Funds of hedge funds eye lending opportunities

Date: Tuesday, May 27, 2008
Author: Laurence Fletcher, Reuters.com

LONDON (Reuters) - Managers of funds of hedge funds are finding good investment opportunities in strategies that fill the gap left by banks hamstrung by the credit crisis, according to S&P Fund Services.

Funds that invest in a basket of hedge funds are increasingly attracted to funds that can lend directly to small and medium-sized businesses, as banks, under pressure from the credit crisis and asset writedowns, leave a growing hole in the market, director of fund research Randal Goldsmith told Reuters.

"There are managers who are prepared to go net long in credit and think there are lots of opportunities there. They see opportunities on the long side in direct lending," Goldsmith said in an interview on Thursday.

"Commercial banks are very constrained in what they can lend. They are reducing their lending books and cutting out more marginal prospective borrowers. A lot of funds of hedge funds think there is a gap for hedge funds to take up."

Whilst hedge funds have also been crimped this year by tighter liquidity conditions, the flexibility of their investment strategies often makes them able to take advantage of market opportunities quicker than others.

According to a report published by S&P this week, a fund of hedge funds run by Signet holds several funds taking advantage of this lending strategy, while Benchmark Alternative Opportunities is also considering it.

Goldsmith also said managers of such funds see opportunities within convertible bond strategies.

"(It's because of) the difficulty of raising finance. It's not that easy for marginal borrowers to borrow from banks any more, and banks are finding it very difficult to get rights issues away," he said.

"The gap that may be in the market is in the convertible bond area. We've had a long period when very few convertible bonds were issued. Now funds of hedge funds are expecting a lot of issuance there."

Convertible bonds give the holder the right to swap them later for shares in the issuer. Typically they pay a lower coupon than regular debt, but the shares are offered at a discount.

Goldsmith said fund of hedge funds managers were "generally very optimistic".

"Hedge funds got redemptions in the first quarter, particularly in the credit area, but ... dislocation in the market creates opportunities. Redemptions from the underlying funds they invest in are leaving more open to new investors."

Last month Reuters reported that Thames River fund of hedge funds manager Ken Kinsey-Quick had been buying battered subprime assets after shorting the sector last year, because he thinks they are cheap.