By Nick Evans
Once again hedge funds seem to be at a turning point, not to
say a possible tipping point.It has been a grisly summer and
start to autumn, with acute alarm about Europes financial
(and political) crisis and mounting worries about global
economic growth prospects triggering wildly volatile and often
chaotic market conditions over the past few weeks.
Performance has not been good for the most part and
very bad in many individual cases. But it has also been very
good in a few select cases with a smattering of funds,
notably in the macro and CTA space, doing exactly what hedge
funds are supposed to do in terms of generating de-correlated
returns when investors need them most.
And, for the industry overall, a 2% loss in August when
markets were down around 15% at one point (although they ended
the month down around 7%) does represent respectable, if by no
means perfect or universal, protection of investor capital in
an abysmal environment.
So talk in some quarters about hedge funds facing a re-run
of the autumn 2008 debacle seems to be wide of the mark, for a
few key reasons.
First and foremost, the increasing institutionalisation of
the investor base has created a much more stable and stickier
capital base for the industry and the influence of
private investors is very much less than it was.
Unlike the private investors, who ran for the hills in 2008
and will always be vulnerable to further outbreaks of panic,
institutional investors have to be invested in something and
hedge funds look to be a much better bet than most other
For institutions like pension funds, hedge funds are not the
problem part of their portfolios and, by and large,
managers are doing the job that these investors need them to do
in terms of providing downside risk protection and portfolio
Second, there is far less leverage in the industry
and, as a result, less risk of the forced deleveraging and
fire-selling that compounded hedge funds problems in
2008, in the absence of another full-blown banking crisis at
And third, most of the liquidity mismatches that caused such
grief three years ago have been eradicated or substantially
mitigated although a few remain, it has to be said.
All the anecdotal evidence points to very limited
redemptions at an industry-wide level. Quite the opposite in
fact with several reports pointing to continued inflows
rather than outflows from institutions and other investors, who
are deeply worried about other parts of their portfolios and
want to have more of their money invested in hedge funds rather
But this is no time for complacency, as all managers are
aware. There are some areas notably long/short equity
where there seem to be deep-rooted and fundamental
Investors are starting to question the increasingly high
correlation of so many long/short equity funds with the markets
themselves, the fairness of the fee structure for what appears
to be increasingly rare and random alpha generation and, to a
growing degree, the whole long/short model at a time when
stock-picking on both sides of the book simply
seems not to be working.
Furthermore, while redemptions generally may be low, those
funds that have had particular disasters over the last few
weeks of which there are more than a few must now
be very close to the brink, with big drawdowns in August
threatening to tip several over the edge.
In economic, market and investment terms this is certainly a
very dangerous time. Things could get a whole lot worse
just as easily, and quickly, as they could get a whole lot
better. That is largely in the hands of the policy-makers.
But this does not feel like a tipping point or
anything akin to 2008. On the contrary it could very well be a
turning point towards the emergence of a more stable,
sustainable and grown-up business where the institutions
that are becoming the drivers of the industry prove their value
as sticky investors with long-term horizons and the willingness
and ability to stay the course.
In return, these increasingly confident and powerful
investors may start to demand better recognition from their
managers of what they bring to the party in terms of
reduced or modified fees, more investor-friendly structures and
In the current climate, and in the interests of a more
mature and robust industry where investors and managers are
properly and strongly aligned as partners, their managers
and those who wish to manage their money in the future
would be wise to listen to what they are saying.