Monday, March 16, 2009

Did San Diego County make a big mistake by investing almost a billion dollars in hedge funds?

Jacob's Jaw Dropping Worry Spreads to Other Issues
Voice of San Diego
Scott Lewis
March 16, 2009

This month's Vanity Fair is almost wholly devoted to financial stories...

But most interesting to locals is this story on hedge funds and "why hedge funds are imploding by the thousands..."

Obviously, the story is interesting from the perspective of San Diego County's pension fund, which has something less than a billion dollars now invested in hedge funds. But the story also helps explain one of the attributes of these hedge funds that has apparently caused some alarm among those who oversee the county's retirement system.

You might remember that when the trustees of the pension fund accepted the resignation of their chief investment officer, David Deutsch, they also talked about their potential losses in the hedge fund WG Trading. WG Trading, of course, is under scrutiny from federal prosecutors who accuse its principals of fraud. And San Diego asked for its $78 million back from the fund late last year.

But they can't get the money back for several more months. Why?

From Seth Hettena's story (emphasis mine):

The pension terminated its relationship with WG Trading on Dec. 31 after the hedge fund refused to cooperate with an SDCERA consultant. Under its agreement with WG Trading, SDCERA is not entitled to receive its money until June 30.

Such restrictions on hedge fund redemptions, known as gates, have caught many investors by surprise, including SDCERA. Board member Dianne Jacob, chair of the County Board of Supervisors, requested a review of all similar restrictions SDCERA might face with other investments.

Take note of that word: "gates."

Vanity Fair helps illuminate Jacob's worry about hedge fund gates:

There are many managers who argue that the industry's problems are at least in part of its own making. Says Leon Cooperman, who founded the $3 billion hedge fund Omega Advisors in 1991, after a 25-year career at Goldman Sachs, "Hedge funds have shot themselves in the foot. They have not treated investors correctly." Atop his list of sins: refusing to allow investors to take their money out, which is known in the industry as "gating" investors.

The author explains more about gating later in the story, which focuses on Fortress Investment Group, a hedge fund that evolved into a publicly traded company.

Managers who employ gates defend the practice on the grounds that it's within their legal rights, and that selling their positions to meet redemption requests would be unfair to those investors who wanted to stay. But the widespread impression among investors is that managers broke a social contract and are doing it to save their own skins. And there may be another reason for the gates. Fortress's documents, for instance, disclose that "our funds have various agreements that create debt or debt-like obligations ... with a material number of counterparties. Such agreements in many instances contain covenants or 'triggers' that require our funds to maintain specified amounts of assets under management."

In other words, gates may mean that the money invested in a hedge fund simply isn't accessible -- or worse, that the assets simply don't exist...

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