Wednesday, September 15, 2010

Dog Days Revisited

And so venerable Ginza department store operator Matsuya (Code #8237) continues to revert (or, choose one: has reverted; will revert more; will overshoot) to some ltime-honoured level commensurate with some long-term market market-memory. It's present cap is just below YEN30 billion, which could just as easily be YEN20billion as it was during the millennial puke a decade ago, and little would change (except for the wealth of any levered specs still long of the stock). Though it must be said, this has been sympathetic with a malaise of similar magnitude amongst Japanese asset prices. Recently however, its decline somewhat oddly has taken on new vigour, particularly on market up-days. One might guess that  the remnants of its largest foreign holder are being puked to perhaps meet investor redemptions at the September quarter-end. So illiquid is the stock in comparison to the magnitude of their holding, even at their reduced levels, they need to start early and stomach (or rather subject their investors to) the resultant impact in order to meet obligations.

Long gone are the glorious thoughts of dismemberment, redevelopment, and pie-in-the-sky valuation estimates per tsubo. One wonders if they ever even met with management, and if so, how frosty and uncomfortable the timbre of such a tete-a-tete. Tumbleweeds like those from a Sergio Leone western, it would seem, will roll through Ginza before foreign carpetbaggers are rewarded for their efforts with a Mori Ark Hills-scale-project where specs are hoisted out of positions at large premia to their average acquisition prices.

At such times, it is worth contemplating the chastened hedge fund manager's options, having acquired illiquid positions earning incentive fees on the way up from self-impact, and now forced to liquidate into a near-vaccuum. He can act the fiduciary and attempt to obtain the best prevailing prices (which in any event are unlikely to be favorable to investors). He can say "fuck it" and just bang out positions without concern, justifying it with him (or herself) that since they are redeeming they deserve it, and anyway, he has acquired sufficient fuck-you money in the process to not care about being a fiduciary again. Or, and possibly this is the dark underbelly of interest conflicts, he could, knowing that the fund and business are "toast", really hammer the stock into the redemption date, and in some form, be it directly or indirectly, take the other side or collude with friends (with more capital) to take the lion's share of the other side at quite literally knock-down prices. The potential benefit is obvious since it is one of those moments when a manager has a true information asymmetry as he knows precisely "why" something is going down, and precisely "when" it will stop. This is not without risk, for  it may be the final ignominious descent to oblivion, Ginza jewel or not.

This may seem a cynical interpretation of possible realities. But they are worth pondering for allocating investors - particularly if one considers the lack of hesitancy by managers to exploit the asymmetries of incentive payments based on mark-to-market returns on the way up. The question is: Is there anything an allocator can do to minimize them? For one, prior to an investment, an investor (allocator) where the manager has or may have large illiquid positions in public market securities, one should demand the manager make explicit representations about actions to be taken in such eventualities, and guarantee to warehouse (and provide upon request) time&sales transaction activity. One can demand (in the Info Memo or by legal representation) blanket prohibition by the manager, its affiliates, its employees and their families, upon dealing in any securities in which the Fund has, or may have an interest in. This seems obvious, but it is rarely codified as such. This is applicable to all liquidity-constrained strategies. Anchor investors can (and should) further demand clawbacks where fees are paid on mark-to-market, or at the very least, non-disbursing fee accruals that float up and down until exit, or some suitably long investment horizon, effectively removing the traders' option. It would be wonderful to simply trust your manager. But jail, or threat of serious legal action under circumstance of contravention may be sufficient inducement to insure one's fiduciary remains, in fact, one's fiduciary.

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