Cash Flow Issues at AlphaMetrix Highlight Counterparty Risks

AlphaMetrix, a private investment platform and commodity pool operator (CPO), has run into “significant cash flow issues” and has fired chief financial officer George Brown as a result, the company said in a letter to investors.

The letter, written by AlphaMetrix president and chief executive officer Aleks Kins, states that the CPO’s assets largely consist of a receivable owed to the parent company, AlphaMetrix Group, and with these cash issues, the CPO and parent company’s liabilities “greatly exceed their liquid assets.” The company has hired accounting firm Arthur Bell to help address these financial problems.

While the company tries to maintain the solvency of the CPO, an immediate consequence of the has been a delay in fee rebates to third party money managers and participants, which were not reinvested into various pools as they should have been, thus affecting the net asset value of the pools.

The issues with AlphaMetrix highlight the counterparty risks that hedge fund investors face when custody is paired with investment management, as is the case with the CPO and most commingled hedge fund structures.

“What’s remarkable about hedge fund investors is how many have not given significant consideration to their counterparties and related exposure,” says Ken Phillips, chief executive officer of HedgeMark, a hedge fund risk solutions and managed accounts provider affiliated with BNY Mellon. Whereas most areas of institutional investing place an emphasis on custody, “when we go to the hedge fund space, the custodial issues are largely ignored,” says Phillips. Instead, he adds, investors make decisions based on the manager they like and often forget to drill down to the operational issues.

In order to ensure assets remain safe, Phillips believes that scale matters. “These little boutique companies, as attractive as they may be, can be gone in a flash,” he says.

The issue does not lie with using a boutique investment manager in and of itself, but rather the problem comes with the commingling of the custody and management process. “Clearly this is the elephant in the room,” says Phillips. This problem came into the forefront following the Madoff scandal, and the AlphaMetrix situation, while not having any indication of malafeasance, once again shows the importance of choosing a sound counterparty.

The effects of AlphaMetrix’s cash flow issues are still in the very early stages, but it has already caused CME Group and National Futures Association (NFA) to wind down their relationship with AlphaMetrix early. These futures organizations have been using AlphaMetrix’s subsidiary, AlphaMetrix360, to provide data aggregation services to check daily balances from futures brokers, but starting October 29, they will no longer use AlphaMetrix. CME and NFA planned all along to bring these services in-house once they had the capabilities in place. Now, however, “we’ve accelerated the process due to recent events,” says NFA spokesperson Karen Wuertz.

Wuertz added that there should always be a contingency plan in place in case a vendor stops performing.