Judgment day looms for hedge fund managers as they ponder the possibility of mass redemptions following market volatility and recent hedge fund failures.
Since most U.S. hedge funds allow redemptions only at year end, and require a minimum 30-day notice, hedge fund managers find themselves on the cusp of the redemption period not knowing what to expect.
While most experts contacted wouldn't hazard a guess as to what will happen, a few expect the U.S. stock market's recent recovery to keep hedge fund investors from running for the exits.
And institutional investors are expected to be the most likely to stay put, based on their long-term investment perspective.
Two such investors are Consolidated Papers Inc., Wisconsin Rapids, Wis., and the endowment fund for the University of Michigan, Ann Arbor.
"We're satisfied," said John Steinberg, treasurer for Consolidated Paper, in regard to the company's $80 million allocation to Tiger Management Corp., Julian Robertson's New York-based hedge fund firm.
While the Tiger fund is close to flat for the year, Mr. Steinberg said, its long-term performance is "spectacular."
ADDING MORE
In the last six months, Consolidated Paper's $650 million pension fund added to its hedge fund lineup, giving two firms $10 million each: State Street Global Advisors, Boston, for a global asset allocation mandate, and Zacks Investment Management Inc., Chi-cago, for a long-short market-neutral allocation, he said.
Michigan, meanwhile, just allocated another $100 million to absolute return strategies.
The University of Michigan hired four hedge fund managers to oversee $100 million for its $2.5 billion endowment fund, said Norman Herbert, treasurer and head of investments.
Hired for $25 million each were: Centurion Investment Group, New York, for long-short equity; Farallon Capital Management, San Francisco, for distressed debt, real estate and arbitrage; Highfields Capital Management, Boston, for equity event arbitrage; and Och-Ziff Capital Management Group, New York, for merger arbitrage.
Michigan has about $300 million invested in total return strategies.
"We wish the results were better" this year, Mr. Herbert said, but he added he is satisfied with the managers, which are sticking with the chosen styles.
HOLDING PAT
Others also said institutions are holding pat. "We have had no performance-related redemptions," said James Berens, partner and director of research for Collins Associates, Newport Beach, Calif., a fund of funds manager.
The recent market turmoil could even lead to institutions playing a bigger role in the hedge fund industry, said Bruce Lipnick, president and chief executive of Asset Alliance Corp., New York, an umbrella investment firm for hedge funds.
"We believe this is a growth area," with much of the gloom and doom surrounding hedge fund losses overdone, he said.
As a sign of Mr. Lipnick's bullishness, he said his firm is in negotiations to buy three different hedge funds with combined total assets of $1 billion.
Even if institutions stick with hedge funds, the typical hedge fund investor -- high-net-worth individuals and family offices -- can be more fickle. If many of them redeem, other hedge fund investors and the market in general could be hurt.
Continuing investors would suffer if profitable hedge fund trading positions had to be liquidated to meet redemptions, while the markets would suffer if those hedge fund redemptions lead to broad selling in illiquid markets.
REDEMPTIONS OFFSHORE
Offshore hedge funds, which are more liquid than their U.S. counterparts, already have experienced relatively large redemptions.
"We're hearing that the offshore money has already gotten out," said E. Lee Hennessee, managing principal with Hennessee Group LLC, New York.
But Ms. Hennessee cautioned that offshore money tends to move around faster than U.S.-based money, so it's tough to extrapolate offshore movement of money to the U.S. hedge fund industry. (Offshore funds are for non-U.S. and U.S. tax-exempt investors).
Further complicating the matter this year, funds of funds are issuing hedge fund managers provisional redemptions that are dependent on the amount of redemption notices they in turn receive from their investors.
While some hedge fund managers are treating provisional redemptions as actual redemptions, and selling assets to cover them, others are hoping to keep some of that money for their funds.
Hedge funds already posting high losses probably are a lost cause.
Hedge funds typically charge a 1% management fee and keep 20% of investment profits. But if there are losses, the 20% performance fee usually isn't charged until asset values surpass the previous high, called the high water mark.
"The redemptions will be huge in the funds that have been hurt," Mr. Lipnick of Asset Alliance said. Funds that are down 40% to 50% will lose their allocations, he said.
Many mortgage-backed securities investors fall into that category, said George Mazin, a hedge fund attorney and partner for Lowenstein Sandler PC, Roseland, N.J.
LOSING TALENT
Funds with big losses also could be hit with the loss of investment talent, if they're unable to pay big bonuses. One possible offsetting factor, however, is the large number of qualified personnel without jobs as a result of Wall Street layoffs, Ms. Hennessee said.
Moreover, funds that were investing in areas that weren't a part of their original mandate are also likely to lose assets, said George Hambrecht, president of Barlow Partners Inc., a fund of funds manager in New York.
But most hedge fund managers don't fall into those categories, Mr. Hambrecht said, and investors are likely to continue with the bulk of hedge fund managers, he said.
Also hanging over the hedge fund industry is the possibility of increased regulation, with officials of both the Securities and Exchange Commission and the U.S. Congress discussing the issue.
Any regulation is likely to come in the form of increased disclosure of leverage as it relates to banks and brokers, said hedge fund attorney Paul Roth, partner with Schulte Roth & Zabel LLP, New York.
"My own sense is that the issue (of regulation) is one of leverage, not of hedge funds," he said.
And the threat of market repercussions from hedge fund redemptions appears to have dampened.
"Everybody was fearful of a December liquidation cycle," said Richard Meckler, chief investment officer for hedge fund manager LibertyView Capital Management Inc., New York. He said managers began to raise cash back in September in anticipation of redemptions, and most now are in "pretty good shape."
