First Drafts - The Prospect magazine blog

Hedge funds say sorry. Sort of.

One of the most arduous tasks a hedge fund manager must perform in these troubled times is to write the periodic letter he sends to investors updating them on the performance of the fund. If things have gone awry, should he manfully take the rap - or should he (Russell Brand-like) evade the blame? Prospect has got hold of one such letter that gives an answer.

In the good times, of course, these documents were lengthy bragathons. In them, the manager usually sought to play down the impact of (generally favourable) market conditions and to play up his own unusual investment genius (known in the trade as his alpha). It was after all these market-beating skills that allowed him to draw substantial fees from the fund.

This style has mutated as the downturn has worsened. Now the market, rarely mentioned on the way up, has emerged as a significant influence on investment performance—as a recent gem of a letter from Toscafund shows. This is a London-based hedge fund, set up by a former banking analyst called Martin Hughes, which has been badly caught up in the downturn by its predilection for investing in banks, fund management companies and house builders, none of which have especially flourished in the recent environment. In the year to 30 September (the investment period covered in the letter) its fund was down 57 per cent.

Here, for the record, is that non-apology in part…

“Dear investor

“As your portfolio managers and co-investors in Tosca, we are writing to inform you that the events of September have had a profound negative effect on our performance. On behalf of the team, we apologise for this outcome. We are confident we can explain how the performance will be recovered.

“In the event that we are inundated with redemptions it is our intention to restructure the fund. This will assist redemptions but will also give those of you that wish to stay the opportunity to participate in the turnaround and the rebound that we believe will take place. The portfolio has been readjusted, but in essence remains fundamentally intact to benefit from a number of corporate actions which we are involved in. We are more than ever determined to succeed in being a catalyst to make things happen and to recoup our losses.

“It is emotionally and financially draining that after eight solid years the fund should be so damaged by the failed global monetary system [my italics]. The system was so damaged that any respect to ownership and valuation of companies has been lost. The speed of regulatory intervention, the mania of negative business coverage and panic, and lack of consideration of alternatives has clearly hurt our mid-term investment plans and given us a considerable setback. The portfolio mangers clearly did not want to deliver such negative headlines and results. Being a secular, self-help and deal-based fund we of course have felt the full impact of these events. The withdrawal of liquidity and impact on cash savings has led to a whole host of prisoners.”

The letter then details some of the specific losses, including a substantial hit from shares in Washington Mutual, a large US bank which went insolvent in September, and another one on an un-named position that “was about to come to fruition when the cash and credit crisis in the US involved the loss of the main backer due to emergency rescue attempts being made in the US”. The average investor might at this point be wondering how these highly-remunerated investment managers, to whom he had paid such high fees, had been so surprised by market events over a year into the credit crunch. But such questions never seem to occur to the managers of Tosca as they continue their hymn of self-pity concerning this vanished position.

“The loss for now of this long-term project at the very last moment adds to the dreadful feelings,”

they sob.

Indeed. The heart bleeds.