Hedge Funds Lower Fees, Lengthen Lockups on New Funds

Date: Wednesday, December 3, 2008
Author: Bei Hu, Bloomberg

Artradis Fund Management Pte, RAB Capital Plc’s Northwest unit and Cannizaro (Hong Kong) Ltd. are cutting fees and locking up investors’ money for longer in new hedge funds that will buy bonds after prices fell in Asia.

Merrill Lynch & Co.’s prime brokerage unit has been approached by at least eight money managers about starting such funds in Asia to buy beaten-up fixed-income securities such as convertible bonds, said Eddie Guillemette, the firm’s regional co-head of global markets financing and services. Some of the hedge fund managers are offering to reduce management and performance-based fees by as much as 50 percent, he said.

“You’ve got people who are now setting up vehicles with long lockups to take advantage of distressed or stressed asset classes where the pricing is now at a multidecade level of cheapness,” said Richard Johnston, Hong Kong-based Asia head of hedge fund consulting firm Albourne Partners Ltd. The UBS Convertible Asia ex-Japan Index is down 37 percent in dollar terms this year.

The fee cuts come as the hedge fund industry endures its worst year in almost two decades because of stock-price declines and a credit freeze that started with rising defaults on subprime mortgages in the U.S. The market slump forced money managers to sell assets to meet $40 billion of investor redemptions in October, according to Chicago-based Hedge Fund Research Inc.

The longer lockup periods are aimed at giving hedge funds managers some respite from pressure to sell assets to meet monthly redemptions before the markets recover, said Albourne’s Johnston.

Lower Fees

To attract money for the new funds, some hedge funds have lowered management fees to 1 percent from the more typical 2 percent rate and performance fees to 15 percent from 20 percent, Guillemette said. Some are considering slashing performance fees to 10 percent from 20 percent, he added.

The management fee for the $55 million Artradis Asian Convertible Bond Fund was set at 1 percent and the performance fee at 15 percent, said Julian Ings-Chambers, a managing director at the Singapore-based firm, which oversees $4.3 billion.

Clients will be barred from withdrawing money from the fund for the first two years, four times the length of the so-called lockup for the $1.8 billion Artradis Barracuda Fund, he said. The Barracuda Fund and the $2.3 billion Artradis AB2 Fund each charge a 1.5 percent management and 20 percent performance fee.

The lower fees reflect both the longer lockup requirement and the long investment strategy of the fund, which will not use leverage or sell borrowed securities expecting to buy them back later at a lower price for profit, said Ings-Chambers.

Cannizaro

“Our feeling is that two years should be long enough to get through to a more normal pricing environment,” he said.

Hedge funds are private, largely unregulated pools of money whose managers can buy or sell any assets and participate substantially in profits from investments.

Cannizaro, a Hong Kong-based hedge fund manager overseeing $475 million, may impose a 10 percent fee on withdrawals during the first year and 5 percent in the second year on a new fund, said Katarina Bendle, a portfolio specialist at Cannizaro. The fund, which may start as early as this month, will buy and hold Asian convertible bonds and other credit products, she added.

The structure would penalize early redemptions, she said. In exchange, the fund will charge a 1 percent management fee, Bendle said. Cannizaro is still negotiating the performance fee with potential investors. Its existing fund charges the standard 2 percent management and 20 percent performance fees.

Longer Lockups

Northwest, an Asia-focused manager acquired by RAB Capital in 2006, is talking to institutional investors, including U.S. pension funds and sovereign wealth funds, to create separate accounts to purchase Asian convertible bonds and other credit products, said Mark Smith, a Hong Kong-based client relationship manager.

Northwest may allow the investors to open accounts with a smaller amount of money with the option to call on more capital if falling prices create more buying opportunities, he said. The proposed structure sits between a hedge fund and a private- equity-type investment, Smith added.

“Convertible bond funds have suspended redemptions, but they will have to sell the securities at some stage,” he said. “Bonds may cheapen and provide a good entry point for investors with the correct capital structure.”

Northwest normally charges 2 percent management fees and 20 percent performance fees, Smith said. The investments in the new products may be locked up for two to three years, he said, adding the arrangements are still being nailed down and may differ from one investor to another.

Mark Shipman, a Hong Kong-based partner who advises funds at law firm Clifford Chance, said some managers are considering offering closed-end funds that lock up investors’ money for as long as six years.

“What I don’t know is to what extent there will be the same sort of investor appetite for these types of lockups,” he added. “It doesn’t necessarily mean it would sell with the traditional hedge fund investor base.”

To contact the reporter on this story: Bei Hu in Hong Kong at bhu5@bloomberg.net