Hedge Fund Crunch

Opalesque Exclusive: As illiquidity is cited as the greatest risk for further economic crisis, asset based lending funds step in to provide liquidity for firms caught in the credit pullback – Part One.

By Kirsten Bishoff

July 1, 2008

This week The Bank of International Settlements (BIS) released its 78th Annual Report reviewing the financial markets. Providing an overview of the 2007-2008 year the BIS notes the hedge fund industry which at first felt much of the blame for market problems has shown itself to be a point of stability in the midst of the credit crisis. “Even though the first signs of strain to emerge were problems in hedge funds associated with large investment houses, the performance of the industry as a whole initially proved relatively robust. During 2007, returns on most hedge fund strategies compared favorably to those recorded in 2006. The main exception was the performance of fixed income funds, which slipped during 2007. Over the calendar year, net investor inflows to all fund sectors remained at levels comparable to those of the recent past.”

Providers of needed liquidity
In an industry that has grown to oversee the investments of approximately $1.8 tln of the world’s wealth, hedge funds as well as other alternative assets have the potential to further serve as a driver towards the recovery of the global economy. The BIS cites the largest risk for worsening financial conditions to be “linked to the response of aggregate demand to the weakened position of banks and tighter lending standards.” It remains to be seen if non-financial firms have the ability to withstand the combination of tightening credit conditions and the possible downturn in profits expected to occur with the consumer’s weakened ability to maintain previous levels of consumption. But the chances for survival for these firms are dependent on the nature of the external credit available, and asset based lending (ABL) funds are stepping into the void created by the credit crisis to provide this liquidity.

As we enter what the BIS has determined is the sixth stage or, “the crest” of the credit crisis it remains unclear “whether liquidity supply and risk appetite [have] recovered sufficiently to help maintain this improved credit market environment on a sustained basis.” ABL funds have come to provide some of the few options for companies looking to raise capital for growth, or to survive temporary profit downturns. Opalesque recently spoke to Josh Zegen at Madison Realty Capital and Dennis Pollack, Senior Managing Director at Laurus-Valens owned by Eugene Grin and David Grin about the ABL space and the changes they have seen over the past few months as bank credit options have dried up and the opportunity set for ABL funds has grown immensely.

The `debtquity` fund, providing liquidity to the backbone of the economy
According to a NY Times article we recently carried in the AMB (Source) hedge funds in the asset based lending arena have quadrupled over the past three years, holding approximately $13bln in assets. “This is really the perfect storm for a firm like ours,” Pollack said. “Banks that traditionally lend to the micro caps typically have a knee jerk reaction and these small businesses are typically the first ones shut out. These types of companies have been and will continue to be the backbone of the US economy. A lot of them are really good companies that will flourish and grow and are having a difficult time getting the capital to do so.”

Laurus-Valens (Eugene Grin ) focuses on micro cap companies whereby they evaluate a fund for an abundance of tangible collateral as well as a growth orientation. This is due to the two pronged strategy in which, “Our transaction typically have both a debt and equity component. We will provide companies with debt intervention through 3 year amortizing loans with a coupon of somewhere around 11-12%. There is this debt piece and we are usually senior secured…But with our transactions, companies also provide us with an equity stake.” In this way, Laurus-Valens, which is providing capital for growth opportunities in micro cap companies, is protected on the downside with hard assets and further rewarded through equity stakes when their financing fuels growth for the borrower.

Asset flow
Laurus-Valens recently launched a Japan Yen Fund to address interest in the fund and reduce currency risk for Japanese investors, and Pollack says ABL lending has come of age. “We are in a business where even though we are a hedge fund, we operate more like a specialty finance company. We are getting more and more interest not only from Japanese investors, but also from the Middle East and even traditional Europe, because it is a straightforward strategy with a model that we have perfected over the years.”

Pollack cites both Greenspan’s and Paulson’s bearish outlook on the “inordinate amounts of losses which still need to be taken. We see that it will remain difficult for these smaller companies to get financing and are positioning ourselves to find the right companies to invest in and believe we can continue with strong returns.”

Laurus-Valens, the New York based investment advisory firm, announced the launch of the Valens Yen Fund. Valens, which currently oversees approximately $1.6 bln in assets and runs a variety of funds, launched the yen fund with assets of 1 bln JPY.

The Fund has been designed specifically in response to Japanese investor interest in the Valens investment strategy and it will provide qualified Japanese investors with access to a mirror image of the Laurus Offshore Fund, with minimal currency exchange risk. “Our yen denominated fund provides our Japanese investors with access to investments in U.S. micro cap and late stage private companies and makes their investments more stable for them, as they won’t be susceptible to the value of the dollar sinking or spiking at any time,” said Dennis Pollack, Partner and Senior Managing Director.

By; Kirsten Bischoff, Opalesque New York:

Dennis Pollack, partner and senior managing director at Laurus-Valens, an investment management firm specializing in investments in small and micro cap companies, announced that Jay Drezner has joined Laurus-Valens as a senior investment analyst. Mr. Drezner has an extensive 9 year background in the finance and investment banking industry.

“I am truly pleased that Jay will be a part of our team. Jay’s background in both domestic and international investment banking will offer Laurus-Valens new insight and opportunities as we seek sound and profitable investments for our portfolio,” said Dennis Pollack.

Mr. Drezner will be responsible at a senior level for analyzing, structuring and executing new transactions as well as working with existing Laurus-Valens portfolio investments to maximize value and return potential. Prior to joining Laurus-Valens, Mr. Drezner spent nine years at Credit Suisse Securities (USA) LLC, most recently as a director in the Leveraged Finance Group where he covered companies in the aerospace and defense, satellite services, and air transportation sectors and executed a broad variety of leveraged finance transactions.

Prior to moving to the Leveraged Finance Group, Mr. Drezner was in the Buyside Insights Group at Credit Suisse, where he worked with corporate clients in the consumer products, business services and mid-cap industrials space to enhance equity values through the use of value-based management consulting techniques. Other roles Mr. Drezner had at Credit Suisse included serving as a vice president in Credit Suisse’s Australian investment banking operation, covering media and telecommunications companies, and two years as an Associate in Credit Suisse’s New York office in the Media & Telecom coverage group. Mr. Drezner began his professional career in the early 1990’s with D’Arcy Masius Benton & Bowles, Inc., an advertising agency, as an assistant media director handling major corporate consumer product clients. “I am thrilled to join Laurus-Valens and look forward to the challenges ahead. I am eager to work with such a knowledgeable and esteemed group of finance and investment professionals,” said Mr. Drezner.

Mr. Drezner holds a BA in Psychology from Cornell University and an MBA in Finance from Columbia Business School.

TCM reports:

“The housing crunch continues. The Los Angeles Times Land Blog has a stunning report on just how bad real estate prices have fallen in California during the past year. According to the California Association of Realtors press release, the median sales price of an existing home fell by a whopping 26.2% from a year earlier. The unsold inventory reached 14.3 months compared with 8.2 months for the same period in February 2007. Nationally, prices fell over the past year at a rate of $338 per week; in California, prices apparently fell at a rate of $2,788 per week. Such declines do not yet show signs of decelerating or even bottoming.

According to  WSJ article, “The credit crunch and market volatility have roughed up other multibillion-dollar hedge funds, which on average have lost about 3.35% this year, according to Hedge Fund Research’s daily global performance index. Platinum Grove Asset Management, the $6 billion hedge-fund firm run by LTCM alumnus Myron Scholes, has lost 13% this month on credit trades, putting it 10% down for the year, according to a person familiar with the fund.

Also, Farallon Capital Management LLC in San Francisco, which manages about $36 billion, has lost 5.6% this year through last week in its flagship Farallon Capital Partners fund.

Bridgewater Associates comment on the credit crunch effecting the hedge funds;

For the most part, hedge funds have gotten through the credit crunch relatively unscathed. For example, the average hedge fund generated a return of 12.5% last year and 2.5% in the fourth quarter. And private equity funds generated an average return of 11%. The main reason that these two groups held up as well as they did is because the equity market has not fallen nearly as much as the bond markets (i.e., spreads), and the majority of the risk allocation of these funds is in the equity market. And because their performance held up, they have not been forced into much asset liquidation to speak of. But stock market action is beginning to pressure the hedge funds and private equity players.

Hedge funds used to be a lot more hedged than they are today. Today, just about anyone who wants higher fees based on total return calls themselves a hedge fund, even if they are just a buyer of assets. And the fat cash flow yields in global stocks have also attracted a number of hedge funds into net long equity positions. As a result, hedge funds are now heavily long the equity market. Based on fund by fund holdings data we estimate that hedge funds are net long about $150 to $200 billion in U.S. equities (foreign equities are not included in this figure).

Hedge funds are also highly leveraged. Losses raise a fund’s leverage ratio, which requires asset liquidations to bring the leverage ratio back to normal.

Laurus-Valens, a New York-based firm specializing in hedge funds that make private investments in publicly traded small and microcap stocks has hired a managing director from A.G. Edwards.

These private transactions typically give the Laurus funds warrants for the right to purchase stock at a discount to market prices. The funds seek double digit returns with lower volatility than the broader markets.

Dennis Pollack, senior managing director of Laurus-Valens, said Thursday that veteran investment banker Kendall Raine has joined the firm as a partner and senior managing director.

“Kendall’s background will offer Laurus-Valens new insight and opportunities during this volatile time in the market,” said Pollack.

Raine, who will oversee a variety of strategic and capital markets initiatives, joins from A. G. Edwards, where he was managing director in the investment banking department. At A.G. Edwards, he was responsible for more than 100 advisory and capital markets transactions for business development, mortgage, and consumer finance companies, private equity firms and other specialty finance companies.

Prior to Edwards, Raine worked for Bear Stearns as associate director responsible for investment banking relationships with Midwest depository institutions. Before that, he was chief executive officer of Los Angeles-based United Pacific Bank and senior executive to the banks’ parent company.  Raine began his banking career as a calling officer in the Asia division of Chemical Bank.

Laurus-Valens, one of the nation’s largest investors in penny stocks, has approximately $1.7 billion in assets under management.  Laurus invests in private investment in public equity, or Pipes, a financing vehicle for small, cash-strapped companies. Hedge funds use Pipes to buy shares at a discounted price and can quickly resell them.

Last March, Laurus Capital Management LLC launched Valens Fund to invest in publicly traded small and micro-cap companies seeking cost effective growth capital.

Ballooning losses from the US mortgage market could force the global financial industry to scale back lending by $2 trillion and trigger a substantial recession, according to a bearish analysis.

The startling figure was suggested yesterday by the chief US economist at Goldman Sachs, Jan Hatzius, who said that an estimated $400bn (£290bn) in losses on mortgages would be magnified as lenders reacted to stay within their solvency requirements.

“Even a $400bn loss does not look all that large compared to the vast size of the US financial markets, and one sometimes hears that it is just equivalent to one bad day in the stock market,” Mr Hatzius told clients. “But this analogy is wrong. There is a big difference between stock market losses, which are mostly borne by long-only investors, and mortgage credit losses, which are mostly borne by leveraged investors such as banks, broker-dealers, hedge funds, and government-sponsored enterprises.”

Even though three of the top ten largest hedge funds in the US lost an estimated $24 billion in assets last year, the overall assets of the top US hedge funds actually rose in 2007 by more than 33%.

JP Morgan topped the list with total assets under management of $44.7 billion dollars. JP Morgan has a number of hedge funds under its management, including JP Morgan Asset Management and Highbridge Capital Management. JP Morgan topped the list even though they suffered from a loss of $8.5 billion in assets, mainly due to redemptions and some losses in their statistical arbitrage fund.

Bridgewater Associates was second on the list with total assets under management of $36 billion dollars. They were almost tied with Farallon Capital Management, who boasted a similar figure in total assets.

Renaissance Technologies came in fourth place with $34 billion dollars, and Och-Ziff Capital Management, the publicly traded hedge fund firm, was in fifth place with $33.2 billion in assets. DE Shaw and Goldman Sachs Asset Management both fell in 2007 due to their exposure to quant funds, and finished up in sixth and seventh place respectively.

Paulson and Company also soared into the top ten due to their aggressive bets against the subprime mortgage market.

Many companies that had significant exposure to quant funds managed to recover in the latter part of 2007. The recover continues in 2008, and it will be interesting to see if firms such as Goldman Sachs can start scaling their way back up the list.

Laurus Capital Management celebrated its Holiday Party at The Metropolitan Club. The evening began with a cocktail reception followed by dinner with music accompaniment by the Cantible Trio. The evening’s speaker, Dr. Irwin Kellner, chief economist, North Fork Bank, spoke on his views on the economy in 2008. Guests were treated to a wine pairing and tasting with a talk by noted sommelier, David Hamburger. Laurus Capital Management, established in 2001, is an investment firm with a strategy of making direct investments in small and micro cap companies with the goal of positive equity returns. Eugene and David Grin, founding principals of the firm, created Laurus to cater to the unique financial needs of rising companies.

Laurus-Valens, a New York-based firm specializing in hedge funds that make private investments in publicly traded small and microcap stocks has hired a managing director from A.G. Edwards.
These private transactions typically give the Laurus funds warrants for the right to purchase stock at a discount to market prices. The funds seek double digit returns with lower volatility than the broader markets.
Dennis Pollack, senior managing director of Laurus-Valens, said Thursday that veteran investment banker Kendall Raine has joined the firm as a partner and senior managing director.
“Kendall’s background will offer Laurus-Valens new insight and opportunities during this volatile time in the market,” said Pollack.
Raine, who will oversee a variety of strategic and capital markets initiatives, joins from A. G. Edwards, where he was managing director in the investment banking department. At A.G. Edwards, he was responsible for more than 100 advisory and capital markets transactions for business development, mortgage, and consumer finance companies, private equity firms and other specialty finance companies.
Prior to Edwards, Raine worked for Bear Stearns as associate director responsible for investment banking relationships with Midwest depository institutions. Before that, he was chief executive officer of Los Angeles-based United Pacific Bank and senior executive to the banks’ parent company. Raine began his banking career as a calling officer in the Asia division of Chemical Bank.
Laurus-Valens, one of the nation’s largest investors in penny stocks, has approximately $1.7 billion in assets under management. Laurus invests in private investment in public equity, or Pipes, a financing vehicle for small, cash-strapped companies. Hedge funds use Pipes to buy shares at a discounted price and can quickly resell them.
Last March, Laurus Capital Management LLC launched Valens Fund to invest in publicly traded small and micro-cap companies seeking cost effective growth capital.

By Natasha Gural, Editor