Hedge Fund Assets to Fall 11% in 2009, Study Says

Date: Tuesday, March 24, 2009
Author: Bei Hu, Bloomberg.com

The global hedge fund industry may shrink by 11 percent this year as funds liquidate and investor withdrawals persist, a Deutsche Bank AG survey said.

Industry assets may fall to $1.33 trillion by December, according to 68 percent of the 1,000 investors surveyed by Germany’s largest bank last month. The respondents, which hold a combined $1.1 trillion of hedge-fund assets, on average expect outflows from the industry to accelerate to $168 billion this year, 8 percent faster than last year.

The deepest financial crisis since the 1930s led to the worst average hedge-fund performance in history last year, prompting funds managed by Citadel Investment Group LLC and D.E. Shaw & Co. LP. to limit withdrawals to stem record outflows.

“If 2008 was a story about performance of hedge funds, 2009 is very much going to be a story about restructuring,” said Sean Capstick, Deutsche Bank’s London-based global head of capital introduction. “Our survey indicates redemptions will continue as a phenomenon for the foreseeable future.”

In a March 13 note to investors, Sanford C. Bernstein & Co. analyst Brad Hintz forecast hedge-fund assets to fall 18 percent this year, dropping below $1 trillion before a recovery in 2013.

The HFRI Fund Weighted Composite Index retreated 18 percent in 2008, its steepest annual decline. Still, that was less than half the 42 percent slump of the MSCI World Index.

Lagging Outflows

Investors worldwide pulled $155 billion out of hedge funds in 2008, marking only the second full-year of net outflow since Chicago-based Hedge Fund Research Inc. started tracking the data in 1990. The withdrawals helped pare hedge-fund assets 27 percent from a mid-2008 peak, HFR said.

Because many funds only allow redemptions once a quarter, “there is a lag time consistently in outflows in the industry versus performance,” Capstick said. Investors will also seek to redeem when funds lift curbs on withdrawals, he added.

As of October, 18 percent of hedge-fund assets, or about $300 billion, were subject to some sort of restriction on withdrawals, according to Peter Douglas, principal of Singapore- based hedge-fund consulting firm GFIA Pte.

Sixty-five percent of the investors surveyed by Deutsche Bank, including funds of funds, family offices, consultants to banks, pension funds, endowments, governments and insurers, expect at least 20 percent of hedge fund managers to go out of business this year.

Fund Closures

“I see no reason why you wouldn’t see as many closures this year as you saw last year,” said Capstick. “Last year’s performance will start to kick in in terms of hedge funds’ profitability.”

A record 1,471 funds liquidated last year, 73 percent more than in 2007, HFR said in a statement March 18. The closures reduced the number of hedge funds and funds of funds in operation to an estimated 9,284.

The investors in Deutsche Bank’s survey are sitting on $294 billion of cash. They indicated they may reduce cash holdings by $82 billion in the next six months.

In Asia, hedge fund assets may have more than halved to $100 billion, from $250 billion at the beginning of 2007, said Harvey Twomey, Hong Kong-based Asia head of Deutsche Bank’s global prime finance sales and hedge fund capital group.

The number of hedge funds may fall 30 percent to 40 percent from the middle of 2008 to the end of this year, outpacing the usual up to 10 percent attrition rate, he added.

‘Less Frenetic’

“It will probably take us to 2012 or possibly 2013 to get back to where the industry was at its very peak, and this time I think it will be less frenetic,” Twomey said.

Growing concerns about risk management and transparency are leading investors to allocate more money to bigger managers at the expense of startups, Capstick said.

“The consolidation of the industry will continue, because only the bigger players will have that level of infrastructure,” he added.

Seventy-eight percent of the investors in this year’s Deutsche Bank survey ranked risk management as the second-most important factor for picking a hedge-fund manager. Performance remained the most important factor, the survey said.

Transparency came in fourth after Bernard Madoff admitted to running a $65 billion Ponzi scheme. Investment philosophy and manager pedigree, two of the top three traditional criteria for manager selection along with performance, fell to third and fifth places.

Ninety-two percent of the investors said they wouldn’t consider allocating money to funds that have frozen assets.

To contact the reporter on this story: Bei Hu in Hong Kong at bhu5@bloomberg.net