The distressed investing firm Avenue Capital Group has begun the process of shutting down its original hedge fund, Avenue Investments, by returning investors’ money. This is amid a trend of shifting to funds with longer term investor commitments and a negative performance. A source close to the group stated that the shutdown involves the disposal of Avenue Investments’ positions as soon as better market conditions prevail, and this is already underway. A spokesman for the group also stated that long-term investment sources with lockup provisions ranging in duration from five to seven years comprise the majority of Avenue’s capital in the distressed investment area. He added that this longer-term lockup structure is representative of the firm’s direction.
Avenue Investments has only $350 million under management, and this represents less than three percent of the more than $13 billion that is managed by Avenue in totality. However, for the 20-year-old organization that has been a key factor in the distressed investing scenario, this is a symbolic event. The group that was founded by Marc Lasry and Sonia Gardner in 1995 opened in the same year with $7 million under management. Two years later, its parent company opened its very first longer-lockup investment vehicle.
In the years since, Avenue began to take on a private equity-style investment structure, which involved investors committing their capital for five or more years. In exchange, investors would potentially receive higher returns. Many Avenue investors in the longer-term funds are returned their original capital, as well as the annual fees they’ve paid to defray Avenue’s expenses (usually 1.5 percent of the assets invested). They are also provided the first eight percent of any upside returns prior to Avenue’s general partners receiving their cut, according to a source close to the group who is well-versed in the firm’s fee structure.
After this, Avenue receives its usual 20 percent performance fee. Also, at this time, any additional profits are shared, with external investors receiving the majority of them, stated the source.
Don Steinbrugge—managing partner of Agecroft Partners, a marketer to hedge funds and a consultant—stated that setups such as these are fast becoming the norm among money managers whose focus is on longer-term and less readily traded investments, such as direct lending to private companies or distressed bonds. He recently stated, “I see a significant increase in interest in longer lockup hedge fund strategies that are focused on less-liquid investments,” he said. He also stated that well-experienced investors do not wish to see a liquidity mismatch.
Steinbrugge gave the example of how allowing outside investors to pull their capital on a monthly or quarterly basis (quarterly is typical of mainstream, long-short hedge funds) could result in a scenario where, before an investment has provided a sufficient return, the money manager is forced to dump out of positions at lower prices. In fact, recently, Canada’s Public Sector Pension Investment Board filed a lawsuit against the hedge fund Saba Capita. During the case, the plaintiff argued that Saba duped the Board by underestimating and setting specific bond prices so that less money was returned to the pension fund. The case highlighted the issue in question well.
The Board’s argument was, due to the time constraints of the Canadian pension fund, Saba had randomly set a material markdown value of certain corporate bonds and then, later, marked the prices up again. Saba, on the other hand, argued that it made use of “industry-standard auction process” to set the bond prices and received prices that were the best available at the time. That the price of these bonds improved later on could not have been foretold by Saba.
All in all, the performance of many hedge funds at this time has not been very good. While circulation of Avenue Investments’ performance statistics is not common or wide, there are many informed sources who maintain that performance numbers this year are down. Also, according to HFR’s monthly data, the average hedge fund is being outdone by the market by a significant margin. For example, in October alone, the Standard & Poor’s rose more than 8 percent to market its best monthly performance in the last four years. On the other hand, the average hedge fund recorded an increase of only 1.7 percent.