Term envy(2)

Amid the debt-market turmoil, private equity funds have something most hedge funds would die for, and vice versa, writes PEI Americas executive editor David Snow.

David Snow:
PEI Americas Editor

The debt market has snake-and-the-elephant-magnitude indigestion, and this spells both problems and opportunities for professional investors. But depending on whether those investors are hedge funds or private equity funds, the problems and opportunities are quite different, and the reason for these differences come down to the terms and conditions of the respective partnerships.

Many hedge funds arguably have it the worst, thanks in part to the traditional structure that allows limited partners to periodically redeem their investments. Many hedge funds allow quarterly liquidity, the poor fools. This is an especially inconvenient term to have allowed when the underlying assets of the fund are not exactly liquid.

Take for example the many forms of structured products owned by hedge funds that currently have no market. Or rather, the market for these products is far, far below what the managers paid. A flood of redemptions sets off a sort of death spiral by which managers are forced to sell semi-liquid positions at deep discounts, which triggers further investor defections.

No wonder the best hedge funds have in recent years gone the private equity route of locking their investors in for many years. Some hedge funds have even agreed to charge lower carried interest for LPs who agree to multi-year lock ups. These terms look absolutely golden in the current market.

The largest private equity firms are, by contrast, looking longingly at the abilities of most hedge funds to essentially do whatever they want with investor capital, be it trade stocks, acquire a forest, buy esoteric collateralised obligations, do take-private or scoop up corporate debt. While many private equity firms have the ability to broaden their investment mandates, most LPs would throw a conniption or have a tantrum, if these GPs dramatically switched styles mid-way through an investment period without first presenting a flip-book on bended knee. You can be sure that a number of major private equity shops are very, very carefully laying the groundwork with LPs to launch distressed-debt programmes, for example.

In the meantime, the sultans of Hedgistan don’t need to ask permission to be opportunistic. This applies to the ones that are still solvent.