Thursday, 23 December 2010

The Top Ten Hedge Fund Stories of 2010

The hedge fund industry is still dominated by America in terms of where the majority of assets are directed and invested. So I have given due weighting to U.S. focused stories in the top ten for the year – they are the first five stories, published by trade press in the States. My own viewpoint and concerns put global and regional stories into the top ten for the year – they are the second five stories here.

Expert Network Insider Trading

Hedge funds' use of so-called expert networks was called into question in late November when more than a dozen money managers were issued subpoenas for information related to a vast government investigation of insider trading.

Among those asked for information—but not accused of wrongdoing—were SAC Capital Advisors, Diamondback Capital Management, Level Global Investors and Loch Capital Management. All stressed they were subjects, not targets of the investigation (the latter, which means the government is likely to bring charges, would likely cause massive redemptions). Loch, which did not respond to a request for comment, is laying off most of its staff by year end, according to Hedge Fund Alert. Firms like Loch and Balyasny Asset Management, which was also subpoenaed, suspended their use of third party research firms as a result.

Drunkenmiller Quits but Team Lives On"I have had to recognize that competing in the markets over such a long time frame imposes heavy personal costs," Druckenmiller wrote in a one-page letter announcing his plans to retire and close the firm, also citing the challenges of running a large fund.
Duquesne was reportedly down 5% at the time, which would have been the fund's first losing year in 30 if it did not snap back by year end, having returned an average 30% annually since 1986. As of November, fund returns had indeed turned positive, according to Bloomberg.

A group of former Duquesne Capital Management managers prepared to start a new global macro fund, Point State Capital, which will oversee roughly $5 billion, one of the largest launches ever, Bloomberg reported in November. The funds come entirely from Druckenmiller ($1 billion) and former Duquesne investors. In addition Wojtek Uzdelewicz, a Duquesne managing director who ran a roughly $500 million technology focused fund at the firm, plans to launch a fund, Espalier Global Management in New York City.

The Goldman-Paulson CDO Scandal

Goldman settled with the SEC in July for $550 million, the largest ever penalty from Wall Street. John Paulson, for his part, was never dragged into the legal mess despite initial concerns that led him to let investors know that he was prepared for a possible legal battle and would personally cover any legal fees.

One of those key facts, the SEC said, was failing to disclose the role that Paulson & Co. played in the portfolio selection process and the fact that the hedge fund had taken a short position against the product (Paulson made about $1 billion on the bet).

In April, the Securities and Exchange Commission charged Goldman Sachs with defrauding investors by "misstating and omitting key facts about a financial product tied to subprime mortgages as the U.S. housing market was beginning to falter."

FrontPoint's Annus Horribilis

FrontPoint Partners, the once highly successful hedge fund firm, had a difficult year.

In October, FrontPoint announced it was spinning out from Morgan Stanley, which had acquired the firm in 2006 when it managed $5.5 billion but was concerned about new hedge fund investment restrictions under the Dodd-Frank Act. But as FrontPoint restructured, an insider trading scandal hit its healthcare hedge fund, causing the suspension of portfolio manager Chip Skowron and the liquidation of the fund.

FrontPoint faced large redemptions—reportedly as much as $3 billion of $7.5 billion, according to the Wall Street Journal—from skittish investors as the insider trading probe spread to more than a dozen hedge funds and put unwanted attention on the use of expert information networks.

Buffett's Hedgie Successor

Until late October, Todd Combs was a successful but largely unknown manager of a small Greenwich, Connecticut hedge fund. But Combs was thrust into the spotlight with the announcement that Warren Buffett has chosen him to manage a large chunk of Berkshire Hathaway's roughly $100 billion investment portfolio, one of the most high-profile money management positions in the world.

Combs, 39, ran Castle Point Capital Management, a financials-focused long/short equity fund launched in November 2005 that managed $405 million as of September. The fund was down 3.93% through September, with a net annualized performance since inception of 5.93%, unspectacular performance compared with its peers.

Hedge Fund UCITS Mushroom

Whilst service providers and some of the managers were over-excited about the prospects of UCITS versions of hedge funds last year, in 2010 there have been some strong growth trends. There are now around 350 UCITS hedge funds, most of which have mildly amended mandates of the mother (offshore) fund. There have been some UCITS only fund launches, but not many.

Early evidence is that UCITS provide a solution to the major drawback of hedge funds that was revealed in the Credit Crunch – the ability to deal in the funds at will. 76% of UCITS hedge funds offer daily liquidity, 21% offer weekly liquidity. The buyers of UCITS hedge funds are client types that put a premium on this positive feature – HNWIs that were much aggrieved at being locked into offshore hedge funds and are buying through wealth management networks; and insurance companies that have problems of admissability of assets when putting capital into offshore funds. UCITS hedge funds manage €27bn of capital.

JP Morgan takes a BRIC Hedge Fund Bias

JP Morgan's 2004 partial takeover of Highbridge Capital for $1.3bn was the deal which said that institutional flows into hedge funds were believed to be for real and for some time. Eventually Morgan bought all of Highbridge. In October this year JPMorgan Chase & Co. agreed to acquire a majority stake in Brazil's Gavea Investimentos Ltda., the fund manager founded by former Brazilian central banker Arminio Fraga.

Gávea Investimentos has $5.1bn AUM invested in hedge funds and illiquid investments, and has a staff of 103 people. The hedge fund industry in Brazil is dominated by bank-run domestic retail flows, but JP Morgan likes the international appeal of Brazilian hedge funds. There are many international investors who use Brazil as a proxy for the best of the BRICs – high employment and industrial production growth, an appreciating currency, a relatively sound fiscal position and a commodity play to boot.

One of the lessons of the post-Crunch period has been that the appeal of emerging markets to investors in developed markets has recovered as well as the prices of iron ore and coffee. Has the JP Morgan deal for Gavea confirmed that emerging market flows are for real and for some time?

Renaissance is Back

In 2006-7 there was a feeling abroad that Renaissance Technologies was going to eat the lunch of a lot of hedge funds by soaking up the flows into the industry as it looked to take in as much as $100bn into the Renaissance Institutional Equities Fund (RIEF). However the large capital inflows turned into outflows when RIEF was down 16% in 2008 and down 7% in 2009. The Renaissance Institutional Futures Fund (RIFF) fared no better in 2008 - it was down 12% when most CTAs were up on the year. The reverse happened last year – RIFF was up 5% and most CTAs were down. Overall firm assets were down 25% last year, and to cap it all founder James Simons retired as CEO at the end of 2009.

After successor co-CEOs Peter Brown and Robert Mercer considered closing the two institutional products, it as well they didn't. This year RIEF International - Series B is up 17.00% YTD, and the Renaissance Institutional Futures Fund is up 17.14%. The latter fund did well enough on a 12-month risk adjusted return basis to win the Best Managed Futures Fund at the AR Awards in November. Renaissance is back.

The Eurocrats Take a Grip

In America the intense interest of politicians, regulators and the media was such that Anthony Scaramucci, founder of fund of funds Skybridge Capital, said "We have felt like a piñata - We certainly felt like we've been whacked with a stick." But it is the European end of the industry that will suffer more from actual interference.

The politicians and Eurocrats have wilfully failed to understand the significance of their proposals, despite lobbying and submissions from the industry. The hedge fund industry gives employment, tax revenues and invisible export earnings – in return the industry got proposals treating all management companies as publicly quoted, regulations on how private companies should pay their employees, damaging increased disclosure of short positions, and little-island-thinking that would have created a fence around the European hedge fund industry. On top of that the UK, home to most of the European industry, increased tax rates to an extent that it has pushed some hedge fund companies and leaders into other tax jurisdictions. The country, continent and industry are not the lands of opportunity they were.

Recovery by Madoff Receiver

The story which has come back with new developments through the year is the efforts of receiver in the case of the Madoff ponzi scheme, Irving Picard, to recover cash from the 2,000 or so net beneficiaries of the scheme. These are the investors who withdrew more money than they invested with the fraudster, and around a thousand of them have been in the sights of the receiver.

The list of banks, intermediaries, investors, friends of Madoff and counterparties to receive suits form Picard is long. Some have been obvious targets, like the 34 affiliates with ties to Madoff feeder fund Fairfield Greenwich Group. But he has been very thorough and looked through to where the "profits" have been deployed. For example, in July the court-appointed trustee took aim at three Madoff family entities, a family fund, an oil and gas properties business and a trading business, seeking $30 million that the family had invested in them.

As the deadline approached for the receiver – he had until the 11th December, the two-year-anniversary of Madoff's arrest, to file the suits – activity accelerated. Picard reached a $625m settlement with Boston billionaire and philanthropist Carl Shapiro this month, and on the last day for possible filings, the receiver filed a suit against Austrian banker Sonja Kohn and dozens of firms linked to her for $19.6 billion—all of the principal he estimates was lost by Madoff's investors and more than twice as much as he has sought in any of the thousands of other lawsuits he has filed since Madoff's arrest two years ago. The single biggest settlement to date was $7.2 billion from the estate of Madoff investor Jeffry Picower.


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