Opalesque Exclusive: Hedge fund managers staying with underwater funds, taking long-term views of their business

From Kirsten Bischoff, Opalesque New York:

For many funds, high watermarks were set in October 2007, and the 21 months since have been a long, hard climb to try and get back to levels where performance fees kick back in. Hedge Fund Research reported on Tuesday that according to its HFRI Fund Weighted Composite Index funds had an average climb of 14.7% to reach that point.

As the industry's performance disappointed throughout 2008 the number of hedge funds contracted significantly, leaving approximately 8,900 funds (down from a high of 10,000+ funds in 2007). However, the worries that numerous managers would fold funds that had descended below high watermarks in order to start new funds that would be eligible for performance fees has not panned out.

Kaufman Rossin Fund Services, LLC (KRFS), a US-based administrator for a wide variety of single strategy funds and fund of hedge funds funds (onshore and offshore), says that when it comes to funds that have been under high-water marks, it has seen managers "sticking it out", taking a long-term view of their funds and the industry in general.

The bounce back in hedge fund performance, happening rather quickly in the first half of 2009 (HFRI Fund Weighted Composite Index is up +9.46% YTD), may have made the decision to stick with their funds a little easier for many managers. "We feel that among many managers, there is a sentiment that 2008 will be an outlier over the long haul," says Christine Egan - Business Development Manager at KRFS.

The reality of the asset-raising environment provided another impetus for managers to stay with underwater funds. Investors took harsh views of managers that gated funds, and liquidating an underperforming fund to start another would likely leave as negative a mark. Especially as hedge fund investors will likely focus on the decisions made during the height of the financial crisis to gain insight into a fund/firm/manager's abilities.

Restructuring
One positive outcome of the industry's 2008 turmoil was the increase in communication seen between managers and investors. As the hedge fund industry underperformed in 2008, it still managed to preserve capital, and in some cases managers that are underwater are still managers that investors want to see continue investing their assets.

KRFS has seen instances where managers with underwater funds have reached out to investors and negotiated models whereby funds can charge performance fees on underwater assets at reduced rates. In exchange, investors will be charged lower performance fees once the fund is above water. Such agreements can be crucial to funds looking to retain the talent that was vital to preserving capital.

Additionally, KRFS has seen funds offering performance fee clawbacks and rebating performance fees collected after subsequent losses. This is a strong example of the emergence of a longer-term view in the hedge fund industry and the increased value that view places on the importance of aligning investor and manager interests in order for funds to attract and retain capital.

About Kaufman Rossin Fund Services
Established in 1994, Kaufman Rossin Fund Services (KRFS) is an independent full-service provider of administration services to the investment community. Born out of one of the nation's top CPA firms, KRFS maintains top-tier technical skills, quality control practices and technology. KRFS "Goes Beyond" its competition by delivering expertise in the complex areas of taxation, accounting standards and financial statement preparation. Clients worldwide rely on KRFS for startup, accounting and valuation, back-office outsourcing, investor services, tax services, customized reporting and corporate services. KRFS has offices in Miami, Fort Lauderdale, Boston, New York and the Cayman Islands. For more information, visit www.krfs.com.