Thursday, September 24, 2009

The Last Hedge Fund Hurrah?

Bloomberg reports that hedge-fund assets increased by $21.4 billion in August:
Hedge-fund assets increased by $21.4 billion in August as managers completed their best year- to-date return in almost 10 years, driven by rising stock markets amid signs of economic recovery, Eurekahedge Pte said.

Assets grew for a fourth straight month, adding about $100 billion, the largest sustained growth period since the end of 2007, the Singapore-based research firm said in a report posted on its Web site. Net inflows into the industry totaled $12.6 billion in August, while gains through performance were $8.8 billion, bringing total assets under management to $1.38 trillion, the firm said.

A rebound in global stock markets has helped hedge funds record their best first eight months since 2000, after managers posted their worst year on record in 2008. The Eurekahedge Hedge Fund Index, tracking more than 2,000 funds, gained 1.3 percent in August, as the MSCI World Index of 23 developed nations advanced 3.9 percent in the month.

“We believe the worst of the crisis has now passed and markets are slowly returning to more normal levels of functionality and performance,” said Spencer Young, chairman of HFA Holdings Ltd., an Australian hedge-fund manager with A$6.16 billion ($5.4 billion) in assets, in its annual report released today. “We have also seen early signs that the redemption levels we witnessed at the height of the crisis have diminished and we are cautiously optimistic that overall fund flows will stabilize.”

Europe, Relative Value

With the gain in August, the global benchmark is up 13.4 percent so far this year, the best eight-month gain since 2000, Eurekahedge said. Gains during August were supported by economic data such as the reduction in the unemployment rate in the U.S. and return to positive gross domestic product growth rate for some developed countries, Eurekahedge said.

Assets of funds investing in Europe rose 1.8 percent from July to $318.9 billion, the biggest percentage increase among five geographical mandates, the report showed. Manager allocations to Latin America had the smallest increase in assets, gaining just 0.9 percent.

All regions reported inflows, led by Asia excluding Japan, which added $1.4 billion, or 1.5 percent of assets. A sell-off in Chinese equity markets hurt hedge-fund performance in the region and led to a 0.1 percent performance-related drop in assets. China’s Shanghai Composite Index tumbled 22 percent in August, its biggest slide since October 2008, pushing the benchmark into a so-called bear market.

New Funds

By strategy, relative value funds had the biggest percentage gain, rising 3.7 percent, while long-short equity funds reported the biggest absolute gain, with inflows of $4.1 billion and performance-related increases of $2.1 billion.

Recovery in the capital markets has prompted managers to start funds, Eurekahedge said. About 300 funds have started this year through August, while the rate of fund closures continued to slow, with 200 of them shutting since the end of the first quarter, compared with about 600 closures through fourth quarter in 2008 and first quarter this year, the firm said.

Eurekahedge forecasts hedge-fund assets to reach $1.5 trillion by the end of this year.

“Hedge funds have benefited from the recovery in global markets and that’s the biggest reason behind the comeback,” said Hideki Hashiguchi, chairman of the Japan chapter of the Alternative Investment Management Association in Tokyo. “We’re starting to see some of the fund-of-funds investors consider to allocate money back into alternative investments, so it seems like the industry slowly but surely is emerging out of the worst conditions.”

Hedge funds are mostly private pools of capital whose managers participate substantially in the profits from their speculation on whether asset prices will rise or fall.

All those assets flowing in explains why hedge funds still aren't reducing their fees:

After posting poor returns and in some cases preventing investors from withdrawing cash, hedge funds had been expected to make it up to investors by softening some of their hard conditions or lowering fees. It appears not.

Research compiled by France's Olympia Capital Management, a fund-of-hedge-funds firm that manages pools of individual hedge funds, found that only a handful of 2,659 funds it analyzed shortened the time between one redemption date to the next, or reduced the initial lockup period they place on investors' capital.

The funds' fees also remained steady, said Guido Bolliger, chief investment officer at Olympia Capital Management, "contrary to expectations."

"Industry analysts expected the level of fees to decrease in order to reflect both the strong decrease in the demand for hedge funds and their disappointing performance," Mr. Bolliger said. But "we have not seen any significant changes in the liquidity terms and the fees taken by hedge funds during the first half of 2009," he said.

In the 12 months to May, the research found that fewer than 1% of fund managers had adjusted their liquidity terms, which include their redemption frequency or notice periods investors must give to exit. A similar proportion hadn't changed any lockup periods they imposed on investors.

That is mainly because performance has been so much better this year. After an average 19% loss in 2008, hedge funds posted a 14% gain in the first eight months of 2009, according to Hedge Fund Research. Funds that survived 2008 also are typically larger and performed better than those that failed, giving investors less power to renegotiate fees or redemption terms.

Funds also may be holding back on offering features that can become a double-edge sword in a crisis. Investors like buying funds that give them the option to redeem at frequent intervals. But it can also make them the first port of call for investors that can't get their money out elsewhere, even when a fund is posting strong returns.

Alex Allen, chief investment officer of London-based Eddington Capital Management, which like Olympia Capital puts together and manages portfolios of hedge funds, said his firm lost between 30% and 40% of its assets from investor redemptions between December 2008 and April of this year. This is despite that Eddington's two main funds of funds had returns of 25% and a 1% loss -- much better than the average 21% loss on Hedge Fund Research's Fund of Funds Composite Index.

After some modest inflows since then, Eddington manages about $155 million, down from a peak of $280 million. "We were a victim of our own success because we didn't gate the fund and investors used it as a cash machine," Eddington Chairman Andrew Popper said last week.

Dozens, if not hundreds, of hedge funds slammed down "gates" last year to prevent investors from pulling money. On top of liquidity terms that can range from one month to three years, hedge funds nearly always have a right in their contracts with investors to put a gate down on part or all of their capital.

It's amazing how a year after the worst financial crisis in post-war history, when hedge funds were closing the gates of hedge hell, things have not changed on Wall Street.

German Chancellor Angela Merkel urged Group of 20 leaders on Thursday to agree concrete new regulations for financial markets at a summit this week, but we shall see if anything comes out of this summit.

Moreover, Paul Volcker, the former Federal Reserve chairman, expressed more doubts over the White House’s plan for financial regulatory reform on Thursday and backed new taxes on banks.

One interesting Bloomberg article that did catch my attention today reported that the IRS told its auditors in Manhattan to develop cases against offshore hedge funds and foreign companies it said are trying to avoid taxes on income from loans they make in the U.S:

The agency, in a Sept. 22 directive, urged the Manhattan field director of the IRS financial services section to pursue a transaction the agency says seeks to improperly take advantage of an otherwise legal tax break. The agency also urged the official to be watchful for similar techniques.

“We understand that foreign corporations and non-resident aliens may have used other strategies to originate loans in the United States, giving rise” to tax obligations, Steven Musher, the top lawyer in the IRS’s international department, wrote in a memo to Kathy Robbins, the Manhattan field director.

“We encourage you to develop these cases and we stand ready to assist you in the legal analysis,” Musher wrote.

It is unusual for IRS lawyers to recommend audit targets to field investigators, said Robert Willens, founder of Robert Willens LLC, which advises investors on accounting and tax rules.

The IRS is “obviously incensed about this and intends to pursue the strategy quite vigorously,” Willens said in an interview.

Hedge Fund Risks

The IRS memo signals new tax risks for hedge funds and foreign investors making and refinancing loans to Americans after the financial system crash, lawyer Roger Lorence, a partner at Sadis & Goldberg LLP in New York, said in an interview.

“Anything that doesn’t involve buying a loan in the secondary market is arguably affected by this IRS action,” said Lorence, who advised clients in a letter today to “consider their structure in light of the IRS’s conclusions.”

“Who knows how far they’ll go,” Lorence said.

How far will they go? It's about time they start cracking down on sophisticated tax avoidance schemes that hedge funds and private equity funds regularly engage in. Joe & Jane Taxpayer are squeezed, scared to death of losing their jobs and health care and we got a financial elite that are using an army of accountants to avoid paying their fair share of taxes.

Michael Moore is right, capitalism has failed and we need a new democracy that addresses the concerns of the restless many, not just those of the privileged few.

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