Hedge Fund Reader

Hedge Funds and Municipal Bonds

-- By Pushpa Sathish, Staff Writer

Following a miserable year that hasn’t exactly seen spectacular returns pouring in, hedge funds are looking to municipal funds to help revive their fortunes. These funds are investments in state and federal government projects, and allow investors to skip on federal, state and local income taxes on interest earned on them.

According to Bloomberg, recent interest in “munis” have pushed them to perform better than U.S. Treasuries and corporate bonds over the past three years. Hedge funds are not just profiting on the interest from these bonds.   

Rather, they are employing various arbitrage strategies to profit from the difference between the yields paid by longer-dated muni bonds and other, shorter-dated securities. One such strategy involves using the bonds as collateral in trusts that issue variable-rate notes.

Delphi in Tussle Between Funds

-- By Pushpa Sathish, Staff Writer

It could well heat up to become the battle of the hedge funds, with Delphi being the spoils, and it could well have an outcome that even an oracle couldn’t predict with accuracy. The auto parts manufacturer which formerly belonged to General Motors is in the middle of a tug of war between Highland Capital Management and a group comprising Appaloosa Management, Cerberus Capital Management, Harbinger Capital Partners Master Fund I, Merrill Lynch and UBS Securities.

Highland, which is the second-largest shareholder in the ailing company, is protesting the $3.4 billion deal struck with the consortium, on the grounds that it will allow the group an advantage over current equity holders in stocks and convertible preferred securities. In addition to this, the Appaloosa-Cerberus group would gain control over the board through its right to nominate six of the total twelve directors, including the chairman.

The hedge fund is countering the offer with one of its own – a $4.7 billion pact that will allow it to buy any unsubscribed shares for a fee of 2.5 percent. Highland will accordingly file a petition against the consortium’s deal on Jan 2, three days ahead of the Delphi hearing at the U.S. bankruptcy court of the Southern District of New York and the Securities and Exchange Commission.

Hedge Funds in Australia

-- By Pushpa Sathish, Staff Writer

I’ve always considered Australia as one of the most laid-back nations in the world – the people there never seem to be in a hurry to do anything; even their speech is a drawl. The same goes for the country’s attitude towards hedge funds. While the rest of the world is trying to regulate the $1.5 trillion industry, the folks down under are happy to just let things stay as they are.

This carefree attitude is an anomaly, because the country has the largest percentage of individual investors, 66 percent when compared to the 44 percent worldwide. But this is because even a minimum of $785 (A$1000) can get you in the doors of a hedge fund.

So are they not at risk just because they stand upside down? No, the Aussie hedge fund industry is fraught with the same risks that come from dealing in short selling and illiquid securities. But the country feels that a disclosure of risks and fees in sales documents is regulation enough.

The driving force behind Australian hedge funds is the Reserve Bank of Australia (RBA), which reports that the industry has experienced a significant growth over the past few years. But will the controls be tightened if there is one big collapse? We’ll just have to wait and watch.

The Devil or the Deep Sea? Multi-Strategy Funds or Fund of Funds?

-- By Pushpa Sathish, Staff Writer

Fund of hedge funds or multi-strategy hedge funds? Are the two similar or do they have their own advantages and disadvantages? Corbin Capital Partners, a New York-based hedge fund which runs a fund of funds but is owned by founders of one of the world’s biggest multi-strategy hedge funds, Highbridge Capital Management, offers an insight into these two investment strategies:

• Both move in and out of various markets to maximize the returns and minimize the losses in each.
• Multi-strategy funds returned more that fund of funds over the past few years because of lower fees and better strategic skills. But since the latter are less volatile, their performance has been better.
• If multi-strategy funds are supposed to diversify and minimize risk, then why did Amaranth collapse? Because these funds use a technique known as cross-collateralization, where leverage is used across the whole firm and assets of all strategies are used to offset the risk. So if one strategy fails, it pulls down the rest like a house of cards.
• Multi-strategy hedge funds tend to put more money on markets that are doing very well. This backfires when the trader handling the strategy demands more money – the fund faces a dilemma to accede or not, because it may be damned if it does and damned if it doesn’t. If it does shell out more money and the strategy backfires, well, you have another Amaranth on your hands. And if it doesn’t, the trader may very well walk out and start his own hedge fund.

Another Thorn in Hedge Funds’ Sides

-- By Pushpa Sathish, Staff Writer

Times, they sure are a-changing, especially in the hedge fund industry. It’s not enough that the U.S. Securities and Exchange Commission (SEC) is raising the financial bar for those wishing to invest in hedge funds and also searching high and low for ways to regulate the $1.3 trillion dollar industry - the taxman is also now closing in on hedge funds.

If a new IRS proposal goes through, funds may be deprived of the trader status tax breaks they are entitled to right now. Firms that engage in a large amount of short-term trading are allowed to deduct some fund expenses like management fees from their taxes. With hedge funds showing a marked interest in private equities that are generally long-term holdings, the relevance of this tax break has come under a cloud.

Private investments in public equities are considered less liquid than other stocks and commodities used in short-term trade strategies. Hedge funds that buy private equities as a buy-to-hold investment will have to take another look at trader status, according to Gina Biondo, a partner at PricewaterhouseCoopers.

Nomura Seeks Larger Share of Global Pie

-- By Pushpa Sathish, Staff Writer

As part of its global expansion plan, Nomura Holdings has acquired 15 percent of the US hedge fund and private equity manager, the Fortress Investment Group, for the princely sum of $888 million. With this sale, Fortress has been offered an entry into the Asian fund market, and can ride on Nomura’s shoulders to offer its products in the world’s largest continent.

The biggest securities firm in Japan is consolidating its attempts to catch up with other global players such as Goldman Sachs and Morgan Stanley, as seen by the move to buy the American electronic brokerage firm Instinet last month. The purchase offered Nomura access to 700 hedge fund clients. But is the Japanese firm paying too high a price as it seeks to compete with bigger fish than itself, as rumors in the industry suggest? NY Times reports:

Still, Nomura may be overpaying as it seeks to match the profitability of Wall Street giants like Goldman and Morgan Stanley. Nomura’s stake in Fortress comes at a higher price, compared with assets, than the $300 million Morgan Stanley paid in October for a 19 percent stake in Lansdowne Partners, a London hedge fund with $12 billion in assets.

We’re Full, Don’t Need Any More Investors

-- By Pushpa Sathish, Staff Writer

House Full – That’s the notice posted on the doors of Renaissance Technologies Corp. The hedge fund, which had a sterling year after increasing its assets by four times to reach the $16 billion mark, is refusing to accept new investors and their money. Why? Because it wants to manage better the hoard it already has!

An investigation into the poor performance of its Institutional Equities Fund, Renaissance found that returns were more forthcoming when it remained a relatively small fund. Too much money in equity strategies is obviously not a good thing, as Ted Aronson will confirm. A main player in the $30 million Aronson+Johnson+Ortiz quantitative hedge fund that closed shop last year under similar circumstances, he says that there is certain evidence that there are capacity constraints on even the best products.

It’s a known fact that hedge funds zealously guard their trading secrets; with the quantitative, mathematical strategies that Renaissance leverages, keeping operations under wraps becomes harder as the money invested in trades increases.

Quant funds such as Renaissance make heavy use of algorithmic trading, or timed trades in small quantities through multiple brokers to hide their intentions. But while algorithmic trading can hide trades in large-cap stocks, big execution orders are hard to mask in smaller stocks. Furthermore, rival hedge funds frequently look to profit from trading against competitors by observing "footprints" -- moves that drive down returns for those looking to hide such trades.

Small wonder then that Renaissance is turning away those knocking on its doors!

SEC Pulls New Regulatory Trick From Sleeve

-- By Pushpa Sathish, Staff Writer

In spite of the setback it faced in enforcing regulations on the hedge fund industry in June this year, the US Securities and Exchange Commission (SEC) is doggedly pursuing its quarry and trying to bring hedge fund managers within its control. Following a federal appeals court rejecting the SEC’s attempt to bring about more transparency in the operations of hedge funds, the regulatory agency is now hitting the industry where it hurts the most – in its financial pockets.

A new SEC regulation, if passed, will increase the lower asset and wealth limit for potential investors in hedge funds; right now, if you are worth $1 million (value of your home included) or earn $200,000 ($300,000 for a couple) in two consecutive years, you are eligible to enter the hallowed portals of hedge funds. According to the proposed changes, only those with $2.5 million investable assets will be allowed to invest in hedge funds. The planned regulation will effectively reduce the number of people investing their money in hedge funds; only 1.3 percent of Americans will pass the test as against the 8.47 percent eligible now.

The arguments against this regulation are flying in fast and furious from the fund industry; lawyers representing the smaller funds claim that the reduction in numbers will affect only their clients, leaving the bigger fish virtually untouched. Employees of hedge funds will find themselves among the most affected, unable to invest in the fund they manage and work for.

The rule has flaws. For one, venture capital funds are exempted because they provide capital to start-up companies, raising the question of how a start-up company differs from a start-up investment manager.

Opposition to the proposed rule is pouring in, raising questions regarding its effectiveness in being used as a regulatory mechanism. If the larger funds do not have to change their MOs in any way after the regulation is passed, how successful is this rule going to be in getting the hedge fund industry to toe the SEC’s line? Let’s wait and watch!

Mittal Extends Stake in RAB Capital

-- By Pushpa Sathish, Staff Writer

Recently in the news for his hostile takeover of the steel giant Arcelor and for the subsequent creation of the world’s largest steel manufacturing plant, Arcelor Mittal, Lakshmi Mittal is making headlines again. The richest Indian is spending some of his wealth on the hedge fund industry with an investment in the London-based RAB Capital.

The Mittal family, which already owns a 3.5 percent stake in RAB Special Situations, the largest hedge fund managed by RAB Capital, has upped its share to 6.2 percent, with the option to increase it to 7.9 percent. According to information provided to the London Stock Exchange by RAB Capital, Mittal now owns another 10 million shares of the fund and also has the choice of buying another 10 million before April 30, 2007.

The investment seems to be part of the long-term plans of the Mittal family, with no redemptions being allowed for a period of three years, and an advance notice period of one year for the next two years.

The shares were bought through the family’s investment vehicle Karrick Ltd. Mittal first associated himself with the hedge fund industry in June 2005 when he bought 18 million shares of RAB Capital. 

Amaranth to Goldman Sachs

-- By Pushpa Sathish, Staff Writer

Amaranth may have bitten the dust after biting off more than it could chew in bad energy calls, but its staff is still being sought after by some of the biggest names in the hedge fund industry. Recent reports claim that Goldman Sachs has roped in 17 of the former hedge fund’s traders to help the company expand its investments in debt markets.

While no formal announcement has been made by Goldman Sachs, sources said that the 14 credit specialists hired from New York and the 3 from Singapore had already started work in New York. Following Amaranth’s collapse, the fund’s top management had offered to help its staff find suitable alternative employment opportunities even while asking rivals to put a hold on recruiting its staff while it gained some control and consolidated its assets to pay back investors. 

Goldman Sachs, the world’s largest securities firm, manages the $10 billion Global Alpha Fund that uses computer-driven models to make investment decisions. It fell 11.6 percent in November after wrong bets that the dollar would rise, equities in Japan would rise, and that stocks in Asia and the US would fall.