Winhall Risk Analytics
Brett Friedman July 2021
Infinity Q: Four Months Later, New Questions
Yes, I know: Infinity Q blew up last February and now it’s June. So why bring it up again? Because something new came out in June that suggests there might be more to this, something that should send any fund investor running to take a good look at their operating agreements. And it’s rare to find misfeasance, malfeasance, and nonfeasance (the feasance hat trick!) all in one place, but Infinity Q seems to have managed it.
By now, the tale is well-known: Infinity Q Diversified Management was a $1.8 billion liquid alts mutual fund run by James Velissaris. Vellissaris originally worked as a PM at Wildcat Capital Management, a family office that manages money for David Bonderman (TPG) and others. Wildcat was a founding investor in Infinity Q. The fund marketed itself as “a hedge fund for the masses” and touted its returns as uncorrelated, low beta, and high Sharpe. So far, so good.
After posting impressive gains and attracting new AUM, especially during the March 2020 Covid related downturn, they announced at the end of 2020 that they were no longer accepting new investments. Then, last February, the SEC announced that it had approved the fund’s request to suspend redemptions due to valuation concerns, alleging that Vellissaris had altered the inputs to the third-party valuation models for variance swaps and other OTC positions. In other words, he overvalued the book. An update was issued at the end of March indicating that the fund had been liquidated and the NAV had decreased from $1.7 billion to $1.2 billion, a $500 mm hit. How much of that was due to wholesale liquidation or adverse market moves is unknown. The fund warned that the February 18th NAV, as well as earlier periods, might be subsequently reduced due to revaluation.
Essentially, the standard tale of model manipulation in an effort to goose returns and attract AUM. But it might not be that simple!
New Developments. On June 7th, the fund filed a Plan of Distribution of Assets with the SEC. In other words, how they plan to give everyone’s money back (or not). Like all such legal documents, it’s heavy sledding but contains some great stuff if you stick with it:
First, the fund was liquidated as of March 19 and is keeping $750 million out of a total of $1,249,485,022 in cash as a “Special Reserve” for “potential liabilities.” The amount was estimated taking into account “potential debts, obligations, and liabilities.” These include: 1) expenses related to litigation (legal and expert fees incurred in defense of the fund), 2) indemnification and legal fees for trustees, officers, and the fund distributor, and 3) plaintiffs’ attorneys fees.
With a $750 mm reserve, they must be expecting a lot of liabilities! Still, after all is said and done and everyone is done feeding at the trough, I suspect investors will be footing the bills and won’t get much.
Second, there is one very interesting paragraph related to the reserve that is worth pointing out and probably escaped the notice of all but the most diligent readers. As is usual, “The Trust maintains insurance that covers its trustees and officers with respect to various losses, including legal fees and other expenses resulting from litigation…” It goes on to state that “certain of the expenses…are not covered by any available insurance.” Adding to that “…available insurance may not be sufficient to satisfy claims that are covered.” The paragraph concludes, “Accordingly, the Fund must reserve assets to fund these expenses and liabilities.”
So, does that mean that in order to “satisfy” claims against the very people that didn’t notice that the fund was misvalued, funds will be taken out of the reserve, reducing the amount left over for the investors? And that’s because the Fund or the Trust or whomever didn’t buy enough insurance or possibly did some stuff so egregious that insurance couldn’t even cover it? If true, then this is truly a "WE LIVE IN A SOCIETY!" moment.
This brings up an interesting point that investors should take notice of. If insurance does not cover, or cannot cover, various events or actions undertaken by indemnified parties, then ultimately it may come out of the investors’ pocket. The amount could easily wipe out whatever was invested. Provisions regarding insurance in case of legal action, indemnification, or liquidation should be examined carefully and the risk assessed before investing in any fund.
Questions still remain four months later:
1. Where were the auditors, the fund administrator, trustees and officers, and fund consultants while all this was going on?
Despite the apparent misvaluation of the portfolio, IQ’s service providers never caught on to the scheme. The fund administrator (US Bancorp Fund Services), auditors (EisnerAmper LLP and their former Philadelphia-based auditor, BBD, LLP), distributor (Quasar Distributors)’ and for that matter, its six trustees and three officers all missed it and apparently just accepted whatever the fund represented. Auditor statements certifying "the risks of material misstatement of the financial statements, whether due to error or fraud” were provided as recently as end-October 2020. The auditors weren’t alone -- Morningstar rated the fund 4 stars for its (fictitious) return, not to mention all the fund consultants that probably recommended it. Of course, the lawyers will have a great time with all this: as the liquidator put it, “Infinity Q is also analyzing potential legal claims against its service providers.” I’m sure the fund’s investors are as well, and rightly so.
A special note on the curious composition of the trustees and officers is in order. Coincidentally, all were from Milwaukee (Quasar’s hometown) and five were employees of US Bancorp, which was also the fund administrator and the past owner of Quasar. In this case, you might have good reason not to believe in coincidences.
Some parties have suggested that it would be unreasonable to hold third parties and directors accountable in cases of deception or fraud. In response, allow me to pose a simple question: if their responsibilities (for which they were compensated handsomely), did not include something as basic as ensuring the accuracy of the NAV and thereby the value of the fund itself, then what was their function? Granted, sometimes deception is subtle or hard to detect but that’s why you have third parties, trustees, and directors in the first place. It is not unreasonable to expect people to do their job. Bluntly, to think otherwise defies common sense and only someone with a vested interest could possibly believe otherwise.
2. How far back did the misvaluation go? If longer than just a few months, it could have serious, and surprising, ramifications.
The fund was founded in 2014 but only started attracting significant AUM in 2019; it had record inflows in March 2020. It is reasonable to assume that the model assumptions and resulting valuations have been altered for some time, and not just over the several months before the fund’s demise. If that is indeed true, then the returns since inception may be called into question and any previous distributions or redemptions could be inaccurate. The ramifications of this are far-reaching. Namely, how should investors who previously sold or redeemed while the fund was still open, and at possible incorrect valuations, be treated? And where did that money come from, exactly, since you can’t pay out money you don’t have! Granted, this is perhaps far-fetched, but it should be at least considered.
Regardless of the answers, everyone involved with Infinity Q is now suffering the classic dilemma: if they didn’t know what was going on, they should have; and if they did know, that’s even worse!