Fund-of-Funds Firms Go on the Defensive

Three large fund-of-funds operators in Europe are making it tougher for investors to withdraw their money, reversing the easy liquidity terms that helped fuel their rapid growth.

The unprecedented defensive steps are being taken by Permal Investment of London, Thames River Capital, also of London, and Geneva-based Notz Stucki. Many others are expected to follow soon with their own defensive measures.

"I think a lot of funds of funds will be doing this," said the chief investment officer of a U.S. fund-of-funds manager. "It is not something we are doing, but I would be a liar if I told you it didn't cross our minds."

The three European firms are paying the price for the investor-friendly liquidity terms they offered during the years leading up to the financial crisis. Their monthly liquidity terms helped them raise capital quickly, particularly from wealthy investors who were eager to put their money to work in hedge funds. Such terms were looser than those imposed by most funds of funds, particularly U.S. vehicles that typically offer quarterly liquidity if notice is given 65 days prior to the end of a quarter.

Permal, with $35 billion under management, is now requiring far more notice than it used to from investors wishing to redeem shares. It wants investors to request their withdrawals 95 days ahead of the redemption date, up from 20 days. The move had the effect of blocking redemptions from those who wanted out before yearend. Permal's next redemption date is Feb. 28, 2009, with notice due by Nov. 25.

Permal is applying the "temporary" notification policy to its vast suite of funds of funds, which have almost all suffered losses. Investors are heading for the exits as the firm's multi-billion-dollar Permal Investment Holdings was down 24% this year through Oct. 27. Other funds of funds it operates have also suffered losses.

Thames River, a money manager with $2.8 billion in funds of funds, is taking similar temporary steps with three of its vehicles: Thames River Warrior Fund, Thames River Warrior 2 Fund and Thames River Sentinel Fund. It is nearly tripling its notification period to 100 days ahead of the redemption date, up from 35 days. Thames River disclosed the new policy in an Oct. 31 letter promising to deal with future redemption requests in a "fair and equitable" manner. The three Thames River vehicles are said to be performing relatively well against their peers.

Notz Stucki, which manages $19.5 billion in funds of funds and advisory assets, is taking a different approach by invoking a "gate" provision written into the offering document of its DGC Pendulum Master fund. The firm is limiting redemptions to 5% of its assets per month. Investors asked to withdraw $605 million, or 16% of that vehicle's $3.8 billion, according to the firm's Oct. 22 letter. Notz Stucki is also struggling with a surge of redemption requests from investors in its DGC Euroarbitrage, Sterlingarbitrage and Swissarbitrage entities.

Notz Stucki believes it has the capital to meet redemptions and intends to give back about $1 billion over the next two months, although some of the money will be steered into new investments. The firm contends that its funds invest only in liquid, multi-strategy vehicles with low volatility.

The recent wave of market-roiling hedge fund liquidations has been in large part driven by funds of funds seeking to redeem shares in order to meet withdrawal requests by their own panicky investors.

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