NEW YORK (HedgeWorld.com)–Morgan Stanley’s Institutional Hedge Fund of Funds LP was hit with a double whammy in 2002 from investments in Michael Lauer’s Lancer Partners Fund LP and Beacon Hill Asset Management LLC’s Safe Harbor Fund, according to regulatory filings.

As a result, Morgan Stanley wrote down the value of its investment in the long/short equity Lancer fund to zero and sued, according to the filing. But Morgan apparently is letting the Securities and Exchange Commission deal with the Beacon Hill mortgage-backed securities arbitrage fund, because it mentioned no Morgan Stanley lawsuit in its filing, but noted the SEC’s November lawsuit. The SEC sued Beacon Hill for allegedly misreporting returns to investors. Previous HedgeWorld Story The firm eventually liquidated.

The fund, a privately sold but SEC-registered fund, is managed by Morgan Stanley Alternative Investment Partners LP, West Conshohocken, Pa. A Morgan Stanley spokesman declined comment. Mr. Lauer couldn’t be reached for comment.

Regarding Morgan Stanley’s suit, the financial giant wants the courts to force the Lancer fund, without naming the fund directly, to disclose its books and records, and produce audited financials, according to the filing. “We will continue, along with legal counsel, to consider the other rights and remedies available to us regarding this investment,” said Jerome B. Baesel, managing director and portfolio manager for the fund, in an investor letter contained in the filing.

Problems at Mr. Lauer’s funds were first made public last year by a New York Post columnist who in January described Lancer’s offshore fund as invested in illiquid penny stocks, and unable to meet liquidations with cash payouts. Instead, the fund was meeting redemptions with stock. And according to a Bloomberg story, investors were set to redeem 29% of the Lancer Offshore Fund’s assets this year, based on what Mr. Lauer said to investors in a conference call.

The Lancer fund performance along with that of the Safe Harbor Fund pummeled the semi-annual returns of the fund. Morgan’s US$719 million Institutional Hedge Fund of Funds took a big hit as a result of its holdings in those two funds. Morgan Stanley had invested US$15.625 million in the Lancer Partners Fund, and wrote its value down to zero in January. It had purchased US$18.75 million in Safe Harbor, and valued the holdings at US$7.7 million based on incomplete information, as of Dec. 31.

Together they lost 330 basis points in the six months ended Dec. 31, dragging the fund’s return down to negative 0.3%. Lancer Partners LP reduced fund performance by 180 basis points in the period, at a time when its portfolio had been written down to 20% of stated value. The Safe Harbor fund, meanwhile, hurt the fund to the tune of 154 basis points. The next best fund in terms of performance was OZF Credit Opportunities Fund LP, which dragged fund returns down 13 basis points in the period.

Had Morgan not owned those funds, performance would’ve been great relative to other hedge fund managers. The CSFB/Tremont* Hedge Fund Index returned 1.69% in the same period, according to the filing. Take out the 330 basis points, and the Morgan Stanley fund would have been close to hitting its variable hurdle rate of 3.49% over the same period, according to the filing.

*Tremont Advisers Inc., Rye, N.Y., is a strategic partner with, and minority investor in, HedgeWorld.

PBarr@HedgeWorld.com