By Mikhail Iliev, Who's In My Fund? -- If you are an investor and your hedge fund advisor plans to merge, your best option may be to prepare your exit.
You can’t influence the merger negotiation and, given the nature of the industry, you have no guarantee your manager will stay.
Hedge fund advisor mergers and acquisitions have not been as high profile or frequent as other company mergers, but this may be changing.
Dealmaking in 2009 was dismal -- the number of mergers and acquisitions among hedge funds dropped to 135, valued at $31.7 billion. That’s a steep decline from just two years earlier, when there were 205 deals valued at $38 billion.
Last year, however, total deals exceeded 220. And although total deal value was low, for the first time ever there were more alternative fund advisor deals than traditional manager mergers.
Last month, Goldman Sachs took a stake in Mount Lucas Management, its seventh thus far, and sold its stake in Claren Road to the Carlyle Group.
Early last year, SkyBridge Capital acquired three alternative asset units from Citigroup with a total of $4.2 billion in assets under management and advisory.
And in likely the largest such merger ever, alternative advisor Man Group agreed to pay $1.6 billion for GLG Partners bringing Man’s total assets under management to about $63 billion.
There are reasons to expect a bigger merger wave in 2011.
The Dodd-Frank Act will push many U.S. banks to sell stakes in alternative managers, with Europeans the willing buyers because they want to minimize the compliance and operation costs due to new regulation there.
Thousands of smaller funds, which saw little of the industry's new capital infusions and which rely more on good results to earn fees, are under the most pressure to merge. With assets still below pre-crisis levels, these funds will profit from merging to share the greater due diligence cost in the wake of the Madoff scandal.
The industry is still too fragmented, experts say, and could use serious consolidation. Nearly1,500 hedge funds folded in 2008, but the $1.7 trillion industry still consists of around 7,000 funds and a further 2,000 or so funds of funds.
However, hedge fund M&A is risky. It is tough to build up support to acquire an underperforming manager. And well-performing managers are hesitant to sacrifice their funds’ independence. Once merged, funds may be unable to keep star traders who can leave and take clients with them. If firms can’t hang on to clients post merger, they will, understandably, be very hard to value. Consequently, many firms may try first to recruit teams before doing big deals. And some, like Och-Ziff, prefer growing by attracting more investors with a good strategy rather than merging.
If your advisor is eyeing a merger, you will be nearly powerless to stop it. Investors don’t have a seat at the table when a merger is negotiated. Nor do they see what the merger documents look like while they are negotiated. The laws do say that advisors must get the consent of their clients before they merge, but that may be cold comfort to investors. The client that an advisor serves is the fund not the investor. All funds appoint a general partner to make decisions for the fund and all its investors, which often includes the decision to consent to advisor mergers.
“The advisor gets the consent it needs from the GP,” hedge fund expert Michael Renetzky explained to Who's In My Fund?, “but that GP is typically the affiliate of the adviser firm itself.”
This investor helplessness appears baffling. The name on the manager’s door is often all that matters and investors’ worst fear is that the name may bolt post-merger.
So, shouldn’t investors ask for more control over mergers before they sign up to a fund?
They should, but they don’t.
“The reason for that,” Renetzky said, “is they can generally get out of a fund on a short notice, sometimes a month and often no more than three months. If you don’t like a merger, you just take your money out.”
Even if investors get consent rights or have the right to know the terms of the proposed deal, it probably makes little sense for them to block it. There are likely many of them and the efforts needed to subvert a deal may require too much time and money.
Of course, investors can always wait and see what happens post-merger. Sometimes, they may even get to see the final merger agreement and gauge for themselves how committed their managers are to the funds or how good the carrots offered to keep them around are.
Disclosure and transparency concerns should compel advisors to send the final merger agreement to their investors to give them fully updated information on their investment, Renetzky said. However, this is not set in stone and in practice investors may not receive anything, he added.
Even if you receive the agreement, figuring out what your manager would do is largely a guessing game. For some managers, no incentive is good enough if they don’t like the new boss.
Eight researchers and traders left shortly after the Man-GLG merger, even though the deal opened up a plethora of new distribution channels and markets, and assets under management ballooned.
So, you can’t stop the merger and you can’t figure out on your own if you’ll get a good deal. In this people-driven space with titanic egos unions fall apart, and carrots and commitments are soon forgotten.
What are you, the investor, to do?
If you are in a fund whose advisor is merging, consider bolting before your manager does. If you are buying into a new fund, make sure you can get out relatively quickly and stump for better consent and merger disclosure rights before you sign up.
Mikhail Iliev is a contributing editor of Who's In My Fund?, a site which groups hedge fund investors by investment, allowing them to communicate directly and discretely with each other in a secure environment and share news and opinion on their investments. Mikhail practiced law for 11 years as an associate at Dewey LeBoeuf, LLP and as Senior Vice President at KBC Financial Products. He has extensive experience in the field of securities law and private investments and has advised clients on financing and offering matters for domestic and offshore funds, mergers and acquisitions and securities regulation. He is also a visiting professor at Segal Graduate School of Business in Vancouver, Canada where he has taught courses on securities regulation and ethics.