Hedge Funds Raised $60 Billion Last Quarter, a Record (Update4)

Date: Thursday, April 19, 2007
Author: Jenny Strasburg, Bloomberg

April 19 (Bloomberg) -- Hedge funds globally attracted $60 billion in new money in the first quarter, almost half what they raised all of last year, as institutions shrugged off the industry's subpar investment gains.

Inflows more than tripled from the final three months of 2006, Chicago-based Hedge Fund Research Inc. said today in a statement. Deposits slowed in late 2006 as returns trailed market indexes and clients reacted to the collapse of Amaranth Advisors LLC. The first-quarter surge brought industry assets to $1.57 trillion.

``Returns last year didn't hit the ball out of the park, and you had Amaranth toward the middle of the year, but that was really perceived by many as a blip,'' Marina Lewin, managing director with Bank of New York Co. who oversees fund administration for $105 billion in assets, said in an interview.

The inflows show institutions are increasing their reliance on the private pools of capital to boost investment gains. Endowments, pension managers and corporate retirement plans are expected to triple their allocations to hedge funds worldwide to more than $1 trillion by 2010, according to a 2006 survey by Bank of New York and consultants Casey, Quirk & Associates LLC.

More investors are locking in hedge funds as part of a permanent strategy, Lewin said. ``They're looking at the long- term potential from the risk perspective, and also out of concern that traditional asset classes aren't meeting their needs.''

`Hot Hand'

Hedge funds gained an average of 2.81 percent in the first quarter, Hedge Fund Research data show. That beat the 0.64 percent return including dividends of the Standard & Poor's 500 Index, a benchmark for large U.S. stocks.

Hedge funds that bet on stocks and debt in emerging markets including China and Eastern Europe led with an average 5.1 percent gain during the first three months of this year. Funds that focus on companies being acquired, a strategy called merger or risk arbitrage, gained 4.8 percent.

Last year, when hedge funds pulled in a net $126 billion, managers gained 13 percent, compared with a 15.8 percent advance by the S&P.

``Top hedge-fund managers have the hot hand as evidenced by exceptional performance in the first quarter,'' Matthew Zorn, senior hedge-fund analyst with Commerzbank AG in New York, said in an interview. ``Besides returns, institutional investors want that lower volatility, because they're not looking to hit home runs.''

Equity-Hedge Strategy

Hedge funds aim to make money regardless of the direction of the financial markets, and many clients pay a premium for lower volatility, or rate of fluctuation in returns, compared with major market indexes. Funds typically charge 2 percent of assets as a management fee and take 20 percent of investment profits.

Last quarter, equity-hedge managers pulled in $20.4 billion, the most ever in a quarter by any investment strategy tracked by Hedge Fund Research. They concentrate on picking stocks that will rise and hedging their risks with short sales, or borrowing securities in anticipation of making a profit on price declines.

The second-highest amount, $10.3 billion, went to managers who follow a relative-value arbitrage strategy. They take advantage of price differences between such investment instruments as stocks, bonds and derivatives including stock options and futures.

Managers in those two strategies and those who invest in companies going through mergers, acquisitions and bankruptcies are the most likely to have benefited from collapses in the subprime-mortgage industry, Ken Heinz, president of Hedge Fund Research, said today in an interview.

Subprime Bets

``Many hedge fund managers identified the subprime problem ahead of time, and when it occurred, hedge funds moved in to provide liquidity,'' by buying loans made to risky borrowers or investing in distressed shares of lenders, Heinz said. ``Hedge funds have demonstrated a propensity to be opportunistically involved in the market.''

Subprime borrowers, those with the worst credit histories, fell behind on mortgage payments at the fastest rate in four years in the fourth quarter, according to data compiled by the Mortgage Bankers Association. At least 50 home lenders have halted operations, gone bankrupt or sought buyers since the start of 2006, according to Bloomberg data.

Managers that have profited from soaring subprime defaults this year include New York-based Paulson & Co., which manages $11 billion. Paulson's 8-month-old credit fund gained 67 percent in February, the fund manager told investors in a March letter. New York-based Harbinger Capital Partners posted record gains in February. Its $6 billion distressed-debt fund returned 8.1 percent, according to an investor update.

Every major hedge-fund strategy tracked by the Chicago research firm increased its inflow last quarter from the previous quarter, the report said. It's based on a database of 6,500 active hedge funds and a total of 11,000 funds tracked since the early 1990s.

To contact the reporters on this story: Jenny Strasburg in New York at jstrasburg@bloomberg.net