Hedge Funds Pump Up The Irony

Date: Tuesday, November 27, 2007
Author: Hedge Fund Daily

Leverage appears to be working over time at hedge funds. While HFs borrow large sums in order to invest and help produce outsized returns, The Wall Street Journal reports, some of them on paper are pumping the leverage into their asset kitty to make them appear larger than they really are. This has come to light now, notes the paper, as the current market turbulence has prompted many a fund to reduce their leverage, thus resulting in reports in some cases of dramatically less AUM. “It’s a pretty common practice that should be stopped,” Bradford Alford, founder of Alpha Capital Management, said in a WSJ interview. It is particularly popular among HFs that focus on the credit market, where borrowing big is par for the course, so that they can invest in complex securities, says The WSJ, and by smaller firms that want to look bigger. The practice may not be illegal, but certainly appears misleading, especially since funds with hefty AUM find it easier to attract even more investors, which tend to gravitate to funds that seem to have already captured the fancy of other investors. In addition to adding leverage as a way of skewing the true AUM, some hedge funds tend to double-count investments - which helps explain why estimates of how much money is in the industry vary wildly. The WSJ cites as an example, RAB Capital, which counts among its $7.1 billion AUM, the money its allocates to its RAB Multi Strategy fund of hedge funds, which also invests in the firm’s other funds. Philip Richards, RAB’s CEO, defended the practice, telling The WSJ, “We are reporting on all the assets on which we earn fees, adding that otherwise “we would have a gap where there were incremental fees coming in out of thin air.”