In the annals of hedge fund history, 2008 may well be described as the year that humbled some of the greatest managers in the industry — and destroyed many of the rest. Redemptions are rising, fund failures are accelerating, and analysts warn that as many as 1,000 of the estimated 10,000 hedge funds in business worldwide may be gone by early next year. So far the walking wounded include such illustrious names as Atticus Capital and Ospraie Management, both in New York, and London-based RAB Capital.
Hedge fund managers often claim to deliver uncorrelated returns, but they haven’t all lived up to their offering documents — or their investors’ expectations. In the midst of a deepening global financial crisis, hedge funds have, broadly speaking, failed to mitigate risk, generate uncorrelated returns or protect investors’ capital. Never before have hedge funds had a worse run of performance: Returns are down, on average, nearly 10 percent this year through September.
And now the insular, lightly regulated $1.9 trillion industry, which manages money for some of the largest pension and endowment funds in the world, is under siege. Although the global banking crisis was not sparked by hedge funds, managers have been accused of spreading rumors, exacerbating market volatility and driving down share prices. In response, regulators in the U.S., Europe and Asia have at least temporarily stacked the rules to make it harder for hedge funds to operate. The very tools that managers need to run their portfolios effectively — ready financing, willing swap counterparties and ample shares to borrow and short — have been withdrawn.
Even worse, the Wall Street investment banks that once served as the industry’s prime brokers have become sources of incalculable risk to the funds they once financed. Few managers ever imagined that they would need protection from as reputable a prime broker as Lehman Brothers, but in the wake of the firm’s bankruptcy, more than half a dozen hedge funds are scrambling to recover hundreds of millions of dollars in trapped assets. And many managers who had purchased swap agreements from Lehman suddenly discovered that their hedges had disappeared.
Further fund losses and failures may be inevitable given that global markets have already seen declines of 30 percent or more this year, but many hedge fund firms are proving resilient despite the pressure. Smart, opportunistic managers who have stayed in the game and posted flat or even positive returns are likely to thrive in the months ahead, and those who succeed in the not-so-simple act of preserving their clients’ capital this year may be amply rewarded for their prudence.
