Thursday, May 07, 2009

Hedge Funds: Not as Weak as Media Portrays

For the last few months, the media has portrayed the hedge fund industry as in desperate need to hang on to as much capital as possible. Hedge fund limited partners have purportedly been lining up demanding breaks on fees and access to capital in the future -- and getting them. The truth is a little different (or at least a little more nuanced) than this perception.

Based on conversations I've had with managers in the industry, there are two factors which appear to differentiate between those hedge funds who have agreed to big concessions on fees and liquidity with their investors and ones who haven't.

The first factor at play is the perceived "quality" of the hedge fund or the manager running it. There appears to be a tiered system for how funds are perceived by investors (Tier A, B, C, D, etc.). I'm not going to say which hedge fund falls into which tier, but Tier A hedge funds have much more negotiating power in discussing terms than Tier C or D.

I know of one Tier A who was instructed recently by a very large and well-known investor to cut their fees and loosen their redemption terms. The fund politely declined. The investor not only kept their money in (at the old terms) but greatly increased their allocation.

On the other hand, Tier C hedge funds are agreeing readily to the demands of their investors.

The second factor at play is what kind of portfolio a hedge fund has. There's a big differnce between funds that have only public equities (especially in large liquid companies) in their portfolios and funds that invest in the illiquid positions valued on a mark-to-model, instead of mark-to-market, basis. DB Zwirn was a former high-flying fund that traded in the former type of positions. It recently sold itself to Fortress as it needed to be able to hold on to its portfolio position for a long time to see any kind of reasonable return. It simply couldn't sell these positions to meet redemption requests.

What's most interesting about these happenings is that, despite the market ravages of 2008, the best managers at the best hedge funds, when push comes to shove, are still in demand by investors. They are not having to cut their fees or loosen their liquidity terms, even when their own 2008 performance was poor. At the end of the day, investors have to place their money somewhere and these managers still have an advantage.

Position: None.

Originally published in on 5/4/2009 4:32 PM EDT

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