More bad news for hedge funds . . . or so it seems.
HFR reports that 291 hedge funds shut down in the first quarter. This is down only slightly from 305 in the fourth quarter but way up from just 217 liquidations in the first quarter of 2015.
And while the number of new hedge fund launches rose in the first quarter to 206 from 183 in the previous period, this is still down sharply from 264 just one year ago. Altogether, over the past 12 months there were 910 hedge fund launches compared with 1,053 liquidations.
This seemingly bad news follows earlier reports that total global hedge fund assets fell to $2.86 trillion in the first quarter, owing to the largest total quarterly investor outflows since the second quarter of 2009. It was also the first time outflows exceeded inflows for two straight months since 2009. These developments suggest an increasingly shrinking hedge fund industry.
During the SALT conference in Las Vegas in May, investors made clear what is bugging them — lousy performance and high fees. “They can’t generate returns to justify their fees,” Omega Advisors’ Leon Cooperman bluntly told the audience. Several of the most elite hedge fund firms, like Paul Tudor Jones II’s Tudor Investment Corp. and Cooperman’s Omega, are suffering major redemptions. A handful of high-profile institutional investors, including the New York City Employees’ Retirement System, have recently said they are getting out of hedge funds altogether.
Do all of these developments mean the golden years of hedge funds are over? Will we look back in a few years and wistfully remember when hedge funds were much more popular?
Definitely not. In fact, the recent developments are actually good news for the hedge fund industry. In a few years hedgie historians will deem this period a healthy, long-needed time of reckoning.
It will be regarded as the time the jig was finally up for all of the crummy funds, as well as those living off long-ago reputations that are a shadow of their present realities. In this new era, hedge funds that want to remain the same size or grow will actually need to perform well. Imagine that. If not, investors will bail. If enough of them bail, the manager will need to shut down. That’s because investors have signaled they are much less forgiving.
Just in the past week, several investors have separately lamented to me that many hedge fund firms make money on their management fees even if performance is lousy. Others have questioned how long firms like Tudor will continue charging fees that exceed the industry’s average even as they post low-single-digit returns year after year. Investors are also lamenting how many firms — especially those of the long-short variety — are crowded into the same stocks.
One longtime investor told me he is starting to look at funds with less than $1 billion. Remember, until very recently, most new money was flowing into firms with more than $5 billion.
Let’s face it: It isn’t the top-performing funds that are accounting for the recent surge in fund closures. It is the worst. If the worst performers go away, that’s good. And if total industry assets don’t return to their record high, it does not mean the industry is out of favor or has become passé. It will more reflect the underlying strength of the industry.
Bigger is not always better. Fewer but better-performing funds will serve the industry better and even help many survivors justify their very high fees.
Another benefit of a smaller, better-performing industry: The composite hedge fund returns touted by eVestment, HFR, BarclayHedge and others will look more impressive. This will be especially true for their unweighted indexes, which won’t be hampered by the chronic losers.
And then everyone will be marveling about how well hedge funds are performing again.
