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Hedge funds find themselves in a marathon, not a sprint

Date: Thursday, September 29, 2011
Author: Jamie Dunkley, The Telegraph

Peter Clarke was in defiant mood on Wednesday. Man Group's shares had just plunged by almost a quarter after a downbeat trading update warned of tough times ahead for the world's largest listed hedge fund.
Man Group's Peter Clarke blamed 'market movements in long only and the impact of foreign exchange translation from the weakening euro'
"Robust" was the word the 51-year-old marathon enthusiast came up with for the company's capital and liquidity position despite the news that investors had withdrawn $2.6bn (1.6bn) of the group's funds since June 30.
But the shares looked anything but, diving 59.6 to 180p. And Mr Clarke, who joined the company in 1993, couldn't offer complete reassurance.
"The extreme volatility of markets in recent months has created challenging performance conditions across asset classes," he said.
He warned that investor appetite was likely to be "suppressed for the remainder of the year", with the group's current $65bn funds under management below analyst expectations of around $70bn.
Management fees were also forecast to fall to $200m during the latest six months, down from $234m a year earlier. Meanwhile, pre-tax profits before adjusting items are also likely to be $185m, compared with $227m in 2010.
For all this, Mr Clarke blamed "market movements in long only and the impact of foreign exchange translation from the weakening euro".

But he stressed: "Our capital and liquidity position remains very robust and the dividend is being maintained pro rata across our new financial year end."

The quarterly performance is a significant blow to the company after its acquisition of rival GLG helped it win back clients earlier this year - after two years of losing investors.

Analysts were split on how significant the numbers were.

Arbuthnot analysts kept their "buy" rating on Man, but warned that cover for 2011 dividend of $0.22 looked challenging.

"Net redemptions and weak fund performance across nearly all strategies drives pre-tax profit and earnings per share 16pc and 22pc below consensus estimates, respectively. Management fee income is slightly ahead of expectations, but overall results will bring into greater focus the ability of Man Group to perform in falling markets."

Others described Wednesday's share price fall as an "overreaction", but admitted it raised issues for the hedge fund industry in general.

Some of the world's most successful funds - including Paulson & Co, Lansdowne Partners and Odey Asset Management - suffered big losses over the summer amid the market turmoil, and banking stocks plunged. Experts are concerned that the losses, combined with the continued turmoil in the markets and a general flight from risky assets, will lead to investors pulling their money from hedge funds.

During the financial crisis, hedge funds were faced with a raft of "redemption notices" that caused managers to either start a firesale of big positions or put up so-called gates to prevent money leaving the fund. Both actions exacerbate market turmoil.

Insiders have raised fears that the next few weeks could see redemptions on a large scale. Some experts have been rattled because some of the hedge funds that were the best performers during the crisis have been among the hardest hit. John Paulson, the American billionaire who has predicted a recovery by the end of 2012, has reportedly lost 34pc in his flagship Advantage Plus fund so far this year, including 15pc in August.

Reflecting on August, Charles Gradante, co-founder of Hennessee Group, an American adviser to hedge fund investors, said: "August was a very challenging month for hedge funds as they were once again 'whipsawed'. Hedge funds were forced to reduce exposure in order to limit losses as the financial markets plummeted. They then underperformed as the markets rallied back strongly into month end."

He added: "Markets continue to be driven by fear, resulting in high correlation among asset classes. The result is one of the most challenging investment environments for hedge funds on record since inception of the Hennessee Hedge Fund Indices in 1987."

Other industry insiders have moved quickly to defend the sector, pointing out that hedge funds are built to withstand and even profit from volatile markets. "Their ability to go both long and short [ie to hedge] means that they do not have to suffer the same kind of losses in down markets that other asset classes do," one insider said.

Gemma Godfrey, chairman of the investment committee at Credo Capital, even claimed that redemptions could actually be a "good thing" for the industry.

"Redemptions get rid of 'hot' money and leave long-term, more stable investors in place," she insisted. "This allows fund manager to concentrate on managing the fund - not worrying about inflows and outflows.

"There's more institutional money invested in hedge funds than retail. Thankfully we're seeing more inflows from institutional money than retail, which is a good thing as retail investors can get spooked at times like this."

As a marathon runner, at least Mr Clarke knows that short-term ups and downs don't always determine the winner of the race.