People do not want to talk about it or face up to it, but trading in hedge funds needs to become more mature.”