CalPERS’ decision earlier this year to exit all hedge fund investments turns out to have been a particularly visible manifestation of a trend underway: that of investor dissatisfaction with hedge funds. CalPERS politely attributed its withdrawal to excessive fees, too much complexity, and the difficulty of finding funds where it could put a meaningful amount of money to work. The latter point gets at the real problem: hedge funds have underperformed and investors are less and less willing to pay big fees for lousy results.
A Bloomberg story revealed that a marked uptick in the number of hedge funds closures this year. Admittedly, the fact that there could be so many shuttered firms is because there are so ‘blooming many hedge funds in the first place. Money continued to flow into big, institutionally-oriented hedge funds, with assets under management at 159 players surveyed up 15% for the year ended June 30. Deutsche Bank pegs the growth of the industry overall as 13% per annum since 2008.
However, the hedge funds being wound up aren’t just newbies, although one would expect small funds to be disproportionately represented. The article mentions funds that have shrunken considerably but are still meaningful in size. However, if a fund has mainly institutional investors, it can enter into a death spiral, since virtually all institutional investors limit the amount of any fund they will hold to 10% of total assets. So if fund withdrawals proceed, an institutional investor might have to reduce his stake simply because his position is now in excess of 10% of the newly-smaller fund. And that reduction can lead to further required selling by other institutional investors.
However, another striking feature of the Bloomberg story was that the strategies within hedge fund world that were taking the biggest hits were the best established, such as global macro and long-short funds. Not surprisingly, commodity funds have taken big hits.
Hedge funds are shutting at a rate not seen since the financial crisis, as many managers post disappointing returns and an elite group of firms dominate money raising…
In the first half of the year, 461 funds closed, Chicago-based Hedge Fund Research Inc. said. If that pace continues, it will be the worst year for closures since 2009, when there were 1,023 liquidations.
“Most hedge funds have not performed extraordinarily well,” said Stewart Massey, chief investment officer at Massey Quick & Co. in Morristown, New Jersey, which invests in the private partnerships. He expects that redemptions will hit small-and medium-sized firms this year, reducing assets to a level where “they will have to make a decision whether to carry on or not.”
Hedge funds, on average, have returned just 2 percent in 2014, their worst performance since 2011, according to data compiled by Bloomberg. Smaller funds have struggled to grow as institutional investors flocked to the biggest players. In the first half of 2014, 10 firms including Citadel LLC and Millennium Management LLC accounted for about a third of the $57 billion that came into the industry.
Yves here. The “worst since 2009” is more damning than it might seem, since some firms that got whacked in the crisis (quant funds were hit hard) might not have completed their wind-down in 2008. Similarly, smaller funds that had largely or solely wealthy individuals as investors would also be more exposed to the 2008 meltdown, since individuals might have decided to reduce risk exposures or needed to raid some of their investment kitties.
Note that this dissatisfaction with underperformance and resulting pullback is a welcome sign that investors are starting to become more skeptical of hedge funds. But with so many investors desperate for higher returns, and hedge funds targeting that segment, it’s going to be quite a while before this romance is over.