Hedge fund redemption spree doesn’t scare U.S. institutions

Large redemptions and the closing of a few well-known hedge funds have had minimal impact on U.S. institutional investors and their favored hedge fund-of-funds managers.

Sources said that's because outflows have mostly been from single-strategy hedge funds, mainly convertible arbitrage and relative value managers. (Convertible arbitrage managers lost more assets in the first six months of this year than any other strategy — net outflows were $5.1 billion or 15% of total assets managed as of Dec. 31, according to Hedge Fund Research Inc., Chicago).

Leveraged funds of funds were hit hardest by the poor returns in convertibles. Some had to liquidate some hedge fund holdings because of margin calls from their lenders and redemptions of "hot money" from high-net-worth investors.

Consultants said U.S. institutional investors and fund-of-funds managers had little exposure to firms like Vega Asset Management (USA) LLC, New York, which had redemptions of about $700 million from its three relative value hedge funds in June alone. According to the firm's June client letter, which was obtained by Pensions & Investments, Vega's assets under management fell to $6.7 billion as of June 30, down from a high of $10.4 billion in July 2004.

U.S. institutional investors also had little money invested with two convertible arbitrage managers that closed their doors and returned money to investors: Bailey Coates Asset Management LLP, London; and Marin Capital Partners LP, San Rafael, Calif.

"We aren't seeing much impact in the institutional hedge funds of funds we recommend to clients or to the underlying hedge fund managers they use," said Patrick Sheedy, senior analyst with a specialty in hedge funds at consultant Stratford Advisory Group Inc., Chicago.

"This redemption situation may have a ripple effect later, but so far there's nothing alarming in our universe," said Susan McDermott, a senior consultant and principal.

Timothy Jackson, a partner and hedge fund specialist at consultant Rocaton Investment Advisors LLC, Norwalk, Conn., said few U.S. institutional investors use the kind of leveraged funds of funds that were forced to liquidate their holdings when assets dropped to pre-set levels and leverage holders started to make margin calls.

Hedge funds with an institutional focus have seen few redemptions, said Jane Buchan, managing director and chief executive officer at Pacific Alternative Asset Management Co., Irvine, Calif.

"I know of two managers who have similar performance and one has lost well over half his assets under management (mostly European high-net-worth and hedge funds of funds investors), while the other (who has a more institutional client base) has seen less than 10% losses" in assets under management.

"I think the key is that … institutions are continuing to be the main drivers of this business. They tend to invest with realistic performance expectations and tend to be well diversified, whereas the other categories (high-net-worth individuals and leverage hedge funds of funds) are going to continue to be the less desirable assets" because they are more fickle investors, Ms. Buchan said. PAAMCO managed $7.3 billion in hedge funds of funds at the end of July, 93% of it for institutional investors.

Many U.S. hedge funds of funds with an institutional orientation skipped the fall of convertible bond hedge fund managers because two years ago they started moving into other asset classes.

Mesirow Advanced Strategies Inc., Chicago, lowered exposure to convertible arbitrage managers to 3% of total portfolio assets in July, down from 14% in January 2004, said Steve Vogt, senior managing director. Mesirow managed $8.3 billion in funds of funds as of June 30, more than 90% on behalf of institutional clients.

"We are very fundamentally oriented and rebalance the hedge funds-of-funds portfolios regularly, based on our predictions of what will happen with market conditions. We began to rebalance out of convertible arb 15 to 18 months ago." As a result, Mr. Vogt said Mesirow's portfolios weren't hit when returns began to fall for convertible bond managers. "We've had a lot of questions from clients about it, but little impact," Mr. Vogt said.

Harris Alternatives LLC, Chicago, began rebalancing its funds of funds out of convertibles at least 18 months ago, said Anita M. Nagler, chief executive officer. "In the big picture, our sense is that these redemptions are isolated to managers in the relative value and market-neutral arbitrage arenas as a result of a diminished investment climate that has gone on for some time," she said.

PAAMCO has a consistent allocation to convertible arbitrage, Ms. Buchan said, but returns from these managers cost the hedge funds-of-funds portfolio only about 100 basis points from late March until the end of May. Since May, the portfolio has regained about 40 basis points; Ms. Buchan said she expects the 60 basis points to be made up before the end of the year.