Archive for the “1861 Capital Management” Category

It used to be common practice for hedge funds like 1861 Capital Management, Citigroup’s ASTA/MAT and Stone & Youngberg Municipal Advantage Fund to tout the promise that first built the hedge fund industry: to produce profits even in tough markets. Now it’s a different story altogether. The hype is faded, and the credit crunch has caused more banks to pull credit lines from hedge funds and investors to shun this once-popular-but-secretive corner of the investing world.

For hedge funds that invest in the $2.6 trillion municipal bond market, troubles are even more pronounced. As reported March 1, 2008, by the Wall Street Journal, turmoil in the municipal-bond market has forced a number of hedge funds to unwind complicated bets and in the process unload billions of dollars worth of securities. Among those hedge funds: New York-based 1861 Capital Management.

Municipal bond arbitrage is considered a complicated, risky investing strategy that involves trades of municipal bonds, short-term notes, and interest-rate derivatives. In recent years, a growing number of hedge funds, including 1861 Capital Management, began to employ municipal arbitrage, buying long-term municipal bonds that had slightly higher yields and pocketing the difference. The funds then hedged against large fluctuations in interest rates by essentially reversing that trade, using taxable securities. 

Municipal bond arbitrage also entails additional risk because in order to bolster returns, hedge funds must pile on the leverage.

Signs of trouble first appeared at the beginning of 2008, when municipal bond yields became hammered from the downturn in the markets. As a result, many hedge funds suddenly found themselves forced to liquidate their leveraged positions. 

It’s these two facts - risk and leverage - that have become a bone of contention for many investors in municipal arbitrage hedge funds. As reported in a January 2009 study from the Securities Litigation and Consulting Group (SLCG) on the recent failure of leveraged municipal bond hedge funds, some 36 hedge funds - 1861 Capital Management among them - were marketed and sold to investors as “high yield, low-risk alternatives” to traditional municipal bond funds.

In reality, nothing could have been further from the truth. All of the hedge funds featured in SLCG’s study contained considerably more risk than investors ever realized. They also produced significantly lower-than-expected returns. In the end, investors suffered to the tune of billions of dollars in losses.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses. 

The Ospraie Fund. 1861 Capital Management. ASTA/MAT. Tontine Partners LP. The freewheeling world of hedge funds has crashed and burned in recent months, its fate tied to the financial crisis, investor redemptions and illiquid assets. As a result, thousands of individual investors, charities and pension fund holders are now facing unexpected and unprecedented financial losses.

The past year has seen hundreds of hedge funds go out of business. In 2008, some 920 funds were shuttered - a figure that eclipses the prior record set in 2005 when 848 hedge funds closed down. On average, hedge funds lost more than 18% last year. The previous worst performance by hedge funds occurred in 2002, posting a loss of 1.5%. In 2007, hedge funds returned 9.9%.

As hedge funds literally fought for survival in 2008, many would lose the battle altogether. Among them: The Ospraie Fund, which posted nearly a 40% loss in 2008. An even worse performance came from the Tontine Partners LP hedge fund, which ended the year down an astonishing -91.5%.

Other funds such as Tudor Investment Corp. and Citadel Investment Group LLC have been forced to limit investor redemptions or risk implosion. Earlier this month, Citadel, whose flagship hedge fund lost 55% in 2008, announced plans to resume payouts to investors. Investors’ access to their money, however, will occur no sooner than April 1.

Hedge funds that trade municipal bonds also are experiencing a rough time these days. As reported Feb. 29, 2008, by MarketWatch, problems with bond insurers and other disruptions borne out of the global credit crunch have pushed yields on municipal bonds close to, or above, those of comparable Treasury bonds. For hedge funds that try to make money from the difference, called the spread, between the yields, the end result translates into the likelihood of margin calls.

That’s exactly what happened to hedge funds like Citigroup’s ASTA/MAT hedge funds. In using a municipal arbitrage strategy, the funds ultimately were forced to sell their positions at fire-sale prices, causing significant losses to investors. 

The dismal performance of hedge funds has continued into 2009. One of the most recent hedge funds to shutter is the Highland CDO Opportunity Fund, which encountered massive losses from its holdings of high-risk collateralized debt obligations (CDOs). In October, similar circumstances forced Highland to close two other hedge funds: the Crusader Fund and the Credit Strategies Fund.

The shocking upheaval in the hedge fund industry is casting new light on the largely unregulated world of hedge funds. Registration with the Securities and Exchange Commission (SEC) is done on a voluntary basis only. At the same time, investments in hedge funds have grown astronomically. At their peak, approximately 10,000 hedge funds managed nearly $2 trillion in assets. Today, the figure is closer to $1 trillion.

On Jan. 29, 2009, a new bill was introduced in the Senate designed to improve oversight and transparency of the hedge fund industry. Described by Senators Chuck Grassley and Carl Levin as an “attempt to address securities law loopholes that enable hedge funds to operate under a cloak of secrecy,” the Hedge Fund Transparency Act of 2009 (S. 344) would make it mandatory for hedge fund managers to register with the SEC and open up their books to government examiners.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.