Fortress Offers to Buy Fund's Illiquid Assets

Fortress Investment, scrambling to manage heavy withdrawals from its $5 billion Drawbridge Special Opportunities Fund, is proposing an unusual maneuver to meet some of the redemptions.

In an April 1 letter to investors, the New York firm sought permission to buy certain illiquid assets Fortress had earlier set aside in special accounts. It's unclear why the firm is interested in purchasing the assets rather than liquidating via secondary-market sales, but presumably Fortress sees an investment opportunity. It also would allow the firm to return some money to investors.

Drawbridge Special Opportunities invests mainly by making direct loans to unrated companies. The U.S. version of the fund lost 26% last year, triggering a flood of redemption requests from investors. In response, Fortress established so-called redemption capital accounts at the end of the year to hold certain assets pending liquidation. The terms of the fund already give Fortress the option of purchasing, on a pro rata basis, portions of all of the assets in those accounts.

The loans the fund invests in are highly illiquid. Rather than try to sell pieces of the loans held in the redemption capital accounts on the secondary market, the fund manager is seeking to maintain control of entire loans. Some of the redeeming investors still maintain investments in the fund, so those investors would essentially be selling the assets to themselves.

In its letter to investors, the firm made another unusual pitch: It asked redeeming investors if they want to participate in a plan to buy back CDO paper backed by loans the fund originated. Many of those loans were securitized as collateralized loan obligations. The CDO issues provided financing used for the assets. The firm told investors it wants to repurchase the bonds in the secondary market, where they are trading at a significant discount to face value. "Such repurchases by the fund would effectively extinguish the debt of such CDOs," according to the letter. Investors would benefit because it would allow them to retire the fund's obligations at a discount, effectively allowing them to retrieve the loans on the cheap.

Fortress is asking investors to approve both maneuvers - the purchase of assets from the redemption capital accounts and the CDO buy-back plan - or reject them both. Investors don't have the option of choosing one but not the other. The firm is giving investors until April 17 to make a decision.

Investors in Drawbridge Special Opportunities Fund and in the $1.5 billion Fortress Partners Funds, which together comprise Fortress' so-called "hybrid hedge funds," issued redemption requests totaling $1.5 billion for Dec. 31. The U.S. version of Drawbridge Special Opportunities had $4.4 billion of assets at the end of 2008. The offshore fund, which lost 29% last year, had $446 million.

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