Citing growing U.S. government concerns about money laundering and terrorism, one of the world’s most successful hedge fund firms plans to bar anonymous investors.
By Hal Lux
December 2001
Institutional Investor Magazine
In a letter sent to investors last month, East Setauket, New York-based Renaissance Technologies Corp. said that it will soon prohibit both individuals and organizations from participating in its hedge funds through third-party arrangements that mask the identities of the actual investors. The letter, signed by Renaissance founder Jim Simons, said that although some investors have legitimate reasons for remaining anonymous, the firm will no longer accept money from them. “Those in this category will shortly be informed of our specific disclosure policy and will thereafter have adequate opportunity to conform to our requirements,” the letter said. “Hopefully, all will do so, but those who choose not to in the time allotted will have their capital returned.”
“It’s a precaution - we haven’t found anything,” says a Renaissance executive. “Given the environment, we don’t want to discover in the future that we’re managing $100 million for various bad guys. We want to know who our investors are.”
The Renaissance action comes amid increased regulatory scrutiny of anonymous hedge fund investments made through private banks. New U.S. anti-money laundering legislation signed by President George W. Bush in October calls for the Securities and Exchange Commission, Treasury Department and Federal Reserve Board to study the need for increased supervision of hedge fund investment practices. The report on hedge funds and money laundering is expected next fall. Meanwhile, The Wall Street Journal last month reported that the Federal Bureau of Investigation is looking into whether hedge funds invested money for Osama bin Laden’s terrorist network.
Some say it’s unlikely that U.S. hedge fund groups will voluntarily follow Renaissance’s lead. Although no one tracks the exact numbers, anonymous investors, operating largely through private banks and trusts, account for a significant share of assets in offshore hedge funds, according to several hedge fund executives. “I think you would lose a lot of investors,” says Antoine Bernheim, president of New York-based Dome Capital Management, which advises European investors on offshore hedge funds. “Offshore, people are used to using nominee accounts and banks.”
Many offshore investors, in fact, now deposit money in private banks that send the money to trust institutions that in turn invest in the hedge funds, says Bernheim. “You have to get through several levels of banking institutions to get to the institution that knows the client,” he says. “It’s very common that the hedge fund does not know the client.”
To be sure, Renaissance Technologies manages $4 billion and can afford to be picky about its investors. With average annual net returns of 37 percent over the past 12 years, the secretive quantitative group run by former mathematician Simons boasts arguably the best performance record in the money management business (Institutional Investor, November 2000). The firm’s flagship Medallion fund, which posted returns of 98 percent last year, has been closed to investors since 1993, and a new hedge fund named Equimetrics closed this year. In last month’s letter Renaissance also told investors that it would increase its performance fees from 20 percent to a staggering 36 percent of profits - nearly double the hedge fund industry average.
Not every hedge fund expert agrees with Renaissance’s new precautions against money laundering. Bernheim argues that there’s no need for hedge fund managers to bar anonymous investors if they deal only with reputable institutions acting as intermediaries. “The bank knows the client under the banking rules of many countries,” he says.
With demand surging for hedge fund investments, many major fund managers could easily replace capital lost from spurned anonymous investors. But U.S. hedge fund managers have a strong incentive not to replace offshore funds with money from U.S. investors: There are enormous tax benefits to managing non-U.S. money. Many U.S.-based managers running offshore accounts pay no immediate taxes on their annual performance fees. Instead, they leave the money offshore in the fund as a form of deferred compensation that allows them to compound their returns for years tax-free. The result: huge personal fortunes for some managers.
