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Hedgeweek Commentary: Behind the hedge fund news

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Barack Obama’s election on Tuesday night as the 44th president of the United States promises tougher times for hedge fund managers, certainly in te

Barack Obama’s election on Tuesday night as the 44th president of the United States promises tougher times for hedge fund managers, certainly in terms of regulation. The president-elect has been an outspoken critic of the lack of regulation on US hedge fund managers and of the offshore tax-efficient structures used by both managers and funds. First up is likely to be a fresh look at draft anti-money laundering regulations discarded by the Bush Treasury department just last week. Still, regulation isn’t always a bad thing – just ask the hedge fund managers caught in a short squeeze manoeuvre by Porsche that may have been legal but many analysts reckon shouldn’t have been.

Garden state governor stands up for hedge fund investment

It’s not all hostility to hedge funds in the so-called blue states that helped deliver the US presidency to Barack Obama on Tuesday night. Jon Corzine, the Democratic Party governor of New Jersey, has come out in defence of the state pension system’s decision to add USD143.5m to its investment in a BlackRock credit hedge fund that has been falling in value.

On Monday Corzine rejected demands for an investigation into the pension fund’s investment policy, saying that "anybody that knows anything" would know that those investments are protected by the government’s Wall Street bailout.

BlackRock Credit Investors, which invests in corporate loans, is down about 25 per cent since the New Jersey pension scheme initially invested USD400m, according to William Clark, director of the state government’s investment division.

Nevertheless, the pension scheme made two investments within a month. On October 17, New Jersey put in USD49.5million – something that drew criticism from New Jersey Senate president and former governor Richard Codey, who complained that it had been deliberately pitched just under the USD50m threshold that would require review by the New Jersey state investment council – followed by an additional USD94m.

Hedge fund managers may be nervous about the intentions of Obama and his party, especially since the president-elect has been co-sponsor of a bill that would impose anti-money laundering requirements on hedge funds and close offshore tax loopholes.

But perhaps they might yet have a friend at court. On Wednesday Corzine denied he had discussed succeeding Hank Paulson, with whom he shared the positions of chairman and chief executive at Goldman Sachs for seven months in 1998-99, as Treasury secretary in the Obama administration, but coyly added: "I am not going to say never to anything."

New president, new hedge fund rules?

Last week the US Treasury Department formally dropped its proposals for anti-money laundering regulations governing the hedge fund industry. This was partly because of the difficulties in enforcing such a system on an unregulated industry with no oversight body in place to do so, but also because Treasury experts say that hedge funds are an unlikely choice of vehicle for money laundering or terrorist financing because of their risk profile and relative lack of liquidity.

However, the situation could quickly change once new president Barack Obama is installed, according to Senator Carl Levin, who describes the decision as "inexplicable, ill-timed and unwise". He says: "The absence of anti-money laundering controls on hedge funds is another regulatory gap that the Congress will have to tackle after the election."

Early last year Obama joined fellow senators Levin and Norm Coleman in introducing legislation that would have required hedge funds to establish anti-money laundering programmes under the supervision of the Treasury Department and also sought to curb abuse of offshore tax havens and tax shelters.

The proposed Stop Tax Haven Abuse Act, a strengthened version of a tax reform bill introduced by Levin, Coleman, and Obama in the previous Congress, also failed to make it into law. But with Obama in the White House and the Democrats with a strengthened grip on Congress, third time might well prove unlucky for hedge funds and other members of the offshore financial services industry.

"Hedge funds are unregulated financial companies that can handle millions of dollars in offshore money without any legal obligation to check who is behind the funds or report suspicious activities," Levin says, incorrectly, since funds domiciled in jurisdictions such as the Cayman Islands or British Virgin Islands are required to run due diligence checks on their investors that are often more stringent than the requirements in the US.

"But instead of plugging the hedge fund regulatory gap by issuing a final rule, the administration went the opposite way, withdrew its anti-money laundering proposal, and offered nothing in its place."

Not everyone in the Democratic Party believes this. Barney Frank, chairman of the House of Representatives’ financial services committee, notes that many financial institutions have been overburdened by anti-money laundering regulations and excessive reporting requirements. But hedge fund managers can expect the new president at the very least to revisit the Treasury decision.

Coffey about-turn reflects changed environment

Greg Coffey is playing it safe and joining veteran fund manager Louis Bacon as co-chief investment officer of Moore Capital Management’s London-based European operation. Until last week the star emerging markets manager at GLG Partners, Coffey is joining Moore with a 12-strong team.

His decision to join another firm rather than set up on his own, as was expected after he announced his decision to quit GLG six months ago, reflects the current state of the financial markets and the availability, or lack of it, of credit.

When Coffey walked away from USD250m in GLG share options and other bonus payments, the idea of starting his own business did not look like a reckless punt for a manager who had achieved a 60 per cent return with the GLG emerging markets fund in 2006 and 51 per cent last year. But the Australian’s decision to play it safe and join another fund manager is a warning sign that the market environment is showing few signs of immediate recovery.

New York-based Moore Capital was founded almost two decades ago by Bacon, who has been its sole chief investment officer since 1990. A macro investor, Moore has reportedly added employees and attracted new capital this year even as other managers have been firing personnel amid investor redemptions.

As for GLG, it is reported to be conducting a "liquidity review" of its funds and halting redemptions from its USD1.5bn Market Neutral fund for six months. GLG’s share price is down 63.3 per cent over the past six months, compared with a 27 per cent drop for the Dow Jones Industrial Average. It looks as though Coffey’s judgement remains spot-on.

Porsche manoeuvre puts squeeze on German markets regulation

It wasn’t as if hedge fund managers needed another reason to dislike Germany, what with its insistent calls for increased regulation of the industry, but last week’s game played by luxury auto firm Porsche has left many managers seething with anger.

Porsches’ steady buying of Volkswagen shares, in a three-year quest to take control of Germany’s largest car manufacturer, had driven up their price to above the level at which it would make any financial sense for Porsche to add to its VW stake. Hedge funds and other investors accordingly sold VW short, with short positions reportedly reaching as much as 14 per cent of the company’s outstanding shares.

However, on October 26 Porsche announced that it owned nearly 43 per cent of VW’s shares outright and held cash-settled options to acquire a further 31.5 per cent, enabling it to control 75 per cent of the company next year. With a long-term stake of 20 per cent owned by the state government of Lower Saxony and more shares held by index funds, this left an effective free float of less than 5 per cent.

This forced hedge funds and the other short sellers to buy shares at any price, driving up VW’s share price from around EUR 200 to more than EUR1,000, making the company temporarily the largest in the world by market capitalisation. Porsche made a paper gain of up to EUR40bn and may have made real gains of as much as EUR12bn after selling off some of its options to free up the market in VW shares.

Porsche says it never intended to make money on its options strategy, but there is some reason to doubt this. In the 12 months to July 2007 Porsche earned three times more money from trading derivatives – VW options – than it did from selling cars: EUR3.6bn of its EUR 5.86bn pre-tax profit. When analysts said the company looked like a hedge fund investing in just one stock, a Porsche spokesman laconically replied: "We make money from hedging and building cars. The difference is that hedge funds don’t make cars the last time I checked."

Analysts believe the biggest loser in the affair – apart from the hedge funds, investment banks and others who have lost money – is the reputation of Germany’s capital markets. In other jurisdictions investors would not have been allowed to corner the market in a share through options positions without having to disclose it.

The country’s financial authorities may not be too bothered – they may if anything be pleased – if hedge funds and other investors they regards as speculators shun their market as arbitrary and ill-regulated. But ultimately German companies may lose out if the result is to make capital-raising for them more difficult and more costly.

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