Hedge Fund Troubles Take Tragic Turn
Kurt Brouwer December 24th, 2008
Large pension plans, charities and wealthy investors moved many billions of dollars into hedge funds over the past few years. I don’t expect that move to stop completely because alternative investments such as hedge funds can add value if they are carefully selected. However, this movement became somewhat fad-like and, like so many fads, it is ending in tears.
For years, investors in hedge funds and enjoyed healthy returns. But now, things have changed. Over the past year, investors have seen the dark side of hedge fund investing as performance faltered and hedge funds closed. Now, we are beginning to see the human toll from hedge fund woes. The following are all the hedge fund-related headlines from yesterday’s Bloomberg’s home page [emphasis added below]:
Madoff Fund Operator Who Had $1.4 Billion Invested Found Dead in New York
Thierry Magon de La Villehuchet, who ran a fund that invested with Bernard Madoff, was found dead today in his New York office in an apparent suicide, Police Commissioner Raymond Kelly said. “Our investigative premise is that it was a suicide,” Kelly said in an interview…
Cerberus Limits Client Withdrawals From Hedge Fund for One Year After Loss
Cerberus Capital Management LLC, the $26 billion investment firm founded by billionaire Stephen Feinberg, limited investor withdrawals from one of its hedge funds after it lost 16 percent this year through November.
The restrictions, known as gates, were triggered after clients sought to pull more than 16.5 percent of their money from Cerberus Partners LP by the end of the year, according to a Dec. 19 letter sent to clients. The limits on redemptions will last for one year.
Billionaire Feinberg Despised in Wisconsin Where Cerberus Lives Up to Name
Just about everyone in Kimberly, Wisconsin, hates billionaire Stephen Feinberg.
“This is a greedy, extremely greedy guy who doesn’t care about other human beings,” said Jeffery Wyngard, a third- generation Kimberly mill worker with 30 years on the job.
“Feinberg has no morals,” said paper mill workers union local president Andy Nirschl.
“There won’t be a lot of Stephen Feinberg Little League fields,” said Bob Brukardt, who also worked at the mill for 30 years. “He sold his soul to the devil.”
Feinberg inspires this reaction in Kimberly because Cerberus Capital Management LLC, the company he founded in 1992, owns NewPage Corp., which closed the town’s 119-year-old paper mill that Local 2-9 of the United Steelworkers says was profitable when NewPage bought it nine months ago. Six hundred people are out of work in the town of 6,200 at the same time Cerberus’s money-losing Chrysler LLC automotive unit was seeking a taxpayer loan…
Tontine Capital to Start New Hedge Fund After Losses Topped 60% This Year
Jeffrey Gendell, whose investment firm Tontine Associates LLC is liquidating two hedge funds after losses of more than 60 percent this year, plans to start a new fund in February.
The Tontine Total Return Fund will invest in stocks believed to be undervalued and won’t use borrowed money, Gendell said in a letter to investors. Steve Bruce, a spokesman for Greenwich, Connecticut-based Tontine, declined to comment.
Tontine, started by Gendell 12 years ago, had been one of the industry’s best performers, with its four funds returning an average of 38 percent annually since inception through 2007. The firm last month said it was unwinding Tontine Capital Partners LP, a fund that plunged 77 percent this year through October, and Tontine Partners LP, which fell 67 percent through September.
“I would be very surprised if people allocated new capital with him after such losses,” said Graziano Lusenti, founder of Nyon, Switzerland-based Lusenti Partners LLC, an investment adviser.
Gendell isn’t the first to seek investments for new funds after losing money for clients. Nicholas Maounis, whose hedge- fund firm Amaranth Advisors LLC collapsed under a record $6.6 billion loss in 2006, started a new fund in October.
Buyout, Hedge Funds Must Reorganize to Avoid Tax Increases, Lawyers Say
Tax lawyers are urging private- equity and hedge-fund clients to restructure their partnerships so they can sidestep the higher taxes that President-elect Barack Obama has vowed to impose on their profits…
Hedge Fund Investing
The term hedge fund is a bit confusing to many people because many ‘hedge’ funds take lots of risk and do not seem to balance out the risks they are taking. Yet, the term hedge itself implies the principle of hedging your bet, which means reducing the risk you take.
The original hedge fund was started almost 60 years ago by an innovative man named A.W. Jones. Today, Jones’ original fund would be known as a long/short fund. That is, it bought stocks the manager thought were undervalued, but also balanced or ‘hedged’ that exposure by shorting stocks he did not like. Jones also used leverage or borrowing to accelerate returns. Jones also pioneered the use of incentive fees.
The term hedge fund is primarily a reference to an investment partnership of some type in which the general partner or managing member charges a management fee and an incentive fee or carried interest. This is often 2% as a management fee and 20% as an incentive fee.
Because hedge funds have so much investment flexibility, investors need to be convinced that the portfolio manager has an excellent strategy and also that the manager cares deeply about the interests of investors. Many hedge funds have a structure that prevents the management team from earning incentive fees until the hedge fund gets back to its ‘high water’ mark. That is, until it gets back all the losses it has incurred. But, if the high water mark is distant, there may be an incentive for the management team to close the fund and start a new one without a distant high water mark.
There is nothing wrong with hedge funds as an investment structure. However, the details are critical. They have to be carefully-selected both as individual investments and as to their impact on an overall portfolio. In short, they have to make investment sense. Another issue to be examined is risk. Does the hedge fund use leverage or borrowed money to enhance its returns? If so, that adds significantly to potential risk. The other issue is cost structure in that their cost structure has to be reasonable for what they do. No doubt there are investment strategies that can warrant the 2 and 20 cost structure, but that is a high hurdle to overcome.
As these headlines indicate, many investors who jumped on the hedge fund bandwagon have now concluded that it is time to jump off. See also Hedge Fund Withdrawals Roil Markets and Many Hedge Funds Closing.
- Hedge Funds , Investing , Money
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Unfortunately the Madoff scandal has raised the likelihood that regulators will require hedge fund managers to register in some capacity which will have a chilling effect on those managers who are starting a hedge fund in the new year.
Bart
You may be right. However, the Madoff scheme was not structured as a hedge fund. As I understand it, the accounts were simply clients of the firm for whom securities were purchased. In turn, a number of hedge funds invested directly with Madoff. So, requiring hedge funds to register would not have made any difference in this case.