Fund managers apologise - and ask for more money

New York

IT HAS been a bruising year for hedge funds. Not even billionaire managers with sterling records were able to escape heavy losses, and several among them have made the industry's list of worst performers. Some lost so much of their investors' money this year that they have written apology letters.

Yet even in this most humbling of years, some of these same hedge funds are soliciting investors for more money and marketing new funds that promise bigger and better opportunities.

Take John Paulson, who made billions of dollars betting against the housing bubble in 2008 but is nursing double-digit losses in two of his three funds this year. He is now raising money for two new funds: a private equity fund and a one focused on healthcare stocks.

This autumn, Larry Robbins, the founder of Glenview Capital Management, apologised to his investors in a letter after losing 20 per cent till October. In the same letter, he offered them the opportunity to invest in a new fund. To sweeten the offer, Mr Robbins promised that the new limited-time portfolio would not charge any fees.

To go to battered investors with a new moneymaking spiel takes a certain self-confidence that seems second nature to billionaires. Some might even call it chutzpah. Mr Robbins appeared to acknowledge as much in his letter to investors. "Unfortunately, the opportunity feels like a punch in the face," he wrote.

The recent fundraising, however, underscores a bigger trend in the industry: Pension funds still want to invest in hedge funds, even as they complain about high fees and years of disappointing performance.

And that has been the case even as some prominent funds shut down and talk grows about the diminishing lustre of hedge funds as an asset class. Investors are, and will continue to be, eager for higher returns in a world of near-zero interest rates even as the Federal Reserve prepares to raise rates for the first time in nearly a decade.

The number of new hedge fund startups is outpacing fund closures this year, despite mounting fear in recent days about the viability of firms that are heavily invested in junk bonds. To date, 656 hedge funds have opened for business, while 599 have shuttered their operations, according to Preqin, a firm that tracks hedge fund and private equity trends. The number of hedge fund closures this year is running well below last year's 731.

That is not to say that the industry has not been hard hit. Based on Preqin estimates, around US$24 billion of hedge fund assets have been liquidated this year. The total that hedge fund managers have available to invest in stocks, bonds, currencies and commodities has also shrunk by the most since the depths of the financial crisis in 2008 as investors asked to pull their money out of some hedge funds and firms returned money, according to data from HFR.

The average hedge fund has gained just 0.3 per cent this year, according to HFR's weighted composite index. That is enough to outpace the 0.75 per cent decline this year in the Standard & Poor's 500 index.

On that score, however, 2015 has been the exception. The broad hedge fund index has underperformed the stock market in America the previous six years. Those years of mediocre returns persuaded some investors, including big pension funds and smaller institutional investors, to pull money from underperforming firms.

Most notably, the California Public Employees' Retirement System (Calpers), the biggest state pension fund in the country, announced last year that it would liquidate its US$4 billion in hedge fund investments.

Yet only a few other public pensions have followed Calpers' lead. Instead, investors have tended to punish underperforming funds by pulling dollars from those portfolios and redeploying them elsewhere - sometimes even to other portfolios managed by the same manager.

This summer, two of the world's biggest banks - Bank of America and UBS - recommended that their private wealth units' clients pull money out of Mr Paulson's Advantage fund. Money raised from the clients of Wall Street banks was a big source of the growth in the assets of the Advantage fund, which had been Mr Paulson's largest portfolio for outside investors.

Today, that fund is down 11 per cent for the year and manages less than US$2 billion in assets. Advantage has been supplanted by another fund that makes bets on mergers and acquisitions; it now manages more than US$9 billion in assets and has taken in some of the investor money once directed to the Advantage portfolio.

Mr Paulson's merger and acquisition fund, however, is also underperforming. The merger arbitration fund was down about 4.4 per cent as at the end of November, said people briefed on the performance numbers.

"The Calpers decision is a bit of an anomaly in the space," said Todd Petzel, chief investment officer at the private wealth management firm Offit Capital, who added that most consulting firms employed by large institutional investors continue to recommend allocating money to hedge funds.

In light of that perspective, he said: "The question then becomes: What do you do with a hedge fund that disappoints over a long period of time? You substitute out."

James Dinan of York Capital, in raising new money, chose to focus on a fund that mainly invests in distressed securities in Europe, a region that has been a bright spot for York Capital. While the firm's flagship fund is down 12 per cent so far this year, its York Capital Europe fund has gained 4.5 per cent.

Boaz Weinstein, a hedge fund manager who began his career at Deutsche Bank making billions trading complex securities before the financial crisis only to lose a bundle in 2008, has been marketing a new fund that will invest in a portfolio of closed-end junk bond funds at a time when many high-yield funds are liquidating or being flooded with investor redemptions.

An October marketing document for the fund notes that "some investors are concerned about exposure to the high-yield asset class, given it is late in the credit cycle". In many ways, Mr Weinstein has been having a good year after three consecutive years of losses. His firm, Saba Capital, has made 6 per cent for investors as at the end of November, according to a person briefed on the firm's performance.

Nonetheless, he is being sued by the Public Sector Pension Investment Board of Canada, once his biggest investor. He was accused of deceptive accounting when the pension fund asked for its money back. Mr Weinstein has denied the allegations and said that he was "shocked" by the lawsuit.

In writing to Glenview investors, Mr Robbins said: "I've failed to protect your capital." Since then, he has recovered some losses but is still down 15.8 per cent this year, dragged down by a bigger rout across healthcare stocks. Still, he has offered investors a chance to put fresh money into a side vehicle that will focus on healthcare stocks on the condition that money does not come from his poorly performing fund. He has raised US$1.5 million in so-called committed capital for that fund, according to a public filing.

Mark Yusko, chief investment officer of Morgan Creek Capital, said that the decision to give new money to a manager who has subpar performance in a given year ultimately comes down to a matter of faith. "What you have to decide as an investor is: Do you believe that the skill level of the managers has changed?" Mr Yusko said. "If you don't, then the portfolio theory of investing says that's when you should be adding capital." NYT