Update: What’s going on at Ritchie Capital?
Euromoney February 2007
In the middle of October, 83% of the investors in Ritchie Capital’s flagship fund agreed to a restructuring plan put forward by the firm and its largest investors to tackle an issue faced by many hedge funds investing in private equity – liquidity mismatches between investors and investments. The multi-strategy fund had been facing criticism from some investors since mid-2005.
In early 2005, Ritchie sent a letter to investors in the fund explaining that, as the fund had been making increasing investments in private equity, it felt that longer lock-ups and gates would ensure that returns would not be damaged by short-term redemptions. Essentially, it argued, the full value of private equity investments would not be seen if money was pulled out early.
The fund had been performing well since its inception in 1999, and when investors came to vote at the end of August for the new liquidity terms, the majority agreed. Unfortunately for Ritchie, the multi-strategy fund had exposure to another of Ritchie’s funds, an energy fund, that had a disastrous August. By the time the losses in the multi-strategy fund were announced to investors, it was September, and some investors were convinced that the lock-up proposals had been orchestrated to stop the redemptions that would follow the downturn in performance. But as Justin Meise, spokesman for Ritchie Capital, points out: “The voting documents were sent to investors in July and the firm had been discussing it with investors for months so the idea that Ritchie trapped investors during a period of underperformance in August is deeply flawed. However, the timing of the letter, the vote, and the August performance was unfortunate and fuelled criticism.”
Not all investors were convinced. Around $1 billion has been redeemed since the beginning of 2005 (Ritchie Capital’s combined funds have $2.8 billion under management) and investors who did not redeem were making their concerns heard. As a result, Ritchie put together a committee to work with the 60% of the fund’s investors in finding a solution, and 90% of its investors voted, with 92% of those agreeing the new plan. In essence the plan calls for the creation of two share classes: an equity class that has a 3.25-year lock-up and a redeeming class that provides a schedule for the return of funds to redeeming investors over a 2.5-year period. All investors are put into both classes – optionality was ruled out by the investors.
| Hedge funds will increasingly move into private equity |
| Are the lines between private equity and hedge funds blurring? |
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| Source: Survey by ACG/Grant Thornton, Oct 2006 |
It’s a sensible plan that ends a messy situation for Ritchie. It’s a difficult task for multi-strategy funds to manage their capital flows when some investments are long-term in nature, but some end investors are not (see The funds of hedge funds that are too hot to handle, Euromoney, this issue) – particularly for those hedge funds that are crossing over into longer-term private equity investments. Ritchie’s chief administration officer, Doug Rothschild, says: “There is so much money pouring into liquid spaces that returns are harder to find. That is why we set up the fund to be able to move into hybrid spaces that required long-term investments.” In June 2004, Ritchie had mentioned to investors that they were moving into private equity and would be looking at having a gate.
“We had always conveyed to investors that we believed the opportunities to be in the hybrid spaces that would require long-term commitment from them but perhaps it was not conveyed aggressively enough,” says Rothschild.
One investor says he knows of several investors who feel angry. “There are investors that are pissed off about the way the whole situation has been dealt with, especially as performance dropped off in 2005. Fortunately the firm has a lot of supporters out there. It will be interesting to see what happens and will give managers an idea of how investors generally react to changes in liquidity.”
“Not all investors will be happy,” admits Rothschild. “The problem is that much of the money coming into the hedge fund space prefers 30-day liquidity. But hybrid investments require hybrid capital. What we hope, however, is that the industry can look at what we have done in terms of communicating with investors and working on a solution together that enables those that want their money back to do that without losing out on the value of the strategic investments the fund has made that need to be played out. I think we’ve been successful in protecting everybody’s best interests.”
Rothschild says that the fund will follow the procedures agreed with investors and review further investments into the fund in line with investors’ demands.