ARTICLE INTERVIEW: Beryl's Radonjic quoted in The New York Times "Fund Within a Fund Creates a Conflict" May 29, 2014

By WILLIAM D. COHAN    
May 29, 2014 12:33 pm

It is taken for granted that hedge fund investors expect superior returns. What other justification could there be for paying routine fees of 2 percent of assets and 20 percent of any profits, or sometimes even more? But what if those returns pale in comparison to the returns that the partners of a hedge fund earn in a separate, secretive fund that is set up specifically for their benefit and not available to the outside investors?

Welcome to the mysterious world of Blue Crest Capital Management, a $30 billion hedge fund founded in Guernsey by Michael Platt, a former JPMorgan Chase derivatives trader. In 2011, for its 130 or so partners, Mr. Platt established a $1.5 billion internal hedge fund known as the BlueCrest Staff Managed Account, supposedly to help Blue Crest attract and retain top talent at the firm — as if making millions of dollars in annual compensation was not enough.

Blue Crest has been on a bit of a hiring spree of late, so no doubt it doesn’t hurt recruiting to be able to offer the partners’ fund perquisite. Partners get their money back from the fund B.S.M.A. when they retire. The Blue Crest partners also have an additional $2 billion of their money in the same Blue Crest funds as the outside investors.

Although neither Mr. Platt nor Andrew Dodd, Blue Crest’s chief financial officer, agreed to be interviewed about the partners’ fund or anything else related to their hedge funds, a person with knowledge of the fund’s performance said it had posted annual returns well above those for Mr. Platt’s two principal funds: BlueCrest Capital International, with nearly $13 billion under management, which declined 1.57 percent in 2013, according to Hedge Fund Research, and BlueTrend, with about $10 billion under management, which lost 11.5 percent in 2013. Before 2011, the Blue Crest partners’ money was commingled with that of the outside investors.

To be fair, 2013 was especially tough for Blue Crest. Since 2000, according to published reports, BlueCrest Capital International had an annualized return of 11.9 percent, well above industry averages, while BlueTrend, which invests based on computer algorithms, has been profitable every year since its inception in 2004, except for 2013. Blue Crest’s assets under management have nearly tripled since 2009 after the firm had a stellar 2008, when many hedge funds crashed during the financial crisis.

That Blue Crest would rather not discuss its partners’ fund is understandable. Why invite the ire of high fee-paying limited partners, who no doubt would wonder correctly what the partner fund is investing in that the other Blue Crest funds are not?

The partners’ fund would have stayed private except for the leak of a report in February by Albourne Partners, a large adviser to hedge fund investors, that questioned the fairness of it. Jane Hughes, an Albourne analyst, disclosed the existence of the partners’ fund in the report and questioned whether it created a conflict of interest, according to Bloomberg News. “We also do not feel that BlueCrest has provided appropriate disclosure to Albourne or to external investors, as far as we are aware,” according to Bloomberg, which had been read the passage from Hughes’s report. “Nor have they been sufficiently open with Albourne when we have tried to discuss the possible conflicts.”

A second Albourne report on the topic further chastised Blue Crest for dragging its feet in answering its questions about the partner fund.

There is no question the Blue Crest partners’ fund creates a conflict of interest with the investors in the other Blue Crest funds, but there is some modest precedent for creating investment funds for senior employees as a way to retain the best and the brightest of them. One big hedge fund, the Tudor Investment Corporation, has a separate fund for employees that invests in Tudor funds and other hedge funds. And 15 years ago, when the big Wall Street firms were worried about losing their top employees to Internet start-ups, managing directors at many Wall Street firm were given the chance to invest in private equity funds set up expressly for them, though such opportunities have mostly disappeared.

Once upon a time, Lazard’s partners invested in their own private equity deals — a few top Lazard partners, including Andre Meyer and Felix Rohatyn, controlled Avis Rent a Car in the 1960s before selling it to ITT for a huge profit. A group of Lazard partners also once owned the Chrysler Building in Manhattan. And Goldman Sachs famously and quietly created something called the Special Situations Group, which invests its most senior executives’ fortunes in deals and companies apart from the investments made for the firm and outside investors through GS Capital Partners, its $20 billion group of private equity funds. Hedge fund managers still talk about the absolute killing the top Goldman executives made by investing in Jinro, a Korean liquor manufacturer, when it was in receivership.

But what Blue Crest is up to is quite different and less justifiable.

“The practice is not common at all,” Vidak Radonjic, the managing partner at the Beryl Consulting Group, which provides independent hedge fund research and advice to investors, wrote in an email. “It is common knowledge that hedge fund managers and their employees (proudly) invest alongside other limited partners to show they have the skin in the game, that they eat their own cooking. Setting up another vehicle just for the manager’s partners/employees seems awkward and redundant unless the manager can clearly explain to their limited partners the reason for the existence of this extra investment vehicle.”

“Not sure why the manager does not keep it simple and just let their partners/employees invest alongside their investors as other fund managers do,” he added. What typically happens at the big private equity firms is that, as Mr. Radonjic points out, top executives invest alongside limited partners in the same deals and in the same funds so there is no question that their collective interests are precisely aligned.

Unlike the big Wall Street investment banks — which have many different lines of business — a hedge fund is supposed to do one thing and one thing only: find proprietary investment ideas for the benefit of its fee-paying investors. The Blue Crest partners’ fund upsets that simple calculus by raising the obvious questions about which Blue Crest funds get the best ideas, and why, and how those decisions are made.

William D. Cohan is a former senior mergers and acquisitions banker who has written three books about Wall Street. His latest book is “The Price of Silence: The Duke Lacrosse Scandal, the Power of the Elite, and the Corruption of Our Great Universities