Articles By Topic
By Topic: Single Investor Hedge Funds
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From Vol. 5 No.1 (Jan. 5, 2012)
Legal and Operational Due Diligence Best Practices for Hedge Fund Investors
In the wake of the financial crisis in late 2008, many investors were left trapped in suspended, gated or otherwise illiquid hedge funds. Unfortunately, for many investors who had historically taken a passive role with respect to their hedge fund investments, it took a painful lesson to learn that control over fundamental fund decisions was in the hands of hedge fund managers. Decisions such as the power to suspend or side pocket holdings were vested in managers either directly or through their influence over the board of directors of the fund. In these situations, which were not uncommon, leaving control in the hands of the manager rather than a more independent board gave rise to a conflict of interest. Managers were in some cases perceived to be acting in their own self-interest at the expense, literally and figuratively, of the fund and, consequently, the investors. The lessons from the financial crisis of 2008 reinforced the view that successful hedge fund investing requires investors to approach the manager selection process with a number of considerations in mind, including investment, risk, operational and legal considerations. Ideally, a hedge fund investment opportunity will be structured to sufficiently protect the investor’s rights (i.e., appropriate controls and safeguards) while providing an operating environment designed to maximize investment returns. Striking such a balance can be challenging, but as many investors learned during the financial crisis, it is a critical element of any successful hedge fund program. The focus on hedge fund governance issues has intensified in the wake of the financial crisis, with buzz words such as “managed accounts,” “independent directors,” “tri-party custody solutions” and “transparency” now dominating the discourse. Indeed, investor efforts to improve corporate governance and control have resulted in an altering of the old “take it or leave it” type of hedge fund documents, which have become more accommodative towards investors. In short, in recent years investors have become more likely to negotiate with managers, and such negotiations have been more successful on average. In a guest article, Charles Nightingale, a Legal and Regulatory Counsel for Pacific Alternative Asset Management Company, LLC (PAAMCO), and Marc Towers, a Director in PAAMCO’s Investment Operations Group, identify nine areas on which institutional investors should focus in the course of due diligence. Within each area, Nightingale and Towers drill down on specific issues that hedge fund investors should address, questions that investors should ask and red flags of which investors should be aware. The article is based not in theory, but in the authors’ on-the-ground experience conducting legal and operational due diligence on a wide range of hedge fund managers – across strategies, geographies and AUM sizes. From this deep experience, the authors have extracted a series of best practices, and those practices are conveyed in this article. One of the main themes of the article is that due diligence in the hedge fund arena is an interdisciplinary undertaking, incorporating law, regulation, operations, tax, accounting, structuring, finance and other disciplines, as well as – less tangibly – experience, judgment and a good sense of what motivates people. Another of the themes of the article is that due diligence is a continuous process – it starts well before an investment and often lasts beyond a redemption. This article, in short, highlights the due diligence considerations that matter to decision-makers at one of the most sophisticated allocators of capital to hedge funds. For managers looking to raise capital or investors looking to deploy capital intelligently, the analysis in this article merits serious consideration.
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From Vol. 3 No.16 (Apr. 23, 2010)
Single Investor Hedge Funds Offer the Benefits of Managed Accounts and Additional Tax and Other Advantages for Hedge Fund Managers and Investors
Managed accounts started 2010 as the ostensible antidote to many of the more egregious evils experienced by hedge fund investors over the last two years. Managed accounts offer transparency, liquidity, control and risk management, whereas during the credit crisis, many hedge funds and other investment vehicles offered opacity, gates, lack of control and increased risk. While the case for managed accounts is not without valid objections – including administrative cost, allocation issues and other issues discussed more fully below – managed accounts are an increasingly popular method of accessing hedge fund strategies and managers while avoiding the downsides of commingled funds. According to a February 2010 survey conducted by Preqin, the alternative investment data provider, 16 percent of institutional investors have a current allocation to managed accounts and a further 23 percent of institutional investors are considering an initial allocation to a managed account during 2010. Similarly, 65 percent of fund of funds managers surveyed by Preqin either operate a managed account currently or are considering doing so during 2010. Preqin also found that larger investors are more likely to demand, and larger managers are more likely to offer, managed accounts, and that the proportion of fund of funds managers operating managed accounts is greatest in North America (60 percent), followed by Asia and rest of world (including Hong Kong, Singapore, Japan and Israel, at 44 percent) then Europe (40 percent). Recently, various hedge fund managers have been exploring an alternative structure that effectuates many of the goals of managed accounts, while offering a number of additional benefits and avoiding at least one of the chief downsides. That alternative structure is the single investor hedge fund – as the name implies, a hedge fund with one outside investor (in addition to the manager’s investment). To assist hedge fund managers and investors in evaluating whether a single investor hedge fund may be an appropriate alternative to a traditional hedge fund, on the one hand, or a managed account, on the other hand, this article discusses: the definition of a managed account; the six chief benefits and eight primary burdens of managed accounts versus hedge funds; the definition of a single investor hedge fund; the six chief benefits of single investor hedge funds over managed accounts; and the two primary downsides of single investor hedge funds versus managed accounts.
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