Are Regulators About to Create Too Big To Fail Hedge Funds?

John Carney is out with his first piece at CNBC. He's reporting on new developments out of the Financial Crisis Inquiry Commission that may result in added burdens for the hedge fund industry.

Carney correctly points out that the new regulations, or even just information seeking, will prove most onerous for smaller hedge funds. This may result in fewer start ups in the industry and mergers of existing firms.

Carney writes:

While requests for information may seem harmless enough on the surface, they create serious legal and compliance costs for hedge funds. Bigger hedge funds and those owned by banks such as Citigroup or JP Morgan Chase can easily bear these costs. They have teams of in-house lawyers and relationships with big law firms ready to handle these issues.

It’s the smaller funds that will feel the sting of FCIC scrutiny. The additional costs make it harder for smaller funds to compete with the big players and create barriers to entry for new funds...The irony is that the anti-competitive effect may cause further consolidation in hedge funds, perhaps creating funds that—like our behemoth megabanks—are too big too fail.

What a surprise, new regulatory environment that benefits the banksters.

Hedge Fund Panic Continues

Investors pulled close to a net $150 billion from hedge funds in December in spite of moves by dozens of funds to halt or suspend redemptions.

The record figure, equivalent to about 10 per cent of industry assets, extends the run of outflows to four consecutive months and has increased the total net outflow for 2008 to $200bn.

Tremont, Tudor Investments, Citadel, Highbridge, Farallon, GLG and Drake are among the hedge funds and funds of funds that have halted, restricted or suspended redemptions.

Some funds, such as GoldenTree, have told investors who want to redeem that they will receive securities instead of cash. Others have split funds in two, liquid and illiquid assets, and paid out only from the liquid assets fund. Still others have shut completely, paying out all their investors from whatever remained in the fund.

Investors Continue to Bail Out of Hedge Funds

The fear of the markets was clear in November.

Investors pulled a net $32 billion from hedge funds last month, making 2008 the first year in their recorded history that the funds have had significant outflows and ending the industry’s 18 years of asset growth.

To understand how deep the fear was, keep in mind that money has been taken out of funds following every strategy, even those – such as macro funds – which were showing positive returns, according to data from fund trackers Hedge Fund Research.

Further, December redemptions appear to be two to three times the November number.

Conrad Gann, chief operating officer of fund tracker, TrimTabs, says the known December redemption number is already at $57 billion and could go as high as $80 billion.

The funds had outflows of $43 billion for the 10 months to the end of October. TrimTabs’ estimate of further significant redemptions for November and December indicates that the funds will show outflows of more than $100 billion for the full year. In 1994, the only previous time they had outflows, the figure was $1 million.

If you are looking for a reason that Treasury bills are trading near 0%, the hedge fund industry is a good place to start. With these kinds of resumptions coming in, the funds put money in the perceived safest possible instrument, Treasury securities, to meet redemption demands. Investors then get the money and put it right back into T-bills.

Once all the fear subsides, things should turn positive quickly given the enormous amounts of money Bernanke is pumping into the system. December 2008 could very easily be the bottom for markets. January could see huge upside action in the markets.

Tudor Jones Suspends Withdrawals from Flagship Fund

Hedge fund industry giant Paul Tudor Jones has suspended withdrawals from his $10bn flagship hedge fund and plans to split out toxic assets into a new fund with lower fees, according to FT.

The Tudor fund is down only 5 per cent but redemption demands are forcing the freeze.

Jones, in a letter sent to clients on Friday, said investors wanted back 14 per cent of their money at the end of the year. This would have left the remaining investors holding too large a proportion of illiquid assets, particularly corporate credit in emerging markets, the letter said.

“I recognise that a restructuring is an unwelcome, but I believe necessary, step against the backdrop of Tudor BVI’s 22-year history of unbroken profitable years,” Mr Tudor Jones wrote. “I believe it is but a brief step, however, on the road to important long-term changes for the benefit of all investors.”

These type of freezes by hedge funds have caused a lot of panic redemption request by hedge fund owners, and in turn has resulted in heavy selling by hedge funds to meet selling pressure.

US Hedge Funds Suffer Heavy Withdrawals

Investors pulled at least $43 billion from US hedge funds in September, according to data from TrimTabs Investment Research.

This continues to explain the growth in M1 money supply. It has little to do with Bernanke adding reserves and eevrything to do with investors pulliing money from hedge funds, money merket funds etc. and putting it in checking accounts at banks.

Hedge Fund Industry Behind Congressman Rangel's Troubles

After 38 years in the U.S. House of Representatives, suddenly Congressman Charlie Rangel wakes up to almost a hit piece a week in New York City newspapers.

In July, the New York Times reported on Rangel's four rent controlled apartments. In August, the New York Post first reported on Rangel's "beachfront villa in a sun-drenched Dominican Republic resort." Yesterday, NyPo followed up with another attack on his failure to report income from the villa. Then there was the report of Rangel using his official congressional stationary to solicit money from constituents for a Columbia University Center to encourage minority participation in government.

This stuff the papers are focusing on is all in a days work for a ranking congressman. It is generally, impossible to get newspapers to feature stories about it. But, as the second scandal broke, we wrote, "Somebody is out to get...Ways and Means Committee chairman, Congressman Charlie Rangel....Reports like this don't come out by accident. Somebody that is very powerful is after Rangel."

The Ways and Means committe chair has always been a hot seat.

Rep. Wilbur Mills (1957-1974) was removed via a set-up affair with a stripper, Fannie Fox; Rep. Dan Rostenkowski (1981-1994) was forced out in a concocted House Post Office scandal, and President William McKinley, who was assassinated in 1901, had previously been Chair of the Ways and Means Committee.

Now it's Rangel's turn. Who is powerful enough and has the money to sponsor and fund the takedown this time?

Wall Street friends tell us that it is the hedge fund and private equity industries.

The hedge fund and private equity industries have targeted Rangel because of his legislation in the House that would have taxed the earnings of hedge fund and PE managers at a 35% income tax rate, instead of the current capital gains rate they pay of 15%. Rangel's legislation for a tax increase on the fund managers passed the House 233-189, but it was blocked in the Senate.

Now it's time for Rangel to experience payback.

One Wall Street insider said to me, "This is almost as much fun as taking out Eliot Spitzer."

Running Money Is Not Easy

It takes a certain type of personality to run money. Former CNBC anchor Ron Insana doesn't appear to have it.

In March 2006, Insana set up a so-called fund of funds.

Two weeks ago, Insana announced that he was throwing in the towel.

Andrew Ross Sorkin at NYT's Dealbook explains the choke hold that a hedge fund can have on an operator:

Eric Mindich, the former Goldman Sachs whiz kid, left the firm in 2004 to start Eton Park Capital Management and immediately raised more than $3 billion. His firm charged a 2 percent management fee and 20 percent of the profits with a three-year lock-up — handing him a $60 million paycheck before he even opened the door.

But most hedge fund managers aren’t like Eric Mindich. They don’t start off with $3 billion and they don’t put out their shingle with a guarantee of riches. Instead, they’re like, well, Ron Insana...

In exchange for getting his investors behind the velvet rope, he charged a 1.5 percent management fee and took 20 percent of all profits. That may not sound like a bad deal — but consider that those fees come on top of the fees charged by the hedge funds themselves. (In the case of Mr. Simons, in particular, the fees are astronomical: a 5 percent management fee and more than 40 percent of the profits.)

Over the course of more than a year, Mr. Insana raised about $116 million. It was a respectable number, to be sure, but it wasn’t $3 billion. And here is where Mr. Insana ran into trouble.

As an investor, Mr. Insana didn’t exactly have the wind at his back. During the 14 months his fund of funds was up and running, the Standard & Poor’s 500-stock index fell more than 15 percent. While some hedge funds managed to eke out gains, many did not. Ultimately, Mr. Insana’s fund lost 5 percent.

In the mutual fund business, beating the S.& P. would be more than enough to survive, and even prosper. Mr. Insana would have been a hero. But the hedge fund business is far more cut-throat. For a small fund like Mr. Insana’s, it is imperative to make money regardless of whether the S.& P. is up or down — and because he didn’t, the 20 percent portion of his fee structure was worth nothing.

That left his management fee, which amounted to $1.74 million. (That’s 1.5 percent of $116 million.) On paper, that may seem like a lot of money. But it’s not. Like many first-time fund managers, Mr. Insana was forced to give up about half of the general partnership to his first investor — in this case, Deutsche Bank — in exchange for backing him. After paying Deutsche Bank, Insana Capital Partners was left with only about $870,000.

That would have been enough if it was just Mr. Insana, a secretary and a dog. But Mr. Insana was hoping to attract more than $1 billion from investors. And most big institutions won’t even consider investing in a fund that doesn’t have a proper infrastructure: a compliance officer, an accountant, analysts and so on. Mr. Insana had seven employees, and was paying for office space in the former CNBC studios in Fort Lee, N.J., and Bloomberg terminals — at more than $1,500 a pop a month — while traveling the globe in search of investors. Under the circumstances, $870,000 just wasn’t going to last very long.

Finally, most hedge funds have something called a high water mark. It requires hedge fund managers to make investors whole before they can start collecting their 20 percent of the profits — regardless of how long that takes. Hedge fund managers don’t get to start from scratch every Jan. 1 the way their mutual fund brethren do.

In the end, the rock was simply too heavy for Mr. Insana to keep pushing uphill. On Aug. 8, he sent a letter to investors explaining why he was closing shop. “Our current level of assets under management, coupled with the extraordinarily difficult capital-raising environment, make it imprudent for Insana Capital Partners to continue business operations,” he wrote.

In the end, you have to know how to smile, cajole and rip money from people's teeth to be a successful hedge fund manager. Bad timing aside, Insana struck me as too nice a guy to make in this Big Swinging Dick sport.

HTnick

Institutional Investors Fear Another Big Financial Firm Failure

FT reports:

Institutional investors expect another big financial firm will collapse within the next six months in the continued fallout from the credit crunch, new research has shown.

Nearly 60 per cent of US and European institutional investors surveyed by Greenwich Associates believe there will be such a failure within the next six months. Another 15 per cent think it will happen in six-12 months...

“Most institutions think we are currently in the most dangerous period for global financial services firms,” said Frank Feenstra, a consultant at Greenwich Associates. “Perhaps if the markets can make it through the next six months, the level of pessimism may begin to subside.”

The survey of 146 institutions by Greenwich Associates, to be published this week, included banks, hedge funds, investment managers, mutual funds and pensions funds in the US, Canada and Europe.

This dovetails with the warning sent out by Black Mesa to its clients.

Hedge Funds Buying Grain Storage Infrastructure

Sounds like some have betting on food inflation is going on.

An offshoot of the hedge fund Whitebox Advisors LLC purchased AGP’s Duluth grain terminal at the beginning of this month, completing its second local elevator acquisition this year.

In April, ConAgra announced plans to sell the Peavey Co. Elevator to hedge fund operator Ospraie Management LLC.

Whitebox has been actively acquiring grain storage infrastructure for more than a year now, initially purchasing a grain elevator in Minneapolis, MN and another in Shakopee, MN. In June, the company paid $2 million for the Lake and Rail Elevator on the Buffalo River in New York.

SEC Harassing Traders

Rumors on Wall Street, you're kidding?

Yes, while the head government honchos can lie without consequences, "Read my lips, no new taxes", "A humble foreign policy", the government decides to go after hedge funds for spreading rumors.

Give me a break, if you are trading on Wall Street, you better verify facts for yourself or you won't be on Wall Street very long. Rumors are for suckers.

But the SEC, in a public posturing mode, has subpoenaed over 50 hedge-fund advisers in a "rumors" investigation, ACCORDING TO A RUMOR PUBLISHED IN THE WALL STREET JOURNAL AND PROBABLY LEAKED BY THE SEC.