Hedge Funds Look to the Capital Markets as Most Other Companies Do
"Permanent Capital." Has a nice ring to it, doesn't it? While some of the definitions differ slightly, permanent capital represents funds that will not or cannot be redeemed.
Financial institutions depend on "core capital", which is really permanent capital as these funds will not be withdrawn. Usually composed of the smaller regular savings accounts of the average depositor, these accounts are very important to banking institutions, although the subject is rarely discussed. Of course, commercial banks and most companies can always issue stock to generate and/or increase their permanent capital base. Hedge funds, havens for many high net worth individuals and institutional investors, are toying with the idea of establishing such a category.
Currently at the total mercy of their investors and banking sources, hedge funds would like to have access to some personal capital to level the vagaries of their investors' whims. Since their chief source of assets come from wealthy individuals, pension funds, endowments, and other institutional investors, hedge funds and their managers are aware that this particular investment group are decidedly against learning bad news. Often, at the first hint of fund downturns, this group will quickly stand in line with their collective investment hands out to redeem their money, at times taking the hedge fund with them.
Since they naturally cannot accept "deposits" within the banking definition, they may use classic business strategies like issuing bonds or going public, either of which approach would change their identity completely. Hedge funds have historically used banks to leverage their assets but this can be an expensive option when compared with the ability to generate permanent capital, if it becomes possible. In fact, raising permanent capital is not a totally new idea as International Asset Managers, a closed-end fund with a product called Alternative Investment Strategies, was the first of its kind listed on the London Stock Exchange in 1996. IAM soon had company when another closed-end fund, Dexion Absolute (with approximately $1.4 Billion assets under management), joined it on the exchange.
As the number of hedge fund initial public offerings (IPO's) increases, so does the intrigue, investor curiosity and, apparently, interest. CMA Global Advisors recently took its closed-end fund of funds public and raised $402 Million. Goldman Sachs bested that raise as they brought its Dynamic Opportunities Fund to market and generated $507 Million. Prior to recent IPO's, hedge funds assets listed on the London exchange were around $3 Billion; after recent fundraising, almost $2.4 Billion, these assets have almost doubled.
Foreign markets are also enjoying similar results. Look at Toronto, Sydney and Zurich and notice they are recording over $2.8 Billion in similar investments, while Amsterdam has been a favorite hedge fund choice. For instance, Boussard & Gavaudan generated $562 Million and Marshall Wace (London) broke the bank with a €1 Billion raise recently. One reason for Dutch fund raising popularity is a result of the ban by the Financial Services Authority on listing of single strategy hedge funds. Amsterdam also has fewer restrictions on short selling transactions. While the Authority has stated it is considering lessening restrictions on investment firms, they admitted that changes of this nature do not happen overnight, with the best hope being around a twelve month window.
Additional hedge funds are stepping up to the plate to offer their menu choices to the investment world. Across the pond, U.S. hedge funds are apparently getting the urge to participate. First to file an IPO was the huge Fortress Investment Group. With approximately $26 Billion in assets under management, after the IPO, Fortress could be valued at around $7.5 Billion. Another hedge fund leader, Citadel Investment Group, with approximately $12 Billion in managed assets, seeks a permanent capital base created through the sale of $2.0 Billion of senior unsecured debt to the investment community. Capital will be the first known hedge fund to use a debt sale as the source of permanent capital.
While raising permanent capital is, of course, a common practice of thousands of companies, hedge funds are a bit different than most. This poses a potentially major problem for investors, regulatory agencies and the market in general. It shatters the regulatory requirement that hedge fund investors should be "qualified" clients with high net worth. But, of course, IPO's provide much smaller, less sophisticated investors the opportunity to participate with hedge funds, traditionally out of reach.
Since investors with only $5,000-$10,000 could now own shares of a hedge fund, regulatory agencies in the U.S. and Europe are concerned and will most certainly take some action. Since hedge funds have been the purview of wealthy investors, who, it is presumed, know ways to protect themselves, regulators will be evaluating methods to protect smaller, less savvy investors. The good news for hedge funds: Their ability to participate in the capital and debt markets displays their economic "maturity" and, to some degree, stability. The bad news: Further regulation, directed at protecting the smaller investor, looms on the horizon, which may limit the level of IPO fund raises in the future.