Zombie Hedge Fund Stakes Haunt Investors a Decade After Lehman

(Bloomberg) -- A struggling casino in Vietnam, a soybean-crushing operation in Brazil, a bunch of high-yield, high-risk loans.

These are among investments that hedge fund managers -- during the depths of the financial crisis -- shoveled into what’s known as side-pockets. Since those dark days, stocks have rocketed and the U.S. economy has boomed, yet these stakes languish in investors’ portfolios like moldy leftovers sitting in the fridge for too long.

The stakes have miffed one investor so much that he’s dubbed them “the little sh-ts.”

The trouble started soon after Lehman Brothers Holdings Inc. went bust and hedge fund clients sought to redeem hundreds of billions of dollars. Even holdings that managers thought were liquid turned out to be tough to sell, never mind the private deals that would have been difficult to exit quickly in the best of times. So, instead of a fire sale, managers pushed the positions into side-pockets, to hopefully be sold at a better price at a later date.

Investors estimate that $200 billion to $360 billion were side-pocketed in 2008 -- or as much as 20 percent of the industry. They calculate that about $25 billion still remains.

In some cases, side-pocketing made sense. The best example may be Lehman bankruptcy claims, which have made tens of billions of dollars for patient investors.

Seeking to alleviate the pain of side-pockets, investor-friendly managers reduced their fees or waived them entirely. They laid out liquidation plans and stuck to them. Not everyone was so generous. Some managers have stubbornly refused to provide details on the investments and made little effort to sell the assets. Many side-pockets have even outlasted the firms that created them.

When will investors get their money back? It’s unclear if they ever will, and time may be running out.

"If you can’t find an exit for them now, when will you be able to?" said Lars Lindqvist, founder of Cattegatt Capital, a broker for secondary interests in private equity, real estate, hedge funds and other illiquid assets. “The markets are healthy, there is good liquidity, there are lots of private equity firms hungry to do deals.”

Here are five side-pockets investors consider particularly irksome. Except where noted, representatives for the firms declined to comment.

Vietnam Venture

Phil Falcone’s Harbinger Capital Partners 2008 side-pocket has two remaining investments: a Vietnamese casino, Grand Ho Tram Strip, in which he invested more than $450 million, and a minority stake in a telecommunications company previously known as LightSquared into which he poured at least $2 billion. (LightSquared filed for bankruptcy in 2012 and has since reorganized as Ligado Networks.) Ten years later, Falcone is still trying to wring money from the investments. He has been pushing Vietnam to change its laws so citizens can gamble in casinos, and he sued Apollo Global Management, alleging it fraudulently induced Harbinger to invest in LightSquared. The suit is pending.

Soy Vey

Rob Ellis, who runs commodities fund Ridgefield Capital Asset Management and once worked for famed investor Julian Robertson, still has a side-pocket that includes two Brazilian holdings, an ethanol plant and a soybean-crushing operation. After holding the investments for a decade, Ridgefield has yet to sell them as Brazil’s economy has tanked over the past five years.

Energy World

Bennelong Asset Management has a side-pocket with an investment in a public company listed in Australia called Energy World Corp. yet the firm hasn’t sold its position. The company has lost about three-quarters of its market value since mid-September 2008.

Private Equity

Thane Ritchie was already facing trouble even before the financial crisis hit. The Geneva, Illinois-based hedge fund segregated its private-equity holdings into a side-pocket in 2005 after big losses in natural gas caused clients to flee. More than 10 years on, the firm has yet to sell all the holdings. Ritchie Capital didn’t reply to a phone message.

Investors Revolt

In October 2008, after incurring heavy losses, Highland Capital Management told investors it would wind down its Crusader and Credit Strategies funds. Both invested mainly in high-yield loans. The plan was to exit the investments over a three-year period. In 2016, the unwind still not complete, a group of frustrated Crusader investors sued the firm and later replaced it with restructuring specialists Alvarez & Marsal, which is still unloading the assets. Investors in the credit strategies fund had their own triumph, winning confirmation of an arbitration award in 2016 over the sale of a position at a below-market price. Highland later agreed to buy back the rest of the assets in the side-pocket, nullifying the lawsuit.

“The funds’ investors were involved in forming and approving the respective plans, and while this approach came with complexity and challenges, it ultimately delivered significantly more value for investors than a liquidation at the market trough,” the firm said in a statement.

©2018 Bloomberg L.P.