| Can a hedge fund be rated investment grade? |
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| 29/04/2007 | |
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As the hedge fund industry enters a new phase of raising financing through the public debt markets, the rating agencies are preparing to rank them. Moody's expects to issue its first ratings on hedge funds' unsecured debt in the coming months. So far, Standard & Poor's has only ranked two, Citadel Kensington Global Strategies Fund and Citadel Wellington. Their $2bn medium-term notes are ranked investment-grade, (BBB/Stable/A-2). The move comes as hedge fund assets have shown a five-year compound annual growth rate of about 21 percent. Some hedge fund managers such as Citadel Group have turned to the public markets, while a host of others, including Fortress, have listed equity. Hedge funds are accessing bank loans to boost leverage, according to a recent Moody's report. "As a result, request for credit ratings are increasing and can come in the form of counterparty ratings, as well as secured or unsecured debt, or bank loan ratings." This is not Moody's first entry into the hedge fund ratings market. Last September it started to issue hedge fund operations quality ratings designed to test the operational strength of a hedge fund's infrastructure. And it already rates Collateralised Fund Obligations (CFOs) whose underlying collateral is a fund of hedge funds. The operational quality ratings are separate from the debt rankings. On the operational quality side, Moody's has rated four hedge funds: Fortress, Citadel, Marathon and Sorin. All received the highest possible ranking except Sorin, which received a rating one notch below the others. The operational rankings have five categories ranging from OQ1 (excellent) to OQ5 (poor). Queue up to get graded On the debt side, a number of announcements are imminent, says Odi Lahav, Moody's European Head of Alternative Investment Ratings. "Hedge funds are mostly considering issuing debt because it is a way for them to diversify their sources of leverage and also to access more permanent capital. They can issue equity, but that would result in management selling their ownership and also expose the company's value to the volatility of the equity market" A rating may also thwart criticism of hedge fund opacity and secrecy. "It is a way for them to achieve public exposure which can help attract new investors," says Lahav. There are several European hedge funds awaiting operational quality ratings, according to Lahav. On the debt side, most of the rating demands are in the US where some of the larger hedge funds are adopting the infrastructure and risk management systems of more established and diversified securities firms, in addition to their capital structures, which includes unsecured debt. Despite the similarities, hedge funds have peculiar characteristics which may prevent them from getting high credit ratings. The most significant risk is that the equity capital in hedge funds is not permanent (investors can require the fund to redeem their investment), reducing the reliability of equity as a cushion for unsecured creditors. Moody's has three general criteria for rating hedge fund debt. It considers the fund's risk management & governance in addition to its financial and business profile. In evaluating whether a hedge fund can attain an investment grade rating, it considers a number of factors, among which, whether it is pursuing a multi-strategy fund, if it has a good three year performance track record, a high operational ranking, a well-laddered capital structure with long-term lock ups on investor redemptions, high liquidity management enabling it to manage twelve months under stress scenarios without default, strong cash flow coverage of debt service from realised returns and deferred manager compensation. VB |
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