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Thursday, August 16, 2007

Time to Reassess Your Hedge Fund Investment?

Ultra high net worth investors are understandably nervous these days about their investments in hedge funds. Whether they have a clear idea of how their money was invested or not, many are thinking it may be time to get out. More poignantly put by a guest today on CNBC, “if you don’t know what you are in, it might be time to sell.” As with any asset bubble, the dirty laundry gets aired when the market goes sour and the hedge fund industry has not escaped this trend.

For example, our clients who had investments in the collapsed Bear Stearns hedge funds allege that the fund managers misrepresented the quality of investments and risk controls in place. The troubles which allegedly surfaced when Amaranth lost a sizable chunk of its investor’s money revealed a trend known as “style drift;” when managers go outside of the fund’s stated strategy.

Unfortunately, when a hedge fund struggles often times investors are the last to know. This is because hedge funds are very lightly regulated and lack transparency. When they do struggle, a hedge fund managers’ interest is not always aligned with the investors’. The manager’s goal is to prevent a “run on the bank” and use his/her trading skills to get back to a profitable position. This is like the gambler who lost money at the black jack table but thinks the next hand will turn his luck around.

So what then, is an investor to do? Knowing redemption policies is a start. Many times an investor must inform the hedge fund of his/her intention to pull out of the fund in writing weeks ahead of time. In fact, many hedge funds require 45 days notice and redemptions are only available at the end of the month, therefore today is the earliest time a redemption can be requested. Today’s Wall Street Journal covered redemption policies and warned of pulling your money from a fund for fear of being sued by those who incurred losses by not getting out in time. This is a concern.

Secondly, investors should participate in every conference call, take notes and always ask the hard questions. Investors are entitled to honest information about a hedge fund’s investments, risk management and asset valuation methods. Investors should be extremely worrisome if any investment schemes drift away from the originally stated strategy. This could be indicative of troubled waters.

If a loss is incurred and the potential for misrepresentation and/or “style drifts,” or outright fraud exists, it’s important to act fast and consider contacting regulators and pursuing your own legal action. Sometimes the venue will be a settlement negotiation, while other times fund managers may be pursued via securities arbitration or the court system.

Remember, even wealthy investors have rights and fraud is illegal no matter who the victim is.

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