Has The Hedge Funds Industry Lost Its Way? by Knowledge@Wharton
For months, the news for the hedge fund industry has been grim. Funds racked up abysmal results last summer, with August showing the biggest monthly loss since October 2008.
Then the prominent Bain Capital Absolute Return Capital hedge fund announced in early October that it would close, having lost money for three years. Soon after, the well-known Fortress Investment Group said it would shut its flagship fund after losing 17% for the year through September. The two funds used a “macro” investing strategy that bet on things like economic trends, currency moves or central banks’ interest rate policies – and trends had been unkind.
At the end of October, Carlyle Group’s Claren Road Asset Management LLC said that a heavy demand from investors wanting their money back would not be met immediately. Instead, two-thirds of the $2 billion in redemption requests would be spread over a number of quarters, a relatively uncommon practice used when heavy withdrawals are seen as potentially disruptive to fund investing strategy.
Poor performance, closures, investors rushing for the exits…. A casual observer might wonder if the industry’s best days are behind it. Indeed, naysayers have long argued that these high-fee investment pools for institutions and wealthy investors could not keep up in an era of low-cost index-style investing, where investors are content to simply match the market.
But, as the saying goes, reports of the hedge fund industry’s decline are greatly exaggerated. In fact, the industry’s assets under management recently set a record of over $3 trillion before pulling back slightly, according to the industry-tracking firm Hedge Fund Research. Many funds started to show better results in the fall, and from the start of the year through September, the industry, while losing 1.5%, beat the Standard & Poor’s 500 and Dow Jones Industrial Average by 3.7 and 7 percentage points, respectively — the widest margin since 2008. In this respect, hedge funds did what they are supposed to do: minimizing losses in a down market.
Many experts say that because stocks are risky and bond yields are near historic lows, sophisticated investors will continue to try to tweak their risk and returns with alternative investments like hedge funds.
“In general, I do not expect large, sophisticated clients to start a big exodus from the hedge fund space.” –Bilge Yilmaz
“It is a no-brainer that there is a demand for alternative [types of investments], and there will be a demand for hedge funds?Twitter ,” says Wharton finance professor Bilge Yilmaz, who follows the industry and is a partner in Ada Investments, a portfolio strategy firm.
Zig vs. Zag
Key to hedge funds’ continued appeal is their ability to zig when broader markets zag, offering diversification that has become harder to find as other assets like U.S. and foreign stocks tend to move in lockstep more than in the past. “In general, I do not expect large, sophisticated clients to start a big exodus from the hedge fund space,” Yilmaz says.
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