Fri, 19/09/2008 - 07:00
After a week that saw a blizzard blow down Wall Street, dominos continue to totter across the financial world. After the collapse of Lehman, the rescue of Merrill Lynch, and the virtual nationalisation of AIG, a bedrock of stability, the money market sector, was the latest to feel the shiver of instability as Lehman's woes forced a venerable fund to halt redemptions. In this febrile environment, a European Parliament initiative calling for greater transparency on the part of alternative funds, something the industry might have ignored a year ago, suddenly has the potential to gain traction.
As the financial market turbulence plumbs new depths, hedge funds are increasing the proportion of cash in their investment portfolios. According to new research from Citigroup, hedge fund cash holdings are now at or close to their highest-ever average level.
The 30 per cent of their assets that Citi estimates that hedge funds currently have in cash amounts to a total of around USD600bn. Before the credit crisis erupted last summer, hedge funds were holding around 20 per cent of their assets in cash.
An important reason for this is that funds are bracing themselves for a potential spate of withdrawals at the end of the year, when the next redemption window opens for many investors have. It's better for managers to gently boost their cash positions now rather than have to liquidate assets in a hurry, or worse, tell investors that they can't have all their money.
Holding assets in cash can also seem a safety option at a time when the value of other assets is plunging, but it may not be quite as safe as it seems - even holding cash can pose liquidity risks, it was discovered this week, when the oldest US money-market fund temporarily halted withdrawals.
The USD64.8bn billion Reserve Primary Fund run by New York-based Reserve Management Corporation this week was obliged to delay withdrawals by seven days after being forced to write down USD785m in Lehman Brothers securities it owned. Citi estimates that around 17 per cent of the cash held by hedge funds - more than USD100bn - is in money market funds.
When instruments that are regarded as being equivalent to cash, the most liquid of all assets, start to pose liquidity risks, it leads one to think that predictions that the credit crunch is coming to an end may be somewhat premature.
A European Parliament paper on regulation of the alternative investment industry, which had included controversial measures such as the forced disclosure of directors' remuneration, corporate earnings and bonuses as well as relationships with prime brokers, has now been watered down.
The new proposals will go to a full vote by the European Parliament later this month, and the assembly has called on the European Commission, which is responsible for initiating European Union legislation, to submit draft proposals by the end of November. However, any legislation will have to be approved by a weighted majority of EU member governments before it can come into force.
The amended report by the parliament's economic and monetary affairs committee, authored by MEP and former Danish prime minister Poul Nyrup Rasmussen, has softened its proposals enough to be welcomed by the European Venture Capital Association, but controversial points still remain. Notably, it calls for private equity and hedge funds to disclose their investment strategies, risk management and portfolio valuation methods.
At a time of industry introspection about risk management and valuation methodologies, the latter requirements can probably be accommodated by the industry without too much grief. But disclosure of investment strategies? Success for many funds depends on the manager being able to keep his positions and strategy confidential. Not to be able to do so would allow other funds to copy winning strategies and perhaps trade against short positions.
There is no certainty, of course, that any of these proposals will become European law. However, if the European Parliament wants to enjoy credibility in the alternative investment sector, it should consider further changes to bring its proposals into line with industry reality.
A few weeks ago, when Stanley Fink stepped down as deputy chairman of Man Group just over a year after assuming the non-executive role, it was speculated that he might make a return to hedge fund investment. This was in part because he owns 9.5 million shares of Man Group, worth GBP58m, and once you are personally involved it is hard to get out of the game.
And now Fink is back. The so-called godfather of the UK hedge fund industry has made a dramatic return, having been appointed chief executive of International Standard Asset Management, an alternative asset manager with some GBP200m under management. The firm has also appointed former Labour Party fundraiser Lord Levy as chairman.
According to International Standard, Fink will take responsibility for the operational management of the business, while both he and Levy will use their extensive network of wealthy contacts to boost the firm's assets under management. The International Standard Gold Fund was launched by former Merrill Lynch gold trader Roy Sher, a friend of Fink, in 2003, and is mainly backed by private investors.
Fink's announcement came at a somewhat inauspicious time, with Lehman Brothers filing for bankruptcy and Merrill Lynch being bought by Bank of America. But surely such a seasoned hedge fund veteran won't take this as an augury of things to come.
The classic characterisation of the British is the stiff upper lip that enables them to face misfortune bravely and resolutely. But perhaps this stoicism keeps those in charge from waking up and smelling the coffee. For if the government does not do something about the alarming situation facing London as a financial centre, there may be a huge price to pay.
Financial services firms are already leaving town. Henderson Group, a UK asset manager, is planning to move its tax residence to Ireland, while hedge fund manager Krom River Partners plan to move from London to Switzerland. These departures are gradually intensifying - and will turn into an exodus if the UK does not respond fast.
With other financial centres becoming more competitive and with London becoming arguably less so, a steady erosion of the financial industry, which is highly mobile, could take place as asset managers and others decide to move out for personal, lifestyle or tax reasons.
While problems mount at home, a new organisation called the Professional Services Global Competitiveness group has been set up to promote London as a financial centre. Its members will be responsible for prioritising international marketing challenges facing the capital's financial services industry. The group will report directly to the UK's finance minister, Chancellor of the Exchequer Alistair Darling, on issues affecting the legal, financial and accounting services of which the UK is a leading provider.
But what will they market? A very busy city suffering from pollution and poor infrastructure, not to mention a perception of rising crime. On top of that the government risks making the industry feel unwelcome through tax investigations and ambiguous fiscal rules.
Changes are needed and fast. The solutions needed are drastic - and will need to focus, one way or the other, on cutting taxes, especially corporation tax. It's either that or companies will start walking - indeed, many of them have already started doing so.
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