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Quitting while they re behind
Some hedge funds are throwing in the towel
Feb 18th 2012 | LONDON AND NEW YORK | from the print edition
THE past few years have been as miserable as I can remember , says Johnny
Boyer of Boyer Allen Investment Management, a British hedge fund focused on
Asia. The fund, which looked after $1.9 billion at its peak, faced the prospect
of spending the next few years trying to claw its way back to pre-crisis asset
levels. Instead the founders decided to shut the fund and give investors their
money back.
Others have also had enough. I ve been doing this for 15 years and I ve never
seen as many people give up as in the last three months, says Luke Ellis of
Man Group, a large listed fund. This trend is distinct from the round of
closures in 2008. Then, managers were hit by investors redemptions and had no
choice but to close; today many are electing to walk away.
For some managers, the markets have become too stressful. Running a hedge fund
today is three times as much work for a third of the fun, says one. But many
are motivated by economics. Hedge funds typically get paid a 2% management fee
on assets to cover expenses and a 20% performance fee on the returns they
achieve for investors. Most funds do not earn performance fees unless they
outperform their peak level or high-water mark . At the end of 2011, 67% of
hedge funds were below their high-water marks, according to Credit Suisse, and
13% have not earned a performance fee since 2007 or earlier.
Funds can survive off a management fee for a couple of years, but four is a
long time to go hungry. Most managers were banking on a recovery in 2011 but
the average hedge fund slid by 5.2% much worse than the S&P 500, which returned
2%. Poor performance is causing changes in the way the industry markets itself
(see article). It also means many funds will have to wait even longer to earn a
performance fee again. According to Morgan Stanley, 18% of hedge funds are more
than 20% below their high-water marks.
Smaller funds have been more likely to close than their larger peers. That s
partly because it used to be possible to run a hedge fund with $75m under
management. Today funds need at least double that amount because administrative
and compliance costs are higher than ever. Larger funds also depend less on
performance fees because their management fees bring in so much cash. John
Paulson, a hedge-fund giant whose flagship fund was clobbered last year, has
pledged to make up investors losses but his fund is so large that he can
easily afford to carry on. That risks distorting the original point of hedge
funds that they are small, limber operations which come and go often (see
chart).
For investors, it is generally a good thing if underperforming managers are
returning cash and not milking them for fees. But others worry that high-water
marks could skew funds investing decisions. Managers who have not earned a
performance fee in years could take bolder bets to get back into the black.
Leverage levels have been creeping up. Some may prefer to go out with a bang,
not a whimper.
from the print edition | Finance and economics