New dawn for Hedge Funds

| 13/10/2008

(CNS): While the future of the Hedge Fund sector may look a little less rosy than in recent times, local expert Ingrid Pierce (left) says it’s not all doom and gloom. Reports say funds are still being formed in the Cayman Islands with more than 100 funds formed last month. While there is no doubt that the industry has been severely affected by the world financial problems some funds are adopting strategies that could mitigate the worst affects and even help the sector flourish.

There is no denying however, that the slide in asset prices and the insolvency of Lehman Brothers has had its toll and there certainly is trouble ahead for the industry. Ingrid Pierce, Partner in Corporate and International Finance Department at Walkers explains what the fundamental problems are. “The industry had to deal with the temporary restriction on short selling of certain stocks, which in some cases represented an important part of its trading strategy,” she said. “Rules requiring hedge funds to disclose short positions are expected to come into effect in the near future.

She explained that given the uncertainty in the markets, many hedge funds have received requests from investors to withdraw their capital. 

Funds with limited liquidity are unable to satisfy these requests or face having to liquidate assets on a forced sale basis, which means they will have to return less value to their investors. Funds therefore have to take steps to maximise returns to investors while ensuring that all investors (including those that have not sought to withdraw their capital) are treated equally. This has led to an increase in funds limiting the withdrawals that investors can make (provided the fund documents permit) or suspending redemptions, which effectively prevents all investors from withdrawing from the fund,” Pierce explained.

 It is however these techniques that she says will allow funds to weather the storm and continue to operate although inevitably some will terminate.

The solution for each fund may be very different and we are advising our clients on a whole range of options, each specifically tailored to the facts and circumstances of the fund,” Pierce added. “What we have seen over the past month is that new hedge funds continue to be formed in the Cayman Islands and new registration statistics through to the end of September have remained robust. The trend evident over the past year where new funds have been formed to pick up distressed and underpriced assets has also continued.

Pierce believes that Cayman’s hedge funds sector will continue to thrive even with a shift in focus to the short to medium term.  

As many commentators have said, while huge outflows from funds are not expected, even a small outflow, combined with funds building up their own cash levels, could depress stock prices. However, there are several techniques that funds in distress can adopt to mitigate the effect of poor liquidity through proper advice and structuring (or restructuring).  The most important message is for funds to act quickly at the first sign of distress, take proper advice and communicate with investors, service providers and the Cayman Islands Monetary Authority,” she noted.

Even though hedge funds are down in absolute terms, in relative terms Pierce says they have still outperformed the general stock market.  Given the current highly volatile markets, we need to watch closely to see if this trend continues.

Whether or not the US Bail out will benefit Cayman remains to be seen and Pierce believes that the important thing is for the US government to see the jurisdiction as a conduit to facilitate the international flow of capital between jurisdictions, both to and from the US.  For example, new hedge funds continue to be formed in the Cayman Islands by non-US investors, providing much needed investment capital and liquidity for the US capital and credit markets,” she said adding that if the US government remains neutral and does not seek to interfere with the way in which Cayman Islands funds are structured, both jurisdictions will see the benefits.



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