October 31, 2008 / 10:05 AM / in 11 years

Hedge funds working to limit redemptions

BOSTON (Reuters) - Dozens of hedge funds have told investors they cannot get their money back right now as managers try to limit a wave of redemptions to safeguard all their clients’ investments — as well as their own futures.

Only a few months ago, hundreds of the world’s estimated 9,000 hedge fund managers made it tough for wealthy investors to put money into their funds by requiring high investment minimums of $1 million (617,500 pounds) or more and charging heavy fees.

Now managers are making it hard for investors to get out.

“Everyone is looking at their gate provisions (mechanisms that limit redemptions) and what rights they have to close their gates,” said Timothy Mungovan, a partner who advises hedge funds at law firm Nixon Peabody LLP. “It is a phenomenon that has been occurring for some time and is picking up pace now.”

On Thursday, Knight Capital Group’s Deephaven Capital Management halted redemptions at two of its hedge funds.

Recently, hedge fund firm Basso Capital told investors it was postponing redemptions. Hedge fund firm Ore Hill Partners imposed a gate in late August.

Before that Drake Capital Management and Pardus Capital Management began restricting clients’ departures and Ellington Capital Management stopped allowing investors to exit one of its portfolios last year.

Blocking investors’ exits, even if only briefly, was once a highly unusual move that often signaled a hedge fund was on the verge of collapse, managers and investors acknowledged.

That is changing now as ever-more managers and investors engage in a tug of war over who can receive money right now.

“Hedge funds are trying to act as the ultimate fiduciary to their investors and the way they are doing that is by restricting the capital that can leave,” said Perrie Weiner, a partner and international co-chair of law firm DLA Piper’s securities litigation practice.

FIRE SALES

Managers argue that, if they had to return investors’ money exactly when investors demanded, funds would have to unload securities at fire-sale prices and many clients who were not looking to get out would be hurt by those moves.

Already, hedge funds have been blamed for accelerating the stock market’s tumble by dumping shares to get liquidity.

“Restricting redemptions allows the managers to withhold selling into unfavorable markets,” said Michael Tannenbaum, a partner at law firm Tannenbaum Helpern Syracuse and Hirschtritt LLP, explaining that panic selling in these markets can be “harmful to both sides: the investor and the redeemer.”

But investors are not wholly convinced by this argument. Many are still asking to get their money back now.

Spooked by hedge funds’ worst-ever returns at a time the average fund has lost 20 percent this year, pension funds and wealthy individuals alike are leaving hedge funds faster than ever before, lawyers and managers said.

Between July and September, investors pulled out a record $31 billion, which helped shrink the industry 11 percent to $1.7 trillion. And more redemptions are expected to flood in by November 15, the deadline to get money back by year’s end, industry lawyers and investors said.

“A lot of people are looking for liquidity which is causing people to redeem investments,” said Dean Junkans, chief investment officer at Wells Fargo Private Client Services. “And hedge fund managers are looking for a variety of ways to keep the capital.”

Some managers and lawyers are saying the stigma of blocking an investor’s exit is disappearing.

“It is a changing environment and in a while these won’t be viewed as a scarlet letter anymore,” Nixon Peabody’s Mungovan said.

Still locking investors in, even if it is only briefly, can breed ill will and many managers are also looking for gentler ways to persuade investors to keep their capital with them for a while longer.

Some firms such as Ramius Capital have proposed cutting fees to keep investors locked in, people familiar with their plans said. Also some managers said they are considering modifying their high water marks, or levels that must be topped before investment managers can be paid their performance fees.

Editing by Jason Szep and Andre Grenon

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