19/11/2009 Author: Zaki Abushal

Is the redemptions wave over?

Hedge funds' performance turnaround this year has seen 2008's talk of mass investor redemptions turn into muted whispers as inflows begin to return to the industry, but, with many funds still holding gated assets, some believe the sector could still be in for an investor backlash.

A stoic warning was issued this month, but it is unlikely that many people heard it. In a well-attended conference in Connecticut, on a panel with hedge fund and fund of hedge funds (FoHFs) managers, one comment stood out: “Redemptions aren’t over and managers are about to get a nasty shock,” according to one long-time hedge fund manager who had just set up a new fund. Could this warning really ring true?

Most likely not, the industry is at its most ebullient, predicting a bumper year in terms of performance if not inflows. It has dealt with the twin issues of transparency and liquidity and looks set for a strong, and arguably much-needed, hit of subscriptions at the beginning of 2010.

In fact, aren’t we about six months late with this tale? Apparently the story of redemptions was all told in June, if not earlier, according to the majority of managers, or maybe that’s what everybody wanted to think. It’s easy to forget that redemptions are not just about the amount of money that will leave the industry on any given day as a result of dramatic drops in performance or fraud cases that force investors to flee for the exits. Just as significant is the money that managers prevent from leaving, through the likes of gates, suspended redemptions and side pockets.

“All the restructuring has finished, people aren’t talking about redemptions at the moment,” according to Ron Geffner, lawyer at Sadis Goldberg, who finds most of his time taken up by regulatory issues and not restructuring.

Clearly the eye isn’t on the redemption ball at the moment. The consensus on redemptions has long been that they’re over. Quarter by quarter, more positive numbers on inflows posted by hedge fund monitoring agencies arrives through the door, and as hedge funds rattle off month after month of positive performance, few in the industry doubt that the crisis is over.

Hedge funds have just registered their first down month in seven, but nobody expects a 0.5% -1.5% drop in October to instigate the kind of rush for the door experienced by the industry earlier in the year. And anyway, the S&P 500 was off 2% in October and the FTSE 100 close to that. “I actually think this sets things up nicely for hedge funds going forward, since you would expect to see large outperformance from hedge funds should the markets sell-off, particularly for those strategies with limited beta exposure,” said George Song who has just set up Aptima Capital, a Los Angeles-based FoHF.

But what of the amount of capital still tied up in gates and sidepockets and suspended redemptions? Last week, Ernst & Young, in conjunction with Greenwich Associates published the findings from a study covering the managers of over $680bn in hedge fund assets. In among the positive talk on structural changes within hedge funds was a veiled warning to managers. According to the survey, 56% of the 31% of those managers surveyed who restricted redemptions in some way said lowering gates and suspending redemptions will, in the long run, prove healthy for the industry.

Respondents believe, perhaps naively, that limiting redemptions, imposing gates or suspensions and the like, will have limited impact in the long run,” according to the report.

Credit Suisse Tremont has been closely monitoring the strength of the industry since the crisis, in particular the withdrawal of restrictions on redemptions. Its most recent report on the state of the industry identifies a gradual reduction in the ‘impaired’ funds as it calls them, those funds that have pulled down gates and introduced side pockets to handle illiquid parts of the portfolio. To date, according to Credit Suisse Tremont, there are still 8.6% of all hedge funds impaired in some way. That means almost $120bn of investor capital tied up. According to the research, 6.7% is suspended redemptions, that’s $87bn gated without any immediate prospect of repayment. The numbers of total impaired funds are down from an estimated 11.6% at the end of 2008 and an estimated 9.6% at the end of Q2 2009, but the rate of change is slowing.

The number of impaired funds may be coming down, but many hedge funds are still working hard to solve ongoing redemption concerns. HFMWeek (issue 164, 29 October) recently reported that HBK had only just concluded its restructuring programme, a protracted two-year affair during which the fund had imposed severe restrictions on capital withdrawals – even so, HBK still suffered more than $10bn in redemptions from its height in 2007, despite the fact that in 2007 HBK had put up a 10% quarterly gate, according to an investor. Almost two thirds of investors – $3.7bn in assets under management – decided to stay with the firm, the rest – $2.1bn – chose the liquidation option.

At least most funds are showing signs of acting in investors’ best interests. However, when most hedge funds are considering the most efficient method to return investor capital, Cerberus, the private equity/hedge fund house, made the decision in September to pull down gates at two more of its hedge funds, a decision taken to safeguard the funds’ remaining assets. Cerberus had made some bad bets on both GMAC and Chrysler and investors weren’t happy, they voted by pulling capital back in July. According to reports, $4.7bn of $7.7bn was pulled, 19% of Cerberus's total AuM. Cerberus responded by introducing three-year lock-ups.    

By and large, the trend is working in the opposite direction. Ken Kinsey-Quick, head of multi manager funds at Thames River, has been pleasantly surprised with the speed that gates have been lifted. “Overall, as liquidity has returned to financial markets, side pockets and gates and have been coming off far quicker than expected and long may it continue!” he says. But Kinsey-Quick remains reticent on the future prospects of those managers who did impose restrictions: “I will not as a general rule [invest in a manger that pulled down gates] although there are always exceptions to any rule but it most certainly is not a positive long-term policy for the industry,” he says.

As for the claim that the industry is in for a shock when a big wave of redemptions hit, most aren’t convinced, “There isn’t another big wave of redemptions out there I don’t think, and we have our ears pretty close to the ground,” says Kinsey-Quick. “Also, year-to-date hedge fund performance has been pretty good and if markets trade sideways for a while and hedge funds continue to perform, I think flows will quicken back into the industry,” he says.
Maybe there is not a big wave of redemptions on the horizon, brought on by a pull-back in markets, but it is highly unlikely the $120bn of impaired’ assets will stay where it is when gates are lifted.