May 17, 2016

Hedge Funds Want a Pony, Um, Permanent Capital, as More Investors Exit

The latest fantasy, even as funds are facing high levels of redemptions when super-low and negative rates ought to make them on of the places to be, is that they should get even better terms. Their pet ask is “permanent capital” as in really long lockups. Yes, and I would like to have a pony. When times are tough, vendors give concessions rather than increase their demands. There’s no indication that the fund managers who want to tie up investor money are prepared to give a big break commensurate with the loss of liquidity, like considerably lower fees.

The Financial Times story does point out that many funds now have monthly redemptions, which looks like a symptom that the fundraising environment has become more difficult than hedgies want to admit. In the early 2000s, only fledging funds offered monthly liquidity; quarterly was the norm, and some funds could limit redemptions to once a year. Monthly redemptions can be highly disruptive, since investors will be tempted to use the hedge fund as a source of liquidity independent of fund performance. Having investors sell (and put funds back) on short notice not only makes it hard to run an investment strategy (which assets do you sell?) but it can lead to cascading sales. If one investor sells enough, it may put another investor at over 10% of fund assets, which is prohibited by the investment policies of many institutional investors. So that investor will have to sell to get back down to 10%, which has the potential to trigger more partial exits.

However, there is a world of difference between getting away from disruptive monthly liquidations and “permanent capital.” George Soros, one of the fathers of the hedge fund industry, always ran his funds with the view that he could liquidate them readily if needed. Despite his successes, he’d never seemed to have forgotten his childhood experience of fleeing the Nazis. Being able (in theory) to shutter his business and take his winnings on short notice was important to his sense of security.

Yet we hear unsubstantiated claims that hedge funds are just about to become the place to be:

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