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What is your perception of the markets?
Reinisch: They are the most tumultuous markets that I have seen in my 20 years in finance. Of all the booms and busts, this is the biggest occasion in which systemic risks are motivating policy and investment decisions. This is not about foolish people investing in dot-coms. It is about the people who oil the wheels of the system running out of oil.
What does it mean for hedge funds?
In the short-term, hedge funds need to see some settling down among the key players and liquidity providers û including prime brokers, regulators, investment banks, dealers. Particularly when you have counterparty risk with service providers either charging you more, having less ability to trade, or not existing at all.
That said, the volatility, and binary outcomes in the sense of having winners and losers in the medium-term makes for a fertile environment for those hedge funds which are still around.
How have conditions changed with service providers?
Terms of business, such as the haircuts and rates have been tightened. We have been discussing with hedge fund managers how they go about diversifying away from a single service provider. WeÆve always perceived the failure of a major player in this space as being the biggest industry risk for hedge funds. This year, two have gone and thatÆs a watershed moment.
How have your funds of hedge funds performed?
Our diversified multimanager products are slightly underwater this year, our credit portfolios are breaking even and our macro and trading portfolios are in the black.
Will this environment change the business model for funds of hedge funds?
People will pay more heed to investor cash flows. When you are in an industry with varying liquidity, it is all well and good when money flows are coming in, but the problem comes when money is going out the door. We have seen net inflows from our investors every month this year. WeÆve managed to avoid those hot money outflow scenarios that have hurt some hedge funds and funds of funds where private bank-style clients may have been disinvesting.
If you were on a private banking platform that was seeing big outflows, then youÆre going to be disinvesting in turn from your hedge fund manager.
Those houses with structured products with leverage will find that as draw-downs take place, they may have to disinvest from their fund of hedge funds.
We may also see some consolidation in the industry. For example, in the credit long/short space, our analyst reports that in a sector comprising 300-400 names, about 100 have disappeared from our database. Maybe they went out of business, or perhaps they donÆt send out their figures û perhaps because they donÆt make good reading. Our analyst is aware of certainly 60 credit hedge funds that have gone out of business in the last 12 months. We werenÆt invested in any of them though. I think that attrition will continue, and that will affect some funds of hedge funds.
Have you disinvested from any Asian managers?
I donÆt think there have been any, but in any case, weÆve always been quite cautious about investing in Asian managers. WeÆve felt the seasoning of the managers and the tools they have in Asia is not yet at the level of more developed hedge funds locations. In secular terms Asian hedge funds might well be the most exciting in the world but they are at an earlier stage of the cycle.
Further afield, we arenÆt reticent about disinvesting where we have to. Sometimes managers adopt style drift, and you need to be rigorous in monitoring them. You canÆt necessarily stop them, but you can disinvest. Also you have to position size with managers that you have less conviction in. So if a mistake is made, it is a smaller one.
What kind of inflection point could break the capital raising logjam?
The inflection point that gets people coming back to hedge fund investing in volume might be an investor like Warren Buffet putting money in an investment bank. He is a deep value investor who has always castigated the investment banking model. However, as ever his investment was careful and cautious, and even Warren Buffet didn't invest in the stock of the bank but in preferred stock.
What are your reactions to shorting being curtailed?
The Americans have a term, æwater finds its own levelÆ. They will find a way to hedge themselves, perhaps at a higher cost, maybe through credit default swaps, perhaps through options and futures. It will happen because these investors use hedging as part of what they do.
If you were allocating now to Asian strategies, which ones would you select?
Valuations in Asia are far from high with air coming out of the larger markets, including China and India. Some of our Asia long/short managers are banging the drum about valuation and saying that it looks promising. I am not sensing the same level of business in Asia and sense of doom and gloom that is raging in London at present.
Equity long/short isnÆt the only area weÆre looking at in Asia. We look at special situations such as Chinese property-oriented prospects with potentially high IRRs that are able to get good title over the assets.
What is the biggest change to the funds of hedge funds industry from the current conditions?
In the recent past there was a sense that æsmall is beautifulÆ. I think that has now reverted to being æbig is beautifulÆ. Business relying on performance fees to pay staff and working capital will have a hard time this year. Longer established businesses will have an easier time weathering the storm and investors should seek that safe haven in preference to the $200-$300 million shops that sounded quite exciting 18 months ago.
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