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San Francisco Hedge Fund Industry Event

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BAHR Panel Discussion on Global Investing Trends
By Bart Mallon of Cole-Frieman & Mallon LLP

The Bay Area Hedge Fund Roundtable convened again today at the Sens Restaurant in San Francisco to discuss the global investing trends and how those trends are affecting the hedge fund industry. The presentation was moderated by Ron Resnick (ConselWorks LLC) and included the following panel participants:

John Burbank (Passport Capital LLC)
John Shearman (Albourne America, LLC)
Matt Kratter (Kratter Capital LLC)
Patrick Wolff (Clarium Capital Management, LLC)

Overall the panel discussion was very interesting and I think that Ron did a very good job of moderating in a kind of “Meet the Press” type of way. The speakers all had interesting viewpoints and were able to keep the audience interested in the topics. Below I will give a very high level run-down of the major topics discussed – if anything does not make sense, it is likely a mistake in my hearing so please do not hold that against any of the speakers.

Additional note: this is not in any way an advertisement for any hedge fund and is not an offering of any interests in a hedge fund. I have never talked to any of the named speakers and everything I am writing below is on my own volition.*

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John Burbank

The discussion was started when Ron asked John was his fund was investing in. John said that he is now investing in the United States in the same stuff as he was before. However, he spent a good deal of time discussing liquidity and how it will affect investment decisions going forward. Central to his discussion were his views on deflation. He ended this part of the discussion by noting that governments (especially the U.S. government) has so many tools to effect the financial markets (in addition to simply printing money) and that many actions are driven by the current liquidity situation.

Matt Kratter

I infer that Matt started his own hedge fund last year because he was asked whether it was a good or a bad time to start a hedge fund within the last twelve months. He noted that it was not the best time to be on your own but that the times serve as a good proving ground that a manager can withstand market downslides. Matt talked about variability of inflation going forward and that he is currently net short. He thinks that multiples are likely to retract in the future.

John Shearman

John was asked whether investor’s hedge fund expectations have changed. He said that investor expectations have come down a bit, but beleives that the forcase for the future has never been better. Post 2008 he sees that there has been a shifting of power back to hedge fund investors and he mentioned two buzzwords – lower fees and transparency. While fees have not really come down recently, there have been huge gains made in expectations of transparency. This is especially true with regard to valuation and verification of assets. Hedge funds have made these changes and it is relatively easy for them to say yes to such requests (as opposed to requests for fee decreases).

John seemed to indicate that there is more opportunity for investors to come together and present a united front with regard to what they want to see in these vehicles, but it has just not happened. A central reason is that foundations and endowments (two of the largest groups of hedge fund investors) are not really in a position to be an agent of change because they are examining the funds they are already invested in. He also mentioned a general increase in separately managed accounts noting that the central driving force is the investor’s need for control of assets – liquidity without conditions.

Patrick Wolff

Patrick was asked point blank while his group did not do as well this year. He said that, unfortunately, they had the wrong investments this year and that the drawdown was not a result of their risk management policies and procedures. Patrick talked about macro themes including China, volitility, carry trades over the last year and the fundamentals of major government players (centrally China and the U.S.). He feels there is a current bubble in China which is likely to last in the near term. He thought that a major macro issue moving forward will be how the governments will continue to be involved in the credit markets. Patrick believes that the U.S. has huge off balance sheet liabilities.

Other Question and Answers

What are the major trends moving forward?

John Burbank – governments changing the rules of the game as it is being played. What is going to happen will be driven by governments subject to: the price of the dollar, commodities, or China.

Why did gold hit an all-time high today?

Matt Kratter – I don’t know, but this is a question which everyone is asking – even the garbageman.

How is capital flowing?

John Shearman – there are a lot of opportunities in hedge funds – lots of alpha and distressed assets. Macro discretionary is a good play right now and there is a lot of interest in commodities.

How is fund raising in this environment?

Matt Kratter – fundraising has been slow since last year but there is more activity at the margins. Fundraising will probably stay difficult for awhile.

Are investors more interested in the investment side or infrastructure side during due diligence conversations?

John Burbank – all investor due diligence is taking longer. Current investors are coming back and asking questions they should have asked earlier. It is now similar to 2003 – there is a lot of excitement. Which makes sense because investors essentially have three choices: mutual funds, do-it-yourself, or hedge funds.

[Someone mentioned that capital is not there for a start up and the question arose as to whether two guys and a Bloomberg really had a chance to raise capital in this environment. John said that start up managers should not be afraid to start out small – he started with about $1MM in AUM and slowly grew to $12MM after three years (his firm now manages over $2 billion). John emphasized that over time good managers will be able to demonstrate their strategy and if the numbers are good, investors will eventually find such managers.]

What about hedge fund regulation?

Patrick Wolff – over hedge fund regulation is not a huge deal. If you are registering with the SEC you are going to be required to do things that, as a good business, you should be doing anyway. The key to regulation is that it needs to be sensible. Regulation itself is not bad.

Questions from the audience

When Ron asked the audience if there were any questions there was a long pause. I eventually asked the panel what they thought about the headlines recently regarding the U.S. dollar and whether it would remain the world’s reserve currency. Patrick responded first that worry about the dollar is overhyped. However, he did note that his fund has had some investors request share classes in a different currency.** John noted the practical limitations of moving toward another currency and noted that if a government needs to get a billion U.S. dollars it can happen, but that wouldn’t be the case with other currencies.

Note on People Who I Met

After the panel there was time to discuss the presentation and do some networking. I had the distinct pleasure of talking with a number of people at the event, including:

  • Jenny West of Probitas Partners (fund placement services)
  • Mason Snyder of Catalina Partners (risk advisory to investment management industry)
  • Rosemary Fanelli of CounselWorks (regulatory consulting for financial institutions)
  • Ron Resnick of CounselWorks(regulatory consulting for financial institutions)
  • Maria Hall of M.D. Hall & Company (CPA services for small funds)

* If you are a named speaker and would like your name and information taken out of this article, please contact me.

** I am in the process of writing an article on this topic – if you are a hedge fund manager who wants to create another class of fund interests denominated in another currency, please feel free to contact me to discuss.

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Bart Mallon, Esq. of Cole-Frieman & Mallon LLP runs Hedge Fund Law Blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund or register as an investment advisor, please contact us or call Mr. Mallon directly at 415-868-5345.  Other related hedge fund law articles include:

Bay Area Hedge Fund Roundtable Event

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Panel Discussion on State of Hedge Fund Industry

Yesterday afternoon (May 6th) the Bay Area Hedge Fund Roundtable, a group of professionals within the hedge fund industry, gathered for a panel presentation entitled “Change…Critical Legal, Tax, Acounting and Regulatory Updates You Need to Know.”  The presentation was moderated by Pamela S. Nichter (Osterweis Capital Management) and included the following panel participants:

Vincent J. Calcagno (Rothstein Kass)
Geoffrey Haynes (Shartsis Friese)
Tony Hassan (Ernst & Young)
Anita K. Krug (Howard Rice)

Presentations like these are great because they allow professionals to share insights into what is going on in different parts of the industry – many of the topics discussed allowed the panelists to really dig deep into the issues and provide some context to what is happening at both the regulatory and investor levels.  I took notes during the presentation and will summarize some of the main points discussed by each of the presenters (please don’t hold anything against the speakers if I mis-paraphrase or mis-interpret and as always nothing in this summary is tax or legal advice)…

Anita K. Krug

Anita discussed a number of the laws which have been discussed or proposed over the past 6 to 8 months including the following:

  • Barney Frank’s Recent Comments (see Reuters article)
  • Mary Shapiro’s Recent Comments (see Bloomberg article where Shapiro says she wants the ability to make rules regulating hedge funds)
  • Discussion of the Hedge Fund Transparency Act which was proposed in the Senate earlier this year (see also Overview of the Hedge Fund Transparency Act)
  • Hedge Fund Advisor Registration Act which was proposed in the House earlier this year
  • Geithner’s hedge fund proposals (see NY Times article for background information)
  • Discussion of the past short selling rules (see HFLB article) and the new short selling rules which will be closer to the old “uptick” rule (see SEC overview; note: I have not yet had an opportunity to thoroughly review these proposed rules)
  • European Rules which have been proposed which may have an effect on US based managers with EU investors (Anita raised many of the same issues which were also raised in this article)

Geoffrey Haynes and Vincent J. Calcagno

Geoffrey and Vincent went back and forth discussing some of the tax issues which managers are likely to face this year and potentially going forward.  This discussion included the following issues:

  • Discussion of the new offshore deferral rules by dint of new Section 457A of the Internal Revenue Code (see generally this alert).  Note: discussions on the ramifications of this new section to managers who currently have deferral arrangements took a majority of the time.  There are a number of issues involved including issues with side pockets, options, and non-conventional performance fee periods.
  • San Francisco Payroll Tax of 1.5% (see background on this issue here)
  • Discussion of the Levin proposal to tax the carried interest as ordinary income (see Hedge Fund Carried Tax Increase?).  [The panelists seemed to think that Congress would not vote on this bill until sometime in 2010 (if the bill was actually even voted on) with an effective date, if passed, of sometime in 2010 – the panelists did not seem to think it would be retroactively applied.]
  • Discussion of a bill which would eliminate UBTI for U.S. based non-taxable investors investing in U.S. hedge funds which utilize leverage (note: I was not aware of this bill and am not sure what bill exactly was referred to – please feel free to contact me if you know about this bill).  The panelists seemed to think this bill was likely DOA.
  • Discussion of the Stop Tax Haven Abuse Bill by Senator Levin (see Senator Levin’s press release)
  • Discussion of Obama’s Offshore Tax Plan (see generally the White House press release)

Tony Hassan

Tony discusses what is changing in the area of hedge fund operations.  Tony’s discussion of current topics was maybe one of the more important parts of the panel in terms of providing insight on current investing trends and due diligence requests.  Many of the items in this section were part of a dialogue between Tony and Vince as noted in the parenthesis below.

  • There is no secret that due diligence is a more central and important part of the investing process than it was previously.  (Tony and Vince)
  • Due diligence is also changing in many respects – at E&Y Tony has had specific requests from potential invests to send them directly the financial statements.  Of course this brings up many legal and client issues (the hedge fund, not the potential investor, is the client of E&Y) and because of this these requests are often denied. (Vince)
  • Managers are providing verified transparency “quarterly reviews” which aim to show investors that the fund’s assets are actually there.  (Vince)
  • Some funds are instituting a half-yearly audit (in addition to the end of year audit).  (Vince)
  • Some funds are instituting agreed upon procedure reports.  In these reports the auditor will come in an verify that certain procedures are being completed.  This may be especially important with regard to the valuation of the fund’s assets.  (Vince)
  • Tony noted that this is really a new form of due diligence and used the term “Hedge Fund Due Diligence 2.0” – a term I used in October of 2008 (see post).
  • Investor questions to hedge funds are changing.  While previous questions would have stopped after “Do you have a 3rd party administrator?”  Now the questioning continues – investors want to know about the administrators technical expertise, who exactly will be the account representative and what type of capital markets experience does that person or group have, what inputs will be used to value assets, etc.  Investors also want to know what sort of contingency plan is in place should the administrator fail or if there is a disaster; investors will want to know if the fund is keeping shadow books.  (Tony)
  • Tony also participated in the discussion with Pamela below with regard to managed accounts.

Pamela S. Nichter

Pamela, the moderator of the discussion, also weighted in on certain operational issues which fund managers should be prepared for in the new climate.  In general Ms. Nichter is seeing more investor requests and communications.  Now there is greater communication between the investor and the fund manager.  Ms. Nichter also discussed the trend toward greater liquidity and transparency through separate account structures.

Separate accounts are something that more and more investors are seeking but there are many considerations for managers.  Specifically separate accounts can be a drain on resources, especially if the investors request their own specific administrators or auditors.  Because of the greater amount of resources which need to go into the back office to handle what is in essence a more traditional asset management business, the manager must be ready to change the business model to a certain extent.  Specific issues will include:

  • having a robust trade allocation policy
  • understanding that there is likely to be a disparity of performance
  • potential registration issues
  • potential integration issues
  • performance reporting issues (may need to go back to GIPS)

Questions and Conclusion

After the panel finished their discussion the floor was open to questions.  During this time there were a number of good questions.  One issue focused on what will performance fees look like going forward which led to a discussion about creative performance fees (like instituting some sort of clawback provision like what is found in private equity funds).  Another issue was whether and to what extent the Managed Funds Association will be representing the industry during this time of legislative/regulatory changes.  The answer is that the MFA will be doing everything it possibly can to represent the hedge fund industry and it is our job to make sure that the MFA knows how the industry feels about many of the current legislative proposals.