Stillwater Capital Partners manages three hedge funds that posted double-digit returns in 2006 through diversified strategies including asset-backed lending, fund of funds, and multi-strategy funds. The asset-backed lending fund makes short-term bridge loans to real estate developers, law firms, and individuals for insurance premiums, earning steady returns through low volatility and correlation to equity and bond markets. Stillwater also manages a fund of funds that seeks out niche and creative asset-backed managers around the world. While conducting extensive due diligence, they avoid managers that demonstrate greed through opaque fee structures or misrepresenting fund capacity.

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If having a diversified portfolio
and product line are the ingre-
dients for a successful hedge fund,
then New York-based Stillwater
Capital Partners is cooking.
Stillwater sports an asset-backed
lendinghedgefund,anasset-backed
fund of funds, and a multi-strategy
fund of funds. All three vehicles
posted double-digit returns last
year, 11.10%, 11.81% and 15.02%
respectively (net of fees), with low
volatility. The firm also manages a
private equity real estate fund.
Managing director Jonathan
Kanterman attributes the funds’
steady returns to low correlation
to the equity and/or fixed income
markets. “A lot of hedge funds say
they’re uncorrelated to the market,
but I think we’re one of the few
who truly are market-neutral, in
the sense that we don’t invest in the
stock or bond markets,” he says.
Bridging The Opportunities
The Stillwater Asset Backed
Fund is a bridge-lending fund that
makes short-term bridge loans in
real estate, law firms and insur-
ance. The fund is fully collateral-
ized, and will not kick in more than
70% loan-to-value. So, if a real
estate developer wants to borrow
money for a property that Still-
water appraises for $10 million,
then it would lend the developer no
more than $7 million.
The typical borrower is not sub-
prime, nor one with bad credit,
according to Kanterman, but a
developer who finds himself in
a time crunch, with perhaps only
two weeks to close on a property.
“We’re faster than the bank and
will send two or three people out
on a Sunday to the property to start
the underwriting and the appraisal,”
says Kanterman.
That is not to say that Still-
water is competing with traditional
lenders on deals. Banks often refer
business to the firm, knowing it can
close more quickly and bridge the
loan until they can finish their due
diligence, according to Kanterman,
and six months later the firm is out
of the picture. “Over 80% of the
time we’re getting taken out by tra-
ditional financing,” he says.
Other sources of deal flow for
the fund include leads from lending
trade publications, mortgage bro-
kers and Stillwater’s own in-house
underwriters. The firm closes on
about four deals each month from
the roughly 100 that appears on its
radar, Kanterman says.
To mitigate property risk, Kan-
terman adds that the firm ensures
the owner has title insurance along
with “every other type of insur-
ance,” including for floods and hur-
ricanes, depending on the region.
Also, in valuing a property, the firm
always gets two appraisals: one
from an independent appraiser and
one from his underwriting team.
Chasing Lawyers
The fund also lends money to per-
sonal injury law firms that are con-
tingency fee-based and need a line
of credit to keep operations running
in between settlements. Stillwater’s
IN DEPTH: ASSET-BACKED LENDING AND HEDGE FUNDS
By Hung Tran
Stillwater Sees Sizzling Deal Flow With Hot Strategies
Stillwater’s Jonathan Kanterman

2. credit is secured by every case that
the firm has, as well as personal
guaranties from the firm’s partners.
“If the law firm is looking at $30
million in gross settlements over
the next year, that represents about
$10 million in fees for the firm.
We’ll lend about $2 million in a
line of credit. Historically, most
firms don’t fully draw down on the
credit line and usually utilize about
50% of it,” says Kanterman.
Thepossibilityoffraudisreduced
because firms are only borrowing
about 20% of their next 12 month’s
revenue, according to Kanterman,
who is further comforted by the
fact that firms run the risk of being
disbarred or losing their license in
the event of a fraud, a deterrent if
ever there was one.
In addition, the fund is engaged
in insurance premium financing,
where it lends capital to high net-
worth individuals who are taking
out life insurance policies. Kan-
terman says the firm utilizes three
estate planning law firms who
are its source of deal flow in this
space.
“They bring us the type of bor-
rower we’re most comfortable
with, which is a 78-year-old high
net-worth individual. They may
already have $20 million in life
insurance and be taking out an
additional $5 million life insurance
policy through a major carrier. We
will lend that individual the pre-
mium payments for two years and
at the end of two years he repays
the loan plus interest.”
If the borrower does not pay
back the loan at the end of two
years, then Stillwater takes back
the policy and, through its stra-
tegic partners, sells the policy on
the secondary market, recouping
its principle plus interest. The firm
charges a 14% interest on the insur-
ance premium loans and an average
of 16% interest in all three lending
categories.
Hands-On Experience
Stillwater’s asset-backed fund of
funds features the same low vola-
tility, low correlation steady returns
as its sister hedge fund. Seventy-
five percent of the underlying man-
agers in the fund of fund’s portfolio
are asset-backed lenders with the
balance is in more liquid asset-
backed securities. The vehicle does
not invest in the firm’s hedge fund
because it was “cleaner and sim-
pler” for Stillwater not to invest
in itself. “If our hedge fund wasn’t
doing well, at what point do you
fire yourself?” asks Kanterman.
The advantage for Stillwater and
its investors in running a fund of
funds alongside a hedge fund with
a similar strategy is the quality
of due diligence on underlying
managers.
“There are certain questions
that we can ask, such as, ‘Do you
have title insurance?’, ‘Can we see
your loan documents?’, ‘How do
you value the collateral?’, ‘Do you
have fire and flood insurance?’ All
of these things hit closer to home
when you have been involved in it
and done it,” Kanterman says.
On the flip side, what Stillwater
requires from its underlying man-
agers also translates into running a
better in-house hedge fund. Asset-
backed lending is not a traditional
strategy in the sense that there is
a prime broker, custodian and an
administrator, Kanterman explains.
When underlying managers balk at
giving Stillwater access to its loan
book, the firm hires a third-party
asset verifier in the form of a law
firm, accountant or auditor.
“There’s no pricing or future
value of anything; it’s just realized
interest on a monthly basis. Two
years ago, we realized we weren’t
doing that for our own clients and so
we engaged our auditor to indepen-
dently do that,” says Kanterman.
Wanted: Creativity
The New Finance Fund, which
currently invests in 40 managers,
interviews several hundred man-
agers per year, according to Jack
Doueck, co-founder and managing
principal, who is keen on a manag-
er’s creative niche within the asset-
backed lending space. “If they
have some kind of specialty and
expertise then we’re interested,” he
says.
“When I went into the hedge
fund business 16 years ago, I think
there was under $100 billion in the
industry, today it is over $1.5 tril-
lion. What that means is that unless
you’re very creative and smart,
you’re just never going to make the
returns.”
And what is Stillwater looking
"We're faster than
the bank, and will
send people out on
a Sunday."
Jonathan Kanterman
Stillwater Capital Partners
"A lot of times,
we run across a
manager who is
really smart, but
greedy."
Jack Doueck
Stillwater Capital Partners

3. for in terms of creativity? Well,
consider that the fund of funds is
currently invested in one Euro-
pean manager who is lending
money on different types of col-
lateral including airline equipment,
and another Brazilian shop, which
lends money to cattle ranchers on
individual heads of cattle.
“Part of the loan is backed by
the Brazilian government and he
gets paid by the slaughterhouse,”
says Doueck. “These were ex-
JPMorgan bankers with great
pedigrees and they found a niche
in the marketplace where they can
charge 18-20%. They hedge out
currency risks and they’re taking
cattle, which is a commodity with
insurance and protection against
disease, and which sounds like a
funny business, and have built a
finance structure around it.”
Unwanted: Greed
Doueck says the fund of funds is
not necessarily looking for a three-
year track record and will invest
early in the underlying manager
if he or she has a good pedigree,
experience and investment thesis.
However, the firm will not tolerate
asset gatherers disguised as port-
folio managers.
“A lot of times we run across a
manager who is really smart but
he has structured his product in a
greedy fashion where it doesn’t
leave a great taste in our mouths,”
says Doueck. “If they make a
bridge loan, the fund gets an
interest coupon but then they also
charge points for that loan. In an
ideal world, the points should go
into the hedge fund and we should
all participate. Some managers
take those points and put them into
a separate deal-origination entity
that they own.”
“We’ve also had managers that
said they were hard closing at a
certain level and didn’t, and that
can be a violation of trust,” says
Kanterman. “Above and beyond
the checks and balances and due
diligence, you want to have trust in
your managers.”
Adding another layer to an
already desirable cake, Stillwater
this month launched an offshore
ABS fund of funds for its Euro-
pean clients who wanted a more
traditional asset-backed product,
complete with a prime broker and a
custodian. Half of the capital comes
from institutions and family offices
and the other half from high-net
worth individuals, according to
Doueck, who says the firm doesn’t
have many large institutional cli-
ents,suchaspensionfunds,because
of capacity constraints.
The firm currently manages
some $700 million in total asset
under management for over 350
clients. “We’re looking to bring in
more endowment and foundation
money this year,” Doueck adds.
Reprinted with permission of
Stone Street Media LLC