A Tougher Gate at DE Shaw: Investor Protection vs. Opportunism
I caught a story in Marketwatch concerning a material change in the gating provisions around one of DE Shaw’s major funds, the Oculus global macro fund. Although not in possession of all the facts, I find this whole story-line very interesting and worthy of some discussion and analysis. The Marketwatch story is provided here:
DE Shaw’s multi-billion dollar global macro Oculus fund is lowering its “gate” to 1/12th of assets from 1/8th of assets starting Jan. 1, 2007, two investors said on condition of anonymity. A representative at the $25 billion New York-based firm declined to comment.
A gate limits the proportion of a fund’s capital that can be withdrawn by investors. By lowering its gate for Oculus, D.E. Shaw is trying to make sure the fund is not forced to sell positions if a large number of investors all want their money back at once.
There’s no sign that D.E. Shaw is lowering the gate in response to more redemptions, but one investor in Oculus who declined to be identified said the move was a concern because it increased the risk that they won’t be able to get their money out as quickly as expected if needed.
Other investors said D.E. Shaw’s move could be spurred by the firm’s expansion into private-equity investing. These types of investments are less liquid than things like stocks and bonds, so hedge funds entering the private-equity world often try to secure investors’ money for longer.
As some hedge fund managers have begun investing in private companies, “fund terms are modified to address reduced liquidity by incorporating some of the terms traditionally used by private equity funds,” Stephanie Breslow and Paul Gutman, partners at law firm Schulte Roth & Zabel LLP, wrote in a 2005 report on hedge funds and private equity. “The gate provision allows the manager to increase exposure to illiquid assets without facing liquidity crises as a redemption date approaches.”
D.E. Shaw, founded by former Columbia University computer science professor David E. Shaw in 1988, is mainly known as a quantitative specialist using computer models to generate trading and investment ideas.
However, much of the firm’s growth in recent years has come from an expansion into other types of investing, such as private equity and distressed debt and lending.
D.E. Shaw agreed in October to invest up to $500 million in The ERORA Group LLC, a private company that owns and develops coal gasification projects.
Hotel and casino operator Riviera Holdings said in November that it received a buyout offer from D.E. Shaw and real estate developer Ian Bruce Eichner.
Hmmm. There is a lot going on here, so let’s look at the issues one by one.
1. Is Oculus a hedge fund or a private equity fund?
Or some kind of hybrid hedge fund/private equity mix? I would assume it is closer to being a hedge fund if it is referred to as being “global macro.” I generally haven’t thought of global macro funds as having much illiquid asset exposure, or anything remotely akin to private equity. I would want to understand Oculus’ asset mix much better before knowing whether the “illiquid asset” excuse is valid or a bunch of smoke.
2. Do global macro investors want and/or know about quasi-private equity investing activity?
This gets to the issue of style purity and investor communication. How does one combine the characteristics of global macro and private equity in a package that represents the wants and desires of institutional investors, regardless of the flexibility inherent in one’s fund document? Now this might not be what’s happening, but if it’s not, then why the change in gating provision?
3. Is DE Shaw securing Private Equity liquidity protection for Hedge Fund liquidity risks?
I know that DE Shaw has expanded into other investment styles such as distressed debt (Laminar) and private equity (like its coal gasification and casino buyout projects), but are activities like this also being done through Oculus or other vehicles? I can see how Laminar and its investors, for example, would benefit from more stringent gating provisions due to the (potentially) illiquid nature of a significant portion of the fund’s investments. I can also see how this principle would apply to a book of deals akin to the coal gasification and casino transactions mentioned above. But global macro?
The Punch Line
My friend Greg and I were emailing about this issue earlier today, and I think he said it very elegantly: “Just as so many investors are paying alpha fees for beta returns, you can also say that they are giving in to PE lockups for HF liquidity. The game remains the same.” I wonder if this is what’s going on here. David Shaw is a tremendous investor and has built a great firm that I respect a great deal, but I want to know if this move represents one of opportunism (“I can get away with it because hey, I’m DE Shaw, and there is more demand for my funds than I know what to do with”) or investor protection (“In a panic with a fund holding significant illiquid assets, everyone gets hurt if they run for the exit at the same time, and I want to protect all those involved”). We may never know for sure. But is certainly is an interesting question, isn’t it?
