Each year, as part of its sponsorship of the GAIM Cayman conference, Walkers invites one of its industry leading clients to attend as a keynote speaker and share their unique insights with delegates. In recent years, conference attendees have enjoyed presentations from renowned hedge fund manager George Hall, founder and president of The Clinton Group and Wall Street media commentator Charles Payne. The Journal reports; second in a two-part series.
After the surreal events of last September, with the bankruptcy of Lehman Brothers and mistakes made by the Fed and the Treasury, both Goldman Sachs and Morgan Stanley could have quite easily folded as well, Virginia Parker said, with unimaginable losses.
Counterparty risk became a huge issue, certainly complicating the firm’s launch of a fund of managed accounts dependent on swaps. Funds, meanwhile, were busy changing their prime brokers and examining their ISDA exposure and CDS protection and whether this went through Lehman. All the while, investment markets were volatile and money markets were frozen.
Frauds could no longer support the house of cards and honest funds could not meet liquidity requirements,” Parker said. “The use of gates and side-pockets became ubiquitous. Some funds acted honourably to achieve a fair situation for investors but others did not.”
Regrettably, particularly for the investors, many funds of funds were exposed to Madoff or other frauds and Parker said the fast money reputation of European banks held true. Investors meanwhile were taking the view that due diligence levels from the fund of funds industry was inadequate. “Investors today are looking for managed accounts with transparency,” Parker said. “But managed accounts are operationally demanding and expensive to run and maintain.”
Going forward, with the traditional hedge fund model broken, Parker said the balance has shifted between funds and investors with investors now in a strong position. “Almost all hedge funds are seeking capital which presents some great opportunities and the chance to negotiate with managers,” she said. “For investors with capital, this is a very good time to improve fees and ensure documents are fair to investors. Managers, meanwhile, are willing to accept lower management fees where they have money locked up over a longer term.”
For counterparty risk, a trend towards asset protection from hedge funds is expected, with multiple prime brokers employed and independent custodians. On the operational due diligence side, it is important that these staff understand hedge funds. “Due diligence must be more continual during periods of market stress,” Parker said. “Each fund of fund investing in Madoff will have made exceptions from their own rules.”
Drawing all these threads together, Parker concluded that hedge fund investing has always been complicated and now is even more so. “Investors are seeking hedge funds and funds of funds that view investors as partners,” she said, “with protection for assets, fees aligned with investor interests and fund documents that are more specific about how gates and side pockets operate.
“The hedge fund industry may have decreased in size but it is here to stay and I think flows could start again in the third quarter. Performing due diligence on a global scale is difficult and demanding for funds of funds. It is important to have leadership in the industry, so that weak spots can be identified and we can work together to build a better hedge fund industry.”
“Mrs. Parker’s speech serves as a reminder that we need to remain vigilant in the area of operational due diligence,” commented Ingrid Pierce, partner with Walkers and head of the firm’s hedge funds practice in Cayman. “Each fund, manager and service provider has a role to play and with increased and disciplined oversight, we can at least reduce the risk of missing red flags and move towards the restoration of investor confidence in this aspect of the hedge fund industry.”