Wednesday, January 07, 2009

Hedge funds fight to survive shakeout

This week's issue of Barron's takes on the great hedge fund industry shakeout of 2008-2009, in a story called, "Hedge Funds Meet Their Match".

Here's an excerpt from that piece:

"Hedge fund managers, the stars of the investing world for most of this decade, were brought to their knees in the turmoil of 2008. The average fund fell far short of its goal of "absolute returns," posting an 18% loss through November.

Old standby strategies, such as buying some stocks and selling others short, suddenly stopped working. Customers bolted in record numbers. Then, at year's end, the industry got a black eye for putting money in Bernard Madoff's black box.

"The hedge fund is being questioned, and it's in danger," says Timothy Brog of Locksmith Capital Management, an activist New York hedge fund.

Indeed, the industry is moving into survival mode for 2009 -- and many funds won't make it. The number of hedge funds, which surged in recent years to an estimated 10,000, could eventually fall to about half that, as small, marginal players are sold or go out of business..."

The article goes on to note that 2008 was the worst year on record (Hedge Fund Research data) in terms of fund performance and investor redemptions. One source estimates that the industry's assets will have shrunk from $2 trillion to $1.25 trillion by the time the shakeout is done.

But hey, we've been here before, right? Previous bear market cycles narrowed the field in the past, with the shakeout that followed the late 1960s hedge fund boom being one notable example.

Nevertheless, hedge funds continued to thrive and grow in size over time. Just ask Barton Biggs, managing partner at Traxis Partners, and one-time employee of the original hedge fund, A.W. Jones & Co.

Related articles and posts:

1. Hedge funds: regulations and redemptions - Finance Trends.

2. GLG's Roman, Roubini predict hedge fund failures - Bloomberg.

3. John Paulson in Bloomberg Markets magazine - Finance Trends.

4. Change ahead for hedge funds - Breakingviews.com via NY Times.

2 comments:

Deepak said...

Dec 2008 is more or less the bottom and from Jan 2009 onwards it should all be up and up. If the hedge funds always stick to the basic common sense approach of not becoming too greedy and leveraged, I think they would prove to be the catalyst for the much awaited recovery.Hedge fund industry does require consolidation through tougher regulations by authorities and smarter due diligence from the investors and this crisis is an opportunity for this industry to find a new and robust base and regain its fading charm.

David said...

Thanks for your thoughts, Deepak.

I'm not sure I agree that hedge funds require regulation (SEC is obviously not up to the task now anyway), but the trend towards increased regulation seems to be in place anyway.

I do think you're right about the excessive leverage employed in recent years.

Most reports I've seen in recent weeks also agree with this theme, noting that hedge funds who got by on easy money and super-leveraged strategies in recent years are prime candidates for failure in this weed-out cycle.