HF and PE managers square off on implications of credit squeeze

9 May 2008

(Madrid, April 25) - The former head of the pension for a large US state has suggested the value provided by funds of funds has increased as a result of market turbulence.  Al Samper, former Head of Virginia Retirement System told a gathering of the Chartered Alternative Investment Analysts Association in Madrid recently that protection against the idiosyncratic risks of single strategy hedge funds is more important than ever for institutional investors.  He also told the audience that a long term investment horizon was a prerequisite for adding alternatives to a traditional portfolio.

Samper was a member of a panel discussing the different views taken by hedge funds and private equity funds on the recent credit crisis.   

Catherine Lewis, a partner with London-based private equity firm Parish Capital, said there was now a significant alpha-generation potential for small private equity funds that focus on niche sectors.  In this segment, she said, transactions are less likely to be over-leveraged and are therefore more likely to flourish in the current credit environment.  Lewis said that the illiquidity crisis facing credit markets was leading to a marked slowdown in new investment activity, a return to more conservative deal structures, postponed exits and smaller IRRs.

However, she pointed out that smaller pools of capital allow managers to wait for more suitable deal opportunities - an advantage vs. larger firms such as the KKRs of the world.  In addition, she said that new expectations are leading to more logical risk and return parameters.

William Furber, Founder and Managing Partner of High Street Advisors, a Boston-based hedge fund stressed the importance of volatility that is commensurate with return targets.  He considered the ability to design a portfolio capable of generating returns without the benefit of leverage to be a critical success factors even before today’s difficult credit conditions.

Both Lewis and Furber told the audience that periods of abnormal or dislocated markets were invariably followed by new investor concerns such as: potential withdrawals, changes in risk tolerance, headline risks, and even the risk that a service provider may run into trouble.  They said that all of these issues can conspire to determine the future success of both hedge fund and private equity managers.

Although there has been a lot of discussion recently about the convergence of hedge funds and private equity, Lewis, Furber and Samper felt this was unlikely given the major differences in investment horizon and liquidity parameters between the two asset classes.  For example, hedge funds usually invest in securities that are more expensive than those purchased by private equity firms (partly due to the fact that private equity firms are often earlier stage investors).

The panel agreed that hedge funds were better positioned to take advantage of opportunities in the distressed debt market since private equity funds were more focused on “distressed equity”.  But despite their different approaches to navigating the credit crisis, both Lewis and Furber agreed that “post-correction markets tend to perform well“.

Special thanks to Sergio Miguez Martin, CAIA for this report

(ed: In a related item, Thomson reported yesterday that, notwithstanding the differences between private equity and hedge funds, the credit crunch was forcing both to adopt ‘hybrid’ structures.)

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