(Bloomberg) – Wasim Rehman is a go-to resource for investors desperate for a way out of the chaotic world of trading troubled, hard-to-sell assets — a sector set to explode as sanctions on Russia and the ongoing stock market meltdown this will lead to mountains of illiquid holdings.
But Rehman – who has invested in more than 200 liquidation funds in the 13 years since retiring at age 28 as the youngest partner of hedge fund giant Marshall Wace – has a message for those tempted by the deep discounts of so-called side pockets money managers create to sort out their problem bets: sometimes it takes more than just patience.
Take his 2014 purchase of claims linked to fraudster Bernie Madoff, mastermind of the biggest financial scam in history. The protracted effort to unwind this investment forced Rehman, one of the biggest players in the secret world of side pockets, to step out of the shadows, take a stand against the executives responsible for liquidating the assets, and even prepare for his fight in the courts . Rehman says it could be years before he makes a profit on his bet.
“This is one of the worst liquidations I have experienced and to date the only situation where I have taken an activist approach,” the London-based investor said in an interview.
Rehman’s ordeal is a cautionary tale for investors after sanctions against Russia following its invasion of Ukraine trapped funds with billions of dollars in stocks, bonds and currencies they can’t easily dump. The ongoing sell-off in growth stocks also threatens to lock investors into unlisted securities, which hedge funds are buying.
Hedge funds like EDL Capital have already shed Russian stocks, while Coatue Management has created a side pocket for bets in private companies. According to a consultation document in March, UK regulators have been talking to retail investor funds about separating frozen Russian assets from core investments, to help new investors avoid exposure to such assets and let existing holders give back the rest of their investment.
The Russian side bags might be too toxic even for him, Rehman says, pointing to the legal complications that can ensue with their handling. It’s also unclear how they could be bought without violating sanctions, he said.
Investors like Rehman buy hard-to-sell assets at deep discounts, hoping to make a profit when those funds are liquidated at higher values. Profits can be beautiful. Jared Herman, president of Hedgebay Securities, which brokers private and illiquid assets, said investors typically earn 15% to 20% annual returns, but in some cases gains can exceed 50% or drop to zero.
The process is lengthy. Divestment of illiquid assets has always been a murky area of finance where patience is tested, thorough research and connections are required and ugly litigation is frequent. “Most investors tell me they’re going in the right direction, but what they almost always get wrong is duration,” Herman said.
Rehman’s Madoff case is a classic example of how bad things can get.
In real dollars, the Madoff Ponzi scheme lost around $19 billion, trapping investors in numerous side pockets and funds in liquidation. Some of them are still running and billions of dollars have yet to be recovered.
The scale of the fraud was extraordinary. Madoff scammed thousands of clients including veteran investors, friends, charities and religious groups who gave him money that resulted in fake outsized returns believing he made $65 billion. He ended up being sentenced to 150 years in prison, he and his wife attempted suicide, and his son killed himself. Madoff died in prison last year at the age of 82.
Rehman’s ordeal linked to Madoff began with the purchase of debt in 2014, which was tied to a Guernsey-based fund called FIM Long-Invest. Established in 1997, FIM was a fund of funds that collected money from investors and allocated the capital to multiple funds for diversified exposure. It had invested tens of millions of dollars in Kingate Global, which was linked to Bernard L. Madoff Investment Securities, the pyramid scheme that collapsed in December 2008.
In March 2010, FIM announced its dissolution and appointed liquidators to sell the assets and distribute the cash generated among investors. Rehman, who bought some of those claims from FIM investors looking to get out, is still waiting for that money. Last year he and at least one other investor took matters into their own hands, seeking the resignation of Anthony Sanderson and Paul Pybus, joint liquidators of Price Bailey Ltd.
“We appear to be caught in a voluntary liquidation as shareholders,” they wrote in their complaint to the Guernsey Financial Services Commission, a copy of which was reviewed by Bloomberg. “The joint liquidators have awarded service contracts to one of their partnerships at a price that represents poor value for money. Carry-over rules, AHV notice periods, AHV requirements have all been interpreted and manipulated at the discretion of the joint liquidators to suit their personal interests and prolong the liquidation.”
Pybus and Sanderson resigned in April. They didn’t respond to multiple emails asking for comment, and neither did Price Bailey. Rehman confirmed the content of the complaint. A spokeswoman for the Guernsey regulator declined to comment on the complaint, citing “strict confidentiality obligations”.
Even after the resignations of the joint liquidators, Rehman’s recovery depends on the outcome of Kingate’s liquidation, which has been going on for 14 years.
“I’m a patient and passive investor and this was a last resort given the horrific treatment of shareholders and the serious concerns I have about how the liquidation has been conducted for many years,” Rehman said. “Although the liquidators have resigned, the questions we raised in February 2021 remain unanswered and are still a matter of serious concern.” Most of the side bags are less complicated than the one Rehman is struggling with. The investment vehicles emerged from the depths of the 2008 financial crisis after hedge funds were caught in an avalanche of illiquid assets. Investors estimate that $200 billion to $360 billion sidelined in 2008 — or up to 20% of the industry back then. While the vast majority of these side pockets have been wound up, some complex liquidations involving billions of dollars remain.
Hedge funds have since grown to more than $4 trillion, and a repeat of the 2008 event would freeze about $800 billion. In addition, more yield-seeking investors have turned to illiquid and private market assets amid historically low interest rates, creating a potential blind spot if funds face pullbacks as global markets and economies falter.
“Should we enter a cycle of redemptions and liquidations, more side pockets and hard-to-value assets may emerge from portfolios,” said Nicolas Roth, head of alternative assets at Geneva-based private bank Reyl & Cie, who has helped clients deal with side pockets . They “can be an expression of some excesses in the system and deviations from mandates of managers.”
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The side bag niche sector has exploded over the years and dozens of companies are attracted by its rich selection. Rehman is one of the most influential players in the industry.
He began his financial career in 2001 as a stock trader at Goldman Sachs Group Inc. after studying mathematics at the University of Cambridge. He worked on the firm’s technology, media and telecoms team and later focused on investing in special situations. Marshall Wace hired him two years later and made him a partner in 2005. Rehman, who is currently pursuing his PhD in quantum mechanics, left the company in 2009 to invest his own money in illiquid assets and fund liquidations.
FIM isn’t Rehman’s only investment linked to Madoff. He still holds bets tied to Kingate, Fairfield Sentry and Fairfield Sigma. Rehman has successfully realized gains on claims he purchased relating to Thema International Fund Plc, the Irish investment fund that helped open the floodgates to European money for Madoff’s firm in the early 1990s, and Hermes International Fund Ltd.
Some liquidations from the 2008 era are still ongoing, Hedgebay’s Herman says. These include a Harbinger Capital Partners side pocket created to park a bad bet on a Vietnamese casino, Grand Ho Tram Strip, in which the company invested more than $450 million, and a minority stake in a telecommunications company, formerly known as LightSquared paid out at least $2 billion. Side pockets associated with Highland Capital Management and Bennelong Asset Management also remain.
“We trade these things and people still have them and they still exist,” Herman said.
Eventually, many of the bets that went illiquid and are sold to investors like Rehman in the secondary market can result in handsome profits, but the wait can be excruciatingly long.
Take Enron Corp. for example. Enron, once the largest US energy trader, filed for bankruptcy in 2001. The liquidation took more than a decade, but its unsecured creditors received a 53% repayment, or more than $21 billion in cash and stock — triple the bank’s estimated recovery estate in charge of overseeing the process.
Some subordinated debt issued by Lehman Brothers before the 2008 collapse could result in a windfall of hundreds of millions of pounds for Deutsche Bank AG and other investors in bad debt. Banknotes changed hands for almost nothing more than they did five years ago. However, the wait goes on.
Much more is likely to come from buyers of such distressed assets.
“The lesson for many hedge fund investors in 2008 was ‘get out first,'” said Andrew Beer, founder of New York-based Dynamic Beta Investments. “Early risers got cash and late risers got side pockets. Given the environment over the past few years, I suspect the side bag nightmare of 2008 will be repeated.”
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