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Whitebox Liquid Alts Exit Raises Questions on Private Funds

By Rachael Levy January 20, 2016

The sudden shuttering of Whitebox Advisors’ mutual funds is raising red flags for some investors around the firm’s private funds, say investment consultants and capital raisers.

The $3.9 billion Minneapolis firm, best known for its hedge funds under founder Andrew Redleaf, planned to liquidate its three liquid alts funds yesterday after facing heavy investor redemptions and lagging performance.

Whitebox’s Tactical Opportunities Fund was down about 21% in 2015, according to Google Finance. Whitebox declined to provide return figures past Oct. 31 of last year.

But Whitebox’s mutual fund woes have not affected its hedge fund line, a spokeswoman says.

The mutual fund closures mark a sharp ending to the firm’s three-year foray into the liquid alts space. In 2012, Whitebox launched its mutual fund business, saying in a press release that its hedge fund managers would oversee the new additions. The firm pressed forward two years later, launching two additional retail funds on the back of rapid asset increases.

Even as the mutual fund business was building up, Whitebox attracted more than $2 billion in inflows overall, according to a person familiar with the firm.

But not all hedge fund investors were pleased to see the firm expand into liquid alts, with some worrying that the new business would distract the firm from its core hedge funds, according to an investment consultant familiar with Whitebox who requested anonymity.

Investment focus was also a concern. For example, Whitebox launched mutual funds using long-short equity strategies, which differed from the tactics it was better known for, such as credit, and this change raised concerns for some potential investors, according to the investment consultant and an investment management professional familiar with Whitebox’s funds.

Staffing changes also can raise concerns for investors, says Jonathan Miles, managing director and head of hedge fund advisory at Wilshire Consulting.

In November, Whitebox’s equity chief, Jason Cross, left the firm, and Paul Karos, a portfolio manager on one of the funds, took the reins, as reported.

“Whenever we see firm instability manifest in team turnover, a whole business line shut down, that is a red flag,” Miles says. “You need to get more information from a due diligence perspective.”

Consultants consider every piece of data in assessing a potential investment, says Dave McMillan, CIO at investment consultant Mercer.

“That information spans the full spectrum of the business,” McMillan says. “To the extent that the business includes both private and liquid [alts] funds, the onus is on us to fully investigate that.”

Whitebox is unlikely to face such scrutiny, says Amara Kaiyalethe, a spokeswoman for the firm. In press statements, Whitebox has said that shutting down the funds was a “strategic” move.

Kaiyalethe declined to comment on whether the mutual fund closures announced last month have impacted hedge fund flows. For now, Whitebox says it has no plans to re-enter the liquid alts space.

Whitebox’s mutual fund shutdown reflects a wider trend in the hedge fund industry, as some private fund managers step back from launching in-house liquid alts funds and turn to subadvisory, as reported.

And liquid alts funds more broadly have had a rough streak, losing $29.1 billion in assets under management last year, according to data from Wilshire Associates.

Liquid alts also underperformed the private fund counterparts they often mimic. The Wilshire Liquid Alternative Index lost 3.52% compared to a negative 0.85% return for hedge funds, according to Hedge Fund Research.

Even though the mutual funds – at $300 million across strategies – represented a small share of Whitebox’s current assets under management, investors may still take note of the change.

“Any large loss of firmwide AUM impacts a manager’s sense of stability with current and prospective investors, regardless of which vehicles are losing the capital,” David Frank, CEO at Stonehaven, a third party marketer, says in an email. “Also a lower asset base produces lower firmwide fees, potentially forcing a firm to cut staff and reduce other resource allocations to adapt to a lower-revenue business.”

Whitebox’s highest-fee mutual fund – the Whitebox Market Neutral Equity Fund – charged as much as a 1.5% management fee and a 3% net expense ratio, according to the firm’s website.

Still, hedge fund managers can turn around the messaging of a failed business line, as long as they communicate clearly, says Tim Welsh, president and founder of Nexus Strategy, an investment advisor consultancy.

“As long as they can point to that it’s not so much the management, but the strategy that didn’t work, they will be fine,” he says.

Strong communication with clients at such times can help retain and even attract investors, says Andy Corn, CEO of E5A Integrated Marketing.

“Staying ahead of the why and satisfying existing and next circle institutions and consultants is key in maintaining brand,” Corn says in an email. “Control the buzz. Make lemonade from what may be perceived as lemons.”

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