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Private equity eyes illiquid hedge fund stakes

Date: Friday, November 20, 2009
Author: Laurence Fletcher, Reuters

Hedge fund investors stuck in products with illiquid assets are increasingly seeing interest in their stakes from specialist private equity or other buyers as markets recover, according to broker Tullett Prebon (TLPR.L).

Head of alternative investments at the British firm, Neil Campbell, said the global market for hedge fund secondaries has grown to several billion dollars a year, and is attracting bargain-hunters willing to take exposure to hard-to-sell assets.

"Prices have risen since the start of the year ... but there are still a lot of sellers in the wings," he said in an interview. "There's a huge overhang."

Some niche firms are buying these stakes at discounted prices, willing to wait months or years until a fund winds up, hoping they've picked up a bargain when they are finally paid out. Campbell said the firm regularly spoke to around six such funds, as well as other buyers.

The market has developed after the turmoil of 2008, when many funds were unable to meet requests to return client money and instead limited or suspended redemptions. Worst affected were funds which had loaded up on illiquid assets such as debt in struggling sectors or certain emerging markets assets.

The price buyers are willing to pay has risen this year, Campbell said, reflecting improvement in the industry as a whole as investors return and performance has picked up.

A large overhang of stock remains, but new buyers such as niche private equity firms are entering the market and, after doing their homework, are prepared to hold the acquired stakes until a fund winds up, Campbell said.

Investors either barred from exiting a fund by redemption restrictions or subject to long lock-ups must get the hedge fund manager's permission before selling on their holding.

"There are ... specialist buyers who buy a position in a fund getting wound up. They look at it like an annuity and hope they get more than par... Niche funds have set up to do this and raised capital for this opportunity."


While deals are far rarer than in listed markets, Tullett's transaction volumes rose around 25 percent between the first and second quarters and about 35 percent between the second and third. The firm has done around 50 such deals this year.

Separately, rival Hedgebay, which also provides a market in hedge fund secondaries, said the average price of trades rose by 400 basis points in October to nearly 87 percent of net asset value for funds that hadn't suspended redemption rights.

Campbell said the large number of sellers of hedge fund secondaries at the moment was partly due to investors book-tidying near the end of the year, and partly due to money trapped in side pockets -- illiquid investments that are separated off from the main portfolio.

Side pockets can hold niche assets such as hard-to-value mortgage debt, emerging market securities or even very large stakes in listed companies and can take years to wind down.

"There's still a huge amount of overhang in side pockets. It could be a stake in a shipping company or a loan to a mine. It will be years, not six months (before these are wound down)."