Late payments by less credit-worthy consumers have hurt U.S. hedge funds, notably funds run by Bear Stearns, but losses recently announced by three Australian hedge funds have fanned concerns that the credit problems on Main Street are spreading to overseas investors.
Australian hedge funds Basis Capital, one of that nation's largest and best-known hedge funds, and Mariner Bridge Investments told their investors that they have incurred significant losses related to problems with subprime debt investments. Meanwhile, a third fund, Absolute Capital, said it had temporarily suspended its Yield Strategies Funds "due to the current lack of liquidity in global structured credit markets."
The losses felt by the three hedge funds come from investments in subprime securities.
"I wouldn't be surprised to see more bloodshed," said Charles Gradante, managing principal and co-founder of New York-based hedge fund investment advisory firm Hennessee Group. "There is a lot of a herd mentality, so if Bear Stearns had an improperly hedged portfolio, other hedge fund managers were following their trades. Word goes down the Street - it's an old-boy system - and there will be more hedge funds that mimicked Bear Stearns, for sure."
Hedge funds typically borrow heavily to amplify their returns. Often they will use the very securities they invest in as collateral for the loans. If these securities see a drop in value, the funds then have to make up the difference in the value of the collateral by advancing additional securities as collateral or by paying the lender more money. Sometimes, funds are forced to sell some of their holdings and this can further erode the value of their securities. Basis Capital told its investors that its lenders have "reduced the valuations of those assets as a consequence of the disruption in U.S. credit markets following concerns in relation to subprime residential mortgages and have made margin calls."
Basis further explained in its note to investors that its fund is "in default in meeting some margin calls which has resulted in a number of its financiers declaring events of default." The fund management warned that demand for these securities had dried up and that "there is a serious risk of substantial losses."
Last week, Sydney-based Basis Capital said it had appointed the Blackstone Group to act as financial adviser to the Basis Yield Alpha and Basis Pac-Rim Opportunity funds. Blackstone, which is also advising Bear Stearns on its hedge funds, declined to comment. A spokesman for Basis also declined to comment.
Investor Reaction
A Basis Capital investor, Colonial First State, one of Australia's largest fund managers, confirmed that clients advised by its platform Financial Wisdom had invested in the Basis Capital High Yield and Aust Rim funds, and that total investments are less than A$1 million ($900,000), while other investors who invested through Avanteos also have more than A$60 million ($52.2 million) exposure to these funds. "As Basis Capital has suspended trading in these funds, investors are unable to trade in these funds," said Colonial First State spokeswoman Amber Saggers. "We will continue to advise clients of developments."
UBS AG also has some exposure to the fund, but the bank declined to comment. A source close to the matter, however, said that UBS's investment was "fairly negligible." Other investors in the fund include Australia's ANZ Private Bank. "Most of these investors [more than 100] have a more aggressive investment strategy and have a very small portion of their portfolio invested in Basis Capital. However, some investors may have chosen to invest at higher levels," says Katherine Rellos, an ANZ spokesperson.
Meanwhile, Sydney-based Mariner Bridge Investments, which has A$302 million in assets, said that it holds bonds with 40% exposure to subprime home-loan debt. "As a result, these investments have performed poorly," said the firm's CFO, Karen McGregor. "The book value of the total U.S. securitization investments has been written down to a level which is approximately 26% below their face value. This writedown has been achieved via significant provisions and also by the acquisition of some of the investments at a discount to face value."
Asked about the reaction among its investors to the losses, McGregor said that Mariner has continuously disclosed its exposure to the U.S. securitization market since February. "They are understandably disappointed, but the remainder of their portfolio is performing strongly," she says, adding that although the portfolio is diversified, the firm "clearly made an error in investing in the U.S. securitization market."
Absolute Capital, in the meantime, announced last week it would temporarily suspend trading in its funds, which have less than 5% exposure to the U.S. subprime market, due to the lack of liquidity in the global structured credit markets, Deon Joubert, group managing director, said in a statement. A spokesperson for the firm declined to comment beyond that. Absolute said that so far there have been a few redemption requests and that given the reduced market liquidity, it believes the funds are not able to satisfy withdrawal requests, which it expects it won't be able to process before Oct. 25, 2007.
The Australian Securities and Investments Commission, which regulates hedge funds, declined to comment.
Market Outlook
Market participants and observers have a grim outlook on the situation and say that the fallout from the U.S. likely will hurt most asset classes and investment strategies over the next couple of years. Some even placed blame on credit rating agencies because they gave investment grade ratings to CDOs.
Peter Douglas, principal and founder of Singapore-based hedge fund research firm GFIA, that without the ratings from credit agencies CDOs would have been a highly specialized and exotic security limited to a small pool of buyers.
"Some CDOs were, in effect, CDOs of CDOs," Douglas said. "Where the underlying asset was impaired [as it is with a pool of subprime mortgages], the collateral is either reduced or possibly ... nil."
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