26 July 2007

Absolute Capital Hedge Fund Suspends Withdrawals

By Laura Cochrane and Stuart Kelly

July 26 (Bloomberg) -- Absolute Capital Group Ltd., an Australian hedge fund that invests in collateralized debt obligations, suspended withdrawals from two of its funds after forecasting losses amid a rout in U.S. subprime mortgages.

The firm froze its Yield Strategies Fund and Yield Strategies Fund NZD, which together have about A$200 million ($177 million) under management, Chief Investment Officer Bill Entwistle said in an interview today. The Sydney-based company is 50 percent owned by ABN Amro Holding NV's Australian unit

Absolute Capital, which says it doesn't invest in the riskiest portion of CDOs, is suffering from the widening impact of delinquencies on U.S. home loans to people with poor credit. Basis Capital Fund Management Ltd., another Australian hedge fund battered in the North American market, has hired Blackstone Group LP to negotiate with bankers to help it limit losses.

``Because of the contagion from subprime, all of the credit sectors are re-pricing,'' Sydney-based Entwistle said. ``There are lots of sellers and no buyers, the market has to settle down before we can get some clarity.''

The Yield Strategies Fund returned 6.4 percent the past year while the Yield Strategies Fund NZD, which started in May, gained 0.2 percent to June 30.

Australia's hedge fund industry has been rocked by losses at Basis Capital, which has said the value of its Yield Alpha Fund may plunge more than 50 percent if its assets are sold at distressed prices. Sydney-based Mariner Bridge Investments Ltd. on July 20 wrote down the value of its U.S. residential mortgage-backed securities.

Biggest Investors

The nation's 20 million people are the world's biggest investors per capita and Australia has the fourth-largest managed funds industry. Unlike in the U.S., where only qualified investors can place money in hedge funds, Australia allows individuals to invest in the vehicles.

Australian hedge fund managers directly controlled A$41 billion in assets as of July last year, the most in Asia, according to AsiaHedge. Assets almost tripled in the two years to June 2006 as money from compulsory pension savings, tax breaks, a new state-owned investment fund and takeovers boosted fund inflows, according to government data.

Absolute Capital said it won't process any requests for withdrawals until Oct. 25, estimating it may take three months for enough buyers to return to the CDO market.

Repackaged Debt

CDOs pool assets ranging from investment-grade debt to high-yield loans, and repackage them into bonds. Different portions of a single CDO have their own rating, ranging from as high as AAA to nothing at all.

Entwistle said 50 percent of Absolute Capital's two funds is invested in the so-called ``mezzanine'' portions of CDOs, which are typically assigned the second-highest non-investment grade rating of BB by ratings companies.

Basis Capital's investments included the unrated portions of CDOs, the first in line for losses when borrowers fall behind on mortgage payments.

``There's probably more pain to come,'' said Michael Birch, who helps manage $133 million at Wallace Funds Management, a Sydney-based hedge fund. ``We need more clarity as to the scale of the writedowns at Basis and Absolute. It might take six months for the full impact to come out.''

The sting from U.S. subprime mortgage delinquencies that hit a decade-high this year is being felt across businesses, regions and asset classes.

Buyers Vanish

Almost 40 companies have reworked or abandoned debt offerings in the past three weeks as after struggling to find buyers. Federal Reserve Chairman Ben S. Bernanke said July 19 there will be ``significant financial losses'' from risky mortgages, pointing to estimates as high as $100 billion.

Bear Stearns Cos., the fifth-largest U.S. securities firm, on July 18 told investors in its two failed hedge funds they'll get little if any money back after ``unprecedented declines'' in the value of subprime mortgage securities.

Investors earlier this month were demanding an extra 10.5 percentage points in yield over benchmark rates to own some of the lower investment-grade rated parts of CDOs, up from about 3.1 percentage points in July 2006, according to data compiled by Morgan Stanley.

Sales of CDOs surged to $503 billion last year, compared with 2003. Investor appetite for the securities is now waning. Analysts at New York-based JPMorgan Chase & Co. said CDO sales in the U.S. this month reached just $9.1 billion at July 20, compared with $42 billion for all of June.

Ratings Criticized

Ratings companies have been criticized by investors for not acting quickly enough to the subprime mortgage crisis. Leah Rhodes, a Melbourne-based director of structured finance at Standard & Poor's, today said losses from U.S. subprime loans ``did exceed our expectation.''

A spokeswoman for the Australian Securities and Investments Commission, the corporate regulator, didn't immediately return telephone calls seeking comment on Absolute Capital.

Kim Ivey, chairman of the Australian Alternative Investment Management Association, which represents 80 of the nation's hedge fund managers, said there will be more hedge funds hurt by the subprime market.

``I expect that it will be contained to just a handful,'' he said. ``More of a concern is what will happen once the fallout moves from the subprime sector to more senior debt, when many more managers have exposure.''

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