Investors in Palisades Equity have had one scary ride this year. The onetime $75 million hedge fund is down over 20% on the year because of a series of calamitous investments, according to fund documents and interviews with investors. Now some distraught investors are jumping out of the four-year-old fund, which invests mainly in PIPEs, or private investments in public equity. The managers of the fund, meanwhile, are drawing criticism for some dubious moves, including an aborted attempt to pull some of their own money out of the Palisades fund and an ill-fated attempt to shelter one bad investment in a so-called side-pocket deal. The decimation of the Palisades fund, which has happened in just a matter of months, is another example of how rapidly fortunes can change in the $1 trillion hedge fund business. The behind-the-scenes maneuvers at Palisades, whose managers have ties to a small Georgia-based investment firm, also offer a peek into the intertwining of the hedge fund business with the brokerage world. "I am astonished at Palisades," said one investor who has redeemed most all of his investment from the fund. "Throughout this whole thing they were trying to be too cute, and they weren't being straight with investors." The most recent stumble at Palisades, which invests mainly in small, cash-strapped companies, occurred in June. That's when, sources say, a $12 million investment in OneTravel became of questionable value after the small travel-services company filed for bankruptcy. To view Lauren Silva & Farnoosh Torabi's video take on this story,
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Right around the time that Palisades' investment in OneTravel was imploding, the fund was forced to write off an $8 million investment in World Health Alternatives, a small health care staffing firm that got ensnarled in an accounting scandal last August and subsequently filed for bankruptcy in February. Last October, the fund's managers sought to separate the investment in World Health by putting it into something called a side pocket -- a separate account that hedge funds sometimes use for hard-to-value assets. But by this summer, it became clear that the $8 million investment in World Health was all but worthless, and Palisades' managers were forced to include it in the funds' overall losses this year. Palisades isn't the only firm to use side-pocket agreements for some investments. It has become a fad with some hedge funds who invest in PIPE deals--a financing deal in which a small company raises money quickly by selling discounted shares or bonds that convert into discounted shares. But regulators recently have started to question the legitimacy of some side-pocket arrangements. The main criticism is that hedge-fund managers can use the accounts to hide risky or less promising investments; this could ultimately enable hedge funds to boost the appearance of the return of the fund. Paul Mannion said he his partner, Andrew Reckles, who jointly manage Palisades, are suffering along with their investors. Mannion says the pair have sunk significant sums of their own money into Palisades and are "sacrificing'' more than most managers would in a similar situation.
Mannion points out that in April, when Palisades already was deep in the red, he and Reckles each invested another $3 million in the fund. But soon after, both men tried to redeem some of their newly invested money. Mannion says they abandoned their redemption request in order to "accommodate their shareholders,'' who also wanted to take money out of the fund. "We took the additional risk and the additional losses the fund incurred," says Mannion. "We decided to take a back seat and not put ourselves in the redemption mix with the other investors.'' But one thing that riles investors is that Mannion and Reckles keep trying to sugarcoat Palisades' missteps. In a recent letter to investors, the two partners suggested the fund's $12 million investment in OneTravel might still be worth something in the future, despite the company's bankruptcy filing. Of course, in the case of World Health, Mannion and Reckles were sounding a similar optimistic tone when they set up the side pocket for that investment last fall. They were optimistic even though shares of World Health were trading around 25 cents when the scandal erupted last August. "There was an awareness that the situation wouldn't be resolved in a month or two, so how do you value something going through a troubled period?'' says Mannion, defending the decision to set up the side pocket.
Indeed, in subsequent investor letters, Mannion and Reckles promised that World Health would recover and reassured investors that the value of the company wasn't completely lost. But despite the managers' promises, the side pocket ultimately became worthless. "They had a lack of judgment and common sense," says the investor, who didn't want to be identified. "They allowed the fund to get very concentrated, and then when they started running into trouble, they started throwing good money after bad." To be fair, Palisades wasn't always having problems with its investments. The fund was up more than 10% for the year in December 2005, and on an annualized basis the fund is still up 31% since its inception a little over four years ago, according to Mannion. In light of their track record, not all investors have soured on Reckles and Mannion. One, in fact, says they managers can still turn things around and put the fund back on a sound footing. "I am extremely optimistic about the next six to 12 months for them," said one investor in the fund. "I think their valuation policy is one of the most conservative and rigorous in the industry.'' Still, the managers don't have a clean slate. In 1995, Reckles was permitted to resign from Prudential Securities after a customer complained about his sales practices. Reckles, who could not be reached for comment, "categorically" denied any problems. Prudential Securities used to be part of Prudential Financial ( PRU).
Some investors also question the fund managers' ties to HPC Capital, a small Georgia investment firm that has served as a placement agent on a number of the PIPE deals in which Palisades has invested. Mannion is a managing director of HPC Capital and a former officer of the firm. A placement agent collects a fee for arranging the PIPE and finding hedge funds to invest in the deal. Mannion says HPC Capital's relationship to Palisades has never been hidden from the hedge fund's investors. Legal experts say there is nothing inherently wrong with a hedge fund manager being affiliated with a brokerage firm, as long as the relationship is fully disclosed to investors. "It is not uncommon that people have affiliated entities or conflicts," says Ron Geffner, a partner with Sadis & Goldberg. "Under the advisers act, investment advisers are required to disclose all potential conflicts of interest to their clients."