Yield-Hungry Investors Lock Up Their Cash For Longer

Date: Monday, September 24, 2012
Author: Tommy Wilkes, Reuters

Investors in hedge funds are becoming increasingly willing to lock up their money for longer and invest in less liquid strategies, in a sign some are choosing the chance to earn bigger returns over easy access to their cash.

Several prominent hedge funds have raised hundreds of millions of dollars this year for funds which keep hold of their clients' cash for years, sometimes as long as three, and much longer than the typical 30 to 45 days the average fund requires.

This trend reflects a sea-change in sentiment since the financial crisis, when investors flocked towards the most liquid funds so that they could quickly convert their holdings into cash during times of heightened market volatility.

But four years of earning next to nothing on government bonds, and even longer grappling with seesawing stock markets, is encouraging some to entrust hedge fund managers to find them returns from more esoteric assets that can take time to exploit.

"I think the quest for yield is in its early stages, not its late...Investors are looking for longer lock-ups for direct lending, for distressed and for structured credit, for things you can't do otherwise," said Anthony Lawler, portfolio manager in the fund of hedge funds team at Swiss asset manager GAM.

Investor Push

The more liquid strategies have attracted the bulk of new cash flowing into the hedge fund industry in recent years.

Commodity Trading Advisors, funds which use computer codes to speculate on futures and sometimes give clients the option to change their holdings daily — very rare in the industry — almost doubled in size between 2008 and the end of 2011, when assets topped $188 billion (£116 billion), according to data group Hedge Fund Research.

This year, however, it is fixed income-focused managers gaining in popularity, including those in structured credit, with the likes of CQS and Brevan Howard launching new funds.

Structured credit — which can range from trading mortgage-linked securities to credit derivative portfolios — is one of the best performing strategies in 2012, driven by huge gains made from betting on a recovery in the U.S. housing market.

Steve Kuhn's $3 billion Pine River Fixed Income Fund, for example, soared more than 23 percent this year to the third week of August while Canyon Capital, which also trades U.S. mortgage debt, has seen its Value Realization Fund rise almost 10.7 percent by the end of July, data seen by Reuters shows.

Many assets linked to mortgages are illiquid — meaning there are fewer buyers and sellers than in other markets — so hedge funds need longer lock-in periods so that they can easily meet redemption requests if their own investors head for the exit.

"This isn't us pushing; this is a certain group of investors coming to us and saying that they are willing to lock up their money in order to get exposure to these illiquid opportunities," said the European head at a hedge fund currently raising money for structured credit investments.

Earlier this year Brevan Howard, the $37 billion hedge fund giant, launched the Credit Value Master Fund, which invests in mortgage-backed securities, collateralized debt obligations and illiquid securities.

London-based CQS, meanwhile, closed its ABS Alpha Fund to new investors in February, a source familiar with the launch said. The $250 million fund has a minimum one-year lock-up period and a maximum 25 percent redemption gate.

Dangers

Dozens of hedge funds have launched distressed debt products over the past few years to target assets they believe European banks will offload at discounted prices in coming years.

Some of these funds only ask their investors to give 30 or 90 days' notice — common among the industry — to redeem, but others want clients to part with their money for years because of the time it can take to haggle with banks over prices.

"It's really dangerous to invest in European distressed and stressed debt with 90-day money," one investor at a private equity firm said. Private equity houses typically require their investors lock up cash for multiple years.

Other hedge funds have launched funds not specifically targeting illiquid assets.

Earlier this month, Stockholm-based Brummer & Partners said it had raised $500 million for a new fund which carries a three-year lock-in period. Brummer says the long lock-in will allow it to exploit trading opportunities that more liquid funds are denied amid market volatility wrought by the euro zone debt crisis.

Despite the rush by some investors into less-liquid funds, however, some warn about the dangers of chasing yields at the expense of liquidity at the wrong time.

"You should be giving up liquidity when the dislocations occurred...We were one of the few managers that allocated to U.S. mortgage backed (securities) in 2009 and then 2010," Andrew McCaffery, global head of hedge funds at Aberdeen Asset Management, said. "People are allocating now. Why? I think it can run but you're very late in the game. It's people being pushed to have to do something, they feel they have to go for yield."