Call it the Groucho Marx problem: investors trying to put money into hedge funds frequently find that the managers they want do not want their cash.
Just as Groucho complained that he would not join any club that would accept him as a member, even very wealthy investors can find themselves faced only with hedge funds they do not want to invest with. As a result, some investors are resorting to devious tactics to get stakes in the best hedge funds.
Many of the industry’s biggest names – Stevie Cohen of SAC Capital, Paul Tudor Jones of Tudor Investments, Louis Bacon of Moore Capital, Steve Mandel of Lone Pine Capital and others – do not need to expand existing funds further and often believe more cash would hurt their returns. Even when they find they have the capacity to take more money, they typically turn to their existing investors first.
“‘Capacity’ has definitely become one of the buzzwords in the hedge fund world,” says Eleonore Dachicourt, head of the hedge fund advisory business at Credit Suisse’s UK private bank.
Too much money chasing too few opportunities has reshaped the hedge fund industry – and not necessarily for the benefit of investors.
The first, and most obvious, effect has been to squeeze returns. While the average hedge fund made double-digit percentage returns for seven out of ten years during the 1990s, there have been only two years of more than 10 per cent returns this decade, according to Chicago-based Hedge Fund Research.
“The days of the big 20 per cent years with hedge funds are probably over,” says Stephen Oxley, head of the London office of Pacific Alternative Asset Management, a fund of hedge funds.
The second effect of the mismatch of supply and demand has been the tendency of successful fund managers to jack up their fees – to 3 per cent a year and 50 per cent of profits in the case of SAC Capital – and impose long lock-ins, preventing customers getting their money back for as long as five years.
The final effect, though, has been the most frustrating for many investors: the refusal of managers to take money from just anyone.
“We try to pick the investors we want,” says the manager of one $2bn London-based hedge fund.
But investors who know the tricks of the industry may be able to find cracks in the door. The most obvious way to get into a closed hedge fund is one that might appeal to Groucho but most people would shy away from: simply send your money to the fund’s depositary bank and rely on the fund’s automatically issuing units.
“It is incredibly annoying,” says a manager of one closed London hedge fund that gets several unwanted money transfers a year. It has now set up a monitoring system to double-check that investors are approved before money is accepted – although wealthy investors are often “flabbergasted” to be sent back their deposits.
Less blatant methods may hold more appeal for investors considering putting hundreds of thousands or even millions of dollars into a hedge fund. Those with patience can simply put their names on the waiting list. Apart from a tiny number of funds that are trying to shrink, most closed funds take in money to replace redemptions.
The trick is to get to the top of the list, with managers preferring investors seen as likely to leave money untouched for the long term. Hedge funds prefer the endowments and pension fund investors. What they call the “hot money” from Geneva-based funds of hedge funds is relegated to last place, with wealthy individuals somewhere in between.
“You really have to build a relationship with the investor relations person [at the fund] if you want to move up the list,” says one big hedge fund investor.
A few hedge funds, such as Absolute Capital, operate a strict “first come, first served” rule. But for the rest, investors who do not play golf with staff from the hedge fund they want to get into may find the waiting painful.
There are quicker ways in, for those willing to pay or for investors who happen to have the right advisers.
A small secondary market, run by Nassau-based Hedgebay, allows investors to buy and sell hedge fund investments, with good funds typically selling at a premium to net asset value.
Most trading goes on behind closed doors, with funds of funds selling to each other. For the individual, the private banks are the best way into this market. When a client redeems a stake in a sought-after fund, it will generally be recycled to other customers, rather than being sent back to the hedge fund manager.
“We would reallocate the the capacity to other Credit Suisse investors,” Dachicourt says. Other private banks operate the same way.
As with the other tricks, hedge funds generally dislike the secondary trading of their units. Sceptics point to the loss of redemption fees as one reason for this, although fund managers claim that private buying and selling make it harder for them to know who their customers are. Some are so annoyed by the practice that they refuse to allow their funds to trade on Hedgebay.
Private banks and other advisers to the wealthy can help get access to many funds that are “soft closed” – open only to new money from their existing investors.
“Hedge funds know us well and we are able to secure capacity from soft-closed managers that are closed to ordinary investors,” Dachicourt says.
Some banks have gone further: when Morgan Stanley bought 19 per cent of Lansdowne Partners, the London hedge fund manager, for about $300m last year, it was guaranteed access to new capacity for its clients. Investors who cannot face the hassle of trying to trick their way into the biggest established funds have only three choices.
They can hope the fund they want reopens – and that raising more money does not damage its performance. They can pick from the thousands of smaller funds that are still open, avoiding the big name managers.
Finally they can take an option that is not so much a trick as an emerging route into the sector: buying shares in listed hedge funds. Several of the biggest funds, now closed, have set up listed “feeder” funds, including Marshall Wace and Boussard & Gavaudan, listed in Amsterdam, Brevan Howard in London and RAB Capital on Aim.
But the value of their investments is then subject to the whims of the market, and the shares may – as now – trade at a discount to the value of the assets.