Here’s your latest asset-liability worry: Hedge funds.
Finance blog Sober Look has an interesting post on the subject which uses a chart from Hedgebay, a provider of a secondary market for investors’ stakes in hedge funds:
To be specific, that is Hedgebay’s Secondary Market Indicator, which shows the average premium or discount (below 100 - the Net Asset Value) paid for hedge funds that trade in the secondary market. It’s basically a sentiment indicator for hedge fund investors, but it can also be interpreted as an an indicator of the cost of liquidity (the liquidity premium, or how much investors will demand in exchange for going into a fund which presumably has some sort of lock-up).
Here’s what Sober Look says:
Such liquidity premium means that funds who provide the best liquidity terms (within their strategy category) will be able to raise more capital than those who have long lock-ups and sidepockets.
It’s somewhat of a dangerous game because this may create an asset-liability mismatch. That is funds will offer unrealistic liquidity terms just to get the capital in the door. As assets become fully priced and rates continue to stay low, hedge funds will be pressured to seek out less liquid strategies to squeeze out incremental returns. They may deploy leverage, making less liquid investments even more illiquid. The liquidity of the portfolio will become “mismatched” with the liquidity terms for redemptions (the liability side).
And when redemptions increase, funds will put up gates and we are back where we started. As much as institutions, particularly funds of funds seek the liquidity holy grail, these investments are not mutual funds, and the most “investor-friendly” liquidity terms may not provide the investor protection these institutions expect.
Vicious circle, no?
Interestingly enough, it seems hedge fund investors are more concerned with their balance sheets than the hedge fund themselves might be. The below is from Elias Tueta, co-founder of Hedgebay, as he announced the launch of a new Hedgebay SMI Index last month (the above chart is presumably the old version).
From Finalternatives:
According to Tueta, the new [Hedgebay SMI] index has revealed another decrease in the average discount of hedge fund assets in September, the third consecutive month that the index has fallen. The fall, compared to stable markets and good hedge fund performance, has shown that hedge fund investors are still using the secondary markets to resolve discrepancies on their balance sheets, rather than generating liquidity. Tueta says the need for such services has driven higher volume on the secondary markets, with the number of trades for the year up 15% on those for 2008.
Related links:
A gigantic lock-up - Lex
Hedge funds: Still hard to get the whole picture - Sam Jones, FT
Return of liquidity lifts hedge funds - FT
Hedge fund liquidity discount - Hedge Fund Appraisal
