For an update on the sad state of the hedge fund industry, we go to the FT which confirms what we had been reporting every week in 2011 courtesy of the periodic HSBC hedge fund industry report, namely that less than one third of all hedge funds in 2011 paid material bonuses to their employees (or if they did, they better have done it without the knowledge of their LPs), because “more than two-thirds of hedge funds are below their high water mark., the point at which they are able to charge investors performance fees.” And since performance fees, or the 20 in the “2 and 20 part”, is where the discretionary component of analyst, trader and PM compensation comes from, it is safe to say that the bulk of hedgies did not have a good year in 2011. And, in fact, for many the anger goes far back: “It can be a long way back. Credit Suisse calculates that 13 per cent of hedge funds have not earned any incentive fees since at least 2007. Most of these are small funds with assets of less than $100m, which struggle to retain staff without the income available from performance fees.” One such fund was of course Citadel which after its abysmal performance in 2008 only managed to climb above its high water mark in the past week for the first time since 2007. And while this is not really news, what is far more curious is that according to Credit Suisse hedge funds have resumed levering once again.
From the FT:
The bank’s hedge fund clients currently have leverage of 2.5 times, meaning that the average fund has $150 of debt added to each $100 of capital, off the post-crisis low of 2.4 times, but well below the 2.8 times high.
Cash balances have also fallen from 25 per cent of assets in the summer to 22 per cent now as confidence has improved.
Since there is just under $2 trillion in hedge fund “equity” or capital, leveraging this 2.5 times means that there is net purchasing power of roughly $5 trillion in the market, and the 0.1 turn of incremental leverage explains why the ongoing redemptions from equity mutual funds are being more than offset by a slowly levitating market.
Yet a far more important question is how many of these funds will fizzle out in the near-term and have to bring their leverage to zero by implication?