“It might be one of the greatest financial performances of 2010—a fortune created even after losing staggering sums for investors. Meet the managers of Tetragon Financial Group. They are five Wall Street veterans who, by luck and design, enjoy what Tetragon investor Charles W. Griege Jr. critiqued as "the most flawed compensation system" he had ever seen. Tetragon is awarding its managers tens, and potentially hundreds, of millions of dollars. This comes despite massive losses in the fund, an offshoot of London-based hedge fund Polygon Investment Partners LLP, which decorated its Park Avenue offices with embossed wallpaper featuring its name. Such boom-era flourishes were common when Tetragon was launched at the market top in spring 2007. Publicly listed in Amsterdam, the closed-end fund quickly amassed a $1.5 billion portfolio, largely in bank loans made for the era's large leveraged buyouts. The timing was bad. The portfolio fell by about two-thirds in value during the dark days of 2009. Its shares suffered, and today are off 61% from their listing price. But now the value of Tetragon's corporate-debt holdings are on the rise again. And Tetragon is pocketing one-quarter of the "gains" it registers each quarter, though it is really just earning back the $767 million in losses recognized over the past year, according to securities filings. A person close to Tetragon said that the fund "weathered an unprecedented time very well," and that its recent share performance—up about 125% over the past year—"is a testament to what they've managed to do." Most fund investors are wary of paying fees for earning back losses. The Game's Dennis Berman and Mean Street columnist Evan Newmark discuss Tetragon Financial Group, which makes money by losing money. That is why they demand "high-water marks," which force managers to post new earnings before the incentive fees kick in. They also have what is known as a "hurdle rate," a baseline quarterly return that the manager must meet before paying those fees. But like Polygon's embossed wallpaper, Tetragon remains ensconced in the boom time. Under the fund's original offering document, the high-water mark is reset every 180 days. And the hurdle rate, originally envisioned at 8%, is based on today's historically low interest rates, which means it has fallen to about 3%. What is more, the fund bases its valuations on a "mark-to-model" calculated on its own. That gives it more discretion than funds that value their assets based on public market prices. It all translates to some big paydays. Tetragon wrote up the value of its holdings by $87.8 million in the fourth quarter. After meeting that meager hurdle rate, its managers are entitled to a 25% incentive fee. That was worth about $22 million last quarter. The person close to Tetragon said the fee structure was disclosed from the beginning "and that's what everyone bought into. If anyone buys in at a later date and didn't read the paperwork, they're crying wolf." Even bigger payouts are likely to come in 2010, based on calculations of two Dallas-based money managers. Mr. Griege of Blue Lion Capital and Scott Johnson of Stream Capital Management estimate the Tetragon portfolio will be written up by about 44% during 2010. That would spit out another $76 million in fees, bringing the total to roughly $100 million and counting. Contrast that to the approach of similar public funds, including KKR Financial Holdings LLC, which deferred fees during 2009 and added new capital. Some of the world's biggest private hedge funds, such as Pershing Square Capital Management, have actually raised high-water marks and relaxed fees to soothe investors. Mr. Johnson noted that Tetragon didn't make any new investments during 2008 or 2009, a period now shown to have been one of the greatest bull markets for corporate debt. "Shareholders are writing a check for doing nothing," he said in an interview. "There is no downside risk, only upside. This is exactly the incentive structure that got Wall Street in so many problems." Write to Dennis K. Berman at dennis.berman@wsj.com Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com More In Deals Email Printer Friendly Order Reprints Share: facebook Twitter Digg StumbleUpon Viadeo Orkut Yahoo! Buzz Fark Reddit LinkedIn del.icio.us MySpace ”
