Hedge funds past their peak performance


Hedge funds are ready to set records this year, but their achievements are not the stuff managers or investors want to brag about.

“The bubble has popped and there is going to be a lot of pain,” said Bradley Alford, the founder of hedge fund advisory firm Alpha Capital Management. “There will be a massive reassessment of where money should go.”

Until recently, it was a red-hot industry known for its double-digit returns, money pouring in and billion-dollar pay cheques. But a growing number of companies are now facing investors asking for their money back as staff worry whether there will be another pay cheque, amid terrible returns.

As pressure from poor returns and redemptions builds, more funds than ever will be forced to liquidate, investors said. Many expect the $1.8 trillion (Dh6.61trn) industry’s 10,000 funds to be winnowed down by a few thousand in a few years.

“This year is going to be really ugly,” lamented one manager, who did not want to be identified because his investors do not know yet about his double-digit losses.

“One day you are off two per cent and, before you blink, you are down 20 per cent. This year is just unpredictable and crazy.”

Tallying the first quarter’s wreckage, including the collapse of hedge funds Peloton Partners and Sailfish, investors agree things will get worse before they improve.

They are not much more optimistic about the private equity industry, where deals requiring big debt financings are getting done less often.

“At this point, when the liquidity spigot is turned off pretty much, it’s a brave new world and one in which the private equity game rules have changed dramatically,” said Michael Holland, chairman of private investment firm Holland & Co and a former partner at Blackstone.

Mounting job losses coupled with the deepening housing crisis may have already pushed the United States economy into recession and certainly frightened Wall Street banks to loan less to hedge funds.

For many managers, borrowed money, or leverage, had been the lifeblood for strong returns and, with those gone, analysts expect investors may be tempted to put their money with managers who charge less than hedge funds’ hefty fees.

In the face of sagging returns, the new trend in hedge funds will not be how much they pull in, but trying to stop the money they have from fleeing, investors and managers said.

In February, investors sent approximately $8.4 billion to hedge funds after adding nearly three times that amount in November, according to data from research firm TrimTabs.

“Hedge funds are going to become the kind of hotels where you can check in, but you can’t check out,” Alpha Capital’s Alford said, explaining that managers are desperately adding restrictions to keep all the money from leaving at once.

Managers are right to fear outflows as industry analysts forecast the average hedge fund probably lost between five and eight per cent in the first quarter of this year.

Those numbers will be released in a few days, but because hedge funds, unlike mutual funds, report returns on a voluntary basis only, the data may paint a misleading picture. Failed hedge funds’ heavy losses are no longer counted and losing managers often do not report either, skewing the data.

Some of the industry’s biggest names are among the losers so far in 2008.

Tudor Investment Group’s $4.3bn Raptor fund lost 5.3 per cent through the middle of March as its assets are half of what they were last summer. The Traxis Fund of Barton Biggs tumbled 13.8 per cent through the middle of March. And Och-Ziff, one of the few publicly traded hedge funds, said its funds are also down in the first quarter of the year.

Losses loom larger still at many less prominent funds that specialise in Asian securities and emerging markets.

But some managers see a silver lining for hedge funds amid the crumbling markets.

“Ultimately, we believe the liquidity crisis will migrate not only within North American markets, but broadly among international geographies, as well, presenting opportunities for investors capable of chasing liquidity on an international basis,” hedge fund firm DB Zwirn & Company told investors last month.

Also a shakeout in the industry where the number of funds might be reduced by several thousand will not be all bad for the industry, investors said, noting this will get rid of people who are less skilled.
A shakeout in the market will also encourage funds, both large and small, to beef up their risk management and reporting systems, which would be a good thing for all investors, especially at a time when more pension funds are putting their retirees money into alternative investments. (Reuters)