HEDGE FUND NEWS
@ Tue 22 May 2007 : GMT

FINTAG COMMENT

My car picks me up later this morning and I am off to Stamford to pick up a boat to Greenwich (not the place with the burnt ship but the playground of Hedge Fund managers). As I leave hospital, a large cheque has been deposited to thank the staff for looking after me. If only I had a Picasso to sell as I could buy the whole hospital. The world is mad and gets madder. Credit is mad; the art world is mad; the FSA is mad; Lehman's debt chief is mad; 130/30 is mad and Germany is mad as hell.

And I have just read that Viagra helps with jet lag...

Lock Me In The Tower News

Blackstone IPO Offering Document (sec)

Bear Stearns energy unit cuts biggest deal (financialnews-us)

Mobius's Templeton trust to offer "staggered" exit (reuters)

Texas hedge fund manager pays penalty for violating antitrust premerger notification rules (webwire)

Returns to suffer as hedge funds lose appetitie for risk? (businessweek)

Chindia ETF combines two of hottest economies (investors)

UTI MF expects gradual gold fund demand (b-s)

Australia Qantas' Jackson warns hedge funds pose risk to share price (iii)

Rabobank brings fund derivatives expertise to Asia (asianinvestor)

HOW MUCH?

Art sales: Billionaires ignite record sales boom (telegraph)
Contemporary art sales soared to a staggering $837 million in New York, thanks to enthusuastic bidding by the new super-rich, says Colin Gleadell

At the contemporary art sales in New York last week, Sotheby's, Christie's and Phillips de Pury & Co realised their highest sales totals ever. In all, a total of $837 million (£425 million) of sales was achieved, with more than 120 artists' records broken. The comparative total last November was $550 million.

Art sales
Iconic: Richard Prince's photograph of a cowboy taken from an old Marlboro cigarette advertising campaign

Although sceptics have been predicting the collapse of an over-inflated market for several years, it has continued to expand. Tobias Meyer, Sotheby's charismatic auctioneer and head of contemporary art, even suggested a year ago that there was going to be another art boom on top of the one we have already been experiencing. In the event, he was proved right.

All the key elements were in place. Global wealth has been increasing dramatically, and the new billionaire classes have been looking at art. In America, this new wealth is typified by hedge-fund managers Steve Cohen and Ken Griffin, who have been earning more than a billion dollars a year and spending hundreds of millions on art.

On Forbes's latest annual list of the world's richest people there are 946 billionaires, 178 of them newcomers. Many of those from Russia, India and China have been buying art, fuelling selective local markets for Russian, Indian and Chinese art and moving into more international markets.

With buoyant auction results and reports of prices from $50 million to $140 million paid for Impressionist, modern and contemporary art on the private market, owners have been tempted to sell their best art at auction. Saleroom experts say that this is where buyers feel more secure, spending in a competitive environment. The combination of the improved quality of supply and increasing global demand has now sent prices spiralling again across the board.

Not long ago, the contemporary art auctions trumpeted $1 million sales; now they are commonplace. In the main evening sales last week, 86 works sold for between $1 million and $5 million. Entering the million-dollar price bracket for the first time were the elusive black American artist David Hammons and the photographer Cindy Sherman, now an acknowledged influence on younger artists. Sherman's Untitled No 92 sold for $2.1 million, four times its price two years ago and three times her previous record.

Thirteen works sold for between $5 million and $10 million. The range of new records here was equally eclectic - from the stark minimalism of Donald Judd to the glaring pop of Tom Wesselmann, the seductive abstractions of Gerhard Richter, and the cartoon-style late paintings of Philip Guston. Guston's Head and Bottle (1975) doubled its estimate to sell for $6.5 million to the London dealer Timothy Taylor.

Works of art selling for several times their estimates are not unusual for younger artists, where sell-out shows and waiting lists can drive the auction price far above gallery prices. But in the $5 million-plus range for blue-chip art, it is a rare sight.

It was extraordinary to see Jean-Michel Basquiat's self-portrait double estimates, already in record-price territory, to sell for $14.6 million; to see five bidders take Francis Bacon's Study After Innocent X over his previous $27 million record to $52.6 million in a matter of minutes; to see Andy Warhol's Green Car Crash double an ambitious estimate to sell for almost $72 million; and to watch bidding go up at one million dollars with each wave of the hand for Mark Rothko's White Centre to $72.8 million. The buyer of the Rothko is thought to be Middle Eastern. The buyer of the Warhol was speaking in Chinese, possibly from Hong Kong.

It is tempting to think that the world's super-rich had developed an obsession with death (car crashes), drugs (Basquiat died of an overdose), distortion (Bacon's twisted vision) and depression (Rothko committed suicide). But what we were seeing was a demand for works of "iconic status", whether that be in art-historical terms or in terms of the familiar branding imagery that younger artists such as Sherman or Richard Prince draw upon. Prince saw his record broken twice, rising to $2.8 million for a photograph of a cowboy taken from an old Marlboro cigarette advertising campaign.

"Art has always followed money, and money follows the strongest markets," says Brett Gorvy, deputy chairman of Christie's. "Right now, those markets are not just in the West, but in the Russian states, the Middle East and in Asia."

Going, going...
# Dealer Larry "Go-Go" Gagosian was one of the biggest bidders at the sales, buying 10 lots for a total of more than $35 million. These included a record $2.4 million for a spot painting by Damien Hirst, a record $17.4 million for a small painting by Jasper Johns, and a record $360,000 for a painting by rising young American artist Mark Grotjahn.Gagosian also bid unsuccessfully on several works including Andy Warhol's $28 million Lemon Marilyn and the record-breaking Green Car Crash, which sold for $71.7 million.

# Works by Andy Warhol contributed $165 million to the sales, more than any other artist, and almost 20 per cent of the grand total.

# Imagine you had bought a property in 1998 for $90,000 and sold it last week for $2.2 million. Impossible? Not if the property had been American pop artist Tom Wesselmann's Mouth, a painting that did just that for its owner, selling to dealer Daniella Luxembourg. Other big mark-ups came for Roy Lichtenstein's 1965 painting on steel Girl in a Mirror, last sold in 1986 for $110,000 and now for $4 million to dealer Jeffrey Deitch, and Jean-Michel Basquiat's $14 million self-portrait, which was originally bought soon after it was painted in 1981 for $3,600.

# Several artists saw their auction records broken twice at the sales. Californian conceptual artist John Baldessari's record rose from $800,000 to $992,000 at Sotheby's, and then to $4.4 million at Christie's for a rare 1960s word painting. British painter Cecily Brown saw her auction record rise to $1.1 million at Sotheby's and then to $1.6 million at Christie's for a painting owned by Charles Saatchi, bought 10 years ago for about $10,000.

# Apart from Warhol's Green Car Crash, Asian buyers accounted for works by Willem de Kooning ($19 million) and Gerhard Richter (a record $6.2 million), as well as setting a new record for Damien Hirst ($7.4 million).

# Two paintings by Jackson Pollock were the most conspicuous unsold lots, but a 1983 copy of his painting Lavender Mist by the appropriation artist Mike Bidlo soared to a record $480,000, selling to New York dealer Nicholas Sands.

WHO IS LISTENING?

Germany Calls for Voluntary Hedge Fund Rules (dealbook)
Germany has switched tactics in its efforts to police the fast-growing global hedge fund industry, hoping to overcome skepticism by other Group of Eight member countries by encouraging the industry itself to compile a voluntary code of conduct.

Washington and London would support a code that emerged “spontaneously” and “voluntarily” from the hedge fund industry, Peer Steinbrueck, the German finance minister, said after meeting colleagues from the G-8 industrial nations in Potsdam over the weekend. If funds adopted a code themselves “then we have the same opinion”, he said in a televised interview.

“The good news is that the hedge fund industry itself is more and more interested in quality standards, in guidelines, to take care of higher market integrity and investor protection,” Mr. Steinbrueck said after the two-day meeting. “Interests are converging.”

His comments come as many member states, like the United States and Britain, have indicated that they are opposed to any top-down regulation for the pools of capital. Their stance has been an embarrassment to Germany, which has made increased transparency of the industry a top priority in its role as the current president of the G-8.

ONE HUNDRED AND FORTY

Institutional Sales Professionals Ramp-up on 130/30 (allaboutalpha)
he Association of Investment Management Sales Executives (AIMSE) bills itself as an “educational forum for those employed in the investment management sales and marketing services profession worldwide” to help its members “adapt to the changing needs of the marketplace”. That mission was on display earlier this month in Scottsdale, Arizona as hedge funds and 1X0/X0 played central roles at the organization's 30th Annual Marketing & Sales Conference.

A panel at the conference entitled “130/30 and other Hybrids: How to Turbo-charge Strategies for Long-only Managers” involved representatives from Northern Trust, RogersCasey, and Acadian Asset Management. The slideware from that session provides some interesting insight into the how the traditional institutional sales community is addressing 1X0/X0.

Along with slide presentations from all the panelists involved with the discussion, AIMSE has posted what appears to be a set of discussion questions. Unfortunately, the answers aren't available. But the questions speak for themselves:

* “What took so long? ... Why now?”
* “Who is best suited to manage and why? Quantitative Managers V Fundamental Managers.”
* “When does 130/30 become a hedge fund?”
* “Could capacity in the aggregate become problematic as the strategy continues to gain traction and shorting volumes increase?”
* “What effect does shorting have on portfolio risk?”
* “Optimal leverage ... Is 120/20 better than 130/30? Should the ratio be fixed or floating?”
* “For clients (such as public plans) who are into securities lending, can they lend to themselves?”
* “Fees + Other Costs to Clients?...Flat or performance-based?..30% higher than a long-only fee?”
* “What do you call it and how do you position it? Traditional or Alternative?...Proper Benchmarks?”

Panelist Jeremy Baskin, Director of Active Quantitative Strategies at Northern Trust Global Investments, reviewed the basics using the following two charts to illustrate the freedom of expression enabled by modest short-selling.

His first chart (not shown above) shows the weightings of a typical long-only fund (with an apparent position concentration cap of +60 bps). Note the maximum possible active bet against each name is dictated by the proportion of the index represented by that name. So for large caps, active bets against a stock can routinely amount to -60 bps. But for most of the universe, active bets against each stock are capped at less than 20 bps.

His second chart (below) shows how those active bets can be much larger by adding the ability to short (again, with an apparent short position concentration limit - this time -40 bps).

Note also how the cash generated through the shorts is applied to more (although notably not larger) long positions.

Jack Gastler of Acadian Asset Management seemed to suggest that 130/30 isn't going to face a capacity constraint any time to soon. Said his slides:

* “Considerable depth in the short inventories of MSCI World index securities.”
* “Less than 10% of index securities have no short inventories.”
* “On average, each security has about 4% of its free-float shares outstanding available for shorting - this is not a function of company size.”

In addition, Gastler submits this paper on short extension strategies by Acadian that includes some pretty nifty scatter plots that make essentially the same argument Baskin did, but compares the removal of the long-only constraint to the removal of other constraints (e.g. country, industry etc.)

Suny Park of RogersCasey addressed some interesting questions about fees such as:

* Should the management fee be based on dollar net exposure or on gross exposure?
* Should management fee be tied to expected alpha?

Park also submits his own November 2006 article on 120/20. In it, he uses some refreshingly frank language to describe what's at stake in the battle for 1X0/X0 supremacy:

“The 120/20 managers take great pains and go to great lengths to defend why the 120/20 portfolios belong in the traditional camp versus the alternative camp where the hedge funds and other alternative investments reside. To a casual observer product positioning may appear trivial, but for the 120/20 managers implications of product positioning and assets that follow as a result are anything but trivial. In the context of the overall plan asset allocation, consider the size of assets that are allocated to the traditional equities versus hedge funds. Even with the outflow of funds from the traditional equities to the hedge funds, the former dwarfs the latter in terms of dedicated assets. Bottom line, the 120/20 managers would like a piece of the much bigger pie.”

Park also presents some proprietary research on 120/20 fee structures. According to RogersCasey, the average 120/20 manager charges 77 bps per annum - 15 bps higher than long-only large cap active managers. Fair enough, says the firm. But it also suggests that the inclusion of a performance fee by several 120/20 managers was downright hypocritical:

“Certainly managers deserve to be fairly compensated for their value-added service but charging a 20% performance based fee simply because shorting is allowed does not seem equitable, especially when they go to great lengths to defend why the 120/20 portfolios are an extension of traditional portfolios. They cannot claim (from the product positioning standpoint) that the 120/20 portfolios are traditional portfolios and in the same breath claim that they deserve to be paid like hedge funds because they possess hedge fund characteristics (mainly shorting).”

Still, RogersCasey's own recommendation is that 120/20 managers charge a performance fee on the 20/20 portion. So apparently they don't dislike performance fees that much.

So there you have it. If you're an institutional investor, get ready for presentations much like these for the next year. And if you're an institutional sales person, this is your new sales presentation benchmark for 1X0/X0 RFPs. Let the games begin.

BUBBLE TROUBLE

The consequences of credit's alchemical transformation (ftalphaville)
High finance has never been more sophisticated. Bankers have never been more clever. Yet huge problems are emerging from the deterioration of lending standards - and at their heart lie the rise of structured financial products and the role of credit rating agencies, say FT commentators, beginning with John Plender in Tuesday's Insight column.

In the US subprime lending boom, “banks have been falling over themselves to advance 100 per cent loan-to-value mortgages to out-of-pocket deadbeats,” says Plender. “Lending standards to private equity, meanwhile, are collapsing just as risks rise and returns are being competed away. 'Cov-lite' loans are the order of the day, meaning that restrictions on a borrower's interest cover and balance sheet leverage cease to apply.” All this, he notes, has prompted Anthony Bolton, the UK's star fund manager, to warn of impending doom.

So what is the explanation for such apparently aberrant behaviour?

“At one level, it is simply that banks no longer have to worry about loan quality in securitised markets where the loans they originate are immediately sold. So the more pertinent question is, why do investors buy from the banks?”

“The answer, as Henry Maxey of the Ruffer fund management group argues in a forthcoming paper for the Centre for the Study of Financial Innovation, is that Wall Street has solved their most pressing problems with its invention of structured products.”

Take the hedge funds, says Plender, in which conventional investors such as pension funds invest increasingly via hedge fund of funds. “These intermediaries typically aim for positive returns of 1 per cent a month, net of fees, with low volatility. If the hedge funds they back fail to deliver on 3- to 6-month performance figures, they are culled.”

“The hedge funds need to make about 20 per cent gross a year, before a welter of fees, to provide that 1 per cent a month for their backers. Such a spectacular return can be gained either by market outperformance, which is beyond most fund managers, or by taking on leverage through borrowing, or trading in derivatives. For most, that means adopting leveraged strategies in illiquid assets,” he writes.

Structured credit products are tailor-made for this task, says Mr Plender. Collateralised debt and loan obligations (CDOs and CLOs) invest in poor-quality assets such as subprime mortgages or loans to super-leveraged buy-outs, and sell matching liabilities to investors (see Gillian Tett's Market Insight column on the effect of collateralised debt).

“Yet the sale involves an alchemical transformation,” Plender writes. “The package is sliced and diced into high- and low-risk tranches, with usually up to 80 per cent being rated Triple-A or AA and the residue being very lowly rated or unrated.” For pension funds and managers of official reserves, the resulting high-grade paper is a boon at a time when Triple-A corporate borrowers have dwindled, he notes.

“For hedge funds the low-grade paper, which provides a cushion against default risk in the high-grade tranches, is likewise a boon, especially since, as Mr Maxey points out, it lends itself to arbitrage whereby hedge funds take long positions in the high-risk tranches and short positions in the low-risk tranches, which are relatively expensive. This ought to increase market efficiency since more investors can buy into a given pool of low-quality credit-enhanced assets.”

“The peculiarity of this trade is that profit is never arbitraged away in the benign phase of the credit cycle because positions are not constantly marked to market. Their illiquidity requires them to be marked to a model approved by credit rating agencies. But rating agencies, who are paid by those who they rate, do not adjust ratings to reflect deteriorating economics. They close stable doors after profligate horses have bolted.” (See the FT's recent analysis of how the Big Three rating agencies are handling their job in the fast-growing and complex market for structured finance),

“It follows, as Mr Maxey notes, that relaxing lending standards is perfectly rational,” says Plender. “To increase lending volume, banks could either reduce their interest rates or reduce underwriting standards. Given the hunt for yield, this is a no-brainer. So collapsing standards will now stretch out the credit cycle while ensuring the delayed downturn will be more savage when the defaults finally happen.”

“This subverts the argument that structured products uniformly enhance market efficiency. Credit is being mispriced, courtesy of credit rating agencies that are insensitive to market risk.”

Plender's stark warning: “Stand by for systemic consequences in due course.”

KITCHEN TOO HOT

Lehman debt chief joins alternatives manager (financialnews-us)
One of Lehman Brothers' most senior structured finance bankers is expected to join a US-based hedge fund, as alternative investment firms extend their trading operations into areas traditionally the preserve of investment banks.

Sridhar Bearelly, former global head of collateralised debt obligation syndication at Lehman, is joining ZAIS Group, a New Jersey-based alternatives manager with more than $10bn (€7.4bn) of assets under management.

Bearelly is expected to take a leading role in running ZAIS' CDO division. ZAIS Opportunity, one of its funds that invest in the complex debt instruments, returned about 17% to investors last year, beating an average of 11% in the alternatives sector.

Bearelly, who worked within Lehman's CDO business for nearly 10 years, has been replaced at the bank by Dorothee Fuhrmann in Europe and Jason Schechter in the US.

A spokesman for Lehman said Bearelly's departure was amicable.

Fuhrmann was former co-head of Morgan Stanley's European CDO business, while Schechter's move was internal.

Bearelly's departure last month followed that of Mark Zusy, a former head of Lehman's CDO banking business, who retired this year.

Hedge funds have been expanding their trading operations into the asset-backed securities markets in recent months. Brevan Howard, a fixed-income global macro hedge fund, and BlueMountain Capital Management, are preparing to launch new funds dedicated to the asset class.

JOKERS

FSA probe ends: No disciplinary action taken (telegraph)
The Financial Services Authority's three-year investigation into the collapse of the split-cap investment trust sector has ended with no one individual receiving formal censure.

Paul Davidson: FSA probe ends with no disciplinary action taken
Paul "The Plumber" Davidson

The FSA, which has been looking into the collapse of the risky investment products since 2004, announced it had agreed varying industry bans with four men involved in the affair, but stressed no disciplinary action is to be taken.

The approach is in stark contrast to the regulator's approach in other areas, where it has attempted to levy heavy personal fines against a number of high-profile individuals including hedge fund manager Philippe Jabre and inventor Paul "The Plumber" Davidson.

But the regulator has ensured £195m of compensation has been paid out from the industry to the former shareholders in the closed-ended funds.

The split-cap sector, which collapsed in 2000, began in the 1970s as a complex investment for saving for school fees or retirement. But high levels of debt in certain trusts, particularly those exposed to the dotcom boom, revealed the fragile nature of the investment strategy as the market turned.

Thousands upon thousands of investors were affected, with the combined losses running into hundreds of millions of pounds.

The FSA yesterday announced that four men, including BC Asset Management (BCAM) chief executive David Bruce, have agreed to various bans on their work in the financial services sector for a range of dates lasting until October 2009.

Mr Bruce has agreed to resign from his role at BC, and to give up his existing controlled functions apart from one. He has also agreed not to perform any significant financial services functions until April 3 2009.

As a result, the financial watchdog has discontinued its investigation into BCAM, one of the many companies that managed split caps.

Separately, Roderick Crawford and Paul Glover, both formerly of Collins Stewart, agreed to refrain from taking on certain City functions before October 2009. A fourth man, Anthony Reid, who was chief executive of the since liquidated BFS Investments, agreed not to perform any controlled functions until October 2009.

The four join another four, including former Aberdeen Asset Management staffer Chris Fishwick, who have escaped formal censure.

But one City observer pointed out that agreeing bans was the best use of resources, and enabled the regulator to tie up loose ends. An FSA spokesman said: "One of our aims was for investors to get a payout as quickly as possible. It was a pragmatic solution to a very complicated issue."