Hedge fund managers are always bargain-hunting. An example is the recent interest in Price Communications ( PR ), a holding company whose sole claim to value is that its stock will become exchangeable into shares of Verizon ( VZ ) on Aug. 15. A year after that, the limited partnership will be liquidated, and owners will get 0.52 shares of Verizon plus roughly $1.25 of cash for each share, says Andrew Baker, an analyst at Cathay Financial. Currently, Price Communications trades at $16.76, and Verizon at $34.78. The ratio implies a discount in Price, which at Verizon's current price would be worth $19.33, including the cash. Of course, the exact return will depend on how Verizon will trade in August. But so far, the Price Communications trade looks like buying Verizon at a discount. Last week, Sowood Capital Management, a hedge fund manager founded by former managers of Harvard University's endowment, announced a 7.9% stake in Price, making it the third-biggest holder of the shares. In fact, the top three largest shareholders are all hedge funds, with Atticus Capital owning 19% of the stock and Westchester Capital Management 8%, according to regulatory filings.
"It is quite surprising that so many people, on the buy-side as well as in academia, are so eager to believe that the sometimes huge alphas reported for hedge funds are truly there," Kat writes in his report. "Returns produced by hedge funds are not very special and there is no specific reason why you should want to invest in hedge funds."
Eric Hage, a portfolio manager with Mohican Financial Management, sees the future in small-cap and mid-cap convertible deals. He says that of 146 deals last year, 23% were mid-cap and 61% small-cap. That doesn't mean that big companies are not coming back in the market with a vengeance. Last week saw a mega-deal with Amgen ( AMGN) bringing $5 billion of five- and seven-year paper. The last deal of this size was Deutsche Telecom, with $8 billion in 2003, says Argent Financial Group's Bobby Richardson.
Dowd estimates that at least 50% of the top 25 largest hedge funds purchased the policies. They get coverage in case of a lawsuit or for costs incurred during a regulatory investigation. Dowd cites the case of a hedge fund investigated last year by the SEC. The agency found no wrongdoing, but the fund had to pay $10 million in legal fees. The premium depends on the fund's size. A $250 million fund typically pays $25,000 for the first million dollars of coverage. Still, says Michael Klaschka, an insurance broker with Integro, many funds remain reluctant to get insurance, simply because they don't want to pay for it. "They don't believe their sophisticated investors will bring a claim, and they are unaware of litigious trends emerging in the industry," he says. And unlike brokers that must carry insurance policies, investment advisers are not required by the SEC to have liability insurance.