The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Cash Management

  • From Vol. 8 No.47 (Dec. 3, 2015)

    Ernst & Young’s 2015 Global Hedge Fund and Investor Survey Probes Hedge Fund Growth Priorities, Fee and Expense Climate, Prime Brokerage and Operational Matters

    Ernst & Young (EY) recently released the results of its 2015 Global Hedge Fund and Investor Survey, entitled “The Evolving Dynamics of the Hedge Fund Industry.”  EY explored fund managers’ perspectives on growth priorities, fees and expenses, prime brokerage fees, cash management, technology and outsourcing.  It also examined investors’ perspectives on sourcing non-traditional hedge fund products through hedge fund managers, fund fees, expense allocations and outsourcing.  This article summarizes the survey’s key findings.  For coverage of EY’s 2014 survey, see “Ernst & Young’s 2014 Global Hedge Fund and Investor Survey Considers Growth Areas for Hedge Fund Managers, Related Costs and Challenges, Operating Expenses and Cybersecurity,” The Hedge Fund Law Report, Vol. 8, No. 2 (Jan. 15, 2015).  For coverage of EY surveys from prior years, see the 2013 survey, Vol. 6, No. 46 (Dec. 5, 2013); 2012 survey, Vol. 5, No. 44 (Nov. 21, 2012); 2011 survey, Vol. 5, No. 1 (Jan. 5, 2012); and 2009 survey, Vol. 2, No. 46 (Nov. 19, 2009).

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  • From Vol. 3 No.15 (Apr. 16, 2010)

    Brokered CDs Offer a Cash Management Alternative for Hedge Funds

    In the course of their operations and investments, hedge funds (or their service providers) obtain and generate cash.  For example, when a new investor allocates capital to a hedge fund, that investor generally sends cash to the hedge fund’s administrator, who in turn sends the cash to one or more designated prime brokers once Anti-Money Laundering, Know Your Customer and similar compliance checks have been performed.  Also, when a hedge fund sells out of a position, the cash proceeds generally are deposited (or “swept”) into the fund’s prime brokerage account.  Similarly, to trade using margin from a prime broker, a hedge fund generally must deposit cash or cash equivalents into its prime brokerage account.  Like stocks, bonds and real assets, cash is a type of asset owned by hedge funds.  Like any asset, cash must be managed.  But the goals of cash management differ from the goals of managing other assets.  In general, the primary goal of cash management, at least for hedge funds, is safety and preservation of capital and access to it across all conceivable outcomes.  Secondary goals of cash management include obtaining incremental yield and keeping pace with or beating inflation.  Also, in the post-Lehman era, counterparty risk looms large as a concern to be addressed when managing hedge fund cash.  By contrast, the general goals of managing other assets involve accepting a certain level of risk for a target return.  Hedge funds traditionally have used a number of techniques to manage their cash, including purchases of U.S. Treasury bonds and other Treasury obligations, purchases of highly rated non-U.S. sovereign credit, purchases of money market fund shares and maintenance of cash balances at prime brokers.  See “Why Do Hedge Funds Have So Much Dry Powder, and What Are They Doing to Keep It Safe?,” The Hedge Fund Law Report, Vol. 2, No. 20 (May 20, 2009).  Mechanically, hedge funds frequently have purchased Treasuries via overnight repurchase agreements, so that the money sleeps in Treasuries and the manager has cash available for investment during the day.  A relatively new approach to cash management, at least in the hedge fund industry, involves investing cash in brokered certificates of deposit, or brokered CDs.  Generally, a brokered CD is a financial product in which multiple CDs issued by different regional banks, of different durations and paying different interest rates, are pooled together by a broker and sold as a single offering or in a single account.  For hedge funds looking to manage cash, brokered CDs offer certain advantages over regular CDs and other cash management approaches, but they also involve potential downsides.  This article highlights, by way of context, continuing concerns about counterparty risk, then explains the mechanics of brokered CDs in more detail; evaluates the benefits and burdens for hedge fund managers of brokered CDs; and suggests reasons why some of the burdens (and benefits) of brokered CDs may be moot in light of the realities of FDIC procedure.

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  • From Vol. 2 No.20 (May 20, 2009)

    Why Do Hedge Funds Have So Much Dry Powder, and What Are They Doing to Keep It Safe?

    It is widely understood that investors pay hedge fund managers to invest money.  A less appreciated, but increasingly common, service provided by hedge fund managers is not investing money.  Is that latter service worth a two percent management fee?  Consider a billion dollar equity long-short hedge fund with a two percent management fee that remained in cash for all of 2008.  The fund would have charged investors $20 million for sitting in cash.  Seems unfair: why should investors pay the manager $20 million when they could leave the same money in the bank more or less for free?  The answer is that a bank is not really a viable alternative: most institutional investors in hedge funds have internal allocation policies that require a certain percentage of assets to be invested in hedge funds.  Thus, the appropriate comparison is not between a hedge fund and a bank, but rather between a hedge fund manager who stayed in cash (or largely in cash) and another hedge fund manager who was fully invested.  If that same billion dollar equity long-short hedge fund were fully invested in the S&P 500 during the same period, it would have lost about 38 percent of its investors’ assets.  Even if half of those losses were offset by a short book, the fund still would have lost $190 million.  Most investors would be willing to pay $20 million to avoid a $190 million loss.  As any seasoned investor will tell you, the first rule of investing is not to lose money.  During 2008 and early 2009, the amount of cash – known in the trenches as “dry powder” – held by the more judiciously managed hedge funds has risen dramatically; the cash has come from asset sales and new investments.  The dramatic increase in cash held (as opposed to re-deployed) has been driven largely by three factors: (1) fear of getting back into the market too early; (2) desire to avoid selling assets at depressed prices to satisfy redemption requests; and (3) concern about being prepared to seize new investment opportunities at a time when the opportunity set becomes more compelling but leverage remains unavailable.  We explain why hedge funds are holding so much dry powder, and what the more prudent managers are doing to keep it safe.  We weigh the pros and cons of money market funds and Treasurys, and highlight what is probably the safest strategy for cash management.

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