Hedge-fund hemorrhage

Date: Wednesday, April 2, 2008
Author: Thomas Kostigen, Market Watch.com

SANTA MONICA, Calif. (MarketWatch) -- If you are considering investing in a hedge fund, you may be shut out -- not because the hedge fund is oversubscribed and closed to new investors, which has been the usual reason until now, but because so many hedge funds have shut down.

Funds representing almost $7 billion in assets have shut down so far this year, according to research published by Absolute Return magazine, a unit of HedgeFund Intelligence. Add that to the approximately 50 hedge funds representing $18.6 billion in assets last year, and the 83 funds managing approximately $35 billion that were liquidated in 2006 (including the collapse of a single firm, $9.1 billion Amaranth Advisors that year) and you have fewer choices in which to invest your money.

According to Absolute Return, major closings include the Sowood Alpha Fund with $3 billion in assets; Citi's Tribeca Global Investments fund with $2.5 billion in assets; Dillon Read's DRCM outside investor fund with $1.5 billion in assets; the NorOdin Macro RV Overseas fund with $1.2 billion in assets; Copper Arch Capital's fund with $1 billion in assets; Cantillon Capital Management's Low Volatility fund with $1 billion in assets; three Bear Stearns's hedge funds representing $1.3 billion in assets; and the Merlin BioMed International Fund representing $900 million in assets.

Absolute Return tracks more than 2,700 U.S. single-manager hedge funds and supplies data on over 8,500 funds. It notes that some of the closings are due to investors choosing to transfers assets to different funds. But in the highly competitive arena of the hedge fund world, where big egos and big assets don't always equal big return, a hedge fund closing signals defeat. That means a manager folds. Sometimes assets are returned to investors. Other times losses are too grave and there is no money left to return.

By number, Absolute Return reports, more long/short equity funds closed than any other strategy, with 16 funds representing $4 billion in assets shuttering. Long/short equity funds are those that buy stocks expected to increase in value and at the same time sell short stocks that are expected to decrease in value. This is a traditional hedge fund approach to investing and doesn't necessarily mean that managers deal in exotic financial instruments (much like those reported in the news of late) to generate returns. These managers are considered "generalists" in the hedge fund world.

Arguably the biggest generalists of them all, multistrategy funds, had the biggest losses last year in terms of assets, with five fund shutdowns representing $7.3 billion. Multistrategy funds utilize several or more different types of investing techniques to generate return. The funds that employ this approach sometimes say they are saving investors money because they effectively are using the same techniques as hedge funds of funds, which offer investors different managers and strategies under one umbrella fund.

The issue with hedge funds of funds is that each of those underlying managers also gets paid a fee -- and that takes away from investors' returns. Multistrategy funds, meanwhile, usually charge investors just one management fee. Still, monitoring different styles meant to complement one another, whether to manage risk or create return, isn't easy, as the number of hedge fund closings in this style clearly shows.

It's important for investors to understand which styles are in and out of favor because, just as with sector investing, when one falls others are sure to follow.

What's also important to note is that the amount of assets under management that these closings represent compared to the entire hedge fund industry is small. The hedge fund industry manages about $2.8 trillion in assets, according to HedgeFund.net, of which $678 billion is domiciled in the U.S. and the rest managed through offshore funds.

Still, closings are the option of last resort. Hedge funds can rack up lots of losses before they choose to liquidate. And that is the scary proposition that the investment industry is in today.

How much and how many more are to come?