Drowning Hedgies

June 5, 2009

May was the best month for hedge funds in nine years, with the average fund rising 5.2%, according to Hedge Fund Research. And for the year, HFR’s most broad-based hedge fund index is up 9.43%. 

So everybody back into the pool then? Well, don’t believe the hype.

Sure it’s great news that hedge funds are running in the black, after the average fund dropped 19% last year. But the hard truth is it could take the hedge fund industry a long time to recover from its worst year ever.

A just released report by TrimTabs finds that even after this year’s gains, the average hedge fund stands 17.14% below its high-water mark.  TrimTabs, which used data collected by BarclayHedge, concludes “it should take around 3 years for the industry to make up these losses.” That means a hedge fund’s longtime investor will have to wait around awhile to get back to even.

The big distance hedge funds need to go before they break even also is bad news for hedge fund managers, who cannot begin collecting performance fees again until their funds exceed their high-water marks. In other words, underwater managers can only collect a 1% to 2% asset management fee. For months and years to come, managers can kiss that lucrative 20% incentive fee good-bye.

And the truth is many managers may not want to stick around for another three years simply to get back to their breakeven points. A more likely outcome is for more managers to throw in the towel–meaning more fund liquidations and further shrinkage of the hedge fund industry.

TrimTabs and BarclayHedge pegged the total assets of the hedge fund industry at around $1.1 trillion, down substantially from the nearly $1.9 trillion in assets that the hedgies controlled not so long ago.

And news isn’t good on the redemption front either. TrimTabs and BarclayHedge say investors withdrew some $31.6 billion from hedge funds in April. Even though hedge funds are posting solid numbers this years, the pace of redemptions is down only slightly from the end of 2008–when investors couldn’t wait to flee funds.

The bottom line is it’s still not much fun being a hedge fund investor. And maybe even tougher being a hedge fund manager. Simply put: don’t believe any carnival barker who tells you hedge funds are back. It just isn’t true.

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