The Legacy of LTCM: Marking to Market

By TOM SULLIVAN | MORE ARTICLES BY AUTHOR

The former co-head of Long Term Capital Management now runs a company that determines a hedge fund's net asset value on a monthly basis.

• Ever wonder what happened to the guys who ran Long Term Capital Management, the hedge fund founded in 1994 by the renowned Salomon Brothers bond trader John Meriwether, who was immortalized in Liar's Poker? He surrounded himself with a who's who of traders and academics, took in $1.3 billion at the fund's inception from top investment banks and, in 1998, nearly created a systemic financial crisis when his fund collapsed.

Only intervention by the Federal Reserve, which brokered a $3.5 billion rescue package from the biggest investment and commercial banks in exchange for 90% of LTCM's equity, saved the day. The big lesson from that debacle was that market values matter for leveraged portfolios, and liquidity itself is a risk factor―a lesson relearned on a much grander and more frightening scale in 2008.

"There was too much risk in the fund in a market that became very illiquid in a very short time," says Hans Hufschmid, the former partner and co-head of LTCM's London office. He's now CEO of GlobeOp Financial Services, a London-based hedge fund administrator he founded 11 years ago. The man who had a front-row seat at LTCM's near-default runs a company with 2,000 employees on three continents that determines a hedge fund's net asset value on a monthly basis.

"We're an independent arm between the hedge fund and its clients," says Hufschmid. "We protect our clients' clients" by sending monthly reports not just to the hedge-fund managers, but directly to the fund's investors, too."

Some hedge funds are still self-administered and calculate their NAVs themselves. But after Bernie Madoff's billion-dollar Ponzi scheme was exposed in 2008, "that's not acceptable to institutions," says Hufschmid.

Hedge funds are obviously coming off a rough patch; many shut down during the credit crisis, ruined by redemptions. But the average hedge fund was down 20%, compared with a 40% drop in equities. "Underlying trends are back to pre-crisis," says Hufschmid, who says the fee he charges hedge funds is based on their assets. Business is good, he adds, noting that his clients are seeing more subscriptions than redemptions and that new hedge funds are entering the industry.

Drafting of rules required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in July 2010, isn't complete. But hedge funds will probably face stringent quarterly reporting requirements. That can only be good for GlobeOp's business, and for hedge-fund investors, too.

SPEAKING OF MADOFF'S TREACHERY and the demand for transparency, new research findings by MyPrivateBanking Research show that only 10% of the world's top wealth managers publish performance data for accounts that give the wealth manager or private bank the authority to buy and sell securities at their discretion.

Even more unbelievable is that just 22% offer specific information about their fees. And just 8% offer at least a three-year track record on the performance of their discretionary accounts.

MyPrivateBanking, an online independent advisor to wealth-management investors, says its results are based on an analysis of public Websites, including all reporting documents that the 40 largest wealth managers worldwide put online. MyPrivateBanking takes the extremely sensible position that discretionary accounts are like mutual funds and should open their books in a similar manner. And investors who can't get this information (and keep in mind, some favored-few heavy hitters probably do) ought to get out, and get out now.

MANAGERS OF PRIVATE-EQUITY FUNDS, another alternative investment sector growing in popularity like hedge funds, appear to be feeling their oats this year after a couple of years of uncertain exit strategies―the ultimate measure of private-equity performance.

Private-equity funds buy often-distressed companies at cheap prices, cut costs and try to expand the business if possible, then take companies public through initial public offerings. In their heyday before the credit crisis, many cashed out by paying themselves special dividends with funds raised in the high-yield and/or leveraged-loan markets.

A recent survey of 207 private-equity fund managers―published last week by accounting firm Rothstein Kass―shows that 67% believe there will be increased IPO activity by private-equity companies this year. According to Rothstein Kass, 65% of the managers in its survey work at funds with assets of less than $500 million; the remainder, at larger firms.

Only 18% believe it will be more difficult to raise capital this year than last, which is a good thing, because 73% of private-equity fund managers, probably anticipating a strengthening stock market, expect purchase prices for acquisition targets to rise this year.

The best news for investors: More than 75% expect downward pressure on fees. 

Winners & Losers

Stock, money and taxable-bond funds had weekly net cash inflows averaging $1.2 billion, $5 billion and $4.2 billion, respectively, in the four weeks through Wednesday, Lipper reports. But muni-bond funds had weekly outflows averaging $395.6 million.

E-mail: tom.sullivan@barrons.com