Hedge Fund Investment Due Diligence – Sample Report From Consultant

Investment Due Diligence Report

Halcyon Asset Management, LLC
Master Custodial Account
Report written by the A Consultant Hedge Fund Research Team

March 27, 2015

Executive Summary
This review has been requested by The Client. The scope of this review and the rating is limited to the general investment capabilities of Halcyon Asset management, LLC (the “Firm” or “Halcyon”) within the strategies listed in the second table below, as well as the anticipated merits of its new European product. It does not extend to an operational due diligence of the Firm.

Halcyon is an investment management firm based in New York. The Firm manages approximately $11 billion across various strategies and products including event-driven multi-strategy, structured credit, liquid loans, collateralized debt obligations, and energy. It is now in the process of launching a new product – Halcyon European Credit Opportunities Fund (the “Fund”), which will invest in distressed and special situations opportunities in Western Europe. This Fund is expected to launch on May 1, 2015 with approximately $100 million.

The Client has negotiated a Master Custodial Account (MCA) agreement with Halcyon that allows The Client to invest up to $125 million in various Halcyon products. The Client may also invest in direct co-investment opportunities that may be offered by Halcyon. The MCA excludes investments in Halcyon’s structured credit (ABS) product. As laid out in its investment plan, policy and guidelines, the MCA enables The Client to initially invest $50 million in the newly launched Halcyon European Credit Opportunities Fund. This investment will be limited to 50% of the total account on a fully built-out basis. In addition, the MCA limits investments to a maximum of 25% to any individual fund and to a maximum of 10% to any individual direct investment opportunity. Exceptions to these limits may be allowed pursuant to a written permission from The Client.

A Consultant research recognizes that the MCA mandate is intended to be flexible and opportunistic. It will allow The Client to invest tactically across a range of Halcyon funds and direct co-investments. While A Consultant cannot vet each future allocation that may be made under this mandate, it anticipates that The Client’s staff will review each investment, independently on its own merit, as well as in the context of the The Client’s portfolio at the time of making such investment.

The Fund has been rated Neutral by A Consultant’s Alternative Assets Committee

Experience: The senior investment members at Halcyon have an aggregate of +60 years of investment experience. The team has invested together over multiple market cycles, thereby providing significant continuity in their investment process. In addition, the industry networks developed over two decades has allowed the Firm to build strong sourcing capabilities, both in the primary as well as in the secondary market.
Investment breadth: The Firm has evolved since 1981, when it traded only merger arbitrage strategies, to date where it manages a fleet of products and strategies. Over time, as new market opportunities evolved, the Firm has hired specialized investment professionals and launched dedicated products to invest in those
Ability to attract talent: Halcyon is able to attract investment talent due to its strong financial situation as well as deep industry contacts. Mr. Damien Miller, who joined Halcyon in 2014, has +12 years of investment experience in distressed debt and special situations in European markets. He was previously the Global Head of Special Situations at Alcentra Ltd and was responsible for investment and portfolio management of the Alcentra Special Situations Fund. This product invested in European distressed debt, high yield, and equity special situations strategies.
 • Key man risk: Mr. Miller will be primarily responsible for all day-to-day investment decisions for the Halcyon European Credit Opportunity Fund. However, the Fund’s legal documents do not identify Mr. Miller as a ‘Key Person’. In addition, Mr. Miller is not an equity partner at the Firm and a retention agreement has not been executed as of this date. The Fund’s liquidity terms include an initial one year hard lock, which may prove to be onerous if Mr. Miller were to depart Halcyon for any reason during that period.
Certain clients of A Consultant have negotiated a side-letter to include Mr. Miller in the Key Man clause.
Lack of dedicated analysts for European coverage: The research team dedicated to the Fund consists of three portfolio managers – Mr. Miller (UK), Mr. Greene (NYC/PM-Multi-strategy fund), and Mr. Dillow (NYC/ PM-Multi-strategy fund). While in general, the research, trading, and risk management functions at Halcyon are centralized and shared, given this Fund’s unique geographic focus, a team of analysts dedicated to it would be ideal. To date, the Firm has not hired any analyst dedicated to this product.
The Firm plans to hire an analyst in Europe to work with Mr. Miller once the Fund is launched. No definite hire has been made as of the date of this report.
New launch: The European Credit Opportunities Fund is expected to be launched on May 1, 2015 with $100 million from four to five investors in the founding share class. The product, therefore, does not have an established track record or deep asset base as of the date of this report.
Track record for Mr. Miller: Due to the contentious circumstances under which Mr. Miller departed Alcentra, he has not been granted the requisite permissions to reference his track record from the Alcentra Special Situations Product (ASSF). Halcyon is therefore unable to (officially) offer any historical performance metrics for Mr. Miller. However, it should be noted that The Client was an investor with Mr. Miller at Alcentra.
Risk management: Mr. John Bader, Chairman and Chief Executive Officer of Halcyon Asset Management, LLC is also the Head of the Risk Committee. An investment professional, who is a key decision maker and stands to benefit directly from a product’s performance, is not considered to be an ideal candidate to head a risk committee. In addition, the risk management function for the European fund is expected to be controlled from New York. The standard preference is to have risk management on-site at the investment decision making process.
Multi-Strategy’s investment in the European Credit Fund: The multi-strategy fund is expected to invest in the European Credit Opportunities Fund. By virtue of its access to the Halcyon’s investment committee, and the overlap of portfolio managers, the multi-strategy fund is expected to have full transparency into the European Credit Opportunity Fund’s portfolio and the investment decision making process. This provides the multi-strategy fund with an advantage over the other investors in the European Fund. The multi-strategy fund, however, does not have any preferential liquidity terms. x



In 1981, Alan B. Slifka started to manage capital for some US high net worth individuals. This was the genesis of Halcyon Asset Management LLC (“Halcyon”). Mr. Slifka was a well-known investor and the founding chairman of the Big Apple Circus. He passed away in 2011.

From 1981-1991, Mr. Slifka managed assets by mostly investing in merger arbitrage strategies. Later, in 1991, he hired Mr. John Bader (current Chairman and CIO) as a senior portfolio manager to expand the investment mandate to other strategies like corporate distressed debt and special situations. In 1996, Halcyon Offshore Asset Management, LLC was officially launched and the investor base was expanded to non-US and offshore institutional investors.

Since then, the Firm has progressively expanded its businesses and global footprint. It currently manages approximately $11 billion in assets across a wide array of products and strategies. The Firm has 14 partners and 125 employees, 50 of whom are investment professionals. Halcyon is headquartered in New York City and has satellite offices in Houston and London. The Firm is registered with the SEC in the US and with the FCA in the UK. 


Firm Ownership

Currently, 80% of the Firm is owned primarily by 14 active partners, none of whom own a majority ownership stake. The remaining 20% is owned by Dyal Capital, an affiliate of Neuberger Berman. This is a passive interest which does not carry any voting rights or investment authority.


 Halcyon table
In addition, there were two partners who retired in 2014 – Mr. Joey Genachowski
(Research) and Mr. Larry Davidoff (Research).
Investment Products
Since its inception in 1981, Halcyon has evolved from being a simple entity that invested in merger arbitrage trades to one that now invests in a diverse range of strategies. As the market opportunities changed, the Firm expanded its scope of investments, teams, and businesses. It now operates via multiple Halcyon Affiliates that trade varied investment strategies. As of February 2015, Halcyon and its affiliates in aggregate managed approximately $11 billion as follows:
Halcyon table 2
The Halcyon European Credit Fund is the latest addition to the Halcyon suite of products. Halcyon anticipates this product to be launched on May 1st 2015 with approximately $100 million in the founding share class. The investor base in this share class is anticipated to be as follows:
Pension 1: $50 million
Pension 2: $20 million
Endowment: $10 million
Foundation: $ 10 million
Halcyon Multi-strategy Fund: $10-$15 million
Halcyon GP (Partners): ~$10 million
Portfolio Management Team
Across all its affiliates, Halcyon has approximately 50 investment professionals. In general, each strategy/product is led by one or more portfolio managers. However, other resources and functions like the research analysts, trading, and risk management are centralized and shared. The overall organization is as follows:
Halcyon table 3
Halcyon European Credit Opportunities Fund:
The European Credit Opportunities Fund (the “Fund”) is expected to be managed by three portfolio managers: Mr. Miller, Mr. Dillow, and Mr. Greene. Mr. Milller officially joined Halcyon in December 2014. He previously worked at Alcentra Ltd, where he was responsible for managing the European Special Situations Fund. The Fund expects to hire a dedicated analyst during the year; however, for the time being Mr. Miller is expected to utilize the analyst and trading teams based in New York. The Fund is expected to be registered in the UK and Mr. Miller is anticipated to be responsible for the day-to-day management of the Fund’s portfolio.
Investment Strategy
Halcyon European Credit Opportunities Fund:
As mentioned earlier, the Halcyon European Credit Opportunities Fund (the “Fund”) is anticipated to be launched on May1st 2015. This Fund will primarily invest in following areas in Western Europe:
1. Stressed and distressed corporate assets
2. Event-driven situations like merger arbitrage, spin-offs, litigations, etc.
3. Liquidations
On the credit side, the Fund is expected to invest primarily through senior debt. While the portfolio is expected to be mostly long biased, the Fund will seek to hedge certain types of market risks. Investments are expected to be mostly in small-mid capitalization companies. The Fund will seek to impose a 20% position limit and a 30% industry limit.
Research Process
All affiliates at Halcyon share a common research and trading platform. On a broad level, the research and investment process at Halcyon consist of following steps:
1. Idea Generation: The research analysts are responsible for conducting an extensive screening process to identify the right investment opportunity. This includes a comprehensive analysis of the investment universe and monitoring news feeds like newspapers, magazines, court filings, SEC offers, industry publications, etc. The analysts also explore their network of resources like lawyers, bankers, buy and sell side analysts, etc. to access information and conduct reference checks regarding the idea. Each analyst works in conjunction with a senior investment professional or a portfolio manager. In most instances, the portfolio managers are responsible for providing the top-down guidelines and for directing the analyst’s research process.
2. Analysis: Each idea that is identified is expected to undergo a rigorous analysis that includes:
a. Fundamental analysis: Reviewing the fundamentals of the company operating margins, gross/net revenues, trends, debt capacity, current/historical leverage, cash flows, liquidation analysis, etc. The team also analyzes these metrics under various types of stress scenarios.
b. Restructuring and Pro-Forma Analysis: This involves a thorough analysis of the potential restructuring options and its impact on improving fundamentals. This review also considers the possibilities of various legal outcomes and the creditors’ rights under those various options. Furthermore, the analysis also considers various implementations and instruments – conversion rights, debt vs. equity, maturity and call features, etc.
c. Strategic analysis: Under this review the analysts are responsible for conducting a market analysis of other strategic investors, key players and their motivations, investor/shareholder base, identifying large investors and their alignments, reviewing existing management goals and incentives, board compositions, other bidders –synergies/dilutions/regulatory concerns, etc.
d. Cost-benefit analysis: Analysts estimate the feasibility of restructuring options, the associated costs,  tax/regulatory impacts, disclosure issues, downside risk, concentration and refinancing risks, potential for frauds, etc. All these costs and risks are put in perspective of the potential for expected minimum/maximum upside under various probability weighted (outcome) scenarios.
3. Investment decision: Each position is thoroughly researched by mini research teams, typically led by one or more senior analysts, and then discussed with the portfolio managers. If the idea is worth an investment, then the portfolio manager discusses it with the investment committee and the trade is implemented based on its merit as well as on the portfolio investment mandate. There are a select number of investment committee members that can authorize a trade.
4. On-going monitoring and Research: Halcyon’s Investment Committee (IC) meets every morning to review big positions within the portfolio. The IC considers the existing positions in light of – current trading levels, any recent developments or news, changing risk-reward dynamics, other compelling ideas, etc. This analysis is dynamically updated by Halcyon’s trading desk. The portfolio managers review this analysis on a regular basis and adjust position sizes based on their assessment of each position’s absolute downside risk and the relative probability and attractiveness of the expected outcome.
All the partners and investment committee members are incentivized based on the overall fund performance rather than the performance of a particular strategy. The analyst receives a discretionary bonus which is directly linked to their individual contribution. Halcyon feels that such a structure motivates the analysts to identify and research the best ideas while at the same time keeping the management team (risk allocators) aligned with overall fund
The research team for the Halcyon European Fund is expected follow a similar research process. Halcyon anticipates adding more analysts to the research team in London during 2015.
Portfolio Construction Process
The Investment Committee (IC) meets daily to review the portfolio and decide on the necessary adjustments. All the IC recommendations are conveyed to the portfolio manager, who is then responsible for implementing the recommendations, including: adjusting position size, industry exposure, commodity risk, systemic risks, and other such factors. The Fund’s portfolio construction process is expected to follow strict risk and concentration guidelines, including:
1. Not more than 3% at cost in a single position
2. Top five positions constitute a maximum of 30-45%
3. Using a bottom-up approach to identify equity or debt positions and use a top-down approach to create a hedge (if possible)
4. The Multi-strategy Fund leverage is capped at 300% gross; historically, the long side has maxed at 150% and the short book has varied from 10-100%. The Fund has never been net short.
Halcyon European Credit Opportunities Fund:
Mr. Miller is expected to be primarily responsible for day-to-day portfolio construction aspects. Mr. Miller is expected to be supported by Mr. Jason Dillow and Mr. John Greene.
Halcyon expects the portfolio to be constructed as follows:
1. Typical exposure ranges: Gross long:75-125%; short: 60-85%
2. Typical instruments used:
a. Bank debt: 0-100%
b. Senior Bonds: 20-100%
c. Re-org and other equities: <50%
3. Typically 25-50 positions, top 10 to be 35-60% of the portfolio
4. Maximum position size of 20%
Risk Management
The Risk Management Committee at Halcyon is composed of Managing Principals responsible for investment management of the funds and managed accounts. John M. Bader, Chief Executive Officer, is Chairman of the Risk Committee. In addition, the risk committee consists of Mr. Manish Garg (Principal), Mr. Avinash Kriplani (Vice-President), Mr. Grant Sweitzer (Analyst), and Mr. Timothy Bubnack (Junior Analyst).
The risk committee holds weekly meetings at which it reviews and adjusts limits to position size, industry exposure, commodity risk, systemic risks, and other concentrations. The committee considers the strategy mix and the biggest risks among the holdings, taking into account, among other things, macroeconomic conditions, the regulatory framework, the political climate, and the potential for companies and/or specific industries to implode. The
risk committee routinely performs stress analyses. In addition to monitoring the individual fund portfolio risk, the risk committee also analyzes the cross-risk across different products and the Firm.
The Halcyon European Credit Opportunities Fund is expected to follow a similar process for risk management and will be overseen by the Risk Committee based in New York. At the portfolio level, Mr. Miller anticipates the portfolio to be hedged using overlays to control the overall credit exposure, equity exposure, macro factors, and volatility to a certain extent. The portfolio may invest in relative value and capital structure arbitrage strategies to limit
individual position risk. However, distressed investments tend to be directional (long) by nature.
Halcyon table 4
Damien Miller: Portfolio Manager
Mr. Miller joined Halcyon in December 2014. He was previously Managing Director and Global Head of Special Situations at Alcentra where he built the firm’s distressed and opportunistic credit investment business and acted as Portfolio Manager having started there in June 2007. Prior to Alcentra, he was a Director and Portfolio Manager for the Special Situations Group at Barclays Capital in New York starting in 2002. Before this, he was a senior analyst at Barclays Capital in London. Mr. Miller graduated with a B.A. in European Business from Manchester Metropolitan University in 1997.
Jason Dillow, Managing Principal
Mr. Dillow joined Halcyon in January 2005. Prior to joining Halcyon, Mr. Dillow, who had worked at Goldman Sachs since 2001, was responsible for investments in the energy, power, industrial, and financial industries in the Special Situations Investing Group, a multi-billion dollar proprietary investing area within Goldman Sachs’ Fixed Income, Currency and Commodities Division. Mr. Dillow received his A.B. with Honors from Princeton University in
John Greene, Managing Principal
Mr. Greene joined Halcyon in March 2002. During his tenure at Halcyon, Mr. Greene has focused primarily on distressed asset investing. Prior to joining Halcyon, Mr. Greene was a distressed securities analyst for J.P. Morgan Chase, where he began his career in 1999 and where he published research on distressed and high yield securities, made proprietary trading recommendations, and worked with J.P. Morgan Chase’s London-based European
High Yield Research team. Mr. Greene received his B.A. from Franklin & Marshall College in 1999.
John M. Bader, Chairman and Chief Investment Officer
Mr. Bader has been portfolio manager for Halcyon’s multi-strategy funds since 1991, after serving as Director of Research at Gruss & Co. Mr. Bader has been a frequent speaker at educational and industry forums on investing, including ones sponsored by NMS Management, Institutional Investor, The Borsa Italiana (Italian Stock Exchange), the World Presidents’ Organization, and Skybridge Capital (SALT). He has participated in the Barron’s Roundtable, and has been featured in the Financial Times, Pensions & Investments, and Bloomberg, among other publications. He has appeared on CNBC and Bloomberg TV. Mr. Bader is a member of the Board of Advisors for the Harvard Law School Forum on Corporate Governance and Financial Regulation, has served as a member of the Research Council of The Greenwich Roundtable, and has lectured at Columbia Business School. A recipient of numerous academic prizes, Mr. Bader received his A.B. from Harvard University, Class of 1984.
Kevah Konner, Vice Chairman
Mr. Konner joined Halcyon Asset Management LLC in 1996. As Vice Chairman and Managing Principal of Halcyon, he shares primary portfolio management responsibilities for Halcyon’s multi-strategy hedge funds, which invest across credit, merger and special situations. Additionally, Mr. Konner serves as a member of Halcyon’s Pricing Review Committee and the Risk Management Committees for Halcyon and affiliated investment managers. Prior to
joining Halcyon from 1992 to 1995, Mr. Konner was Co-head of the proprietary Risk Arbitrage Department for Smith New Court Inc. From 1985 to 1992, Mr. Konner was a senior analyst specializing in event driven situations for two proprietary trading operations: Gruss & Co. (1987 to 1992) and Ladenburg Thalmann & Company (1985 to 1987). Mr. Konner’s professional career started in 1983 at Asiel & Company, where he traded for clients and for the firm’s account in Merger and Convertible Arbitrage and other situations. Mr. Konner received a M.B.A. from the Leonard N. Stern School of Business, New York University in 1989, and a B.S. from the Wharton School of Finance and Commerce, University of Pennsylvania in 1983.
Disclaimers and Disclosures
• Past performance is no guarantee of future results.
• The opinions presented herein represent the good faith views of A Consultant as of the date of this report and are subject to change at any time.
• Information on market indices was provided by sources external to A Consultant, and other data used to prepare this report was obtained directly from the investment manager(s). While A Consultant has exercised reasonable professional care in preparing this report, we cannot guarantee the accuracy of all source information contained within.
• This report may contain confidential or proprietary information and may not be copied or redistributed.
In addition, it is important that investors understand the following characteristics of non-traditional investment strategies including hedge funds, real estate and private equity:
1. Performance can be volatile and investors could lose all or a substantial portion of their investment
2. Leverage and other speculative practices may increase the risk of loss
3. Past performance may be revised due to the revaluation of investments
4. These investments can be illiquid, and investors may be subject to lock-ups or lengthy redemption terms
5. A secondary market may not be available for all funds, and any sales that occur may take place at a discount to value
6. These funds are not subject to the same regulatory requirements as registered investment vehicles
7. Managers may not be required to provide periodic pricing or valuation information to investors
8. These funds may have complex tax structures and delays in distributing important tax information
9. These funds often charge high fees
10. Investment agreements often give the manager authority to trade in securities, markets or currencies that are not within the manager’s realm of expertise or contemplated investment strategy


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