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Investors predict wave of fund closures

Date: Wednesday, March 5, 2008
Author: William Hutchings, Financialnews-us.com

A 12% decline last year in the number of new European hedge funds created and the amount of capital they raised, the first since at least 2000, is a sign of worse to come for hedge fund managers, according to investors.

A total of 370 European funds was created last year, compared with 420 in 2006, a decline of 11.9%, according to data provider EuroHedge.

The European funds created last year raised $33bn (€21.8bn) of assets, 10.8% less than the $37bn raised by European funds opened in 2006. This is the first time since EuroHedge’s first survey, in 2000, that it has registered a fall in both the number of funds created in a given year and the total amount raised.

The decline came in the second half of 2007, after some hedge funds recorded losses of 10% or more in less than two weeks in August and as the crisis grew in the credit markets. Global fundraising for hedge funds also slowed, from a record $60bn in the first quarter last year to $30bn in the final quarter, according to data provider Hedge Fund Research.

The difficult environment left few asset managers and proprietary traders willing to risk launching a hedge fund. David Nazor of Bank of America was the only significant newcomer to the European industry, leaving his bank to launch Ironshield Capital Management, a $420m distressed debt hedge fund.

The rest of the 20 largest European hedge funds launched last year included four funds created by companies that had spun out of existing hedge fund firms – Jabre Capital Partners, Talaris, Clive Capital and Hazel Capital – and 15 funds launched by established managers.

A wave of hedge fund managers closing will follow this fall in fundraising, according to managers and investors.

Soondra Appavoo, managing director of P-Solve Alternative Investments, said: “The tide of hedge funds shutting has only just begun; there is a long lag between poor performance and money flowing out of the door.

“Hedge fund losses in August were not great, but November was worse and January was worse still.”

Hedge funds lost about 1.5% in August and more than 2% in November, say data providers.

The hedge fund industry registered a loss of 2.26% in January, its worst start to the year since at least 1989. Long/short equity funds lost 4.34%, their worst month since records began in 1990.

Quantitative directional funds, whose positions are determined by computers and which will be affected by overall market moves, also fell, according to Hedge Fund Research.

Rival data provider Credit Suisse/Tremont said hedge funds had lost 1.48% in January, with long/short equity falling 4.05%. The equity markets fell about 10% that month. Appavoo said: “Anybody who recorded a loss of more than 10% in January will struggle to keep their fund open.”

Funds of hedge funds, which are supposed to protect investors from hedge funds’ worst losses through astute selection of managers, fell 2.93% in January, according to Hedge Fund Research.

This was worse than the average hedge fund, and the fund of funds’ third-worst month since 1990.

They lost 3.37% in April 2000, when the dotcom bubble ended, and 7.47% in August 1998, when US hedge fund Long-Term Capital Management collapsed.

Redemptions from funds of funds will have a knock-on effect on the hedge funds they invest in.

Underlying hedge funds with easier redemption terms are likely to be hit hardest because they will be the first port of call for funds of funds that need cash to meet redemption requests. Several long/short equity funds allow investors to redeem once a month, whereas many funds that follow an arbitrage strategy allow redemptions only once every three months.

Managers who managed to outperform the average in August, November and January are likely to do well from the fallout. Investors are still keen to place their capital in hedge funds, as shown by the fact that Dexion Absolute, a fund of hedge funds listed on the London Stock Exchange, raised $263m in a secondary issue of shares last month, taking its assets under management to $2.9bn, despite the turbulence in the equity market. New capital will flow to those managers that avoided excessive falls.

The chief executive of one of Europe’s largest hedge fund managers said he expected many hedge funds to shut this year. He expects to find opportunities to hire investment staff, although only a minority are likely to meet his standards.

A partner of a much smaller UK hedge fund management firm said lack of size caused significant business problems.

His company’s investment returns have averaged 6% a year since its launch early this decade, but it has gone through periods when it has lost more than 10% in three months and in the past three years its assets have fluctuated between $100m and $500m.

He said: “One of our investors, a global institution, found itself accounting for half the assets in our fund after some other investors pulled out. It said it would have liked to have stayed, as it had confidence in us, but could not remain in the position of us relying on it that much. It could not reduce its position, it was a large investor and its investment was already at its minimum size.”