Guilt by association? Rise in interest rates and credit delinquencies

Basis Capital Suffered Subprime Losses in February (Update1)
By Laura Cochrane

July 19 (Bloomberg) -- Basis Capital Fund Management Ltd., an Australian hedge fund caught up in the rout in U.S. subprime mortgages, suffered losses as early as February.

In a letter sent to investors July 6, Basis Capital said its investments in collateralized debt obligations, or CDOs, had been tarnished by ``guilt by association.'' Less than a week later, the Sydney-based hedge fund, which had assets of $1 billion in May, said its two funds lost 9 percent and 14 percent last month. Withdrawals from the funds have been frozen and some margin calls have been missed, research firm Zenith Investment Partners Ltd. said in an e-mailed note today.

Basis Capital is the first Australian hedge fund to report losses from the shakeout in the U.S. subprime market. Most of the pain may be borne by individuals, who are allowed to invest in Australian hedge funds, unlike in the U.S. where the largely unregulated pools of capital are off limits to retail investors.

``There will be a flow on in the marketplace surrounding the problems experienced by Basis and its investors, but it's too early to say exactly how that will pan out,'' said Bill Entwistle, chief investment officer at Absolute Capital in Sydney, who invests in the rated portions of CDOs.

Most of investors would have been attracted by Basis Capital's high ratings and returns, he said.

The Aust-Rim Opportunity Fund returned almost 12 percent on average the past five years and the Yield Alpha Fund averaged a 15.5 percent return, according to reports by Zenith Investment Partners available on Basis Capital's Web site earlier today.

Both funds had five-star ratings from Standard & Poor's. The ratings were suspended yesterday.

June Losses
The Yield Fund lost 14 percent in June, and the its Aust-Rim Opportunity Fund declined 9 percent, Basis Capital said July 12.

Some of Basis Capital's lenders are seeking to sell the fund's assets, Zenith said, citing a disclosure notice from the hedge fund. A sale at ``distressed'' prices could cut the net asset value of units in the Yield Fund to below 50 percent of the level as at May 31, the notice said.
``This latest information is obviously very concerning,'' Melbourne-based Zenith, which rates investment funds, said today. ``This could lead to significant losses to investors in the Yield Fund, which in turn will also adversely affect the Aust-Rim Fund.''

Delinquencies on U.S. subprime mortgages -- home loans to people with poor or meager credit -- surged to a 10-year high this year on rising borrowing costs. CDOs based on these loans have plunged in value and caused loses at hedge funds worldwide. Sales of CDOs rose fivefold to $503 billion last year compared with 2003.

`Fund of the Year'
Bear Stearns Cos., the fifth-largest U.S. securities firm, yesterday told investors in its two failed hedge funds they'll get little if any money back after ``unprecedented declines'' in the value of securities used to bet on subprime mortgages.

Basis Capital, founded by Steve Howell and Stuart Fowler in 1999, invests in the most risky portion of CDOs, the so-called equity tranche, which is first in line for any losses as borrowers fall short on mortgage payments. Investors in the equity portion aim to generate returns of more than 10 percent.

Howell, a former director of Asia-Pacific trading at American Express Bank in Singapore, and Fowler, a former Salomon Smith Barney trader, worked together at County NatWest. Basis Capital was named `Fund of the Year' at the 2005 AsiaHedge awards and Macquarie Bank Ltd.'s Skilled Manager of the Year in 2004.

Basis Capital is in talks with creditors after banks seized and began to sell off its investments, the Financial Times reported today.
Calls to Basis Capital's office today were referred to the marketing department, which didn't immediately return messages.

Hedge Fund Regulation
In Australia, all hedge funds have to be licensed by the Australian Securities and Investments Commission, allowing them to sell to retail investors. Australian investors, mostly individuals, have A$675 million invested in the two funds, the Financial Review said today.

To sell to retail investors in the U.S., a hedge fund would have to register with the Securities and Exchange Commission, a move most shun to avoid scrutiny.

A spokeswoman for the Australian securities regulator declined to say whether it was investigating Basis Capital.