The storm that swept through the hedge fund universe with the collapse of Lehman Brothers in September 2008 may have mostly blown over, but not without an aftermath.

Faced with mounting redemptions and drooping portfolios, some hedge funds suspended valuations while others froze redemptions or staggered withdrawals over time. A few funds implemented simpler measures like prolonging notice periods. Portfolios were also revamped via “side pockets”, special purpose vehicles and the like.

Much of the industry’s discussion so far has centered around whether these “restructuring” methods were a legitimate tool or a ploy to hold assets and collect fees.

Karim Leguel, investment chief of Swiss advisory firm Rasini & Co in New York, says equity funds definitely did the wrong thing by slamming their doors and straying from their mandate of liquidity. Global macro funds are in the same camp because they offered attractive liquidity and should have managed their portfolio accordingly.

Multi-strategy funds, in his view, have fared the worst since they moved a significant portion of their books into less liquid trades where their exit was dependent on other hedge funds or leveraged structures.

However, for most funds, restructuring was not a choice but a necessity, says independent fund director Don Seymour of DMS Management of the Cayman Islands. Following Lehman’s collapse, the market had come to a complete standstill and no one could sell anything at any price, notwithstanding the quality of the asset. So when investors began redeeming, “as a practical matter, that couldn’t be achieved”, Mr Seymour says.

Yet, pinning the liquidity woes on Lehman alone would be overly simplistic, some industry practitioners say. For one thing, numerous funds were offering better liquidity terms than their portfolios could support. Their investments, meanwhile, were becoming increasingly esoteric and private equity-like, altering the balance between assets and liabilities.

Additionally, the severity of the market crisis caught some managers and investors off guard. Valuations became tricky as managers struggled to assess what their assets were worth. Some investors became concerned with the timing when markdowns were booked. Some reckon that managers collected higher fees by delaying the timing of asset haircuts.

The market recovery of 2009 has helped many hedge funds turn a corner. Since May, many funds have largely wrapped up the restructuring and freed up more cash than they previously expected.

“In some cases, it benefited all investors to halt redemptions and wait out the liquidity crisis. Market conditions have improved and fire-sales have clearly been averted,” says Randall Dillard, founder of Liongate Capital Management which has $2.3bn (£1.4bn,
€1.6bn) of assets under management.

Even so, the fund of funds operator has redeemed from funds that tightened liquidity. Liongate blacklisted managers who changed terms arbitrarily for obvious issues of investor trust; funds that restructured with investor approval have also exhibited a lack of risk management and asset/liability matching.

With the benefit of hindsight, it may appear managers did the right thing by retaining assets, says Mr Dillard. However, at the time it was wrong for managers to tell investors they could not redeem. It was their money, after all. Gatings and side pockets were designed to give managers time to work through problems for the benefit of “all” their investors and not to make market timing calls on their behalf. Liongate itself did not gate or suspend in 2008. Thanks in part to that, it has added $500m fresh capital this year and $1bn last year.

Funds that have maintained liquidity, performed reasonably in 2008 and have booked gains this year are the “rock stars of the hedge fund space today. Investors want to speak with them,” says Vernon Barback, who oversees operations at fund-administrator GlobeOp Financial Services in New York. By leaving their exits open, they have felt the “ATM effect”, but they will eventually be beneficiaries of the goodwill they have generated among their investors.

Most market practitioners concur that restructurings have been constructive, as they have helped managers to safeguard the interests of their funds and their investors, says Ezra Zask, who runs an eponymous financial boutique in Lakeville, Connecticut. “There are times when allowing redemptions would jeopardise those interests by forcing liquidation of securities at values the manager believes are too low, which would hurt other investors,” adds Mr Zask.

As a result of the crisis, managers and investors have begun paying greater attention to fund offering documents. “Some managers are creating more flexible documents,” says Ingrid Pierce, who oversees the hedge fund practice of Walkers in the Cayman Islands. “On the other hand, some funds of funds or other significant investors want more bespoke language hardwired into these documents so they understand precisely what powers they have.”

Additionally, open communication is vital for any fund restructuring, says Schulte Roth & Zabel partner Udi Grofman. “We’ve been advising our hedge fund clients to have a dialogue with their investors. Explain to them what you’re doing and why.”

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