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Hedge Funds: How the Smart Money Looked Dumb

Date: Wednesday, October 15, 2008
Author: Stephan Gandel, Time.com

The ups and downs of the Dow are making Wall Street's so-called "smart money" look dopey. Hedge funds lost nearly $300 billion due to bad investments in the first nine months of the year, according to an analysis of return data by TIME.com. If the losses stand it would be by far the worst year for these funds, which are unregulated and open only to high-net worth investors, since their returns began being tracked in the mid-1970s. "It's not going to be a good year," says Peter Laurelli, vice-president at HedgeFund.net. "We can be pretty sure of that."

The calculation does not include gains some of the funds may have made in Monday's rally, but analysts say that won't be nearly enough to erase the hundreds of billions of dollars the funds are down. "The losses should concern every investor because these are supposed to be the smartest guys out there," says Charles Gradante, who is the co-founder of hedge fund advisory firm Hennesse Group. "If they can't manage their investments how is average person with a 401(k) supposed to cope?"

What's more, it's not just no-name investors who are suffering the losses. Many of the industry's biggest stars are licking their wounds this year. Last week, Tontine Partners, a formerly $10 billion hedge fund based in Greenwich, Conn., told investors it had lost 65% of their money. Tontine's manager Jeffrey Gendell made Forbes magazine's list of richest Americans in 2008 with an estimated net worth of $1 billion. Och-Ziff Capital Management Group, which became one of the first hedge fund companies to go public last November, recently reported that its Asia fund had fallen nearly 17% for the year. Even the fund of David Einhorn, who was one of the first to publicly say Lehman Brothers investment bank could fail, is off nearly 13% this year. Also in the red are the funds of such well-known investors as Julian Robertson and Steven Cohen.

Still, despite the big losses, hedge funds have fared relatively well compared to the overall market. The average hedge fund was down 10.3% through the end of September, according to Hennesse. That compares to a drop of 21% for the Standard & Poor's 500 index in the same time period. Many large mutual funds such as Fidelity's Magellan fund are off even more.

But what makes the hedge fund losses notable is the outsized fees that many investors are willing to pay in the belief that these funds will do well in good times and bad. That's where the name "hedge" fund comes from. Indeed, by some measures, hedge funds as a group have never had a down year before now.