Hedge funds under fire for not spotting market rally

Date: Wednesday, May 20, 2009
Author: Elena Moya, Guardian.co.uk

First they failed to provide a "hedge" against falling markets, now the world's highest paid fund managers have failed to spot the recovery.

New research on the performance of the world's hedge fund industry shows clients running for the exit as the credit crunch casts doubt on their once fabled ability to beat the market.

Investors asked for nearly $104bn (£68bn) back from hedge funds in the first quarter of the year, or about 7.4% of the industry's assets, according to data from Hedge Fund Research. This leaves the industry with almost half of the $2tn of assets it managed at the peak of the ­market in 2007.

Investors withdrew most money from equity funds, many of which have failed to capitalise on the soaring stockmarket. On average these funds gained 2.7% in March, and 5.7% in April. However, this lags behind recent rallies in equity markets: the FTSE100 has gained more than 20% since 9 March – when the markets bottomed – while the Dow Jones European Equity Index has soared by more than 30% over the same period.

Industry experts defended the performance, arguing it is virtually impossible to time the bottom with precision.

"These are very volatile markets, hard to read even for the most experienced manager," said Huw van Steenis, a financial institutions analyst at Morgan Stanley. "If a manager has made money and controlled risks well, then most investors will be broadly satisfied."

One reason for the underperformance is that big hedge funds, mostly based in London and the US, are keeping much of their money in cash, fearing the rush of redemption requests from investors may not be over.

"We estimate there were 20% redemptions in the second half of last year, and 10% in the first quarter, this year," Van Steenis said. "We have evidence that hedge fund redemptions are reducing, although the pruning of portfolios continues to take place. But things have calmed down and people are taking time to evaluate options."

Hedge funds also face public scrutiny for their role in betting that bank shares would fall – adding to uncertainty in times of crisis – and a European Union directive to regulate them more tightly. Traditionally, unlike other asset managers, hedge funds do not have to disclose their ­strategy to a regulator.

"We are just asset managers, yes we short-sell, that's publicly unattractive, but this directive is a populist vote-gathering," said one hedge fund manager, who declined to be named. "Having higher capital requirements will add more costs and will be a disadvantage to small funds, although it may be good for established funds."

The directive is now being reviewed by each country – although only the UK may show support for the industry since London hosts most European hedge funds.

"The UK would be crazy not to fight; they have the monopoly of hedge fund industry in Europe," a hedge fund manager said. "For the regulator it is good PR, it's good to go against hedge funds – but the problems came from the regulated banks. Regulated banks caused this problem, not hedge funds. It's a bit of a joke this whole thing." New regulation may raise barriers of entry to the industry – but more scrutiny and transparency may make the industry more legitimated, analysts say.