Clinton Group to turn its loss into marketing ploy

NEW YORK — Clinton Group Inc. finds itself with plenty of capacity in its hedge funds strategies — at least $5 billion — while the rest of the industry is bursting at the seams trying to absorb all the new money.

And it's probably going to have to be new money that will rebuild Clinton Group's asset base after devastating losses of $3.9 billion, or about 74% of its assets under management, since Oct. 31.

Following what he described to clients as "the toughest period in this firm's history," George E. Hall, Clinton Group's co-founder, president and chief strategist, is using the capacity created by the losses as one of his selling points as the firm regroups.

The New York-based multistrategy arbitrage manager was exonerated in the last three weeks. Investigations by the Securities and Exchange Commission and the Commodity Futures Trading Commission and audits by two accounting firms found no evidence of the portfolio misvaluations alleged by a disgruntled former employee, senior trader Anthony Barkan, who left the firm in late October.

Many hedge fund observers are not surprised that a mere rumor could wreak such havoc on a manager.

"This kind of situation can easily arise in the hedge fund world because of its very nature: non-transparent, non-communicative, non-servicing. The fact that there is such a lack of communication, such a lack of hard news, makes people more willing to listen and act on rumors," said William Wechsler, vice president, Greenwich Associates LLC, Greenwich, Conn.

Mr. Wechsler also noted that the way hedge funds are structured predisposes investors to act fast at the first hint of trouble.

"You don't want to be the last one on the sinking ship. You definitely want to jump first before everyone else. The way they are structured, they tend to go down in a nasty spiral as performance is impacted by redemptions, and redemptions are impacted by performance. People know this. They've seen it happen over and over. So they are trained to react quickly," Mr. Wechsler said.

Redemptions made early in the seven-month period of chaos caused by Mr. Barkan's parting comments probably will mean those clients won't be giving money back to Clinton Group any time soon.

"It's really unfortunate that the SEC investigation took so long. Many of Clinton Group's clients, especially the fund of funds (companies), could not remain in the funds once the company was being investigated (because of the stigma), and now too much time has gone by. The money had to go somewhere in the meantime," said Luke Imperatore, managing director, Putnam Lovell NBF Securities Inc., New York. Mr. Imperatore heads Putnam Lovell's alternative investments unit that incubates new hedge fund companies and provides marketing services to hedge funds.

"It's going to be a whole new ball game when it comes to marketing. A lot of their investors probably will be new ones," Mr. Imperatore predicted.

Mr. Hall said Clinton Group is ready for the challenge. He has trimmed staff to 120. About 30 people were laid off in early March; 20 left voluntarily since the end of October, Mr. Hall said.

Mr. Hall recently relinquished the functions of chief investment officer to Richard Cohen, who had been head of research and technology and created the firm's statistical arbitrage strategy. Mr. Cohen is heading up an effort started last summer to develop more rigorous risk management and capital allocation processes, Mr. Hall said, and that has started to pay off in better returns.

The firm's $850 million Multi-Strategy Fund was up 4.8% year-to-date through April 30, for example; it returned an annualized 11.07% through April 30 from its inception in February 2001.

Mr. Hall said the returns of his firm's six relative value hedge funds "were exceptional over the past 12 years," except for last year, when returns were poorer in the latter part of last year because of high redemption rates.

Also, the firm's well-known $1.2 billion Trinity Fund, which suffered losses of 21.5% in 2003, has been closed to new investors while the fund's management implements new investment guidelines. The guidelines broaden investment possibilities for portfolio managers beyond the previous restriction to mortgage-backed securities. The firm is evaluating whether it should reopen the fund to new investors.

A chief operating officer's job also was created, held by Michael Vacca. He continues to oversee Clinton Group's convertible arbitrage and event-driven strategies.

There are nine marketers — an unusually high number for a hedge fund company — headed by Patrick O'Meara, director of marketing and client relations, whose job it is to "get out in front of investors," Mr. Hall said.

"I don't know (of) any other firm of our size that has gone through this level of scrutiny. Having gone through it, I think, adds an element of strength," Mr. Hall said.

Mr. Hall noted that the capacity constraints of many hedge fund-of-funds companies, whose underlying hedge fund managers are capping their asset pools, also may attract assets to Clinton Group. Since the firm at its peak last June managed $5.7 billion, the infrastructure remains robust enough to service at least $5 billion, Mr. Hall said.

Consultants and competitors said they think Clinton Group has a good chance of regaining lost ground.

"I think the potential for misvaluation is always a concern with certain types of hedge fund strategies, especially those with more illiquid types of securities. The Clinton Group incident seems to be an isolated one, given the termination of the SEC's recent investigation, which found no wrongdoing," said Patrick Sheedy, senior analyst at consultant Stratford Advisory Group Inc., Chicago.

A competitor of the Clinton Group, who asked not to be identified, said he expects Clinton Group to come roaring back.

"We've seen over the years that when a firm has to undergo something like this — intense pressure and scrutiny and eventually is cleared of allegations — that the remaining people are very determined to prove themselves, to come back and regain what they lost and then some. I think that's what will happen with Clinton Group," said the competitor.