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.
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“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.”
Dear Lord, how many of these parasites are there? I suppose that when one dines with the Schwarzmans and Finks one wishes to eat off their plates. Hence the proliferation. Talk about David and Goliath, Ms Smith, you’ve bitten off quite a mouthful.
“Investors desperate for returns” is the story of the 20th c. I dunno if banksters are really criminal in the clearest sense of it all (actually I don’t think they are but I think they come very close and the resulting damage is the same), but they undoubtedly have devised way-too-clever “vehicles” for the purpose of high returns. Which indicates high returns became ever harder to achieve. Became unreal. It was probably 40 years ago (?) that fund managers, both retirement and hedge, thought that since 8% returns were then possible, that they could build a foundation for retirement-eternity based on 8% returns. And now the whole thing is coming down. 2% returns on retirement funds is going to be a tad painful. But it is interesting that that is also the Fed’s goal. 2%.
I have a feeling that this is in part a result of increased SEC scrutiny. Institutional investors now know that investing with the smaller funds is an even bigger gamble considering the fact that they have less pull in DC and more likely then to be on the receiving end of aggressive prosecution.
I can understand the desire for institutional investors to reduce or eliminate HF exposure altogether for the reasons Yves cited, but I wonder how many of these investors are going in with reasonable expectations about what various HF strategies offer in terms of risk and return. The objective in many cases is to generate consistent returns uncorrelated with other asset classes. Anyone expecting to get rich using long/short or convertible arbitrage managers (or any other number of strategies) was fooling themselves into thinking that something highly unlikely was going to happen. Either these HFs did a laughably poor job marketing themselves and setting expectations (quite possible in the quest for assets at 2/20) or the investors didn’t understand what their mandate around HFs really is (also quite possible in the quest to be thought of a “sophisticated” client).
Headlines about huge winners such as those that bet big on subprime are not the norm, they are the exception, and those aren’t really so much hedge funds as they are traditional value investors. But what made those outsized returns possible was the epic volatility that came with that period. Many HF strategies do quite well when volatility is high and mispricings occur. Since 2008 we’ve seen a slow steady decline in volatility in the market (the VIX is a pretty good measure) and consequently HF returns have declined as well. The broader US equity market also posted some very strong returns, furthering the case for “index it and forget it” to generate low cost returns.
What those that are exiting HFs have recognized (explicitly or otherwise) is that volatility has decreased, and by exiting now they are making the call that it won’t increase in the near future.