Sudden Demise of $1.8 Billion Fund Points to Long-Feared Danger
(Bloomberg) -- An early sign of trouble for James Velissaris’s complex mutual fund emerged in the waning days of a chaotic year.
Investors in his $1.8 billion fund at Infinity Q Capital Management received a message in December that it would stop accepting new money at month’s end. Customers would be notified as soon as it re-opened.
That day never came. The short advisory belied the turmoil still coming for the Infinity Q Diversified Alpha Fund and its founder. This week the firm shut the fund and relieved Velissaris of his duties after federal regulators raised concerns that he may have tampered with valuations on derivative investments.
It’s an abrupt turn for a money manager who earned the financial backing of billionaire David Bonderman, co-founder of private equity firm TPG Capital. It also cuts to the heart of an issue the Securities and Exchange Commission has long fretted about: While derivatives in the plain-vanilla world of so-called ’40 Act mutual funds can boost returns, the complex instruments may not be appropriate for retail investors because they can increase risk and be difficult to price.
In the case of Infinity Q, a significant portion of the mutual fund’s shares were owned by clients of brokerage giant Charles Schwab Corp., a filing shows.
Infinity Q’s announcement Monday that it’s freezing redemptions is highly unusual for the industry -- akin to an earthquake in its rarity and significance. The firm said it may take “several days or weeks” to figure out how to value swaps that account for about 18% of the fund’s reported assets after learning that Velissaris had allegedly accessed and altered a third party’s valuation models for the instruments. His attorneys have said he acted in good faith and will continue to do so.
“These are pretty unique instruments to be used in a ’40 Act mutual fund product,” said Bobby Blue, an analyst in the multi-asset and alternatives manager research group at Morningstar Inc. “It’s a lot of complexity for the typical retail investor, which is obviously who this is being marketed to.”
The SEC has long grappled with whether and how to restrict the growing popularity of derivatives in funds that, governed by the Investment Company Act of 1940, offer investors daily access to their savings. “Alternative” mutual funds proliferated in the years after the 2008 financial crisis as investors hurt by that tumult sought to diversify beyond traditional stocks and bonds, embracing illiquid assets and complex strategies used by hedge funds.
Velissaris set up his mutual fund business in 2014 with Bonderman’s backing. The idea was to offer an alternatives strategy underpinned by quant models, potentially using derivatives and borrowed money, but still letting investors withdraw on a daily basis.
In December 2015, the SEC proposed rules to limit how much mutual funds could wager with derivatives. That regulation was never finalized. Then last year, the agency rolled out a revised and less restrictive approach that gave managers 18 months to comply. It also passed rules for valuing assets, with a similarly long deadline. That means Infinity Q and other funds aren’t yet required to meet the new policies for risk management and board oversight of valuations.
The Infinity Q episode underscores dangers that have long lurked for individual investors in funds using complex products and pricing. When the SEC informed Infinity Q of suspected irregularities, the agency was acting out of concern that investors could be harmed, according to people familiar with the matter.
“This kind of situation is pretty unusual,” said David Grim, a former head of the SEC division that oversees the mutual fund industry who’s now a partner at Stradley Ronon Stevens & Young. Mutual funds can’t suspend redemptions without the agency’s blessing, he noted, and “the SEC doesn’t grant that relief very often because that right is so fundamental to what it means to be a mutual fund investor.”
One of the best-known examples of such a move was in 2015, when Third Avenue Management, founded by Martin Whitman, suspended redemptions at a $788 million mutual fund that specialized in high-yield bonds. The move rattled credit markets and led to the departure of David Barse as chief executive officer. The episode still comes up at industry gatherings.
Velissaris, a former Harvard University football player, ascended swiftly in the world of money management, clinching support for a venture of his own by age 30.
He had spent some of his formative years in the industry at Arden Asset Management, joining the fund of funds in 2008, a period when firms were adjusting to heightened investor scrutiny. In 2012 he joined Wildcat Capital Management, originally Bonderman’s family office, working as a portfolio manager.
When Velissaris formed Infinity Q, Bonderman’s money helped it get started. That association featured in marketing. Until earlier this month, the “About Us” page of Infinity Q’s website began with the sentence: “Infinity Q Capital Management is a pioneering investment advisor managed by David Bonderman’s family office.”
Then last week, according to a company statement, the SEC told the firm’s non-executive chairman that it had information showing Velissaris adjusted models used to price swap contracts held by the diversified fund, likely resulting in incorrect valuations being reported to investors.
“David Bonderman is a passive investor in a family investment vehicle which, in turn, made a $2 million non-control investment in Infinity Q Capital Management, and made passive investments in Infinity Q’s funds,” a spokesman for Wildcat said in an emailed statement. “Mr. Bonderman and his family investment vehicle have never had any input, oversight, or participation in investment decisions or investment reporting by Infinity Q.”
Velissaris’s lawyers reiterated in a statement via a spokeswoman for this story that “his focus has always been on delivering and preserving value for investors.”
The fund has noted in disclosures that it may sometimes use additional discretion around pricing, in cases where dependable market quotes are unavailable or when a security’s “fair value” isn’t reflected in valuations provided by its pricing service.
Infinity Q Diversified Alpha Fund did better than most peers, returning 4.87% on a three-year annualized basis through Thursday, Bloomberg data show. That placed it in the 70th percentile of similar funds -- but still far behind the S&P 500 Index.
A regulatory filing in May shows Charles Schwab clients owned 23.67 million of the fund’s institutional shares, or 27.3%. The brokerage’s customers also held 2.1 million of the fund’s retail shares, or 64.7%. Schwab said in an emailed statement that it’s “committed to timely, transparent communication with our clients as we learn more.”
Signs of mistakes emerged months later. One filing from Infinity Q Diversified Alpha’s fiscal year at the end of August showed the fund had to recalculate its net asset value at some point during the period.
Then this week, the company’s website went into “maintenance mode” as the fund froze. The site has since gotten an overhaul. On Wednesday, it offered a statement to customers on the suspended redemption, promising updates with press releases and “periodic reports.”
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