After Strong Year for Hedge Funds, Investors Return
By PAUL SULLIVAN
Published: April 16, 2010
WHILE the stock market was surging back last year, so, too, were hedge funds.
Are you investing in hedge funds or steering clear? Why?
This recovery may anger the average investor who equates hedge funds with the bad deeds of Wall Street. And the funds’ quick return may surprise sophisticated investors who are still smarting from the money they lost in their rush to move their portfolios to cash.
But in its most recent report, BarclayHedge, which tracks the flow through hedge funds, said 2009 was the best year for the industry’s performance against the Standard & Poor’s 500-stock index since the company started tracking this in 2000.
As a result, money has started to return to hedge funds, particularly into those focused on distressed debt, fixed-income and so-called event-driven strategies where a manager takes a position in a company because he believes its situation is about to change. In February, investors put $16.6 billion into hedge funds, according to BarclayHedge. Assets in the industry as of the end of February stand at a 16-month high of $1.5 trillion.
“After it’s all said and done, hedge funds did outperform the broader stock indices in 2008,” said Sol Waksman, president of BarclayHedge. “As bad as the losses were, they were much worse in the broader stock markets.”
An even more optimistic prediction by Deutsche Bank’s Alternative Investment Survey estimated that $222 billion would be invested in hedge funds this year. Mr. Waksman said he believed this was overly rosy. “It’s a record-setting number,” he said. “I hope they’re right.”
Even if Deutsche is wrong, the point is that interest in hedge funds appears to be picking up again. So will this time be different? Are investors who are returning now chasing something that has already passed? Here are some of the crucial points to consider:
WAS IT REALLY LIQUIDITY? At the nadir of the credit crash, the rap against hedge funds was that they used their gating provisions to prevent investors from pulling their money out. In some cases, this increased investors’ losses, because they ended up selling other securities to get cash.
In reality, provisions surrounding when and how investors could withdraw their money had been clearly stated in hedge fund documents. The hasty sales were driven by the fear that the entire system was going to collapse.
What happened 18 months ago is not going to change how top managers allow their investors to pull out their money, advisers say. Hedge funds will continue to require investments to be locked up, particularly the top-performing funds. That means people need to accept quarterly, semiannual or yearlong lockups.
“If you want to invest with the best managers, you have to live with their rules,” said Martin Gross, president of Sandalwood Securities, a fund that invests in hedge funds focused on debt. “Some people get this and want to be invested with that great manager. Others are very nervous about locking their money up.”
He pointed out that a lack of liquidity forces people to stick with their investment strategy. The bad news is that those who filed forms to redeem their money at the end of March 2009 missed out on the rally.
A liquidity budget may be the better option. This is essentially an assessment of how much money you can stand to have out of reach and how much money you need to keep liquid. Investors with those budgets would have been able to set aside a safe amount of money and allow the hedge fund strategies to play out.
NOTHING GOES UP FOREVER On the whole, hedge funds were down 18 to 19 percent at the end of 2008. This shook up some people, even though the broader market indexes were down as much as 40 percent.
“Clients fall into two groups,” said David Bailin, global head of managed investments at Citi Private Bank. “The ones who believed in absolute returns — that hedge funds will never go down — are shell-shocked and gone. The second group did the tough analysis.”
By this he means they looked at hedge funds for their relative returns. And those who stuck with that strategy have been rewarded. Mr. Bailin said 75 percent of the funds his group worked with were at or above their Jan. 1, 2008, high-water marks.