June 10, 2010, 11:23 p.m. EDT By Alistair Barr, MarketWatch
SAN FRANCISCO (MarketWatch) — Many hedge funds are adopting a new way to avoid a repeat of the massive redemptions that crushed managers during the 2008 financial crisis. Some investors like the changes, while others don’t.
So-called investor-level gates are popping up all over the $2 trillion industry, replacing more traditional fund-level gates, according to investors.
King Street Capital Management, one of the largest credit hedge fund firms with more than $19 billion in assets, introduced an investor-level gate recently.
Philip Falcone’s Blue Line distressed debt hedge fund, launched last year, has an investor-level gate. Falcone’s main hedge fund suffered big redemptions during the financial crisis.
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Oliver Russ, fund manager at investment firm Argonaut Capital, talks to MarketWatch about why he’s positive on the outlook for European equities. Central bank rate decisions, dividends are in focus.
Ore Hill Partners, another credit hedge fund firm overseeing $2.5 billion, added one after surviving a slew of redemption requests in 2008. Read about Ore Hill.
The new approach limits investors to withdrawing a portion of their money from hedge funds at any one time. A common investor-level gate limits redemptions to 25% of an investor’s money each quarter over four quarters.
In contrast, fund-level gates were based on redemptions representing a certain percentage of the overall net asset value of hedge funds. For instance, if redemptions totaled more than 25% of a fund’s assets, the manager could put up a gate limiting total withdrawals to 25%. That meant all investors in the fund would only get 25% of their money back.
During the 2008 financial crisis, fund-level gates contributed to redemption mayhem in the hedge fund industry. Many investors put in withdrawal requests just because they were worried other investors would redeem ahead of them and trigger an across-the-board gate.
Pros and cons
“In the past, you could theoretically withdraw all of your money in one go. That’s the downside” of new investor-level gates, Jennifer Spiegel, a hedge fund lawyer at Paul Weiss, said. “But the upside is that your liquidity isn’t tied to other investors in the same fund.”
“Also, over a defined time period, you can get all of your money out,” she added in an interview, while declining to talk about specific hedge funds. “This allows the fund manager to anticipate liquidity and cash needs over time. Unwinding a fund can be done more deliberately too.”
King Street investors voted for an investor-level gate during the second quarter of 2010. The firm, run by O. Francis Biondi and Brian Higgins, has raised a lot of new money in recent quarters and may have wanted to protect itself from a future rash of redemptions if credit markets get ugly again, investors said on condition of anonymity.
King Street also used to offer some of the most generous liquidity terms among the large credit hedge funds, with monthly redemptions. The firm changed this to quarterly, while switching to an investor-level gate, one of the investors said.
Ore Hill — run by Ben Nickoll and Fritz Wahl — adopted a similar gate, so when investors put new money with the credit hedge fund firm, they can withdraw it 25% at a time over four quarters.
Nickoll said one of Ore Hill’s investors suggested the firm make the change.
“Some other managers are using it too,” he added.
Institutional investors with long-term investment horizons like the new gates because they may protect them from being swept by redemption waves triggered by other investors with more-pressing liquidity needs.
“While investors should not be unduly deprived of their access to liquidity, managers should smooth maximum allowable redemption pressure over a long period of time to ensure that the liquidity risk premium is not subsidized by long-term investors,” Utah Retirement Systems wrote in a memo last year summarizing the way it likes to deal with hedge funds.
“Investor-level gates provide an automatic redemption-smoothing mechanism,” it added.
Other hedge fund investors aren’t so sure. For funds of hedge funds, which allocate client money to a range of underlying managers, investor-level gates can be tricky. That’s because they may be offering quarterly or monthly redemptions to their investors, while being limited to withdrawals of 25% a quarter.
Some hedge fund investors said managers shouldn’t have investor-level gates if they trade liquid securities.
But that hasn’t stopped some hedge funds focused on liquid strategies like equities from trying to adopt investor-level gates, the investors said on condition of anonymity.
Alistair Barr is a reporter for MarketWatch in San Francisco.
June 7, 2010, 4:40 p.m. EDT
Managers have worst month since November 2008: data
Xerion’s ‘firewall’ holds up in ‘flash crash’ test; Moore Capital down more than 10%
By Alistair Barr, MarketWatch
SAN FRANCISCO (MarketWatch) — Hedge funds suffered their biggest losses since the depths of the financial crisis in May as European government debt woes, signs of cooling in China and the so-called “flash crash” tested managers’ efforts to avoid market mayhem.
Managers tracked by Chicago-based Hedge Fund Research Inc. lost 2.26% on average last month, according to early estimates released Monday. That leaves HFR’s main hedge fund index up 1.28% so far this year.
May’s downturn was the biggest since November 2008, when managers lost 2.67% on average, HFR data show. Those losses came after the collapse of Lehman Brothers (PINK:LEHMQ) and the bailout of American International Group (NYSE:AIG) in September of that year.
This time, hedge fund losses came as equity and credit markets fell on concern about the solvency of governments rather than financial institutions. See special report on the second debt storm.
“In our view, the present macro squall was triggered by investors who are beginning to connect the dots between the rally in risk assets that has been supported over the past 18 months by cheap government money, and daily reminders that governments can’t afford it,” Daniel Arbess, head of the $2.1 billion Perella Weinberg Partners Xerion fund, wrote in a June letter to investors.
Xerion fell 4.23% in May, leaving the fund up 3.37% so far this year. Equity strategies pursued by the fund lost 6.41%, while credit strategies shed 1.84%. However, short positions on the euro and the Australian dollar, along with hedges designed to protect against a drop in the Standard & Poor’s 500 index, offset some of that. Arbess declined to comment.
“Our hedges are intended to help blunt the first moves down, and provide firewall protection if downside selling becomes absolutely systemic,” Arbess wrote in the letter, a copy of which was obtained by MarketWatch. “But we are still net long, which means we will have down months during episodes of broad downward correlation.”
Hedge funds tracked by consultant Hennessee Group lost 2.99% on average last month. That would make it the industry’s worst month since October 2008, according to Hennessee data. However, the losses were less than the equity market — the S&P 500 Index dropped more than 8% in May.
“Hedge fund managers avoided significant losses and outperformed traditional benchmarks on a relative basis due to conservative exposures, hedging and short positions,” Charles Gradante, co-founder of Hennessee Group, said. “Given the negative headwinds that exist and potential global crises, hedge funds continue to operate with low gross exposure levels as they navigate an increasingly challenging investment environment.”
Trading in early May was marred by the flash crash in which the U.S. stock market plunged suddenly.
“While there have been several rumors about what caused it, an official explanation has yet to be announced,” Gradante said. “However, it is clear that there was a problem, likely due to high frequency or computer-programmed trading, as several fundamentally sound stocks approached unreasonable price levels. Panic and fear prevailed and liquidity disappeared.”
Xerion’s “firewalls” were tested by the May 6 swoon, but the fund was positive as the market touched the lows of the day, Arbess explained.
“Had markets broken fully through their February lows instead of bouncing, our protection might even have brought us positive performance for the month,” he added.
Moore Capital, run by Louis Moore Bacon, struggled to avoid losses in May. The firm’s main hedge fund ended last month down more than 10%, according to an investor who spoke on condition of anonymity.
The loss was the worst monthly performance in more than 20 years, exceeding a drop of more than 6% in May 2006, the investor noted.
Xerion’s Arbess sees more “macro squalls” as sovereign debt problems persist and global economic imbalances are resolved. Reducing consumption and borrowing in Western developed nations, while increasing consumption in Eastern developing countries is the solution, but that will take time, he explained in the June letter.
“In addition to tightening their own fiscal belts, governments will have to work together using globally coordinated interest and exchange rate policies to level the playing field so Western companies enjoy export opportunities too,” Arbess wrote. “China needs to establish a social safety net so its own consumers become comfortable enough to consume more, after which it can begin to re-value the Yuan.”
While recent signs of cooling in China’s economy dented markets, Arbess sees this as a positive step that could prevent overheating.
That led Arbess to see May’s sell-off as a buying opportunity. Indeed, he told investors in his June letter that there are “plenty of interesting opportunities right now.”
Xerion has been rebuilding positions in “solid stressed credit situations at attractive prices,” he noted.