Patricia Ward talks to hedge fund managers and allocators about their perception of Cayman as a fund domicile.
"Cayman was one of the first offshore locations to grasp the potential value of hedge funds and to set about accommodating them",says Geneva-based Dr. Ghaffar Farman-Farmaian, a long-time private hedge fund allocator, who has extensive experience in dealing with diverse domiciles. "Cayman has benefited from its pioneering policy, and I understand that this jurisdiction now has the highest number of registered hedge funds."
Over time, Cayman has maintained its popularity as a hedge fund domicile in the face of increasing competition, thanks at least in part to the Cayman authorities responding to the evolving needs of the hedge fund industry. “They have modified laws to accommodate hedge funds with more than one class of shares and have approved legislation to legally isolate each class of shares financially from the others,” points out Dr. Farman-Farmaian. “Thus they have provided financial safeguards for holders of one class of shares against the bankruptcy of another class of shares within the same hedge fund structure.”
Divide and rule out cross-liability
Looking at Cayman from a similar perspective, David Beach, founder of London-based commodity trading advisor Beach Capital and a Beach Horizon principal, adds: “A big attraction to many fund managers is the ability to register a fund as a Cayman Segregated Portfolio Company (SPC).”
SPCs have been designed as a cost-effective means of creating a group of companies with a common founder and directors, but with the ability to be viewed as independent entities, such that if one SPC fails, it does not impact the others. While the theory that creditors of a failed SPC cannot raid other SPCs run by the same manager has not yet been tested by US law, some managers feel they are robust enough to make it worth their while to move funds from other jurisdictions to Cayman.
Beach was sufficiently impressed by the features of Cayman SPCs to move Beach Capital Funds from its original domicile to Cayman in 2004. Consequently, when the Beach Horizon Fund was launched in 2005, it was natural that it would also be domiciled in Cayman.
David Beach sees SPCs as suitable for both newer and long-established funds. And he should know. From June 1989, until his retirement in April 2006, Beach ran the highly successful flagship Beach Discretionary Program, which produced an annualised average return of 19.5 percent.
“If Beach Horizon were to bring out a 3X geared fund as an SPC that shared many features with the main SPC fund, it would be treated as a separate legal entity,” says Beach. “These protected portfolios leave investors in one fund inured from the effects of another fund’s performance. They also enhance cost efficiency from a number of perspectives, for example, by reducing accounting bills.”
Prior to the development of SPCs, managers had the expense and inconvenience of setting up each fund as a whole new legal entity in order to protect investors from cross-liability.
“SPCs have proven to be a clever way of removing the cross liability that existed between different share classes of the same fund prior to their creation,” says Robert McGregor, the Cayman Island-based chief operating officer of CFM, Cayman Islands Ltd.
Like so many other managers, McGregor and his colleagues at London-based futures trading advisor City Fund Management Ltd. (CFM) appreciate the creativeness of the local legal community that has led to SPCs being developed. He says: “The wealth of lawyer experience here is so high that Cayman should continue to be at the leading edge of creation in terms of innovative and efficient legal structures.”
So popular are these SPCs becoming that other jurisdictions are increasingly developing their own versions of the Cayman-pioneered model. “Cayman has been a leader in accommodating offshore domiciled hedge funds,” says Dr Farman-Farmaian. “Now other offshore locations, having seen Cayman’s success, are duplicating its laws and even attempting to improve on these with more user-friendly innovations.”
Mastering the feeder structure
Tushar Patel, who is managing director of Investment Management at London-based Hedge Funds Investment Management Ltd. (HFIM), has also watched the Cayman authorities respond and evolve to meet changes in the hedge fund industry’s diverse requirements. “The Cayman regulatory environment provides hedge funds with a range of fund structure possibilities,” he says. “Take, for example, the development of the master-feeder structure, which allows investment managers to manage funds allocated to by both US and non-US investors through a single structure.”
The Cayman master-feeder structure is popular with both funds of hedge funds, such as that run by HFIM, and single-manager hedge funds. London-based Armajaro Asset Management, for example, runs two single-manager, Cayman-domiciled, master-feeder structured hedge funds. “The master-feeder structure is very user-friendly,” says Armajaro Asset Management director Neil Heywood. “Investors into our master-feeder funds come from all over the world, including Japan, Hong Kong, Singapore, Australia, the US, continental Europe, the UK and the Middle East.”
As is the case for many other Cayman-domiciled funds, the Armajaro funds’ global investors range from institutional to private, an indication that the Cayman master-feeder structure can meet the requirements of a wide range of investors based in diverse locations. So popular with investors has the discretionary Armajaro Commodities Fund proven since its inception in 2004—from then to the end of February 2007, it returned over 45 percent—that it reached capacity earlier this year at over $600 million dollars.
“We are fortunate to have a diversified and balanced investor base in the fund,” commented Armajaro Asset Management chief executive Neill Brennan. “Armajaro directors decided to soft close the fund at current levels in order to protect performance, whilst maintaining trading opportunities in the current market climate. The capacity will be monitored on an ongoing basis and investors will be kept informed should the fund reopen.”
With approaching $300 million under management, Armajaro’s Coolum market-neutral long/short equity fund is proving sufficiently popular for Armajaro to prepare to launch a developed Asia-focused version of Coolum, which can invest in New Zealand, Australia, Singapore, Japan, Hong Kong and Korea. Like Armajaro’s current funds, the new one will also be a Cayman master-feeder fund.
“We are fortunate to have a diversified and balanced investor base in the fund” - Armajaro Asset Management chief executive Neill Brennan
A deep resource pool
As regards some other aspects of Cayman flexibility, Patel says: “Unlike certain jurisdictions, Cayman allows funds domiciled there to use administrators and custodians outside Cayman. For example, the administrator and custodian can be based in Dublin, which can draw on a large pool of skilled professionals. These administrators and custodians are to a certain extent subject to local regulatory requirements and are required to have local approval to operate in Dublin—a time zone convenient to Europe-based investment managers.”
That said, many managers and allocators are more than happy to use Cayman service providers. “Cayman has a long history of good local fund administration, which is very important to the hedge fund industry,” says McGregor.
While he is impressed with the local legal and administrative talent, McGregor is concerned that a recently introduced policy means that foreign nationals cannot stay on Cayman for more than seven years without seeking to become a national status holder. He fears this could reduce Cayman’s ability to retain the level of expertise on which alternative investment funds rely.
Like CFM, other managers are concerned that people servicing their funds number among the leading professionals. HFIM, for one, prefers funds to which it is considering allocating to be serviced by reputable custodians and administrators. “Some allocators are more comfortable when funds are serviced by reputable established custodians and administrators,” says Patel. “This provides additional due diligence comfort when investing in a fund domiciled in Cayman.”
As he has been working out of Cayman for CFM for the last 18 months, McGregor has gained first-hand experience of the hedge fund domicile. To those concerned about the annual hurricane threat, like the one that engulfed Cayman in 2004, he points out: “People here have learned from that experience that they have to make serious business-continuity contingency provisions for extreme weather.”
While many UK-based managers domicile their hedge funds in Cayman, very few have employees based there. McGregor, however, finds that Cayman’s time zone is helpful as he trades on the US futures markets on behalf of CFM’s flagship multi-strategy futures-trading Constellation Fund, which was set up in Cayman in November 2002. Returning over 3 percent for the year to the end of March, the fund has proven itself able to weather the inclement futures trading climate of late.
McGregor finds that Cayman’s being a relatively inexpensive domicile in which to set up a hedge fund is especially appreciated by the newer hedge fund operations that have relatively tight budgets. As HFIM’s fund of hedge funds aims for absolute returns through allocating to innovative managers, many of whom have relatively short track records, Patel is also aware that Cayman is a popular domicile with such managers, especially those from the UK.
Managers also point out that for UK-oriented managers and allocators; Cayman’s has an additional advantage in that Cayman law has much in common with UK law.
An eye on the future
Furthermore, by comparison with many other fund domiciles, Cayman is perceived as a forward-looking regime. As such, Dr Farman-Farmaian thinks it can be the flag bearer for the right of the man in the street to invest in hedge funds. “The mutual fund industry has over $10 trillion in investments made by the common man into funds that have a minimum investment of around $1,000,” he says. “Why shouldn’t the man on the street be allowed to invest the same minimum in a relatively safe fund of hedge funds that has the potential to provide protection against losses during a bear market?”
For regulators who continue to resist making provisions for localised hedge funds, Dr Farman-Farmaian has a warning: “As time goes on, and more and more hedge funds show how stable their performance can be during both bull and bear markets, investors will question the authority of governments and their agencies to legislate on their investment decisions and limit their access to investments in hedge funds.”
Dr Farman-Farmaian would like to see regulators make provisions for funds of hedge funds with diversified portfolios of no less than 25 hedge funds that have a minimum investment of $5,000 or less. “With such legislation, the common man can benefit from the more stable performance and returns of such funds,” he says. “If governments and their agencies fail to understand this, the smarter hedge fund managers or active financial institutions will find a way.”
Regulators that maintain uniform high minimum investments for all types of local hedge funds could learn from the popularity of stock exchange-listed close-ended funds, according to Dr Farman-Farmaian. “While you need a minimum of £50 million in a close-ended hedge fund in order to list it on the London Stock Exchange, once quoted, shares can be sold to the man on the street for less than $1,” he says. “Hedge funds are here to stay and, in the long run, no force can stop them or limit their progress by legislation.”