Hedge Funds Playing Key Role As Financiers To Distressed Funds

by Carla Johnson, Investors Offshore.com

22 May 2006

The trend for hedge funds to invest in distressed funds that are in liquidation has grown significantly over the past two years, due in large part to the simultaneous increase in the capital managed by hedge funds and the number of distressed opportunities, according to Walkers, the global offshore law firm.

While traditionally, investment opportunities for distressed funds have been limited by the reluctance on the part of banks to lend unless repayment of the loan could be assured, hedge funds have flocked to the sector with their greater appetite for risk and nose for high return potential.

According to Walkers, a hedge fund will typically buy out as much of the original investment in a distressed fund as it can, with the intention of becoming the sole, or at least the largest, investor. They may then step in with priority liquidation funding for litigation against wrongdoers or to recover other assets. Whatever funds are recovered in the process are then distributed to all the investors, including the investing hedge fund, which also receives back its loan in priority to all other claims.

“We’ve witnessed a sizeable upswing in this trend over the past two years,” observed Sandie Corbett, a litigation partner at Walkers in the insolvency and restructuring group.

“With so much money and fewer traditional investment opportunities, hedge funds readily accept these types of unconventional high-risk, high-payoff ventures," Corbett added.

Walkers says that the trend has seen high interest coming from funds based in the New York and London markets. Companies that have benefited from hedge fund intervention include Foamex International, Inc., Krispy Kreme, and even Enron Corporation whose international assets are due to be purchased by a group of private equity and hedge fund managers.

Hedge funds accounted for 12 percent of all loans allocated to institutional investors in 2005, as compared to less than one percent in 2001, according to S&P.

“Financing liquidations were formerly the domain of private equity funds,” Kevin O'Connor, a partner in the investment funds group at Walkers, said.

“As private equity funds and hedge funds continue to converge, we see an increase in hedge fund involvement in distressed funds liquidation," he added.

O'Connor says that Walkers itself is expanding its expertise in the area in order to accommodate this niche business.

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