Dollar Compounds Funds of Hedge Funds\' Madoff Woes |
Date: Tuesday, February 10, 2009
Author: Laurence.Fletcher, ThomsonReuters.com
The European fund of hedge funds industry may
shrink to a quarter of its size as hits from currency hedges and the
withdrawal of bank funding compound problems in a sector still reeling
from the Bernard Madoff investment scandal.
The shake-up could see strong funds of funds buy weaker rivals, as
some in the market question a business model that charges a premium for
selecting the best managers—but underperformed benchmark hedge fund
indices.
"I think outflows will be at least in line with the overall
hedge fund industry, and could easily be 50% or even more than that,"
said Chris Manser, global head, fund of hedge funds at AXA Investment
Managers. "I think we'll see a lot of consolidation, and increasingly
managers just going out of business."
Mr. Manser's flagship fund was down 8% in 2008. In total, Manser runs 3.5 billion euro ($4.48 billion) in assets.
Redemptions of 50%, plus last year's losses, mean the industry could end up 75% smaller than the start of 2008.
Within the closed-end sector, meanwhile, investor appetite for
funds of hedge funds has weakened, with funds now on an average
discount to net asset value of more than 20%.
"[With] the whole fund of funds universe, a lot of people are
questioning whether that is an effective business model," Tom Anderson,
hedge fund manager at Yorkville Advisors, said.
Funds of funds account for around 40% of the overall hedge fund
industry, and surprised last year by performing worse on average than
for single manager hedge funds. Hedge Fund Research's HFRI Fund of
Funds index fell 19.97% in 2008, with only three months out of 12
positive. By comparison, hedge funds lost 18.30%.
Greenback Hurts
Margin calls on currency hedges after the dollar's rapid rise
will be another blow, forcing fund-of-funds to pay out hundreds of
millions of dollars, money that could otherwise have been used to meet
client redemptions.
European funds of hedge funds' assets tend to be
dollar-denominated hedge funds, but their liabilities—what they have to
give back to investors at some point in the future—are usually in
pounds, euros or Swiss francs.
Most therefore put in a currency hedge, which protects them from a weakening dollar but hurts when the dollar strengthens.
After the dollar's recent rise—the British pound has weakened
from around $1.85 in September to below $1.40 last month, while the
euro has weakened from nearly $1.50 to below $1.30—many have had to
stump up cash to meet margin calls.
While this does not represent a financial loss—their new, lower
dollar holdings still equal the same amount in sterling or euros—the
ready cash was vital in meeting client redemptions when some holdings
are hard to exit.
Dexion Absolute, a listed fund of hedge funds, had to pay out a
staggering 20% of its net asset value, or £250 million ($373.6 million)
in cash, on a currency margin call, meaning it could not use the money
to buy back its own shares. Moreover, the problem has been compounded
after some banks withdrew credit lines to funds after the Madoff
scandal.
"The currency drain would be a constant drain on a fund of
hedge fund's cash, when cash is already tight due to redemptions—it's a
double whammy," said AXA's Mr. Manser. "With a stronger dollar and
client redemptions, losing the credit line can be another blow to a
fund of funds liquidity, and could be too much to manage."
New Models
Funds face the problem of how to raise cash, without selling liquid holdings and leaving investors with an illiquid rump.
Many, such as Thames River Capital's funds, have told clients
they can only draw out their money every 90 days, and those that
survive the downturn may have to invest in more liquid assets or lock
up investors for longer.
"There are some fundamental issues with funds of funds that
have become apparent, particularly that of liquidity and
asset-liability mismatches," said Odi Lahav, vice president at rating
agency Moody's alternative investment group. "These in themselves will
probably cause investors to submit more redemptions than they would
have otherwise and put pressure on the business models to change,
either toward managed accounts or less favorable redemptions terms for
investors."
By Laurence Fletcher
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