Friday, August 24, 2007

Here We Go - Cue The Excuses.....

I didn't particularly want to be writing about specific hedge fund failures unless it was a monster one, mainly because, in reality, smaller funds are failing all the time, for one reason or another. This story, however, peaked my interest and its not a hedge fund.. A $1.6bn cash manager (small, in the grand scheme of things), Northbrook, Illinois-based Sentinel, wrote to investors last week saying that it could not meet client redemption requests without selling securities at a deep discount.

Would you like me to write that again? the company "could not meet client redemption requests without selling securities at a deep discount".

So follow the logic on this one (and please if I have got this all let me know) a 'short term' cash manager is investing money given to him by hedge funds and the like (funds that are suppossed to be 'un-invested', one would imagine) and then investing these in the market...hmmm...

Following the ethos that now "is a good time to get bad news out" they wrote this letter to clients saying:

'Investor fear has overtaken reason and has induced a period in which most securities have simply ceased to trade. We've all read the stories about one hedge fund or another suffering losses related to sub-prime exposure and closing down or being rescued.

'This fear has spilled over into the rest of the credit market and liquidity has dried up all over the street. This liquidity crisis has caused bids to disappear from the market and makes it virtually impossible to properly price securities or to trade them. High-grade securities are trading like junk bonds as panicked investors dump names like General Electric at Tyco-like prices.

'We had previously thought that the market would return to some semblance of order and that our clients would not join in the panic. Unfortunately, this has not been the case. We are concerned that we cannot meet any significant redemption requests without selling securities at deep discounts to their fair value and therefore causing unnecessary losses to our clients.'

Re-arrange this well know saying "CROCK - WHAT - A"

'High grade securities trading like junk'. I know I have been away for a few days and haven't really been paying too much attention but I must have missed this particular meltdown.

Forgetting the financial equivalent of 'the dog ate my homework' excuse what is the logic here? You pay your 2 & 20 fees to a hedge fund which you have, presumably, done your research on. There would have been a note in the prospectus about Sentinel being short term managers and you assume this would be overnight stuff aimed at getting a better return on cash... Then you find that the cash manager has been trading in securities that 'are impossible to properly price' in a fast market....

I don't know about you, but I would be looking in my contacts file under 'flesh eating lawyer'.

After having their trading strategy eating by Fido, Citadel Investment Group, a hedge fund manager that has already acquired distressed credit portfolio assets over the past month from Sowood Capital, bought a reported USD312m in assets from Sentinel at a discount of at least 10 per cent. It turns out this was not a popular move.

Investors, such as Penson Worldwide, said "the assets had been sold at an unfair price" without consulting creditors and against agreements between the companies. While this was being argued Sentinel filed for Chapter 11 bankruptcy protection.

The SEC is now bringing fraud charges against Sentinel, saying that a previous inspection had revealed that it had been concealing losses and had submitted false client account statements. Something tells me that Sentinel will need to get a bigger dog.

The SEC claims: 'For a period of at least several months up to and including the week of August 13, Sentinel's advisory clients suffered undisclosed losses and risks of losses as a result of several unauthorised practices engaged in by Sentinel.

'These include pledging securities owned by clients as collateral in order to obtain a line of credit [from Bank of New York] as high as USD500m for Sentinel, placing at least USD460m of client securities properly belonging in segregated customer accounts in Sentinel's house proprietary account, commingling client assets without the ability to verify ownership of particular securities by particular clients, and providing false client account statements that did not accurately reflect client portfolio holdings or the fact that securities had been encumbered by Sentinel.'

A Chicago bankruptcy judge ruled on Wednesday that Sentinel could distribute to investors the USD312m proceeds of the asset sale to Citadel, but the money currently remains blocked by an order from the National Futures Association.

Although some investors are understood to have recovered their assets from Sentinel prior to its collapse, Paris-based hedge fund manager Capital Fund Management has told investors that its Discus Master Fund may face losses of as much as USD407m.

It is a very odd situation when a company such as this has the internal structures that allow this to happen. We have individual discretionary accounts where client funds are managed via block trading in deals. When setting up the accounts we have the ability to be 100% fully in charge of the accounts if clients so wish, but we never, (and cannot see a time when we ever would) have this facility put into our terms and conditions, why would we? When would there possibly be a time when clients funds would need to be sent to a proprietary account of our company?

I feel sorry for those who have lost money from this debacle, but I have to say, that if we had invested into a 'cash manager' who was playing the markets without adequate backup for the bad times, then we would have a hard time explaining to our investors why we didn't know this....

I hope that there will be no 'investment speak' given to investors that have lost out in the funds that used Sentinel, but I fear that there are a few hedge fund managers dogs who will be taking the blame for this...

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