(December 8, 2011) — Plagued by redemption pressures that have worried clients and advisors, fund of hedge funds (FoHFs) Cadogan Management is shutting its doors to new business and transitioning its operations and talent to Cantor Fitzgerald.
In a letter released by the firm to investors, the firm states that the current low interest rate, lower returns environment makes it difficult to foresee how the current structure of hedge funds can be sustained. Cadogan reveals in its letter that earlier this year, in one quarter, the firm experienced an unexpectedly high level of net redemptions. “Although, given the liquidity of our investments, the redemptions were not sufficient to destabilize our portfolios, they did destabilize the perception of many of our clients and their advisors,” the letter states. “In spite of what has been acknowledged to have been very candid and clear communication on our part, we were unable to fully overcome the concern of enough of our investors with regard to being the last investor in any of our funds.”
Consultants and other industry sources express concern over Cadogan’s net redemptions, questioning whether this provides a peek into the dire fate of HFoFs as they suffer lackluster average performance and high fees. Some in the industry note that Cadogan’s fall represents the start of a trend where many HFoFs will be forced to shutter, closing their operations while lowering fees or merging — the direct result of an unsustainable business model.
In the letter to investors, Cadogan states that beginning earlier this year, it greatly stepped up its efforts to locate a strategic partner with which to work with to preserve Cadogan’s flagship funds as well as its intellectual property. The letter states: “After a series of very interesting and productive discussions with a variety of top-quality industry participants, we focused primarily on working with Cantor Fitzgerald. This multi-service firm has yet to fully break into the asset management business but appears to have a desire to do so and their ability to acquire a top-quality team was a good solution for them, our professionals and potentially our clients as well.”
Cadogan’s letter to investors continues to explain the impact its shuttering has on hedge fund investing. “Over any meaningful period of time, uncertainty generally benefits hedge funds operating on mean reversion. A more in-depth understanding of balance sheets, companies and industries can allow for positions to be taken with greater certainty, often against the tide. This can also create disproportionate upside. However, in the shorter run, it remains a difficult environment. Low interest rates continue to put pressure on short selling and random volatility from macro events continues to whipsaw many managers attempting to control risk. The lack of clear governmental leadership and direction makes many global macro and CTA strategies tricky as well. The current low level of corporate defaults tends to limit new distressed opportunities. Low spreads on plain vanilla deals and reduced activity in M&A generally limit interest in risk arbitrage and many event strategies. We believe investors should be looking at hedge funds in the short run more in terms of risk mitigation than upside capture.”
Commenting on the future of the hedge fund industry, the letter explains: “Historically at Cadogan, we have tried to lead the charge in attempting to affect fundamental changes in how fees are charged and how hedge funds are structured and run. We hope going forward some of the participants in our Roundtables will be willing to take the time and effort to sustain these efforts. We think it will be a win/win situation. With major financial institutions needing to limit their risk-taking functions, independent investment firms should be in a strong position to gain market share in many investment strategies. Institutions looking to access differentiated return and risk streams are likely to continue deploying capital into alpha-oriented strategies. However, there is increasing knowledge and sophistication in the buyer market and the value proposition will need to be more clearly defined. This is particularly true in the intermediary market, where FoHF’s and consultants must justify the fees they charge. We anticipate the big will get bigger for some period of time, but remain confident the real future of the intermediary market institutionally…”
“The fund-of-funds landscape is markedly different to the pre-crisis industry,” Amy Bensted, Preqin’s Manager of Hedge Fund Data, said in an April study by Preqin that highlighted the downfall of HFoFs. “Assets under management for the industry as a whole are much lower and there is a bimodal distribution of firms emerging, with peaks at the lower end of the scale as the smaller niche boutiques appeal to the maturing hedge fund investors, and at the larger end of the spectrum the ‘brand name’ multi-strategy firms still prove appealing to the newer investor,” she said.
The decline, the alternative asset research provider explained, is largely due to heightened investor caution as a result of fraudster Bernie Madoff’s multi-billion dollar Ponzi scheme. Preqin stated: “Changes in the industry are a consequence of increased investor caution following the economic downturn and the Madoff incident.”
Furthermore, Preqin noted that as the industry continues to recover from the difficulties of the past couple of years, the firm is seeing an increase in niche, multi-strategy offerings which meet changing investor demands.
As assets under management in the hedge fund-of-funds industry continue to trail well below its peak of $1.251 trillion at the end of 2008, is Cadogan’s demise the taste of a trend that is likely to persist?
Read an aiCIO Magazine feature story that questions whether fund of hedge funds will perish.