“There is nothing riskier than the widespread perception that there is no risk.” – Howard Marks
Q1 2017 Letters
Hedge fund branding drives asset flows
Since the market correction of 2008, a vast majority of hedge fund net asset flows have gone to a small minority of hedge funds with the strongest brands. A recent report from Hedge Fund Research shows that approximately 69% of hedge fund assets are controlled by firms with over USD5 billion in assets under management and 91% are controlled by firms with over USD1 billion in assets. This is a significant increase from the 2009 percentages of 61% and 86% respectively.
Don Steinbrugge of Agecroft Partners writes that each year many hedge fund investors are inundated with thousands of emails and phone calls from managers requesting a meeting. To filter through the overload of information, investors are turning more and more to a firm's brand when choosing which funds to meet and ultimately invest with. However, having a strong brand is not limited to just the largest managers. For example, many investors will allocate to start-up firms that spun-out of other high profile organizations, despite the fact they have no audited track record. In reality, a strong brand is even more important for hedge funds with less than USD250 mil-lion in AUM. Despite the fact that these managers represent a vast majority of the approximately 15,000 hedge funds, they only represent 2.94% of assets.
A brand is an investor's perception of the overall quality of a hedge fund based on multiple evaluation factors that evolve over time. A high-quality brand takes a long time to develop, but once achieved, it significantly enhances a firm's ability to raise capital and retain assets during a drawdown in performance. Over time, Steinbrugge believes the trend concentrating a higher percentage of assets in the largest managers will reverse. He expects this to happen due to increased sophistication of institutional investors, poor recent perfor-mance of many of the largest, well known hedge funds, the pressure institutional investors are receiving to enhance returns, and the belief that smaller, more nimble managers have an advantage in a performance environment increasingly dependent on security selec-tion. This is especially true for small managers operating in less efficient markets or capacity constrained strategies. For the small number of new hedge fund launches that are successful each year, their high-quality brand was typically created at their previous firm. This may include having held a senior position at another top-quality brand hedge fund, having spun out of a top investment bank proprietary trad-ing desk, or having been seeded by a well-known investor. For the hedge funds not fortunate enough to launch with such fanfare, the key question is, what are the firms that have developed the strongest brands doing differently? There are three critical issues to consider in creating a strong brand and raising assets in today's competitive environment: the quality of the fund offering, the investor's perception of the quality of the fund offering, and the marketing and sales strategy.
Ex-hedge fund chief on suing the government: "I don't think they want the truth to come out"
David Ganek's lawsuit against federal authorities alleging improper conduct that led to the shuttering of his $4 billion New York hedge fund is inching closer to a long-sought conclusion. After Ganek and his legal team prevailed against a motion to dismiss, the government appealed. "Two years ago ... most people would've said we had very little chance of surviving what was ultimately their filing of a motion to dismiss it," the Level Global Investors founder told CNBC.
In February 2015, Ganek filed a complaint in US District Court for the Southern District Court of New York against US Attorney Preet Bha-rara — often referred to as the "sheriff of Wall Street" — and federal authorities involved in an FBI raid of Level Global in November 2010 and the related investigation. Shortly after the raid, massive investor redemptions forced the closure of Level Global. Ganek, who was ultimately never charged, wants to clear his name. With celebrity attorney Barry Scheck and former federal Judge Nancy Gertner in his corner, Ganek argues in the case that the affidavit in support of putting Ganek on the search warrant contained "false statements" that Ganek knew about alleged insider trading at his firm. The complaint accuses Bharara and the other defendants of violating Ganek's con-stitutional right not to be deprived of property or reputation. "I don't think they want the truth to come out," Ganek told CNBC. "And I think they are ... taking the legal limits to suppress the truth."
"If that office can be exposed for what I believe are serious problems and ethical issues, I think that actually has an ultimately powerful effect on the whole system," he said. But in such a fight, Ganek said, "You need resources, you need facts and you need will." In Novem-ber 2010, in addition to Level Global, Diamondback Capital Management of Stamford, Connecticut and Loch Capital Management of Bos-ton were also raided. "On that day, the government raided three businesses [that] in aggregate had $10 billion of institutional assets under management. All three of the businesses were ultimately shuttered, and the requiem to that is there were zero convictions," after an appeals court in 2014 overturned the convictions of a Level Global partner and a Diamondback trader, Ganek said. No charges were ever filed against Loch or any of its employees.
Hedge fund genius fails to cut prison sentence after "throwing stolen data in the Yangtze river"
A Sanderstead hedge fund investment "genius" who stole highly valuable algorithms from his employers and then took them to Hong Kong in a bid to get another job has been told he cannot complain about his sentence. Ke Xu, of Westfield Avenue, decoded confidential algorithms that belonged to Trenchant, which operates the hedge fund G-Research, where he worked as a qualitative analyst. The algo-rithms, which he helped to develop, can predict changes in the stock market and are used for automated trading on financial markets. The 33-year-old Chinese national then tendered his "abrupt and secretive" resignation and flew to Hong Kong on a one-way ticket in Au-gust 2014 to try and make money from the stolen algorithms by using them to land a contract with another firm. But he was arrested in the former British colony, extradited and jailed for four years in September 2015 by Judge David Tomlinson at Southwark Crown Court after he admitted fraud by abuse of position.
The court heard how Xu felt he was not being paid well enough by Trenchant. Despite taking home a £400,000 bonus on top of his £85,000 salary, he felt he should have been paid £1 million. Judge Tomlinson told him: "Most of the people who appear in front of me could only dream of the sort of bonuses from which you would have continued to benefit for many years to come but which, from some of the evidence I have seen, you felt were inadequate." He was also made subject to a serious crime prevention order - which was de-signed to force him to hand over any copies of the stolen algorithms and reveal anyone else he might have told about them. On good behavior, he would have been released from prison by now, but in January he was given an extra 18-month sentence for breaching that order after a private prosecution by Trenchant. He denied any wrongdoing and claimed all of the electronic devices he had the confiden-tial information stored on had been lost or destroyed - with some thrown in the Yangtze river in China.
However, he was found guilty of two breaches of the order, on the basis he had confided in family members and failed to disclose the locations of copies he had made. He challenged his sentence at the High Court with his lawyers arguing the order should never have been made and that 18 months was too long for the breaches. But his case was dismissed by three of the country's most senior judges, who said that Xu had consented to the order being made and there was no suggestion he didn't understand what he was agreeing to. Sir Brian Leveson, sitting with Mr. Justice Jay and Mr. Justice Garnham, added: "In all the circumstances, this case is simply not one where it is appropriate for this court, by way of appeal or review, to revisit the circumstances which were investigated before the trial judge in the original prosecution."
Xu graduated from Cambridge University with a first in mathematics and worked for Goldman Sachs for six years before moving to Trenchant. He developed systems which allowed computers to trade shares without the need for human input, using publicly available information to predict share prices. They were protected with card passes, biometric entry systems and CCTV, while all employees were made to keep their work in secure notebooks which they were prohibited from taking out of the building. Before leaving he accessed programs developed by colleagues and was captured on CCTV leaving his office with his secure notebook and work laptop in a suitcase. His swift departure alerted Trenchant and the business sought an order to stop him using the information he made off with. He claimed that he wanted to be with his wife who worked there and his father who was very ill. He was arrested in Hong Kong on August 14, 2014 and extradited back to the UK that December. When Xu was sentenced, Richard Wormald, defending, told the court: "It is quite a fall from getting a first at Cambridge to sitting here in the dock."
Paul Singer's son screws up, hits "Send" on email to merger target
Gordon Singer, who works out of the London office of his billionaire father's activist hedge fund Elliott Management, mistakenly sent an email meant for friendly eyes only to a rep from Dutch paint conglomerate AkzoNobel — one of the hedge fund's targets. "We need to be ready to roll," the younger Singer wrote in a group email that accidentally copied Akzo's investor relations rep Lloyd Midwinter. Singer was referring to the hedge fund's attack plan after calling for a special meeting to oust the Dutch-based painting and specialty chemicals company's chairman, Antony Burgmans. Elliott wants Akzo to consider a $26.3 billion dollar takeover bid from Pittsburgh, PA-based PPG Industries and thinks Burgmans is blocking the deal.
In addition to outlining tactics for future dealings with Akzo, Gordon's email, first reported on by the Financial Times, also instructed an Elliott employee to alert PPG that the hedge fund had requested the special meeting. The Elliott employee responded that he had already made arrangements for a compliance officer to join him on a call with PPG "so there is no issue with getting cleansed to trade in the near future." The "cleansing" was a measure to ensure that Elliott and PPG weren't unintentionally sharing inside information about Akzo. Nevertheless, Akzo was concerned and alerted Dutch regulatory authorities about Elliott leaking "potentially price sensitive information" to PPG. Akzo also demanded, in a press release that Elliott disclose its communication history with PPG. "It would be preferable from PPG's perspective if AkzoNobel would speak with us rather than about us," PPG said in a statement. The Pittsburgh-based company added that "there are currently no agreements or arrangements, in whatever form, between PPG and Elliott Advisors."
Hedge fund closures hold nuggets for stock market investors
Hedge fund managers may be criticized for their recent returns but they have consistently displayed a razor sharp sense of timing when it comes to picking when to sell their own businesses. When Och-Ziff, the New York-based hedge fund founded by the former Goldman Sachs trader Daniel Och, decided to sell equity to the public markets it did so near the top of the market in late 2007. Investors in that pre-crisis deal, including Dubai International Capital which purchased a $1.25bn stake, have since lost more than 90% of their money excluding dividends. Three years later the then New York-listed GLG Partners sold itself to the UK's Man Group at a 55% premium to its market value for £1.1bn. Today, Man Group is worth about 40% less than when the deal was struck. Shares in the private equity compa-nies Blackstone and the Carlyle Group are also trading below the price where they were sold to the public.
So what is to be made of the timing of the news that Eric Mindich has decided to shut his $7bn Eton Park hedge fund and return money to investors from what he called a "position of relative strength"? The closure of Eton Park has a symbolic resonance on Wall Street. Once the youngest partner in the history of Goldman Sachs, Mr. Mindich left the bank in 2004 to set up Eton Park. It became one of the largest launches in the history of the hedge fund industry and, emboldened by his and others' success, a whole generation tried to follow him.
Much has already been written about how Eton Park's decision to call time is yet further evidence of how clients are no longer willing to pay hedge funds high fees in return for mediocre performance, and that as a result the industry is steadily declining. We also know that Eton Park lost about 9% last year and has not made double digit returns since 2013, when it generated 22% against the S&P 500's gain of 32%. Yet considering Mr. Mindich describes the closure as a decision he took, rather than an outcome forced upon him by clients pulling out their cash, the end of Eton Park may also be telling us where we are in the current market cycle. Why would a financially motivated individual who had spent his entire career working in markets choose this moment to relinquish what is effectively a free option poten-tially worth hundreds of millions of dollars in fees? Mr. Mindich is already a very wealthy man and may now lack the motivation to con-tinue to battle though market conditions he described as "unfavorable". Shutting down a $7bn hedge fund seems to be a strong signal that he believes his ability to make money for both himself and his investors will be limited over the coming years.
Equity valuations in the US mean bargains are scarce. Anyone buying shares today is locking in valuations that may only be justifiable over the medium term if you are confident there will be a sharp upturn in corporate earnings and the Trump administration will seam-lessly usher in a new era of economic expansion. Neither of these outcomes is anywhere close to being a certainty. Hedge fund managers ultimately earn their money by making well considered bets when the odds are in their favor. Professionally, this is done by identifying investment opportunities where the risk of losing money is considerably less than the chance of making it. Personally, this is by knowing that they will be entitled to a fifth of all profits should they make any, and can console themselves with a fixed management fee on their clients assets should they fail. In spite of all this, Mr. Mindich has decided to take his chips off the table. Considering the record of hedge fund managers when it comes to knowing when to cash out, the closure of Eton Park may well mark an ominous sign for an increasingly toppy-looking market.
The liquidity supernova continues
BofA Merrill Lynch (via Zero Hedge)
Central banks have bought $1tn in assets YTD
BofA Merrill Lynch (via Zero Hedge)
The investor anxiety that the market's "fear gauge" is missing
Article by Bruno J. Schneller, CAIA & Miranda Ademaj - Skenderbeg Alternative Investment
See the full PDF below.