Stan Druckenmiller, one of the top-performing money managers of the past three decades, discovered a hard truth when he started investing in other hedge funds: Most don't treat their clients fairly, he said.
Partnership agreements frequently leave investors on the hook for legal fees associated with the misconduct of fund employees, or allow managers to suspend redemptions for any reason, Gerald Kerner, Mr. Druckenmiller's lawyer since 1997, wrote in a paper presented yesterday to a group of endowments and foundations.
Now Mr. Kerner is fighting back, pushing for changes in an industry where managers wield clout with their investors and typically charge the highest fees in the asset-management business. He is urging investors to push for contract changes and refuse to invest with funds that won't agree to change their terms.
The unfair provisions “can cost investors many millions of dollars down the road if not remedied,” Mr. Kerner wrote in the 14- page paper titled: “Hedge Funds: Problems Under the Hood.”
Paula Volent, senior vice president for investments at Bowdoin College, presented that paper yesterday at the NMS Management Inc. conference in Scottsdale, Ariz. She'll also talk about it on Jan. 29 at Morgan Stanley's hedge-fund conference at the Breakers in Palm Beach, Fla.
Mr. Kerner declined to comment beyond the contents of the paper, as did Mr. Druckenmiller, 60, who managed part of the endowment of Bowdoin, his alma mater, for many years. Druckenmiller, a former chief strategist to billionaire George Soros, managed one of the top-performing hedge funds in the industry at Duquesne Capital Management, gaining an average of 30 percent annually from 1986 to 2010.
“I prefer to give investment dollars to sponsors whose documents match their good character so that in the unlikely event down the road, that the contents of the documents matter, they provide the protection that I want to have,” Mr. Kerner wrote.
He wants documents changed to make clear that managers are responsible for any legal fees that result from employee misconduct, even if the manager did nothing wrong himself, because that “comes with the territory of being in charge and being paid fees to be in charge.”
Mr. Kerner also asks that managers not be able to suspend withdrawals for any reason, as is stipulated in some documents. Some documents say that a manager can stop redemptions if the firm deems them to be “impractical or prejudicial to the partners.” That language leaves clients open to fund managers who restrict withdrawals for their own benefit, rather than for the benefit of outside investors, according to Mr. Kerner.
Most agreements don't even hold the managers to their own contracts, he said. The standard wording says that a fund manager isn't liable for losses unless they are the result of gross negligence, willful misconduct or the violation of a law. The clause should also include the “material breach of the limited partnership agreement” in the list of bad acts, Mr. Kerner wrote.
Another provision Mr. Kerner wants remedied involves the way managers ask investors to vote on changes to their fund documents. When funds send out the materials to be voted on, they generally stipulate that if clients don't respond within 20 days, their vote will be counted as a “yes.” Mr. Kerner said that at the very least, the time period should be extended and should be accompanied by multiple attempts by the fund to contact the investors to make sure they are aware of the vote.
In the paper, Mr. Kerner discusses his own experience trying to get documents changed. In many instances, the investment managers said they weren't even aware of the contents of their own documents. Nor are most investors, since he was often told that he was the first person ever to complain.
He regularly got pushback from the firm's lawyers, who told him that they wouldn't change the documents because they were industry standard.
Mr. Kerner, who compares the common use of these provisions to the replication of a faulty gene, said the “flaws will remain as 'market standard' until enough investors balk and then the standard will shift as necessary to enable the sponsors to raise the investment capital that they seek.”
Mr. Druckenmiller shut his hedge-fund firm more than three years ago and now manages his own wealth through his Duquesne Family Office.