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Open-end fund (LOF), full name is "Listed Open-Ended Fund". Is a listed open-end funds issue, investors can either purchase a specified network and the redemption of Fund shares can also be traded on an exchange of the Fund. But if the designated outlets investors purchase shares in the fund, you want to throw the Internet, need to go through some custody transfer procedures; Similarly, if the exchange line to buy shares in the fund, you want to redeem at a specified network, but also the custody transfer to go through certain formalities.
December 2004 The convergence of private equity and hedge funds in Asia By David Goldstein, White & Case Despite their similarities, private equity (or management fees are paid on both invested and committed funds) and hedge funds have always uninvested commitments until the end of an been viewed as distinct disciplines in the alternative investment or commitment period, after which asset industry. Over the last few years, however, funds cannot make new investments. Cash is market factors have resulted in the convergence distributed to investors upon realisation of fund of these two parts of the industry, with both the investments, and current income, if any, is either committed fund side and the hedge fund side of retained by the fund for reinvestment or distributed. the alternative asset industry taking on Investments by committed funds tend to be long- characteristics of the other. Investment style drift, term and illiquid in nature. That is the main reason personal interests of investment managers, the why these vehicles have traditionally not offered interest of asset managers in offering a broad any means to redeem interests short of a legal, array of products, and fund raising imperatives tax or regulatory issue making it inadvisable for are some of the many factors driving certain hedge the fund to keep a particular investor in the fund. funds to seek private equity investments. Perhaps more interesting, however, are the steps committed Hedge funds likewise include a tremendous array fund managers are taking to make themselves of fund types, such as long/short, fixed income, more attractive to hedge funds who are seeking macro, merger arbitrage, other event driven, fixed to invest in committed funds. Several key trends income, distressed securities, convertible arbitrage, are emerging and new terms and mechanisms are and market neutral strategies. Hedge funds are being adopted by committed funds in order to structured to provide liquidity for their investors compete in this changing landscape. by being either open-end or listed closed-end vehicles. Open-end funds provide liquidity in the Committed funds and hedge funds form of redemption rights and offer new interests preliminary notes periodically, unless investment managers The term committed funds includes funds in voluntarily close the fund to new investors. Before many different types of strategies, including considering certain mechanisms funds employ to traditional private equity, venture capital, distressed slow down the possible flight of capital from a debt, real estate opportunity, real estate core or fund, liquidity options in open-end funds might core/value and mezzanine among others. However, be monthly, quarterly, semi-annual or annual or these funds share a few key characteristics that longer. The key point for a fund manager, however, distinguish them from hedge funds and other is that the underlying trading strategy of the fund types of open-end funds. The primary shared must be consistent with the liquidity options it feature is that they represent long-term investments provides. Closed-end funds issue securities that DAVID GOLDSTEIN for their equity holders, with no redemption rights are listed on an exchange or are otherwise tradable, PARTNER and little or no liquidity for their interests. Capital therefore providing their investors with liquidity NEW YORK OFFICE 1 212 819 8757 commitments to the funds are generally drawn to the extent of interest in the secondary market. email@example.com down over time on an as-needed basis and Closed-end funds are the fund managers ultimate 1 December 2004 dream: permanent capital. However, institutional investors tend to inundated with a steady flow of information and investment avoid closed-end funds since they can trade at a discount to their opportunities, perhaps bored with their core business and looking net asset value. for a new challenge, decide to venture into the deal world. One of the most notable examples of this phenomenon is Edward Lamberts Strategic convergence building alternative asset acquisition of Kmart and then Sears in the United States. platforms Many large money centre firms including global banks and Wall Hedge fund managers have also entered the deal world by investing Street investment banks have concluded that managing hedge funds in private equity managers as stake, seed or lead investors. While is synergistic with their other asset management businesses and an hedge fund managers have sought deal-making capability in the important part of their product portfolio. For example, in the second past, the present trend is remarkable for its breadth, and it shows half of 2004, JPMorganChase acquired Highbridge Partners and no signs of abating. Much of this trends strength is attributable to hedge fund administrator Tranaut Fund Administration; Lehman the need of hedge fund managers to deploy effectively the large acquired GLG Partners; and Merrill Lynch prepared a bid for the Man amounts of capital flowing into hedge funds. Hedge fund managers Group. Also in Europe, BNP Paribas bought a 50 percent stake in have driven a tough bargain, often taking significant portions of the Fauchier Partners, a boutique UK fund manager and announced that carried interest while paying a reduced carry on their capital. They the new venture, BNP Paribas Fauchier Partners, is looking to acquire have sought, with mixed success, varying degrees of control over managers of funds of hedge funds. investments and their terms, representation on portfolio company boards, and termination rights more favourable than third-party The steady income and cash streams from a hedge funds investors would typically seek. Hedge fund managers have management fee may prove to be the biggest attraction for the banks, aggressively sought co-investment rights from committed fund smoothing earning from other parts of their operations. In fact, some managers, creating potential conflicts of interest for these managers. investment bankers have discussed lowering the performance fee For the managers of committed funds, the lure of an endorsement rate of their firms hedge funds in exchange for a higher management from a successful hedge fund manager and the related boost to fund fee. The certainty of this cash flow, compared to the relative uncertainty raising efforts in a difficult market are enough to cause the committed of the performance fee, is likely to increase the value of a hedge fund fund manager to seek out these arrangements, despite the manager and definitely make it easier to value the manager, leading compromises entailed. to transactions that can thrill the hearts of investment bankers such as mergers and acquisitions or IPOs involving hedge fund managers. Committed fund managers changing their terms The recent IPO of Cohen & Steers, a New York-based manager of to attract hedge funds as investors mutual funds that invest in real estate investment trusts may serve Why is the current fundraising environment so difficult for so many as an example of this new enthusiasm by investment bankers for committed funds relative to hedge funds? A good way to sum it up this industry. is that for several years committed fund investors have suffered a deadly combination of low returns over prolonged periods of time One of the most significant trends in the alternative asset industry without a foreseeable exit strategy for their investments. The liquidity is the activity of hedge fund managers in the committed fund space. offered by hedge funds and the superior returns recently generated Distressed investing strategies has played a significant role in this by many hedge fund managers has made investing in committed trend. These strategies provide a logical extension from hedge fund funds less compelling than it was five to 10 years ago. In this structures to committed fund structures because many distressed environment, committed fund managers, especially new managers managers want to hold investments for longer periods than traders, raising their first fund or those managers under intense pressure to while others want to play an active role in restructurings and other raise money in order to close transactions, have taken some unusual distressed securities transactions. As distressed managers started steps to attract hedge fund investments, including aggressive to look at real estate investments, the need for committed, locked- deviations from traditional committed fund terms. up capital also became evident. Other managers suffer from style drift, unable to find suitable investment opportunities within their Preferred interests one of the most aggressive moves taken by discipline. Sometimes this happens because hedge fund managers, committed fund managers to attract hedge funds as investors has 2 December 2004 been to offer a class of interests in the committed fund in preference distributions must be paid out upon redemption, and once a to the traditional class of investor interests. This other preferred redemption date has passed, the interests exercising their redemption class benefits from a priority upon liquidation and a cumulative rights have priority to all distributions until the redemption amount dividend distribution in preference to distributions to the ordinary is satisfied, including priority to any other preferred (or ordinary, if class of equity and in respect of the carried interest. It also benefits applicable) interests still held by the redeeming interest holder. from the huge cushion of the ordinary interests below it, getting 100 percent of the cash flow until their preferred distribution is received. Mandatory redemption the corollary, of course, to an investors In cases where this structure has been used, the preferred class has redemption right is the committed fund managers right to buy out represented approximately 30 percent of total capital. A majority of the preferred interest holders prior to the optional redemption date. the portfolio will have to under-perform in order for the preferred This redemption right generally arises after the second anniversary class to receive less than their distribution targets. of a closing and is priced at a premium to the purchase price plus cumulative unpaid dividends. This feature has the effect of encouraging The preferred class of interests is entitled to a preferred return at a the general partner to make regular distributions, to the extent rate comparable to or higher than the pref the ordinary class would possible, in order to minimise the premium payable in the event of typically receive. This return is cumulative and all arrearages, on a a mandatory redemption. If the general partner has a generous compounded basis, must be paid out before the ordinary interests number of investment opportunities, the balance to be struck is to receive any distributions. After the preferred interests receive their make regular distributions to the preference class but not the common cumulative distributions, including arrearages, the next dollars go class, so long as the general partner can stand proceeding without to the ordinary equity holders until they catch up to the return realised carried interest distributions. On the redemption date for a given by the preferred holders. The fund sponsor will have to wait for tranche of securities, the security holders can each elect to redeem distributions in respect of its carried interest until an amount equal their interests or convert them to common interests at an amount to all of the capital invested has been returned to the investors. Then equal to their invested amount minus any premium paid for the the general partner receives distributions of next dollars at the rate preferred interests (and as adjusted in accordance with any anti- of up to 80 percent until it has caught-up and received a 20 percent dilution protections that have been invoked). cumulative carry. Thereafter, dollars are distributed in a traditional manner, with the limited partners sharing equally based on capital. Ability to accumulate cash in these hybrid transactions, investors have generally concluded that making a cumulative preferred Optional Redemption some committed fund managers have distribution to the preference class before any distributions can be agreed to provide liquidity to their investors, representing a serious made to the common interest holders and especially the fund sponsor departure from traditional committed fund terms. This term has or general partner has been considered sufficient to assure that the proven most significant to hedge fund investors, who by their nature investors interests and the general partners interests are sufficiently are uncomfortable with long-term relationships. Redemption rights aligned. In most deals, the preferred interests holders have even have been paired with other terms that have made them more prevented the general partners interests from taking distributions palatable for the committed fund manager to agree to. For instance, for tax payments in order to further assure that the use of cash is a committed fund offering redemption rights should be able to retain consistent with the interests of all parties. The preference class has cash, rather than distribute it, in order to be able to satisfy redemption also imposed stricter investment limitations than is typical in a private requests as they come due. (Always one step ahead, hedge fund equity fund. These limitations seem to be influenced by the managers have sought mandatory distributions of cash reserved in collateralized debt obligation sector, with transactions outside the excess of the amount necessary to fund redemption requests and parameters set out in the funds governing documents requiring the anticipated cash outflows from investment operations, in order to consent of a super-majority of the preference class. prevent committed fund managers from redeeming them prior to a big realisation. (See paragraph on mandatory redemption below.)) As an alternative to accumulating cash, the funds governing The optional redemption rights are spaced out over two or three documents should provide that the fund can issue additional new years, so that no more than approximately 10 percent of the funds interests. The difficulty with this approach is addressing whether the capital can request redemption in any one year. Cumulative new interest holders will share in the funds investments existing at 3 December 2004 the time the new capital is raised. However, this issue does not have return multiple was below a certain hurdle, the carried interest to be resolved between the new holders and the preference class if percentage for that investment would be reduced to 15 percent. the proceeds of the new equity raised are going to be used to redeem Finally, an investment realised after the fourth anniversary with a the preference class. Debt issuance possibilities are limited without sub-par return (which is higher than a sub-par return for an the consent of the preference class, unless the proceeds from the investment realized in years three and four) would result in a 15 new debt is used to take out the preference class entirely. percent carry with respect to that investment. To keep the general partner from getting too far ahead, the carried interest percentage Enhanced Liquidity Hedge funds have insisted, with some success, applied to any realisation would be an average of the appropriate in requiring committed funds to increase liquidity options available carry percentages weighted by the amount of capital invested in for investors in addition to redemption rights. In some instances, each deal compared to the aggregate invested amount. This weighted funds have created mechanisms to effect Dutch auction procedures average would be recomputed upon each realisation. Losses would or agreed to provide information to secondary purchasers in order be allocated pro rata to each realisation in order to prevent them to facilitate their due diligence prior to purchasing fund interests. from being applied to the low-yielding investments or high-yielding These arrangements address both hedge funds liquidity needs and investments, to the detriment of either the investors or the general the committed fund managers desire to avoid redemptions to the partner. extent possible. Conclusion Realign incentives an entirely different approach was taken by The convergence of private equity funds and hedge funds, and in one committed fund manager seeking to attract hedge fund particular the strategic convergence noted earlier, has accelerated investments. In this case, a lead investor accounting for 20 percent rapidly in the West and in Japan. The factors that contributed to this of the funds commitments negotiated for a redemption right arising trend in those regions exist in the rest of Asia, while other factors, on the third anniversary of closing at a price equal to the fair market such as fast-moving investment styles, huge capital inflows and value of its interest, but not in excess of a 10 percent annually savings rates, and a pool of investment professionals eager for compounded return. In addition, the funds general partner was innovation, make it equally or more likely that convergence in Asia incentivised to seek fast dispositions by an innovative carried interest will be more pervasive than what has been evident in the West to formula. For investments realised within two years of acquisition, date. These commercial considerations, and the very sensible the general partner will receive carried interest at the rate of 25 regulatory currents stirring in Hong Kong and the progressive percent. If the amount realised was more than a certain multiple of regulatory atmosphere in Singapore, are creating the right the invested amount, a carried interest of 30 percent would be environment throughout Asia for the creation of a new generation calculated on that gain. For investments realised after the second of asset management firms. anniversary of the investment date but before the fourth anniversary, a 20 percent carried interest would be calculated. However, if the www.whitecase.com 4
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