Hedge funds change rules to stem redemptions

By Martin de Sa'Pinto and Laurence Fletcher - Analysis

ZURICH/LONDON (Reuters) - Hedge funds are trying stem the rising tide of investors taking out their cash but conditions they are imposing may result in a permanent reduction in the high management fees they charge.

In the last two months, more funds have taken steps to staunch outflows as cash-needy investors withdrew assets.

These have included suspending withdrawals, imposing gates -- which limit investor withdrawals in a specific period -- and introducing lock-ups, whereby investors commit their money for an agreed minimum period.

In return for accepting these conditions investors are asking for, and getting, reduced fees. And once the current period of market turmoil subsides, funds may find it difficult to raise them again.

Hedge funds are responding to a sharp acceleration in withdrawals as the end of the year approaches. Recent data from Chicago research company HFR showed that in October outflows exceeded inflows by $40 billion.

This was far beyond the $31 billion in net outflows for the entire third quarter and contrasted sharply with the record $194.5 billion net inflows to hedge funds in 2007.

It wasn't unexpected given the state of the markets and the scarcity of cash. Evidence suggests that several funds have built up a large cash position in anticipation of further withdrawals.

Investors don't object to funds holding cash to manage redemptions, but they don't want to pay for the privilege.

"I'm not paying a hedge fund a 2 percent management fee for holding cash, I'd rather take it back," said Mark Schindler, portfolio manager of alternative investments at Swiss private bank Clariden Leu.

Managers trying to stem redemptions "will recognize that to keep business they need to decrease or waive management fees," said one manager of a fund of hedge funds who asked not to be named. "When there's a continuation or restructuring plan fees are always part of the discussion and they rarely go up."

Even some of the best-known hedge fund firms have introduced protective measures for one or more funds, in return for lower fees. They include BlueBay Asset management (BBAY.L), Henderson Global Investors and RAB Capital.

DOUBLE-EDGED SWORD

When funds have to return investors' money, unless they have sufficient cash they have to liquidate assets to satisfy the requests.

That can be especially tricky for highly leveraged funds who borrow money to invest in securities using their portfolio as collateral. It is an important tool in the hedge fund armory, and its cost is one justification for the high fees many of them charge.

But while leverage can enhance gains when the manager gets it right, in down markets it can accentuate losses at the very moment that investors are clamoring to get their money out.