Growth trend in investment funds expected to continue

Jonathan Tonge, Investment Funds Partner	Mark Lewis, Senior Investment Funds Partner
Grant Stein, Senior Partner	Iain McMurdo, Investment Funds Partner

Monday,  January 9, 2006

The accelerated growth in hedge funds and private equity funds have continued to fuel the financial sector in 2005 and are expected to continue to grow in 2006, according to financial industry experts at Walkers. 

The Cayman Islands Monetary Authority (CIMA) reported that 960 new investment funds have been formed for the first nine months into 2005, which was 15 percent higher than the same period in 2004. This is on top of an already record-breaking year in 2004 with 1405 new hedge funds.

The growing demand for higher returns by institutional and individual investors as well as the growing markets in Asia and the Middle East are fuelling this growth. 

Around the world, the overall level of assets rose in 2005, primarily because pension funds invested into alternative investments vehicles. More than US$2.5 billion were invested in alternative investment vehicles in Japan primarily through hedge funds domiciled in Cayman. Walkers’ Hong Kong office also saw growth from these global trends. 

Pension funds are also driving new hedge fund structures including side letters, which is a special arrangement for select fund contributors, according to Walkers Senior Partner Mark Lewis. 

“Side letters are often needed to allow a pension fund to invest in a hedge fund without violating the terms of the pension fund’s charter documents or the provisions of the Employment Retirement Income Security Regulations, (ERISA)” said Mr Lewis. 

“Driving this trend is a significant increase in the funds allocated to the alternative investment sector in all jurisdictions from Japan and Dubai to the UK and the BVI.” 

Mr Lewis explained this trend is likely to continue well into 2006, especially given the poor performance of major global financial indices.

“Side pocket allocations are becoming more standard. Fund managers are constantly trying to generate higher rates of return in an increasingly competitive marketplace, and are using side pocket investments as off-market and illiquid vehicles,” added Mr Lewis.

The US Securities and Exchange Commission (SEC) will also bring increased regulation for hedge funds given the work being done by investment managers to prepare for 1 February registration deadline.

Walkers Investment Funds Partner Jonathan Tonge said many fund managers are electing to offer closed-ended hedge funds to avoid registration. 

“It is widely anticipated that the increased burden of regulation will increase operational costs for the start-up managers, although many are electing to offer shares in their funds with 25-month lock-ups to avoid registration,” said Mr Tonge.

“We also expect a year of consolidation in the market place as many smaller fund managers look to merge to achieve scalability of size.”

Private equity funds have also experienced exceptional growth in 2005 for several reasons according to Walkers Investment Funds Partner Iain McMurdo. 

“Private equity funds and hedge funds seem to be moving closer in terms of structure and strategy. We anticipate seeing even more of this and we are actively working for our clients on a number of these hybrid funds which will be launched early in the New Year,” said Mr McMurdo. 

“In addition to an increase in activity in jurisdictions such as Asia, the sheer size of private equity deals continues to grow as groups continue to take business units or entire companies private.”

One example of this trend include recent acquisition of Dunkin’ Brands Inc by Bain Capital, The Carlyle Group, and Thomas H Lee Partners. Other examples include the purchase of Toys ‘R’ US by a group with KKR Group, Bain Capital, and Vornado Realty Trust and the acquisition of Agilent Technologies’ semiconductor business by Silver Lake and KKR. 

In 2005, the Walkers team formed a number of new private equity funds for existing clients and was involved in a number of portfolio sales and acquisitions by its clients. Key deals included the sale of Japan Telecoms by Ripplewood to Softbank, the subsequent spin-off of Ripplewood’s private portfolio and RHJ International, which was the spin-off of the Soros Private Equity Group to form TowerBrook Capital Partners. 

It also advised Stone Point Capital in the capitalization of Harbor Point Limited.

Another area of expected growth in 2006 will be Shariah-compliant investment funds, which are funds that comply with Islamic law.

With the emerging of financial centre Dubai as a financial hub, Dubai prominence in the capital markets is expected to increase.

Over the past two years, Dubai’s equity markets have top performers in the global market growing by 41 percent since 1998 in the private equity market. Private equity investments now total approximately $1 billion. Current estimates call for this trend to accelerate to approximately $2.1 and $2.6 billion by 2007. 

Furthermore, over 80 percent of the investment in the region is currently offshore, which increases the need for the local business community to draw on international expertise.

Senior Partner of Walkers Grant Stein said Walkers opened an offshore law firm in November 2005 so it could cater to the growing market in the Middle East. 

“The top 30 global asset managers consider the Middle East to be a significant area of growth including UBS, Morgan Stanley, Deutsche Bank and Fidelity International, which are already active in the region,” said Mr Stein. 

“And the number of Islamic mutual funds has grown from 127 in 2002 to 445 by Quarter 3 of 2005,”said.

“With offices in London, Cayman, Hong Kong, the BVI and now Dubai, Walkers brings connections with the major financial centres, as well as knowledge of financial products, to better serve our clients around the world.”

shurna@caymannetnews.com

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