A New World For Hedge Funds

Date: Friday, February 6, 2009
Author: Michael Maiello, Forbes.com

Fewer funds, lower leverage and maybe fewer limited partnerships--how the crisis tamed the wild hedge fund world.

In December, Forbes was a media partner to Markets Media, host of the Global Markets Summit in New York City. Forbes Intelligent Investing Editor Michael Maiello moderated a hedge fund industry panel that included activist investors Clay Lifflander of Millcap Advisors and Stephen Roseman of Thesis Capital, along with Samuel Hocking, global head of sales for the prime brokerage at BNP Paribas and Kenneth Springer of Corporate Resolutions.

During the discussion, Hocking predicted a 30% failure rate for hedge funds in 2009, rising operating costs and higher margin requirements. Lifflander and Roseman discussed strategies for low-margin investing and the implication of hedge fund failures on shareholder activist strategies. Springer, a former FBI investigator and due diligence expert, revealed the increased scrutiny that hedge fund managers will have to bear.

Also, the group discussed a development that might change the still-young hedge fund space altogether--the rise of private accounts, as opposed to limited partnership agreements, could bring down fees for investors and make lock-up arrangements a thing of the past.

Other recent Intelligent Investing hedge fund features include John Jacquemin's short picks in "Short Regional Banks," and "Hedge Funds Try To Cope," a discussion held in the wake of the Bernard Madoff news.

Excerpts from the conversation follow:

Maiello: I'd like to start with our two managers and have you tell people what you've been doing. Clay, I know you backed off leverage early before the crisis really picked up steam. And maybe you can tell us why you did that and what your experience has been since that.

Lifflander: Sure. We had been running a slightly leveraged, long-only activist strategy since 1996 in the small-cap arena, focusing on manufacturing companies, health care companies and business services companies. As activists, we look for companies that were vulnerable to a proxy fight if we needed to exert influence on the board or management.

And from a value perspective, one of our key benchmarks was buying companies who were trading at or below their leveraged buyout value. And in the summer of '07, people may remember the leveraged buyout market ground to a halt. And that could be viewed as an understatement. So, our floor, our underpinning of our valuation metric, went out the window. And before that happened, we had gotten very nervous starting even in late '06. Because we were starting to see private equity transactions going at prices that we did not think were sustainable. And we started to think that risk wasn't being priced at all, some people would say mis-priced.