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Third of Hedge Funds Face ‘Wipe Out’ After Slump, Godden Says

Date: Monday, December 15, 2008
Author: Tom Cahill, Bloomberg

Almost a third of hedge funds will shut or merge after the $1.5 trillion industry posted its worst ever performance this year, according to IGS Group, which advises hedge funds on raising money.

“The failure rate is going to go up, the closure rate is going up, and the merger rate is going up,” IGS Chief Executive Officer John Godden said in an interview in London. “It’s going to be a 30 percent wipe out.”

The number of hedge funds more than tripled in the last decade to a record 10,233 at the end of June, according to Chicago-based Hedge Fund Research Inc. That number will likely tumble after funds dropped 18 percent in the year through November, the worst year since HFR started its Fund Weighted Composite Index in 1990.

IGS will team up with Grisons Peak, a financial advisory firm to start Alternative Investment Management Banking, a firm that will advise hedge fund managers on mergers. Godden and Paul Sullivan, a partner at Grisons Peak, will oversee the venture, with each firm contributing three to four employees. The firm aims to advise on six to eight transactions next year.

Hedge funds typically charge a 2 percent management fee and keep 20 percent of profits, while funds-of-hedge-funds typically charge 1 percent and 10 percent of profits. Profits are usually based on high-water marks that could take years to reach again.

Many funds may have been “cavalier” about actually charging management fees, giving rebates to large investors or distributors on the expectation the fund manager would more than make up the shortfall through performance fees, said Godden.

‘Crowded Space’

Prime brokers, the banks that provide loans and handle fund administration, are cutting off firms they don’t expect to be profitable clients, Godden added. Hedge funds will need to manage at least $300 million in assets, up from $100 million a year ago to stay in business, Sullivan said.

Funds of hedge funds, in particular, are likely to combine, Godden added. There are roughly three funds-of-funds for every single hedge fund, up from one to seven in 2001, according HFR.

“And even one to seven was too many,” said Godden. “It’s a very, very crowded space with way too much overlap. The only thing that would threaten it was a change to the economic environment which is what we’ve got.”

Godden and Sullivan said they expect more transactions such as fund-of-fund Pacific Alternative Asset Management Co.’s decision this month to hire the investment team of KBC Alpha Asset Management, adding $700 million in client assets to the $9 billion it already oversaw.

To contact the reporters on this story: Tom Cahill in London at tcahill@bloomberg.net;