The case of the incredible shrinking industry

Fri Mar 6, 2009

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Two thousand and eight was quite a year. It was also year that the InvestHedge Billion Dollar Fund of Hedge Funds Club shrank by nearly 30%, taking it back to the size it was in June 2006. How did we go from a growing industry with potential to this battered and bruised universe of funds?


By Niki Natarajan, editor



Two thousand and eight was quite a year. It was also year that the InvestHedge Billion Dollar Fund of Hedge Funds Club shrank by nearly 30%, taking it back to the size it was in June 2006. How did we go from a growing industry with potential to this battered and bruised universe of funds?

If Sherlock Holmes were investigating The Case of the Incredible Shrinking Industry, he would be able to deduce very quickly that 2008 was the culmination of: sloppy practices; growing too fast; taking too much for granted; not listening to investors; getting too greedy; and no longer thinking logically.

Clearly not all of this applies to everyone. But Petters, Madoff, Amaranth, Bear Stearns, Bayou and other notable "hiccups" all appeared in a lot of portfolios. You can get it wrong once. Maybe twice, but after that it becomes a discredit to the industry as a whole.

Part of the problem facing funds of funds is that they are an easy target. Like any intermediary that charges fees for a service, such as estate agents and head-hunters, the argument of whether or not fees are "worth it" will always be a subject of debate.

All industries want to cut out the middle man. But those hedge funds that have been defaming the funds of funds industry by saying that they add no value have in fact cut off their own nose to spite their face. There are always two sides to the story and in this case hedge funds want to have the assets directly from the end investors.

While the value of some funds of funds may be questionable, the industry is not a homogeneous unit. Indeed, this diversity will become abundantly clear for those that attend the 7th Annual InvestHedge Awards in a few days. More than 70 funds of funds across more than 10 strategies will gather in New York to be judged on three-year performance. These are the role models for successful fund of funds businesses.

And here-in lies the problem. Like it or not, even with a Billion Dollar Club at only $744 billion in assets, funds of funds still manage close to half the assets of the hedge fund industry. The truth is there is plenty of pie for everyone, as long as end investors do not become disillusioned with the concept of hedge funds, irrespective of packaging.

As the Universities Superannuation Scheme in the UK follows in Hermes' footsteps to build its own hedge fund portfolio, many believe the end is in sight for the funds of funds model. And yet it seems blindingly obvious that the two can co-exist. As Sherlock Holmes was always fond of saying: "When you eliminate the impossible, then whatever is left, however improbable, is the truth."

Let's not forget that only some 30 funds of funds had Madoff, while thousands of end investors went directly because it was an "easy" choice. Going direct is not for everyone, so there will always be a need for funds of funds. End of story.

AIMA has just published a report showing that the majority of the hedge fund assets are now coming from institutional investors. So surely it is in the best interest of the industry that hedge funds, funds of funds and end investors work together to get the best from the absolute return world. This is a subject that will be discuss by a big-name line up in next week's Global Briefing Seminar in New York.

As the Chinese usher in the year of the Ox, prosperity through fortitude and hard work is on the cards. Does this way of looking at the world make any difference? Probably not, but last year was a chance to wipe the slate clean.

Many of the bad eggs got found out. So like a good spring clean, one can hope that the best have survived, with more knowledge and humility.