By Steve Taub
Illustration by Jonathan Bartlett
Centaurus Capital wasn’t the worst-performing hedge fund firm last year by a long shot. But the London firm’s event-driven fund—Centaurus Alpha—fell about 20%, leading to a mad dash for the exits by investors. With monthly liquidity for those giving three-months’ notice, Centaurus received redemption notices from about half its limited partners. Like a number of other funds in such a situation, Centaurus became, as one person close to the firm notes, “a bank account.”
But unlike others who continued to run their funds with fewer assets and a high-water mark to meet before earning fees again, Centaurus managers Bernard Oppetit and Randy Freeman decided to close up shop and start anew. Centaurus is one of a number of prominent hedge fund firms, including Ospraie Management, Polygon Investment Partners, Gandhara Advisors, Amber Capital and Tontine Capital, that have done the same. After closing down funds in the past year, they’ve either opened a new fund, or are planning to do so soon.
For Centaurus, the decision was a tough one. Late last year, the two founders, who started Centaurus in 2000 after leaving BNP Paribas, had a dilemma. Should they simply give the money to all of the investors who want to redeem? That would mean they’d have to sell everything they could, leaving those willing to stick with the fund with everything else. Or they could have thrown up a gate, like more than 100 other funds did. Oppetit and Freeman even proposed restructuring the fund, giving back 50% in cash and locking up the rest for a year, but investors were not in a position to lock in capital.
So, the two men took more drastic action. They closed Centaurus’s flagship fund, which was down from a high of $4 billion to just $1 billion. And by March, they were back in the market launching a new vehicle, called Centaurus International Risk Arbitrage Fund (dubbed CIRAF), which as the name suggests invests in risk arbitrage, one of the strategies of the old fund. By mid-October, CIRAF—which permits redemptions after 30 days’ notice—was up about 19% for the year and had amassed roughly $400 million. That would make it one of the biggest new European funds this year.
Centaurus’s success is partly due to the fact that roughly 80% to 90% of the new fund’s investors had previously been in the old one. How did Centaurus lure them back? One draw for former investors is that they don’t have to pay a performance fee for the first 18 months—about the amount of time it might have taken Centaurus to hit its high-water mark in the old fund. And there’s an added attraction: The new fund charges lower fees—a 1.5% management fee and 15% performance fee versus the prior fund’s standard 2% and 20%.
All of the firms that shut down and are trying to come back with new funds suffered huge losses in 2009. Their ability to raise money so soon suggests that investors have a short memory and are quick to forgive, especially if the manager acts in good faith when shutting the fund—and offers concessions for those willing to give them a second chance. Still it’s a tough fund-raising environment, and in each case, the amount these hedge fund firms have raised in their new funds pales in comparison to the amount of assets the terminated funds enjoyed at their peak.
These are not the first hedge fund managers to launch a new fund after closing down an earlier one. Several notable managers have done it in the past—with mixed success. In January 2004, Bill Ackman launched Pershing Square a little more than a year after closing down Gotham Partners. Though Pershing Square has lately suffered a setback with its Target investment, Pershing overall has definitely been a winner. Since inception, Pershing Square netted an annualized 22.5% through September.
More infamously, John Meriwether started a new fund a year after his first hedge fund, Long-Term Capital Management, collapsed in 1998. Meriwether’s second fund, Relative Value Opportunity II, reportedly lost some 44% from September 2007 through February 2009, and was shut down earlier this year. Unbelievably, Meriwether is now trying to launch his third fund.
The current crop of second acts are occurring in a unique environment. Last year was a banner year for hedge fund blowups, with more than 500 globally, according to HedgeFund Intelligence. At the same time, this year’s new fund launches have been paltry. In the U.S., new fund launches with $25 million or more under management garnered only $3.9 billion through mid-June, according to Absolute Return’s midyear new funds survey, well below the $19.5 billion amassed last year during the same period. A mere 21 new funds that met the $25 million threshold came on the scene, the lowest number for the first half of the year since Absolute Return began its new fund survey in 2004.
“This is a difficult time to get started,” says Judy Posnikoff, a founding partner and managing director at Pacific Alternative Asset Management Co., a leading fund of funds. “It’s a tough environment to raise money.”
Investors have been particularly skeptical about giving money to hedge fund managers who shut down last year. They say the ability of these managers to get a second chance will depend on such issues as their long-term track record, why they blew up in the first place, whether they violated their risk discipline or took on too much leverage, and the actions they took when investors tried to pull out money from the former fund. Starting anew with more investor-friendly terms seems to be a key to success as well.
“It definitely does not leave a good taste in your mouth to hear a manager abandoned ship and reopened with new high-water marks,” says Jeffrey Vale, director of research at Infinity Capital Group of Atlanta, which invests in hedge funds, referring to the most criticized aspect of the fund manager who closes shop and starts anew. If a manager chose instead to stay in business, he would have to keep working for investors until he earned their money back—and met the high-water mark—before charging performance fees again. Vale says that in most cases he would not invest with such managers.
But last year was a special case, say other hedge fund investors. They are mindful that dozens of hedge funds lost between 20% and 50% in 2008, including many with otherwise excellent long-term records. This year’s comeback in performance for hedge funds in general is also helping soften investors’ views. “It is easy to say ‘I just want managers who did well,’” says Mike Hennessy, managing director of Morgan Creek Asset Management. “But some strategies were more vulnerable than others.”
A number of issues come into play. “It depends upon how they acted,” adds Bradley Alford, head of Alpha Capital Management in Atlanta. For example, how did the manager communicate its problems at the old fund? How did they honor redemptions? Did they throw up a gate? Did they stray from their stated strategy?
ONE manager whom many investors say they might consider giving another try is Dwight Anderson of Ospraie Management. In September 2008, the commodities specialist announced he would close down his flagship Ospraie Fund, after losing 38.6% for the year at the time. “I am extremely disappointed with this result and the Fund’s sudden reversal in performance,” Anderson said in a letter to investors in September 2008, which was as close to an apology as he got. He blamed the losses on a substantial sell-off in a number of his energy, mining and resource equity holdings during a six-week period “characterized by some of the sharpest declines in these sectors in the past 10 to 20 years.”
Ospraie had an unusual provision that overrode the fund’s lockup and allowed investors to withdraw all of their capital once the fund exceeded the 30% drawdown threshold, leading to massive redemptions and prompting Anderson’s decision. He promised to give investors 80% of their money by the end of 2008, which he did. The rest, he said, might take three years to liquidate. As of October 2009, the Ospraie Fund had returned about 82% of the assets.
On July 1, Anderson launched two new funds—Ospraie Commodity Fund and Ospraie Equity Fund. In a letter to investors on May 12, Anderson wrote investors that opportunities were “as compelling as I have seen in my 15-plus years of investing in the basic industry space.” Ospraie Commodity Fund invests in commodities and their related derivatives. Ospraie Equity Fund focuses on equities in the basic industry and commodity sectors.
Anderson initially offered investors who were below their high-water mark the ability to invest prior to January 1, 2010, in a share class with a permanently reduced fee structure of a 1% management fee and a 10% incentive fee.
However, after his letter went out, Anderson decided to give legacy investors a choice. They could forgo the high-water mark and pay a 1% management fee and 10% performance fee forever, or they could keep the high-water mark, pay a 2% management fee and no incentive fee until they get back to even, and then pay the former rate of 1.5% and 20%. Anderson would not comment, and a spokesman would not say when Anderson made the change in the fee structure, or whether he received push back from potential legacy investors after the letter was sent.
New investors are being charged a 1.5% management fee and 20% incentive fee. One big difference is the liquidity: Both funds will permit investors to withdraw their money quarterly. Previously, investors had to tie up their money for three years. Those who opted for a two-year lockup had to pay an extra 3 percentage points for the privilege: 2% and 23%.
Anderson, a star manager who previously worked at Paul Tudor Jones II’s Tudor Investment and Julian Robertson’s Tiger Management, also promised to invest the “substantial majority” of his liquid net worth in the new funds, and investors think it may take a year or more of good performance numbers to convince many institutional investors to sign on. Through September, the commodities fund was up 4% while the equity fund rose 4.4%. Altogether, Anderson is managing a modest $250 million, including his own money. Ospraie Fund peaked at about $4 billion in July 2008.
If Anderson does perform well, he could see get more money as some are willing to give him some slack. “He shut down in an honorable way,” says Hennessy, a former investor in Ospraie who is thinking about giving the firm money again. “Historically, he has been a very good commodities manager. I don’t think he got dumb overnight.”
Polygon of London and New York City, which once managed $8 billion and was the 13th largest hedge fund firm in Europe, according to EuroHedge, is another firm trying to rise from the ashes. But it may have more difficulty than some others. In October 2008, the firm said it would close down Global Opportunities Fund, its then-$4 billion multistrategy fund, which lost 48% for the year after rising in the single digits the previous year. Polygon had also thrown up a gate, did not start returning money until June and doesn’t plan to return all the money until the end of 2011—although it has given back more than 30% and still plans to return 40% to 50% by the end of the year.. “I don’t know who would give them money,” says Vale.
Apparently there are some. So far, Polygon has managed to amass more than $100 million for two new funds—European Equity Opportunity Fund and Convertible Opportunity Fund. Individuals close to the situation say that most of the money came from outside investors, and Polygon is hoping to raise more: $500 million to $1 billion for each fund. This year to date, the European fund, which launched at the beginning of July, is up more than 25% while the convertibles fund, which started trading at the end of May, is up more than 30%.
Polygon was founded in 2003 by Reade Griffith, Alex Jackson and Paddy Dear. Its troubles began in early 2008 and by September, Jackson had left, leaving Griffith and Dear to run the firm. Jackson, who headed up Polygon’s credit and convertible arbitrage operations from its New York City office, was quoted as saying that he was relinquishing his investment and management duties to spend more time racing sailboats.
The trio has impressive pedigrees: Jackson previously spent nine years at Highbridge Capital Management while Griffith, who graduated from Harvard Law School, had previously launched and headed up Citadel Investment Group’s European investment division. Dear was previously with UBS of Zurich.
GANDHARA is another firm that could have tough sledding raising money. Having decided to return cash to investors in its hedge fund in February, the firm is planning to trot out a new one by the first or second quarter of 2010, according to an individual close to the firm. Gandhara does not have a name for the new fund and has yet to solicit investors.
The firm, which was based in London and Hong Kong, was founded in 2005 by Davide Erro, former managing director and global portfolio manager of the global value group long/short equity fund at the DB Advisors division of Deutsche Bank. Prior to that, Erro—who is a U.S. and Italian citizen—was head of the Asia division at Goldman Sachs equity arbitrage and a member of the Goldman Sachs equities risk committee, the non-Japan Asia operating committee and the equities managing director selection committee.
At its peak, Gandhara, which specialized in Asian and European long/short fundamental stock picking, managed as much as $3.8 billion. Through 2007, it had an annualized return of between 18% and 19%. In 2008, Gandhara Master Fund fell 19%; about half of those losses came from private equity positions.
Gandhara received redemption requests for about $800 million of the roughly $2.5 billion that was still in the fund at year-end, but it could have survived easily.
Under the fund’s offering documents, Gandhara was able to pay out the redemption requests in equal amounts over the ensuing six quarters. The fund also was down about 15% to 16% for its fiscal year, which ends January 31, say investors. As a result, Gandhara was not far from reaching its high-water mark. What’s more, the fund, which charged a 1.75% management fee and 20% performance fee, had a modified high-water mark, which would have allowed it to charge a 10% performance fee until it earned two and a half times its loss.
As a result of those provisions, some investors were shocked that Erro decided to close the fund down. The firm returned 85% of the fund’s NAV to investors on April 1. People who know Erro say he believed the business was too complicated, with 30 of the firm’s 45 employees based in London while Erro is in Hong Kong.
Perhaps the most surprising person to be passing the hat again is Tontine Associates’ Jeffrey Gendell. Last year, most of Tontine’s funds declined by 65% to 75%, leading the founder of the Greenwich, Conn., firm to tell investors he would close two funds—his flagship Tontine Capital Partners and Tontine Partners.
In March, Gendell launched a new fund—Tontine Total Return, plus an offshore equivalent. Earlier this year, he said in a regulatory filing he raised more than $12 million from 63 investors for the new vehicle. In June, the total figure was more in the range of $300 million to $500 million, including $300 million from one individual, according to someone in a position to know. At the time, all of the money for the new fund came from existing clients who lost big bucks last year.
The new funds are said to be managed more conservatively with less leverage than those that imploded last year. They also charge a 1% management fee, a 20% performance fee and—perhaps most important—are honoring the high-water mark for investors who switch from Tontine’s other losing funds.
Little is known about the new fund, including whether it raised additional money when it opened to new investors on July 1. But some investors in the funds Gendell is planning to close aren’t happy. An investor in one of those funds says less than 30% of the money has been returned so far. This investor adds that Gendell has promised to wind down the fund over the next six months but laments that he does not communicate much with investors.
TONTINE, which managed $6.5 billion at its peak, is just a shadow of its former self. By the end of the second quarter, its equity portfolio as reported to the Securities and Exchange Commission had just $1.2 billion, compared with $6.5 billion last September and $10.6 billion in June 2008. Still, it was double the $577 million Gendell reported in the first quarter.
Although he has been a hedge fund manager for about 12 years—including a successful stint at Odyssey Partners before starting his own firm—Gendell didn’t become a star until 2003, when his Tontine Financial Partners rose 79.4% and Tontine Partners surged 197%. That was around the time he started moving into industrial companies, such as steelmakers, iron-ore companies, lumber suppliers and what he called “the low-end casting and forging” business, anticipating a historic boom in the industrialized sector. He also loaded up heavily on home builders. Gendell followed up with a 101.4% gain at Tontine Partners in 2004, thanks to bets on home builders, steel and cyclicals. Little wonder he amassed nearly $3 billion by the end of 2004. At the pinnacle of his success, he had become a billionaire.
Gendell’s reputation was formed by his willingness to avoid the Internet-tech bubble of the late 1990s, which initially cost him dearly. Tontine Partners was down 1% in 1998. However, his view paid off as the tech bubble burst, with the funds rising by single-digit percentages in both 2000 and 2001, when the S&P 500 fell 9.1% and 11.9% respectively.
On the other hand, for most of the 1990s, Gendell was aggressively playing what he correctly deemed to be the consolidation of the U.S. banking industry. In 2001 and 2002, Tontine Financial Partners surged 42% and 33%, respectively.
In 2007, Gendell started to show some cracks in his strategy when Tontine Financial Partners crumbled by 58%, overshadowing a 43% gain in the larger Tontine Capital Partners fund.
Last year, when many hedge fund managers blew up, Gendell suffered perhaps the worst losses among hedge fund managers except for those tied up in Bernie Madoff’s ponzi scheme. In an October 2008 letter to investors, however, Gendell seemingly blamed a perfect storm of outside forces. Not once did he concede any of the failures were of his own doing, although he did say “we are embarrassed by this performance.”
But a look at letters he sent to investors during 2008 reveals that Gendell, far from being an investment genius, was blindsided by reality. In an April 18, 2008 letter to investors, he asserted “We do not believe there was actually a credit crisis.” Gendell followed that up with a July 21, 2008 letter, in which he stated “We still do not believe the banking system is even remotely in dire straits and we believe there is a huge excess of capital in the banking system.” He went on to identify four factors that “could provide support for the equity markets in the last half” of the year.
Gendell’s fate and infamy were sealed, however, when he turned very bullish in mid-September when Lehman filed for bankruptcy, believing the lows in the third week of September “were the ultimate lows for the equity market.” Investors in his fund speculate he leveraged up at that time, resulting in gargantuan losses over the ensuing 10 weeks, when the global markets went into free fall.
Gendell has blamed the combination of falling commodity prices, massive anticipated hedge fund redemptions and the seizing up of credit markets for his nightmare year, which he described as “once in 13 years” for his funds in a letter to investors last October.
Even so, some unhappy investors are not surprised Gendell has been able to raise money. “He still has the ability to pick stocks,” says one otherwise unhappy investor. “In a normalized environment, he will be successful.”
Maybe normal market conditions are what all of these hedge fund managers are hoping for. AR
