Side Pockets Persist

Chidem Kurdas

Even as markets and hedge fund returns recovered from the crisis of 2008, some managers continued to keep hard-to-sell assets in separate portfolios that have restricted redemption. The practice was initially a response to extraordinary circumstances but persisted largely because managers believe they can salvage losing investments if given more time.

Side pockets limit withdrawals by investors while the agreed-upon redemption conditions still apply to the assets in the fund proper. Thus some of Perry Capital’s investments were moved to side pockets after losses in 2008. The losses came in part from Perry’s trades in Porsche’s attempted takeover of Volkswagen. 

Perry is one of the managers suing  Porsche for $1 billion, claiming the company deliberately caused a short squeeze. Meanwhile, the side pockets stayed in place.

Last year HedgeFundAlert reported that Perry proposed a new high-water-mark arrangement, whereby investors were offered a lower fee rate if they agreed to the manager taking performance fees while the fund is still under water.  This followed a 26.8% 2008 loss in Perry’s flagship fund, which managed $6 billion of the firm’s $8 billion assets at the time.

Perry has plenty of company. Side pockets have become so ubiquitous that the fund administrator SEI recently expanded its capabilities for processing and accounting of side pocket investments. The accounting is complicated by the illiquidity of the investments.

SEI says side pockets have become more prevalent and as a result the processing of assets in the pockets has come under greater scrutiny. Methodologies vary across managers and are complex but it is possible to identify a set of standardized best practices that can be automated across liquid and illiquid assets, according to SEI.

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Tags: Porsche, Volkswagen