Monday 4th May 2015
NEWS TICKER: FRIDAY, MAY IST: MYOB will return on Monday next to the ASX, selling 228.3mshares at $3.65 in the company’s IPO. The company raised AUD833.1m, giving it an implied market capitalisation of AUD2.13bn. Bain Capital will retain 58% of the firm’s stock. “We saw a significant level of participation from eligible retail noteholders in the offer, with approximately 57% of holders exchanging their notes into shares. We see this wide range of investor interest as a strong vote of confidence in MYOB.” MYOB chairman Justin Milne says. ASX trading in MYOB shares is set to begin on 4 May under the code MYO. MYOB was listed on exchange from 1999 to 2009 – The volume of US municipal bonds soared by 42.1% in April, according to Thomson Reuters’ data; the ninth straight monthly gain. Issuers brought $37.76bn to market in 1,210 issues, up from $26.58bn in 939 issues in April 2014. Low interest rates, and the reluctance of the US Federal Reserve to raise rates over the near term has resulted in a dash by municipal issuers anxious to secure low cost funding as many refinance their debts. Other than refinancing, new issuance per se looks to be tailing off. New money transactions declined by 5.6% to $12.68bn from $13.43bn, while combined refunding and new money transactions increased 42.5% to $7.17bn from $5.03bn in April last year. Negotiated bond sales increased 62.4% to $28.97bn from $17.84bn, competitive deals rose 15.4% to $8.62bn from $7.47 billion and private placements plunged 87.2% to $162mn from $1.26bn. Sales of revenue bonds increased 49.9% to $22.84bn in 421 deals from $15.24bn in 306 deals. General obligation bond volume jumped 29.9% to $14.73bn in 788 issues from $11.34bn in 633 issues. Tax-exempt deals were up 42.4% to $33.88bn, while taxable deals were 24% higher to $3.30bn.Fixed-rate issues increased to $36.75bn in 1,167 issues from $24.85bn in 891 issues the previous year. The volume of deals with bond insurance more than doubled in par amount wrapped to $2.54bn in 161 deals from $1.06bn in 104 transactions. California claimed the top spot among states with $21.47bn of issuance thus far in 2015, up from its No. 2 ranking in the same period of last year with $12.03bn. Texas dropped from first to second with $17.85bn, an increase from $12.31bn the year before. New York remained in third place with $11.91bn so far this year, up from $10.29bn year to date - This morning Lloyds Banking Group said that in Q1 it had made a net profit of £913m and underlying profit was up 21% on the same period last year, to £2.2bn. Moreover, the group said that it was raising its net interest income target above the original target of 2.55%. Graham Spooner, investment research analyst at The Share Centre, says: “These results are good news for investors as they are ahead of forecasts and demonstrate a continued improvement in the company’s performance. The part UK government owned bank additionally reported that it has been benefitting from a resurgent British economy which has led to reduced bad loans and fuelled demand for mortgages. Lloyds announced its first dividend in February since being bailed out and investors should acknowledge that the increasing signs of recovery will boost hopes for a significant dividend growth in the near future. Analysts have become a little more positive on the group and its long term restructuring plans, which appear to be happening faster than expectations. However … the sector [remains] under pressure, as a result of regulatory issues and ahead of the next government sale.” - The Straits Times Index (STI) ended 0.24 points or 0.01% higher to 3487.39, taking the year-to-date performance to +3.63%. The top active stocks today were SingTel, which declined 0.23%, OCBC Bank, which declined 1.84%, DBS, which gained 0.19%, UOB, which gained 0.29% and Keppel Corp, with a 1.02% fall. The FTSE ST Mid Cap Index gained 0.47%, while the FTSE ST Small Cap Index rose 0.18%. The outperforming sectors today were represented by the FTSE ST Real Estate Holding and Development Index, which rose 1.00%. The two biggest stocks of the Index - Hongkong Land Holdings and Global Logistic Properties – ended 2.02% higher and 2.23% higher respectively. The underperforming sector was the FTSE ST Consumer Goods Index, which slipped 1.04%. Wilmar International shares remained unchanged and Thai Beverage declined 3.38%.

After the Deluge

Saturday, 01 January 2005
After the Deluge In late October the US Securities and Exchange Commission (SEC) voted three to two in favour of hedge fund registration. SEC chairman William Donaldson had pushed hard for registration, arguing that as less well to do investors increasingly put their money into hedge funds, not enough is known about them. Even so, money has continued to flood into hedge funds during 2004, sometimes from surprising sources. By some estimates, industry assets now exceed $1trn. Neil O’Hara assesses the impact of tighter regulation and the general outlook for an industry that has promised much and yet this year, at least, has delivered only a lacklustre performance. http://www.ftseglobalmarkets.com/
In late October the US Securities and Exchange Commission (SEC) voted three to two in favour of hedge fund registration. SEC chairman William Donaldson had pushed hard for registration, arguing that as less well to do investors increasingly put their money into hedge funds, not enough is known about them. Even so, money has continued to flood into hedge funds during 2004, sometimes from surprising sources. By some estimates, industry assets now exceed $1trn. Neil O’Hara assesses the impact of tighter regulation and the general outlook for an industry that has promised much and yet this year, at least, has delivered only a lacklustre performance.
The number of hedge fund start-ups continues to grow dramatically,” says James Hedges, founder, president and chief investment officer of LJH Global Investments, an advisory firm that helps clients select and invest in hedge funds, “The demand for hedge funds is unabated, the number of hedge fund managers bringing in substantial assets is unbelievable.” Hedges notes that investors are gravitating to “mega-funds” that manage $500m or more. “It is creating a very bar-belled industry. Some 90% of the industry’s assets are clustered around 10% of the number of funds out there, and the remaining 90% of funds hold 10%,” he says.  As a consequence smaller players face immense pressure to escape the competitive disadvantage of subscale operations.

Funds of hedge funds account for an increasing proportion of new money flows. “I estimate that 80% of funds coming into hedge funds go through funds of funds today, up from 50% two years ago,” says Hedges, “They are the conduit of choice because they have the capability to do professional due diligence and ongoing monitoring. You get diversification across strategy, across managers, you get risk mitigation. You make it somebody else’s problem.”



Even so, outsourcing of fiduciary responsibilities comes at a steep price. “The funds of funds business is going to be plagued by its mediocrity,” he says, “Most of them have terrible performance. It is all going to get out there at some point. It is two or three years out.”

“A typical fund of funds, if it is trying to hedge its bets all over the place and be totally diversified, becomes closer to an index fund,” expands Michael Tannenbaum, president of the Hedge Fund Association in New York. “The value added by the manager in picking the sub-funds diminishes.”

Funds of funds levy management fees up to 1% and performance fees up to 10% on top of the underlying funds’ 1%-1.5% management fees and 20% performance fees. “Some of the funds of funds are reasonable, some aren’t,” he says, “A number don’t charge performance fees, or charge performance fees that are very modest, or that are modest and in excess of a benchmark.”

As assets under management balloon, spreads have shrivelled for some popular strategies, such as merger and convertible arbitrage. Although merger activity has picked up, total transaction volume remains far short of the peak reached in 2000. Convertible bond issuance has not kept pace with hedge funds’ asset growth, either. “The market becomes more efficient as the amount of money and the number of players increases,” notes Tannenbaum.

The search for higher returns is leading hedge funds into commodities, exotic securities and even private equity, which increases the risk. “Illiquid investments are inconsistent with a strict hedge fund model,”  Tannenbaum explains.  “Hedge funds typically are open-ended products.  Private equity or venture capital investments are illiquid.  As a result there are valuation problems.” Hedge funds segregate private equity deals into “side pockets” that lock in participating investors until the underlying investment liquefies, fixing the value.

Government agencies in Washington are split over the merits of hedge funds. The Federal Reserve, the central bank of the United States (US), more commonly known as the Fed, and the Treasury Department relish the liquidity they provide. On the other side, the Securities and Exchange Commission (SEC) looks at them askance. “I sat down with Alan Greenspan and with (Treasury) Secretary Snow and his staff, and they are just so delighted that hedge funds are there in the illiquid markets,” says John Gaines, president of the Managed Funds Association (MFA), “Then you go to the SEC and they say we have valuation problems. It is like you have crossed a border.”

Valuation difficulties extend to over-the-counter swaps, derivatives and other securities for which no ready market exists. “There is no such thing as an independent valuation service,” scoffs Hedges at LJH, who believes the lack of valuation standards is the biggest threat to the hedge fund industry, “The administrators cannot do it; they do not understand the instruments.” In the absence of a market price, managers follow procedures described in their partnership agreements – which they drafted. “It is quite arbitrary,” he says, “Hedge fund managers are the ones that decide or define valuation – not a market maker, not a broker dealer, not an auditor, not an administrator.”

In its 2003 report Sound Practices for Hedge Fund Managers, the MFA recommends a fair value approach but recognises the limitations for illiquid securities. “The value of that money going into our capital market outweighs the difficulties that are associated with valuation,” says Gaines, “That’s not to say there’s a simple answer to valuation, but it is one of full disclosure and consent by the investor.”

Fraud based on bad valuations contributed to the SEC’s decision to force most US hedge fund advisers to register by February 1, 2006. The agency ignored intensive lobbying by the MFA, the US Chamber of Commerce (USCC) and others opposed to regulation. The rule captures advisers who manage more than $30m and have more than 14 US investors in funds with a lock-up period less than two years. Longer lock-ups let private equity and venture capital funds off the hook.

Tannenbaum worries the incremental cost may deter some younger players, who might otherwise bring new ideas and energy to the industry. He also fears registration is the thin end of a regulatory wedge. “I refer to it as the slippery slope problem,” he says, “Okay, we will file the form and we will adopt the rules, but where does that lead to?”

The SEC acknowledges it must “recognise the important role that hedge funds play in our markets” and denies any intent to dictate hedge fund strategies. Its assertions convince no one. “Of course there is more to come,” says LJH's Hedges. “It is unfortunate the US is starting to increase regulation at a time when the rest of the world is starting to liberalise their regulatory regime.” He believes the new rule is wasteful and misconceived. “I don’t believe It is going to protect the retail investor. I don’t believe it is going to protect any investors.”

Tannenbaum suggests that foreign hedge fund managers, many of whom already face regulation in their home country, may be reluctant to submit to multiple jurisdictions. “Maybe there should be some reciprocity,” he says, “I fully understand that there’s no reason the SEC should give a person registered with the Financial Services Authority in London a pass. They could sort that out.”

Foreign managers may prefer to evict enough US investors to escape the threshold rather than submit to SEC scrutiny. “I think some funds will jettison that number of US investors to get under 15 so that they can avoid duplicative and perhaps inconsistent regulation,” says Gaines. Sophisticated investors will have fewer choices if foreign managers forsake the US market.

The USCC believes the SEC lacks authority to impose the new rules and has threatened to file suit. In 1985, the SEC defined a “client” under the Investment Advisers Act to include a limited partnership but not individual limited partners because they do not receive independent advice. A letter commenting on the SEC's proposals from Wilmer Cutler Pickering Hale and Dorr LLP argued that legislative history back to 1940 supports this approach.

When Congress amended the Act in 1970, it altered the registration requirement but not the way advisers count clients. “If Congress has met, tinkered with the statute, made changes, and not seen fit to change or override an interpretation, there’s a presumption that the interpretation is correct and has the approval of Congress. Therefore, to change that interpretation requires an Act of Congress,” Tannenbaum explains, “That is the argument. I do not know if it has legs.”

Although the MFA has fought hard against registration, it has no plans to challenge the rule. “That is history. We lost and we are going forward,” Gaines says, “We look forward to working with the SEC. If they need to develop information and knowledge about the hedge fund industry, we are in a unique position to provide it to them.”

Gains points out that registration brings other rules into play. Registered advisers must adopt a written code of ethics and appoint a chief compliance officer. “It is not just putting a postage stamp on a form and sending it in,” he says.

The SEC argues the rule does not impose a significant burden because many hedge fund advisers have already registered. Mindful of their fiduciary responsibilities, most institutions allocate money only to registered hedge fund advisers. “Quite apart from the Commission’s actions, any major player in this business, or any wannabe (sic), would have had to register anyway,”  Tannenbaum says, “I think the industry needs to be realistic about that.”

As more pension plans invest in hedge funds, the pressure to register increases. Any fund that has more than 25% of its assets from the Employment Retirement Income Security Act (ERISA) plans, which covers a wide range of employee benefit plans, becomes subject to the “plan asset” rule.

“The application of the plan asset rule is inconsistent with operating a hedge fund,” Tannenbaum says, “It interferes with performance fees, interferes with soft dollar arrangements.” A hedge fund manager can avoid the plan asset rule by becoming a Qualified Professional Asset Manager if it meets three tests, including $750,000 net worth in the management company and at least $50m under management. “Guess what the third is?” asks Tannenbaum rhetorically. “You have to be registered as an investment adviser.”

Hedges distinguishes SEC registration (that he vehemently opposes) from the Treasury’s proposed anti-money laundering rules for investment advisers. “Regulation that protects our national interest so that unregulated vehicles don’t become conduits for people who gained their capital illegally, or use it illegally, that’s a different deal,” he says.

MFA members share that view, according to Gaines, because anti-money laundering has a demonstrable benefit. Hedge funds have no desire to shelter money derived from criminal enterprises, political corruption or terrorists. “I didn’t have one member object to what the Treasury proposes to do,” he says, “In fact, they were extremely supportive with their talent and their money and their time to develop guidance to Treasury to get it right.”

Tannenbaum hopes the Treasury Department issues final money-laundering rules soon. “The worst thing about rules is not knowing what they are,” he says, “You might have people doing it one way, and then all of a sudden you have another evolutionary scheme out there, and as time goes by they continue to diverge.” He describes the final rules as “regulatory vapourware”. The Treasury published the proposed rules in April 2003. Hedge fund managers won’t have to wait for new rules governing deferred compensation to take effect. Many US-based offshore fund managers defer their share of the performance allocation, which allows them to avoid paying tax until a later date. They did not change the creditor relationship; they just made it harder for the creditors,” Tannenbaum explains, “Offshore rabbi trusts are outlawed by the new rule.”

Offshore rabbi trusts are trusts set up in foreign jurisdictions to fund non-qualified deferred compensation programme. Generally speaking a rabbi trust is nothing more than a promise to pay compensation at a later date.  Rabbi trusts have commonly been used as top-hat deferred compensation plans for high ranking executives. Under these plans a beneficiary can put stocks, insurance policies or other assets in trust.  As a result, a number of hedge fund managers have used offshore rabbi trusts as a means to defer income from current taxation. US regulators have been concerned however that offshore rabbi trusts are set aside often out of reach of a corporation’s creditors – which actually defeats the original purpose of the US Inland Revenue Service allowing them in the first place. Under recent legislation, managers can still defer compensation, but must accept tighter restrictions as well as greater exposure to credit risk – although few managers will have to worry about large deferrals in 2004.

For 2005, the MFA has its work cut out to prepare members for registration. “It is education, seminars, compliance guidance; all kinds of things go into the implications of that rule. It is huge,” says Gaines.

Will performance rebound? Perhaps – but the deluge of money may make it harder for managers to deliver excess returns.

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