The Economist on secondary market for hedge funds

Trading hedge funds

Online matchmaking

Aug 4th 2005 | NEW YORK
From The Economist print edition

A new way for alternative investments to find new owners FOR those who fancy tucking a few million dollars into a select hedge fund, classified ads in newspapers will not do. But Hedgebay, a tidy secondary market for stakes in hedge funds, just might. Hedgebay is a website where serious investors take part in an online auction, finding and selling rare and coveted hedge funds that are closed to new investors. It began as a niche market in 1999, but its volume tripled in 2003 and now grows at an annualised rate of 20%.

Hedgebay furnishes a web-based market without precedent in the murky world of hedge funds, and thus opens an illuminating window on to it. The site lists more than 600 hedge funds–offshore only, to keep the regulators happy. Hedgebay sorts them alphabetically and by strategy, and then invites registered (and carefully scrutinised) users to post offers and bids. After buyer and seller are introduced and come to settle on a price, Hedgebay oversees their transaction, handles the tricky paperwork and takes a cut of 1% or less. The manager of the fund that is changing hands retains the power to veto any sale.

Hedgebay is, in effect, marketing liquidity. Sellers who use the site avoid the lock-up periods during which they cannot sell their shares–which can be three years or more and are enforced by redemption fees. Even the most lenient funds tie up 90% of an investor’s assets for a month and the remaining 10% for much longer. Jared Herman, one of Hedgebay’s founders, estimates that the site’s average seller reclaims the balance of his assets two months earlier than he could ordinarily do.

Sellers may also rejoice in the fact that stakes in good closed funds tend to be worth more than their net asset value: 70% of sales on the site last month commanded a premium. Buyers are happy to spend their way into closed funds at a time when the supply of renowned managers has grown scarce. This year Hedgebay has seen about a dozen trades per month, at an average value of $3m-5m each. Most users are fund-of-hedge-fund managers and all are authorised to invest in offshore funds.

As a gauge of investor sentiment, Hedgebay’s listings, updated daily, can be revealing. In July, which saw the highest volume this year, funds employing long-short strategies (owning some assets outright while betting on the price of other assets to fall) attracted the highest premiums. Convertible arbitrage strategies have landed with a thud: some $61m-worth are for sale on Hedgebay against demand for only $17m-worth. A credit-arbitrage fund, hit especially hard by the junked ratings of General Motors and Ford, has $36m in shares marked for sale, most of them at a discount. By contrast, users have posted offers for $116m-worth of European long-short equity funds, mostly at a premium, against a supply of $22m.

Hedge funds are credited with using their high-grade and locked-up investors to bring greater liquidity to remote corners of the capital markets. But the investors’ own unslaked demand for liquidity makes Hedgebay an appealing market. Though such high-flying investments may look out of place on a web-based auction block, Hedgebay has every reason to expect its trade to keep growing.

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