Stream of Lehman-Claim Payouts Is Drying Up

Lehman losses, REITS losses, and PE returns not what they promised. This does not sound good for those relying on yield.  Aivars Lode

Court Ruling Results in Some of the First Losses for Hedge Funds Due to Lehman

On the sixth anniversary of the firm's collapse, hedge funds got some losses on their Lehman claims. 

The smooth ride for hedge funds holding certain claims tied to Lehman Brothers Holding Inc. hit a speed bump last month.

A court ruling in the case hurt a swath of managers, including some of the biggest firms in the industry, that have in recent years enjoyed a steady stream of profits from the claims. The losses are among the first for hedge funds due to Lehman claims, managers and investors in hedge funds say.

Davidson Kempner Capital Management LP, which manages $23.7 billion, and Highfields Capital Management LP, with $13.1 billion, held some Lehman claims that lost about 10% in a day, according to people familiar with the matter. The hit contributed to the firms posting monthly losses of 0.3% and 1.3%, respectively.

Similarly, $22 billion King Street Capital Management LP, whose most profitable bet last quarter was Lehman, lost about 0.2% last month, in part due to those claims, investors say.

Lehman has "been the gift that keeps on giving" in the form of reliable payouts, said Stephen Nesbitt, chief executive of Cliffwater LLC, which advises institutional clients on alternative investments.

The recent losses are small on a percentage basis and come after big profits by hedge funds on Lehman, including Davidson Kempner and Highfields. Still, hedge-fund clients say such dips are rare for the marquee firms.

Last week marked the six-year anniversary of Lehman's collapse in September 2008, the largest Chapter 11 filing in history. After the bank failed, some creditors didn't want to wait for their money or take a chance that they wouldn't get paid at all. Hedge funds were willing buyers of their claims, betting they would gain in value after the initial panic subsided.

Since the bankruptcy, Lehman has consistently increased estimates of how much creditors would get back, helping hedge-fund managers rake in profits.

Some managers have assembled outsize positions. Lehman claims amounted to nearly 10% of Davidson Kempner's portfolio in its flagship fund, according to a person familiar with the matter.

On Aug. 5, the Second U.S. Circuit Court of Appeals issued a ruling that affirmed Barclays BARC.LN -1.07% PLC's right to billions of dollars in assets that the Lehman brokerage, Lehman Brothers Inc., had claimed belonged to it. The nearly $6 billion in securities and margin assets had gone to Barclays when it bought Lehman's U.S. brokerage business amid the unfolding of the financial crisis in September 2008.

After the ruling, unsecured claims against LBI, which had been trading around 46 cents on the dollar, dropped to 40 cents before closing the day around 42 cents, where they remained last week, according to an investor who holds some of the claims.

A negative ruling for LBI already was partially reflected in the claims' prices before the ruling, but some hedge funds believed a surprise ruling in favor of the brokerage would have sent quotes into the 60-cent range.

Claims against parent company Lehman Brothers Holdings Inc. dipped that day, too, though to a lesser degree.

LBHI claims are up about 25% this year, and recently changed hands at an all-time high, according to holders. LBI claims remain down nearly 10% this year.

Many funds bought LBI claims in the low 40-cent range. One hedge-fund holder said he expected to lose some money or break even on those claims, but said any losses would pale next to his profits on Lehman overall.

Hedge-fund giants Paulson & Co. and Elliott Management Corp. have collected some of the biggest Lehman profits. Paulson was largely unaffected by the LBI dip, according to a person familiar with the matter, holding few of the claims because it didn't like Lehman's chances of success on appeal. Elliott's position is concentrated in claims against Lehman's U.K. entity, said a person familiar with the firm.

While Lehman emerged from bankruptcy in March 2012, it has billions of dollars in remaining assets and more money to pay back creditors, along with continuing litigation with several parties.

The bank is expected to exist in some form for years to come. Creditors of the Lehman companies in the Chapter 11 case have received more than $80 billion, with the next distribution set for early October.

The brokerage business, which is under the purview of the bankruptcy court but not technically in bankruptcy protection, paid back retail customers almost immediately after Lehman's collapse. The trustee unwinding the brokerage, James W. Giddens, has paid back more than $105 billion to customers and hopes to have returned more than $110 billion when he is finished. Customers get 100% of their money back, while unsecured creditors get much less.

Hedge funds have been adapting to life after Lehman, said Eric Siegel, global head of hedge-fund investments for Citi Private Bank, increasingly making bets around mergers and in distressed situations in Europe.

"At this point, it's probably in at least the seventh inning or so," Mr. Siegel said. "You're getting toward the end of the trade."

Juliet Chung, Joseph Checkler - Wall Street Journal

Calpers Shows Masters of Hedge-Fund Universe Have No Clothes

The most surprising thing about the California Public Employees' Retirement System's announcement Monday that it will be exiting its $4 billion investment in hedge funds over the next year may not be the decision itself, but that it took so long.

In the fiscal year that ended this June, the pension fund's hedge-fund investments returned just 7.1%. That compares with a 12.5% return for the Vanguard Balanced Index Fund, which follows the allocation of 60% stocks, 40% bonds that pension funds have historically followed. In the prior year, Calpers's hedge-fund investments returned 7.4% versus 10.8% for the index fund.

It isn't just Calpers. Hedge-fund tracker HFR's composite index, which measures the equal-weighted performance, after fees, of over 2,000 funds, has been underperforming the passive bond-and-stock portfolio since 2009. During the crisis year of 2008, it lost 19%, only marginally better than the index fund's 22.2% loss. That performance made it a bit harder to accept the idea that hedge funds' ability to offer downside protection justifies the hefty fees they charge—typically a 2% management fee and 20% of investment profits.

What has happened to the onetime masters of the investing universe? Hedge funds may have become a victim of their own success. With assets under management tripling to $2.8 trillion from their 2004 level, according to HFR, the field has become so crowded that it isn't as easy for managers to consistently deliver strong performance. Indeed, just as actively managed mutual funds struggled to deliver returns commensurable with their fees and expenses as they boomed in the 1990s, hedge-fund returns have suffered over the past decade.

Certainly, within the broad universe of hedge funds there are managers who can consistently deliver strong performances. But within an increasingly crowded field, picking them is a skill in itself. That further reduces their allure for big investors like Calpers. Such funds can hire outside managers to do this, and incur additional fees, or develop that expertise in-house, and incur additional costs.

Indeed, Calpers said it wasn't hedge-funds returns, but the costs and complexity of running a portfolio of hedge-fund investments that drove its decision. Hedge funds represent just a tiny fraction of the $298 billion Calpers manages, so regardless of whether they performed very well or very poorly, they wouldn't do much to move the needle. For hedge funds to be worth the effort, the pension fund would have had to dedicate a far larger chunk of its portfolio to them.

Given how big Calpers is, and how crowded many hedge-fund strategies have become, such a move would further cut into hedge-fund returns. That is a particular risk since other pension funds, seeing Calpers as a bellwether, might have followed suit.

Instead, other pension funds may follow Calpers's lead and cut or reduce their hedge-fund exposures. One place the money might go is lower-cost strategies that mimic the aggregate returns of various hedge-fund strategies—something that Calpers has begun doing. These promise to provide institutional investors index-like investments that can round out the risk profile of their portfolios like hedge funds do—but without the high fees.

Calpers's move is hardly a death knell for hedge funds. There will always be smaller, sophisticated investors with the patience and experience to find great hedge-fund managers. And there will always be others, seduced by the mystique hedge funds offer, who invest in them even though they shouldn't.

But the high-water mark for hedge funds may have passed. Increasingly, investors will question why hedge funds charge so much for what they do. Hedge-fund managers who don't have a performance-based answer will be in trouble.

By Justin Lahart  - Wall Street Journal