Hedge Funds Hold Investors ‘Hostage’ After Decade’s Best Year

Date: Wednesday, January 20, 2010
Author: Saijel Kishan, Bloomberg

Hedge funds’ best year in a decade is giving little comfort to Jason D. Papastavrou.

The founder of New York-based ARIS Capital Management LLC, which has about $250 million invested in hedge funds, is still waiting to get back $155 million from 22 managers that restricted withdrawals in 2008.

“We don’t object to the illiquidity,” Papastavrou said in an interview. “We object to how some managers are abusing the situation and holding investors’ money hostage to generate fees.”

Hedge-fund firms including D.E. Shaw & Co. and Harbinger Capital Partners LLC that froze client assets during the financial crisis have yet to pay back a total of about $77 billion to investors, according to estimates by Credit Suisse Tremont Index LLC, which tracks hedge funds. That’s after the biggest stock-market rebound since the 1930s and a record rally in credit markets revived demand for some assets considered illiquid a year ago.

The market recovery helped managers post returns of 20 percent last year after losing a record 19 percent in 2008, according to Chicago-based Hedge Fund Research Inc. The gains exclude some hard-to-sell assets, such as emerging-markets real estate or aircraft-engine securitizations.

“While I’m sympathetic to managers who weren’t able to sell assets back in October and November 2008 because bids were hard to come by, there are few excuses more than 12 months later,” said Michael Rosen, chief investment officer of Angeles Investment Advisors LLC, a Santa Monica, California-based firm that advises clients on investing in hedge funds.

$1.4 Trillion Industry

At the end of last year, about 5.5 percent of the $1.4 trillion hedge-fund industry’s assets were restricted by managers, compared with 11.6 percent of what was a $1.5 trillion industry at the end of 2008, according to Credit Suisse Tremont Index, a joint venture of Credit Suisse Group AG and Tremont Capital Management Inc.

While some hedge funds don’t want to sell at prices that would harm remaining clients, others are using this as an excuse to retain assets to generate fees and remain in business, said John B. Trammell, chief executive officer of New York-based Cadogan Management LLC.

“Managers are running a high risk of damaging relationships with investors,” said Trammell, whose firm invests $3.5 billion of client money in hedge funds.

Millennium Global Investments Ltd., the London-based hedge- fund firm founded by former Goldman Sachs Group Inc. executive Michael D. Huttman, restricted withdrawals from its $600 million high-yield bond fund after it lost 26 percent in the first 10 months of 2008. Clients were previously able to take their money out every quarter, according to an investor.

Two-Year Wait

The firm divided the bond fund, which was managed by Joseph G. Strubel, in two after half of its clients voted to liquidate it. Those investors were told that it would take as long as two years to get their money back. As of September 2009, the fund had returned $68 million in three payments, according to a letter to investors obtained by Bloomberg News.

Caroline Villiers, a spokeswoman for Millennium, declined to comment.

Another London-based company, Polygon Investment Partners LLP, had returned just 40 percent of the assets in its main fund as of the end of last year, according to a person familiar with the situation. The firm, run by Reade Griffith and Paddy Dear, had told clients in October 2008 that it was liquidating its Global Opportunities Fund, which lost 48 percent that year, according to an investor letter.

‘Taking for Granted’

“Many managers took their investors for granted,” said Amit Shabi, a Paris-based partner at Bernheim Dreyfus & Co., which invests client money in hedge funds. “As a result, they’ve lost respect from the investment community, even if they have recouped losses.”

Highland Capital Management LP, the $24.8 billion firm run by James D. Dondero and Mark K. Okada out of Dallas, said it’s struggling to return money because investors can’t agree on the terms of the liquidation. Highland has yet to return all money to investors who put in redemption requests before the firm said in October 2008 that it’s liquidating two hedge funds.

Highland had said its Highland Crusader and Highland Credit Strategies funds would be liquidated over three years. Investors in the funds were previously able to withdraw their money either on a quarterly or semi-annual basis. The funds, which had combined assets of more than $1.5 billion, were closed after losses on high-yield, high-risk loans and other types of debt.

Credit Market Rebound

The average price of actively traded high-yield, or leveraged, loans had dropped to around 70 cents on the dollar when Highland decided to shut the funds, from 100 cents in June 2007, according to Standard & Poor’s. The loans rose above 90 cents as of yesterday.

“No party would like to finalize the investor-led mediation and distribute funds more than Highland,” the firm said in an e-mailed statement. “Highland has committed monies, waived fees, waived our voting rights and dedicated numerous staff to expedite this process. However, in support of the mediation, we are waiting for it to reach its conclusion, which we are optimistic will occur shortly.”

To separate the most illiquid assets and avoid selling them at fire-sale prices, some managers put them into separate funds, so-called side pockets. Existing investors have to wait until the assets in the side pocket are sold before they can get their share of the investment back.

Waiving Fees

Philip A. Falcone, the billionaire founder of $8 billion firm Harbinger Capital Partners LLC, limited withdrawals from his biggest fund in 2008 to about 65 percent of assets and told clients that it may take as long as two years for them to get all of their money back.

The New York-based firm returned less than 10 percent of the assets that were withheld and put into a separate share class, as of the end of last year. A second payment of about 10 percent may be made in the coming months, according to a person familiar with the firm.

The value of the assets in the side pocket declined 3.6 percent in the first 11 months of 2009, according to a November investor letter. Harbinger doesn’t charge clients fees on those holdings. Carolyn Sargent, a spokeswoman for the firm, declined to comment.

Investors in Harbinger’s main fund, which focuses on distressed debt and gained 45 percent last year through November after a 29 percent loss in 2008, are usually able to take their money out every quarter with 90 days’ notice. The hedge fund, which had built stakes in companies including New York Times Co., where it is the biggest shareholder, and energy firm Calpine Corp., has been reducing those holdings, according to an investor letter and regulatory filings.

Not as Planned

“When the redemptions came, we saw that some funds had invested more in illiquid asset classes than what they may originally have planned,” said Peter D. Greene, a partner in New York at the law firm Lowenstein Sandler PC, whose clients include hedge funds and investors.

Not all hedge funds kept clients waiting to get back their money. Highbridge Capital Management LLC, which suspended redemptions from its multistrategy fund after it lost 25 percent in 2008, returned 77 percent of the money that clients had sought to withdraw by July and 90 percent by Oct. 1, according to a person familiar with the firm. The New York-based fund had told clients it may take as long as 18 months to get their money back.

Canyon Partners LLC, which moved about 40 percent of its main fund into a side pocket in 2008 after posting a 29 percent loss that year, had returned 82 percent of those assets by July, according to a person familiar with the matter. The $17.2 billion firm is based in Los Angeles.

‘Screaming for Money’

“Everything has a price; it’s just that managers may not want to accept the lower prices being offered, even though many of their investors are screaming for their money back,” said Geoff Varga, an insolvency and liquidation partner at London- based Kinetic Partners.

Drake Management LLC, the New York-based firm run by Anthony Faillace and Steve Luttrell, told clients in April 2008 that it’s liquidating its biggest hedge fund. As of the end of 2009, it hadn’t returned all the money. Drake said in a letter in October 2009 that its investments included a Turkish-based textile company, GISAD, which may have engaged in fraud, and two Brazilian companies that had defaulted on their debt.

D.E. Shaw, the $28 billion investment firm run by David E. Shaw, restricted quarterly redemptions on its two biggest funds in November 2008 even after one of the funds had made money that year and the firm told clients that it had enough cash to meet Dec. 31, 2008, redemptions, according to investors.

‘Pretty Lax’

D.E. Shaw plans to return all money to investors by the end of this month, including $3.4 billion from its Occulus fund, which gained as much as 6.9 percent in 2008 and 10.5 percent last year through October, investors said.

Paul Welsh, a spokesman for New York-based D.E. Shaw, declined to comment.

Hedge-fund managers shouldn’t have to shoulder the all the responsibility for relations with clients that have soured, said Vidak Radonjic, managing partner at Beryl Consulting Group LLC.

“If investors didn’t know what they were signing up for, they weren’t doing their job properly,” said Radonjic, whose Jersey City, New Jersey-based firm advises clients on investing in hedge funds. “For some, the due diligence they did was pretty lax.”

Some investors have sold their stakes in hedge funds in the secondary market to raise cash, using intermediaries such as London-based Tullett Prebon Plc and Hedgebay Trading Corp. in Nassau, Bahamas. Cadogan’s Trammell said his firm is approaching other investors looking to offload their holdings that were restricted by managers.

Arbitration

Papastavrou’s ARIS is in arbitration with Javier Guerra, who runs Quantek Asset Management LLC in Miami, after filing a complaint in New York state against him in October, accusing him of inflating the value of the fund and withdrawing his personal money before suspending investor redemptions. Guerra says the allegations are “false and misleading.”

“Our motion to dismiss succeeded in prevailing to move any concerns or questions this investor may have into the proper forum, arbitration,” Guerra said in an e-mailed statement. “We are looking forward to resolving this accordingly.”

Papastavrou, who declined to comment on the arbitration, said he plans to increasingly use separately managed accounts as a way to invest in hedge funds.

“More investors are saying ‘Enough is enough,’” he said. “The more investors learn about abuses, the more difficult it will be for those managers to raise money.”

To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net