Funds Of Hedge Funds Face Liquidity Squeeze
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By Margot Patrick
Of DOW JONES NEWSWIRES
LONDON (Dow Jones)--Funds of hedge funds may no longer offer quick turnovers for investors, because the funds they invest in are imposing longer waiting periods on the money they manage.
Hedge funds increasingly are imposing longer lockups of the money they manage, or putting some of it into illiquid share classes, usually to match moves into longer-term investments. By holding investors' money for more than two years, hedge funds also avoid a new requirement to register with the U.S. Securities and Exchange Commission.
Funds of hedge funds in turn are facing a mismatch with the liquidity they offer to their own investors, and some said they will have to start extending their own lockups of investor cash.
Last week, Switzerland's Bank Leu, a private bank owned by Credit Suisse Group (CSR), had to freeze one of its listed fund of hedge funds, citing problems valuing illiquid investments held in a multi-strategy fund run by Ritchie Capital of Geneva, Illinois.
"When people look at hedge-fund investing, they think of them as liquid investments," said Virginia Parker, president of Parker Global Strategies in Stamford, Connecticut. "As a manager of funds of funds, it is a real problem to have two- and three- year lockups. At some point, there needs to be a realistic matching of underlying funds and funds-of-funds liquidity."
Funds of hedge funds market themselves to investors as a way to access diverse pools of hand-picked hedge funds, either through flagship funds or custom-made portfolios.
According to Chicago-based Hedge Fund Research, funds of hedge funds hold about $395 billion of $1.1 trillion in total hedge-fund assets under management.
Investors in funds of hedge funds - wealthy individuals, insurance companies, pension funds and other institutions - typically can redeem their investments quarterly within a written notice period.
But as many hedge funds move into less liquid investments, such as distressed debt and equity stakes in private companies, it is getting harder for funds of hedge funds to maintain monthly or quarterly liquidity.
"The mainstream areas for hedge funds are becoming increasingly crowded with lots of intelligent participants trying to make money off each other. They are looking for new opportunities, and that often means longer-term strategies," said Chris Mansi, a London-based senior investment consultant who heads up hedge fund research at Watson Wyatt, one of the world's largest advisers to pension funds.
"We are still mainly seeing quarterly redemption periods in funds of hedge funds but the trend is toward lengthening," he said. "It is becoming more common to see an (initial) one-year lockup with six-month redemptions rather than quarterly, and to have a gate provision to keep all of the money from walking through the door at the same time."
Gates limit the amount of money that can be withdrawn from a fund at any given redemption period. Hedge-fund managers say gates give their funds greater stability. If they had to liquidate a large portion of their assets to pay out exiting investors, it wouldn't be fair to new and remaining investors, managers say.
Less-Liquid Investments
Bank Leu's Prima Relative Value Fund ran into problems after Ritchie Capital's $1 billion Multi-Strategy Global Fund carved out about 20% of its shares for less-liquid investments, mainly stakes in up-and-coming companies.
The shares are only redeemed if and when those investments are realized, a move approved last summer by Ritchie's investors, including the Bank Leu fund. Ritchie also put in place a gate on the fund, limiting quarterly redemptions to no more than 10% of the liquid part of the fund's net asset value.
A Ritchie spokesman stressed that Bank Leu had agreed to the changes and said it provides investors with monthly valuations of both the liquid and illiquid shares. He said that investors can still redeem their liquid shares on a quarterly basis, subject to the gate provision.
Bank Leu's head of alternative investments, Peter Gruenblatt, declined to comment about the matter but said fund-of-hedge-fund managers likely will have to change the structure of their own products to reflect longer lockups and illiquid share classes at the hedge funds they invest in.
The Prima Relative Value Fund, along with three other funds of hedge funds managed by Bank Leu, currently offers investors the ability to redeem their money on a monthly basis.
"We have to take it as a fact and take corresponding measures," Gruenblatt said. He said question marks arise, however, when hedge-fund managers active in liquid strategies such as long/short equities still demand a two- or three-year lockup simply because investor demand in their funds is so strong.
A senior executive at one of the world's largest funds of hedge funds, who declined to be named, said lengthy lockups are an unavoidable phenomenon as long as certain managers consistently post stellar returns.
"You either buy their story or you don't but in general, high-quality managers do have the upper hand," he said. "Unfortunately, the end investor always wants high liquidity."
-Margot Patrick, Dow Jones Newswires; +44 20 7842 9451; margot.patrick@dowjones.com
(END) Dow Jones Newswires
February 10, 2006 11:31 ET (16:31 GMT)
Copyright (c) 2006 Dow Jones & Company, Inc.- - 11 31 AM EST 02-10-06 |
