Hedge funds haunted by Asia pre-IPO deals

By Michael Flaherty and Jeffrey Hodgson

HONG KONG (Reuters) - Before the Chinese initial public offering boom began to fizzle late last year, hedge funds jumped to buy stakes in hot companies before they went public, an investment known as pre-IPO financing.

What seemed like a good idea at the time is about to come back and haunt them.

With Asian capital markets all but shut, forcing billions of dollars worth of IPOs to be shelved, many hedge funds are sitting on illiquid and often hard-to-price pre-IPO investments that in some cases could end up worthless.

The problem might not be as severe if markets were still rising or at least steady. But the financial market bloodbath of recent weeks has made a miserable situation dire for many Asia hedge funds, one of the world's worst performers even before the latest surge in volatility.

"You can hold at cost, but when people start demanding their money back, that's when you get into trouble," said a Hong Kong based investment fund manager who did not want to be named.

Huge numbers of clients are said to be pushing to redeem their investments. Sources close to the situation say the hedge funds under the greatest pressure, small players holding a large percentage of illiquid investments like pre-IPO stakes, will be forced to close up shop.

Among the firms that took part in pre-IPO financings of Asian companies were DKR Oasis, as well as U.S. hedge fund giants such as Stark Capital, Och-Ziff Capital Management Group LLC (OZM.N) and Citadel Investment Group LLC, according to several investment bankers who did not want to be identified.

The four firms declined to comment.

"We have a few," said Liang Meng, a managing director at U.S. hedge fund D.E. Shaw, when asked at a conference about the financings. "But we're not the guys who in the last two years invested in a lot of pre-IPOs."

Abax Global Capital, a hedge fund partly owned by Morgan Stanley (MS.N), confirmed it also participated in two deals worth less than 5 percent of assets. The majority of its investments are privately negotiated transactions with public companies.

Unlike most hedge funds, Abax requires investors to lock up their capital for three years, though they can redeem a small portion after a year if they're prepared to pay a penalty. Long lock ups are more common with private equity funds.

"Since we began, our focus has been on privately negotiated investments. We recognised the inherent mismatch between these longer-term investments and standard hedge fund terms," said Benjamin Happ, the firm's head of business development.

NOTHING IN THE KITTY

Pre-IPO financings are privately arranged deals, making it difficult to identify which hedge funds are most exposed, and at what cost.

Property companies, among the darlings of the IPO boom, were especially prone to pre-IPO financings because their businesses were low on capital but high on hopes of cashing in on China's real estate boom.