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Hedge Fund Monthly

The Dilemma over a Manager's Departure
Ray Heath

March 2003

Hedge fund managers moving on can be a hazard for investors, but what should they do if the person to whom they entrusted their cash suddenly leaves?

This is very much a caveat emptor market, and hedge fund managers can be a restless bunch. Like nomads they seek greener grazing grounds. For the vast majority of hedge fund investors, the light regulations on this largely private business mean there is little comfort to be had from the official watchdogs.

Equipped with investment skills, the entrepreneurial spirit and egos to match, successful managers are quick to shift to new houses which offer better rewards, or set up their own boutiques. But whatever satisfaction the shifts might bring to the manager; these changes leave investors without any guarantee that the successor has the same abilities which originally attracted them to the fund.

Hong Kong is one of the only fund management centres in Asia which can provide some regulatory assurances of continuity, but only for funds which are authorised for sale to the retail sector.

As there are just three of those so far, the level of protection remains sparse, but the guidelines set out by the Hong Kong regulatory agency, Securities and Futures Commission (SFC), do set a benchmark which could be followed in other jurisdictions.

The rules were tested much sooner than could have been expected when Roger Ellis, chief investment officer of JF Asset Management, and manager of the hedge fund JF Asia Absolute Return Fund (AARF) resigned in early February, only weeks after the fund was authorised under Hong Kong's pioneering rules that allow general marketing of hedge funds. Ellis' skill and experience in the region's tricky markets were a major selling point of the fund.

For investors in the AARF it could have been a plunge into the unknown. His departure raised serous questions about its future direction and strategy, but JF was able to point to the promotion of Miles Geldard as the fund's manager, and his long time experience helping to run AARF with Ellis.

This fitted in with the SFC's insistence on experienced personnel running hedge funds:

"Our guidelines on hedge funds make it very clear that a fund company must have at least two key investment personnel, if it is to fulfil the requirements, and each must have at least five years experience in hedge funds, and two years in the type of fund in question," explained Sandra Mak, associate director at the SFC.

Commission officials were satisfied that JF's back-up system met their requirements, but Ms Mak admitted that there was little that the SFC could do about the wanderlust that occasionally grips managers.

"We can't regulate how long people stay with a particular firm, but we would insist that when someone leaves a firm that it has a sufficiently experienced back-up person. Investors should have the comfort that as long as the fund remained authorised it would remain in the hands of qualified people," she added.

In November last year the SFC also beefed up its guidelines, stipulating that all funds must disclose changes of key personnel in quarterly reports - although industry insiders say that no reputable fund would wait that long. "If management changes appear to be altering the nature of the fund, the directors would be called in to discuss how the changes should be disclosed," said Ms Mak.

Ellis' departure in Hong Kong caused nothing compared to the brouhaha when seven managers quit the hedge fund unit of Lazard Asset Management in New York. The walkout - led by rising hedge fund star William von Mueffling, has been portrayed as simple case of greed.

Von Mueffling, it was alleged, wanted too much in return for having built up LAM's hedge fund operation into a US$4 billion business in five years. On the way he also rewarded investors with a compound return of 57%.

Supporters of Von Meuffling say the $40 million he was looking for was nothing more than he deserved for putting LAM onto the hedge fund map. He is now expected to open his own boutique business - but should those investors who benefited from his skills at Lazard follow him? That would seem the obvious solution, but first they should ask themselves the key questions which any investor must address when faced with management changes:

1) The departing manager may have plans for a new fund, but how long before it is up and running?

2) Will the new fund be following a similar strategy? And how much of the performance came from a team effort if the fund was part of a bigger institution?

3) Was the fund run on a discretionary basis, which gave the manager great freedom, or was it a computer generated, quantitative strategy?

4) Who takes over? Are the new manger's qualifications and experience sufficient to ensure continuity?

5) Are there penalties for early redemption? If so, are they waved in cases like the manager's departure?

6) Will a new boutique fund have the same cost and charging structure as one which is part of a bigger group?

7) What were the reasons for the manager leaving? Are there concerns about internal disagreements on strategy? Is this an isolated incident, or have there been a number of resignations? If so, why?

8) If a manager has left a heavily institutionalised fund, will the new venture have similar, or at least, sufficient, financial backing?

Talking to the departing manager can reveal much regarding the real reasons for leaving. Investors in mutual funds rarely have sufficient cash invested to make it worthwhile carrying out the necessary due diligence in the event of a management change. Hedge fund investors usually have a much larger commitment so can, and should, demand more information.


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