The extraordinary influence hedge funds can sometimes have on markets was on full display recently when a small number of hedge funds and some individual investors together forced the sovereign South American country Argentina, with a population of almost 42 million people, to default on its debt commitments. The group led by US hedge fund Elliott Capital Management stood firm on its demand for full payment on its loans to the sovereign nation and won backing from the top US court after a series of lawsuits forced the Argentinian government to either pay the group in full or face default.

Origins of the Dispute

Argentina’s current crisis with debt has its roots in 2001 when the country defaulted on more than $80 billion of debt. The country, however, managed to persuade a vast majority of its bondholders to take a cut of approximately 70 percent on the amount they were owed and restructured its loans. Those investors who agreed to the cut and exchanged their original bond agreements for the new ones are commonly referred to as exchange bondholders.

However, a small group of investors which included NML Capital, a subsidiary of the New York based Elliott Capital Management, and a smaller hedge fund named Aurelius Capital Management, as well as some private individual investors refused the amended terms and took Argentina to court. This group of investors is referred to as holdouts, and as per the court ruling Argentina currently owes the group over $1.5 billion in principal and interest.

Hedge Funds Force Second Default

The holdout group was led by billionaire hedge fund manager Paul Singer whose relentless pursuit to demand full payment put the sovereign nation on the spot. Singer, age 69, is driven by his worldview in his crusade against Argentina. He is a Republican donor but has strong libertarian leanings.

Widely followed fellow hedge fund manager Daniel S. Loeb, who himself has launched several high profile campaigns to impose his view on companies, is all praise for Singer. “He doesn’t get into fights for the sake of fighting. He believes deeply in the rule of law and that free markets and free societies depend on enforcing it,” says Loeb of Singer.

Singer’s Elliot Capital now manages over $23 billion and has returned an average of 14 percent a year since its founding in 1977. The fund has in the past won similar cases against other sovereign nations and managed to obtain payments through court orders from countries such as Peru and Congo-Brazzaville. People familiar with the fund say that its bets on suing governments make only a small proportion of its portfolio.

The US court ruling has virtually brought the case to a stalemate. The ruling prevents Argentina from making interest payments totaling $539 million to exchange bondholders who agreed to restructured loans of approximately $23 billion without first paying in full the approximately $1.5 billion owed to the holdout group. The court ruled that such payments will be deemed illegal.

Difficulties in Paying the Holdout Hedge Fund Group

At first the outstanding loan amount of $1.5 billion owed to the holdout group may seem insignificant, given that Argentina has foreign exchange reserves of approximately $30 billion. But paying the holdout group would lead to a larger problem as a clause in its restructured debt agreement prohibits the country from offering anyone a better deal than what the restructured creditors received, unless they also get the same deal.

As a result, paying the holdout group its full due of $1.5 billion would force the country to extend the same deal to the remaining 93 percent of investors who participated in its debt restructuring. This would in turn would trigger claims of more than $120 billion – which the country does not have.

However, this prohibiting clause is set to expire at the end of this year and according to Lutz Roehmeyer, a fund manager at LBB Invest in Berlin, a solution to the holdout group is likely only after this clause expires.

Relevance to Job Market

This case of hedge funds taking on a large sovereign nation is an exception, but it brings to the fore the active aggressive investment style of a typical hedge fund, characterized by calculated risk taking following rigorous due diligence. On the contrary, most mutual funds are passive investors and spread their investments across a large number of companies to minimize volatility. Most hedge fund managers have significant portion of their personal wealth invested in the fund which provides the drive to come up with creative ways to generate big profits.

Commenting on the legal wrangle, Columbia University professor and economist Joseph E. Stiglitz warns that the issue is not just about Argentina. He says Singer and Elliott have already done a lot of damage and adds that their tough posture will extend the economic misery of other over-indebted countries. This extraordinary ability of hedge funds to influence financial markets and other outside forces is often a factor that attracts top talents to this profession.

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Sensing a favorable environment for hedge funds among US institutional investors, a number of UK-based hedge funds are setting up operations in the US to grab a slice of the growing institutional money moving into hedge funds. Well known UK funds such as Winton Capital, Odey Asset Management and Cheyne Capital are among a large number of London-based hedge fund groups that are either starting afresh or boosting existing operations in the US to get exposure to big institutional investors such as pension funds that are increasing allocation through a shift from fixed income to hedge funds.

HF Regulation in Europe Becoming More Stringent

Raising capital in Europe has become difficult following a directive from the regulators to subject alternate investment managers, such as hedge funds, to a host of new requirements including new reporting and disclosure requirements. The directive more commonly known as the Alternative Investment Fund Managers Directive aims to subject hedge funds and private equity funds to the same rules as mutual funds in the hope that such a rigid approach to hedge fund regulation will curb excessive risk taking and prevent the severity of an unforeseen financial crisis.

Commenting on the regulation, Troy Gayeski , senior portfolio manager at SkyBridge, a New York-based fund of hedge funds says, “Europe is going out of its way to make it difficult for investors to invest in hedge funds. The US is still the largest market with the deepest pools of capital and [UK hedge funds] would be crazy to not at least try to expand”.

UK Hedge Funds Flock To US

As the pool of assets available in Europe stagnates, UK hedge funds are flocking in large numbers to the US  to take advantage of the growing number of institutional investors warming up to hedge funds.

Winton Capital, which has $25 billion in assets, last month set up its first US office in New York with six employees. It plans to add to its sales team this year. Another UK hedge fund Odey Asset Management, with $10 billion in assets under management, set up its first US office in New York late last year while a third fund, Cheyne Capital, with $6.5 billion in assets, opened a New York sales office early this year and plans additional hiring. Another London-based fund Cube Capital made its first foray into the US last month when it named Stephen Petretto as the US Director of Marketing. The $1 billion fund plans to set up an office in New York or Boston in 2015.

Some European funds that already have a foothold in the US are planning to boost their teams to seize the positive industry momentum. Such funds include the $14B hedge fund group CQS and the $12B fund Polygon – both of which have offices in New York, but plan to expand their US teams.

US Institutional Investors Also Ramp Up HF Exposure

Unlike its European counterparts, US hedge funds are witnessing strong interest from institutional investors such as insurance companies and pension funds. A recent survey by Deutsche Bank found that 57 percent of institutional investors plan to increase allocations to hedge funds this year. Institutional investors now contribute to two thirds of the overall US hedge fund assets compared to only one third of the assets prior to the 2008 financial crisis. Many large institutional firms which once stayed clear of hedge funds are now including hedge fund investments as part of their portfolio.

Relevance To Job Market

The European rush to tap US institutional money that is moving to hedge funds highlights the positive perception of hedge funds by US institutional investors. It is somewhat ironic that hedge funds are witnessing a favorable fund raising environment at a time when the industry’s returns are consistently and notably falling short of major US financial averages. Hedge funds are viewed as a good investment option especially at a time of uncertainty. With the stock markets stubbornly holding on to historic high levels with questionable improvement in the economy, many large investors are comfortable hedging their position with hedge funds even if the returns are underwhelming. This general positive undertone will likely have a positive impact on the hedge fund job market.

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