Opportunity or meltdown?

Investment fund turmoil is not just top reading fodder for financial services publications, it’s of worldwide interest with the collapse of Madoff’s US$50 billion Ponzi scheme splattered across newspaper headlines everywhere. Campbells’ annual Cayman Fund Focus has therefore never been a more timely session on analysing the latest developments within the industry. Business Editor, Lindsey Turnbull reports.

Now in its seventh year, the Cayman Funds Focus produced by attorneys Campbells and to be held on Friday 13 February (hopefully a lucky day for the markets) at The Ritz-Carlton, Grand Cayman, will be focusing firmly on the recent turmoil within the markets and the likely outcome of this turmoil on Cayman’s own funds industry.
Alistair Walters, Managing Partner with Campbells and chairman of the conference outlines specific areas of interest to be discussed: “There is a wealth of different issues that can arise from market losses resulting from the credit crisis and from fraud. Obviously the credit crisis has caused some cases of fraud to be uncovered because pressure from redeeming investors has caused “ponzi” type schemes to fail. This will no doubt lead to discussions on better due diligence by investors and the issue of independent administrators.”

Independence of key service providers is a hotly discussed issue within the industry right now. Indeed, a recent Financial Times report said that Swiss private bank Union Bancaire Privee, one of the world’s largest investors in hedge funds, may pull client money out of hedge funds unless they hire independent administrators. According to the report, investors have blamed the absence of independent administrators as a key factor in Bernard Madoff’s success in setting up an alleged fraudulent Ponzi or pyramid scheme. UBP invested client money with some of the largest names in the hedge fund industry, including Cerberus, Citadel, DE Shaw and SAC Capital, the FT said, and the bank apparently had a $700 million exposure to the Madoff fund.
To this end, Campbells have assembled a panel of experts – Kelli Moll, from US attorneys Schulte Roth & Zabel, Dermot Butler from Custom House Group, Gary Linford from DTMC Group, Keith Miller from Paul Hastings, Janofsky & Walker, Matthew Morris from Lovells LLP and Boris Onefater from Constellation Investment Consulting Group – to discuss the extent to which recent turmoil in the financial markets has affected the structure and strategies of new and existing funds. They will discuss how the relationships between funds, prime brokers, custodians, auditors, directors and administrators have changed and ultimately whether funds are making money or facing total meltdown.

Onefater says, “Undeniably 2008 was a very difficult year for the hedge fund industry. In the 1920s and 1930s – the last time the market meltdown of this magnitude was upon the world – the hedge fund industry was not even in existence. Clearly the current industry participants have no living memory of the Great Depression or a financial meltdown.”

He continues, “When Alistair Walters was planning this year’s conference during the summer most of us expected a difficult year, but a very few of us, if any, were prepared to deal with the consolidation and bankruptcies of giant financial institutions like Lehman Brothers, Merrill Lynch, Bear Stearns, and now Smith Barney being sold to Morgan Stanley. The most startling aspect of the meltdown was the speed at which it all unraveled. The Great Deleveraging of 2008, unprecedented level of redemptions, lack of liquidity, lack of financing, fund closures, and to top it all of–the greatest ponzi scheme in history that Bernie Madoff gave the industry as a Holiday gift. Given the year, that was one gift we could have all done without.”

Onefater says that given the challenges industry faces, attendees at the Cayman Fund Focus will have the opportunity to examine all these issues and many more.

He furthers, “The panels of experts will not only focus on the issues of the last year, but discuss lessons learned and what impact these changes will have on the industry as a whole. Panelists will discuss new and improved fund structures that may look like a hybrid between a private equity and a hedge fund for more illiquid funds, as well as examining the Brave New World where financing is difficult to obtain and multiple primes are in use. Akin to this issue is the fund’s ability to retain the capital necessary while navigating through redemptions, gates, and suspensions. The one key issue that will be the area of valuation-this has been top of mind for every fund. We will explore the current guidance and ways to deal with valuation and discuss best practices in the area where directors and administrators are front and centre.”

According to Onefater, administrators have a unique set of challenges in this difficult environment and says it is no secret that administrators’ margins are between 20 and 30 per cent.
“With the equity market down over 30 per cent, multiple fund closures and few new launches, do the administrators have the right operating model and revenue model to survive?” he wonders. “We are also going to discuss how outsourcing to an administrator may be the norm as more investors are insisting on independence and a segregation of duties.”

The role of directors will forever change as well, says Onefater. Actively participating in client activities is another trend that is long overdue. Gary Linford will provide the conference with the director’s perspective as he shares his experiences with some of the world’s most complex funds.

He confirms they will also be discussing hedge fund litigation, liquidations and investigations. “This is one event you would not want to miss,” he says.

Walters confirms discussions will focus on the importance of having independent administrators and the need for greater oversight by independent directors and stronger boards i.e. a better balance between investment managers/their nominees and independent directors. Better transparency with relationships with prime brokers – e.g. how are assets held, are they lent on etc – will also be examined, following on from problems with Lehman Bros and the inability to recover assets held.

The regulatory response to all these issues will be discussed by a panel comprised of Keith Miller, Yolanda Banks McCoy, Head of the Investment Division at the Cayman Islands Monetary Authority, Boris Onefater and moderated by Walters. This session will include a look at CIMA’s interaction with management of distressed funds and the steps directors need to consider taking to protect the fund, investors and assets when a regulatory investigation develops in the US. It will also examine the response of industry participants to the risk of greater regulation.

Walters says that all these issues raise again the question of how best to ensure more transparency, less conflicts of interest and better oversight within funds and as between funds. Whether this can be achieved though increasing regulation is debatable.

Looking forward, he says, funds are likely to want to increase their ability to lock investors in for longer periods to ensure better prospects of earning performance fees and to avoid redemption problems. He ponders whether investors would be content with that, especially fund of funds investors?

With the busy conference schedule at the start of the year, the feedback from the local industry is for conferences to be better spread throughout the year.
With that in mind, and with the departure of MARHedge Cayman Islands conference, organisers have decided to postpone the 2009 conference which was scheduled for 13 February to 9 October 2009.